Europe: Repeating the Mistakes Of the 1930s?
"We are back in a danger zone," says a top economist at the International Monetary Fund. Though an understatement, it captures the central paradox of this year's annual meeting of the IMF and World Bank. Everyone is alarmed at the swift deterioration of the economic outlook, but there is no leadership - no consensus on what to do or, even when crude agreement exists, little conviction that practical politics will permit action. There is a hazardous vacuum of ideas and power.
Actually, what needs to be done is not obscure. Europe is now the flash point of global concern. Most of its major countries are heavily indebted. The economy has slowed to a crawl; the latest IMF forecast (perhaps optimistic) puts next year's growth at about at 1 percent. Banks are threatened by their exposure to depreciating government bonds. What looms is a vicious circle: Slower growth makes it harder to cut budget deficits; this causes investors to dump European government bonds; interest rates rise; banks weaken; and the economy gets worse.
One way to break this cycle is to create a new global lending facility that would buy European debt and, in the process, lengthen maturities and charge modest (non-panic-driven) interest rates. This would provide time for Europe to make gradual changes - reducing spending, raising taxes - to bring budgets under control.
Call it a "bailout," a "rescue" or a "refinancing." By whatever label, it probably couldn't work without China. It has the money to become, in effect, Europe's lead banker. Its foreign exchange reserves total $3.2 trillion and are growing by hundreds of billions of dollars a year. But the United States and Europe don't want to call China, and the Chinese don't seem to want to be called. The result: stalemate.
It's easy to understand why. Americans and Europeans don't want to cede power to China, whose goals are suspect. China might seek a new world order based on China's interests, while ditching the existing system of "open, rules-based trade," writes economist Arvind Subramanian in his book "Eclipse: Living in the Shadow of China's Economic Dominance." China's involvement would probably trigger an uproar in the United States and Europe, with unpredictable consequences. Similarly, China apparently disdains the choices it would face. How heavy-handed would it be in lending? How would it deal with losses?
Political paralysis meets economic drift. We are flirting with a renewed global recession, driven by slumps in Europe and the United States. With 44 million already unemployed in advanced countries, the social and political implications are fearsome. Worse, a new recession might snowball into an even deeper and longer downturn.
The alternative is that Europe muddles through. Though possible, the odds seem increasingly against it. The Europeans' assumption that they can handle their debt problems smacks of wishful thinking.
There's too much debt. In the spring of 2010, the interest rates demanded by financial markets indicated that about 5 percent of the euro zone's debt was considered highly risky, says the IMF. That represented only Greece. By late summer 2011, the portion judged risky was 46 percent and included Ireland, Portugal, Spain, Italy and Belgium. If financial markets added France to this group - a possibility - the share of threatened debt would rise to 66 percent.
It's implausible that the strong half or third of the euro zone (the 17 nations using the euro) could rescue all the weaker members, in part because "strong" countries also have high debts. Everyone knows about the debts of Greece, Italy and Ireland, which are, respectively, 166 percent, 121 percent and 109 percent of their annual output (gross domestic product). It's less well-known that Germany's debt is 83 percent of GDP and France's, 87 percent. (Americans should not smirk. The U.S. debt - using similar assumptions - is 100 percent of GDP.)
Europe is hostage to financial markets because maturing loans and ongoing deficits mean many countries must regularly borrow huge amounts. Already, Greece, Ireland and Portugal have been excluded from private markets; lenders demanded crushing interest rates. That fate could await others. Some countries face staggering 2012 borrowing needs. The IMF estimates that Italy requires new loans equal to one-fourth of its GDP; for Spain and France, the amounts are about one-fifth of GDP.
Europe is caught in an economic pincer: slow-growth assaults from one side; fickle financial markets from the other. One obvious way out - the China option - seems barred by geopolitics. There is precedent. Historians blame the Great Depression's severity in part on poor international cooperation. Economist Charles Kindleberger found a vacuum of power: Great Britain, the old economic leader, could no longer lead alone; and the United States - a replacement - wasn't ready to help. Is there a parallel today between the United States and China? Are we repeating the mistakes of the 1930s? Unsettling questions.