Financial markets have performed impressively well since the beginning of 2013 reaching pre-crisis levels early in March. The UK FTSE 100 was back to the levels reached before the Lehman Brothers collapse while the Dow Jones hit an all-time record at the same time. But to what extent is this financial market enthusiasm being transferred to the real economy? Not much, if one were to examine the hard economic data coming out of the eurozone.
EU growth stimulus programmes have been either very weak or non existent
Mario Draghi said so much when he was commenting on the lack of “positive contagion” between the exuberant financial markets and the real economy. With Italy becoming even more ungovernable following the February elections, the eurozone economic crisis is now threatening the institutions of democracy as happened in Greece following their first round of election in 2012.
The tender shoots of economic recovery in distressed eurozone countries like Greece, Italy, France and even Ireland are still not evident as unemployment continues to grow as a result of fiscal austerity measures that have choked most economies in Europe.
The European economics chief Olli Rehn sticks to the agreed Commission script and like Chancellor Angela Merkel repeats that the eurozone’s weaker countries, especially those known as the Club Med, have no option but to stick to the austerity strategy.
So far, EU growth stimulus programmes have been either very weak or nonexistent. So unemployment continues to rise and some countries are already in a state of economic depression or very near being so. As long as the European Commission keeps ignoring the fundamental flaws in the euro’s structure, the eurozone will continue to falter.
It just does not make sense to “cram fiscally different nations with widely divergent competitiveness into a single currency area”. Austerity will simply not provide the solution that eurozone political leaders long for but are not prepared to implement.
The respected German Ifo Institute’s European Economic Advisory Group (EEAG) says that the eurozone crisis is in fact “three different crises rolled in one; sovereign debt and banking crises are, in effect, mere symptoms of an underlying problem of divergent competitiveness which has resulted in an un-reconciled, good old-fashioned balance of payments crisis”.
In the good old days when the absence of a monetary union in the EU left each country to correct its balance of payments deficits by painful devaluations to regain competitiveness, such problems did not last for long. Now eurozone countries cannot revert to devaluation and instead they try to correct their imbalances by financing deficits through bank borrowing.
But when the banking crisis erupted, partly as a result of this strategy, the weaker countries had to rely on the European bailout funds that are built with taxpayers’ money.
The European Council has stubbornly discarded the most logical solution – that of pushing defaulting countries form the euro club. A defaulting country that willingly or unwillingly left the eurozone would have to resort to massive “external devaluation” of its currency to restore its competitiveness. EU leaders fear that kicking even a small country out of the club carries unacceptable contagion risks for the wholeeurozone. So they are left with two other options.
The first option is that of “internal devaluation through falling prices and wages in deficit nations”. Greece has already swallowed this medicine and it certainly does not look any stronger. This solution which seems to be the EU’s favoured one does not only bring about a recession but inevitably leads to a depression that is long and painful.
Another alternative is internal devaluation through rising prices in the eurozone strong core. But will the Germans, Dutch or Finns ever accept to tolerate high inflation to help the weaker states to restore their competitiveness? It is no wonder that Angela Merkel who faces a tough election in September has strongly rejected this solution.
Goldman Sachs analysts have suggested that Germany will need to tolerate inflation of four per cent per annum or higher over the next 10 to 15 years to help the weaker eurozone states to catch up with German competitiveness. This would in turn destroy 40 per cent of German wealth mainly held by hard-working German citizens.
The austerity strategies may be improving the fiscal imbalances in the weaker eurozone states but are not helping economic growth despite the increasing froth in the equity markets. The European Commission needs to come up with more convincing plans based on a rewriting the governance rules of the eurozone if economic recovery is to be accelerated.
johncassarwhite@yahoo.com