Is the European crisis over or still yet to start?

Seeing light at the end of this tunnel is becoming more elusive as each day passes. The dynamics relating to this crisis are particular, mainly because the various fire fighting tools which have historically been used in such circumstances are losing their effectiveness. There is no fat in the system to rely on, no fiscal tools or other bailout plans large enough to achieve short term solutions. We must go through short term pain for long term gain. Structural budget reform is needed immediately in the main problematic European countries – anything else will only be postponing the very much needed budgetary discipline.

Reality calls for extensive cuts in government spending which will also impose disciplinary spending cuts at household level- Karl Micallef

The most worrying facet of the eurozone crisis is that every solution requires underlying economic growth during implementation to be successful. This is very far from reality and can already be seen in Greece where the austerity plans being executed were doomed to fail before even starting. Ultimately, such plans must make mathematical sense and the maths will only tally if the underlying assumptions are realistic. This is where the problem lies. Politicians currently faced with this financial mess are not willing to take long term views.

On the one hand they are aware of the extent of the crisis and the harsh realities they need to impose on their own people to bring their country back to a financially sound position, while on the other hand they are also aware of the fact that votes will be lost if such harsh measures are imposed. Therefore a middle route (which in reality does not exist) is chosen whereby a mathematical solution is discovered that is based on unachievable assumptions. This way it would seem that the problem is being tackled only to see the same solution fail shortly after because the underlying assumptions did not make economic and mathematical sense at the outset.

So what needs to happen? Among others, governments need to become more financially responsible with their annual budgets. Reality calls for extensive cuts in government spending which will also impose disciplinary spending cuts at household level. A nation cannot keep borrowing ad eternum without an equivalent increase in government revenues in order to maintain the nation’s capability of servicing the increase in interest payments. Furthermore, the European countries experiencing financial distress need to become more efficient, more competitive and savings need to increase. The eurozone needs to stick to austerity if it wants to have a fighting chance of coming out of this situation successfully. There is no easy way out.

This probably means that it will take many years for any real sustainable economic growth to be registered. National and household balance sheets need to be rebuilt and one needs to accept the fact that quick easy money will not be around for many years to come. This is where the pain lies – it is far easier to adapt to a more comfortable and luxurious lifestyle than it is to impose upon oneself the need to work harder and save more, resulting in a tougher and less luxurious standard of living.

It would be best if both governments and households faced this reality and reacted to it of their own free will rather than wait for someone else to impose austerity measures on them – psychologically the former is more acceptable than the latter.

In the meantime and possibly in answer to the title of this article, German 10-year Bund and US Treasury yields fell below two per cent last week as investors fled to safe-havens due to concerns that no clear direction is provided in addressing the eurozone crisis, coupled with the European bank recapitalisation strategy which also seems to be collapsing under the weight of the economic downturn. The fall in German Bund yields have heightened fears that some western markets could be sucked into a Japanese-style scenario of extremely weak economic growth.

This article is the objective and independent opinion of the author. The information contained in the article is based on public information. Any opinions that may be expressed here above should not be interpreted as investment advice, nor should they be considered as an offer to sell or buy an investment. The company and/or the author may hold positions in any securities that might have been mentioned in this report. The value of investments may fall as well as rise and past performance is no guarantee of future performance. Curmi & Partners Ltd are members of the Malta Stock Exchange and licensed by the MFSA to conduct investment services business.

Mr Micallef is an executive director at Curmi and Partners Ltd.