di Martin Wolf
da Financial Times
the eurozone crisis over? The answer is: “yes and no”. Yes, risks of an
immediate crisis are reduced. But no, the currency’s survival is not
certain. So long as this is true, the possibility of renewed stress
The best indicator of revived confidence is the decline in
interest-rate spreads between sovereign bonds of vulnerable countries
and German Bunds. Irish spreads, for example, were just 205 basis points
on Monday, down from 1,125 points in July 2011. Portuguese spreads are
465 basis points, while even Greek spreads are 946 basis points, down
from 4,680 points in March 2012. Italian and Spanish spreads have been
brought to the relatively low levels of 278 and 362 basis points,
this improvement lie three realities. The first is Germany’s desire to
keep the eurozone intact. The second is the will of vulnerable countries
to stick with the policies demanded by creditors. The third was the
decision of the European Central Bank to announce bold initiatives –
such as an enhanced longer-term refinancing operation for banks and outright monetary transactions for sovereigns – despite Bundesbank opposition. All this has given speculators a glorious run.
Yet that is not the end of the story. The currency union is supposed
to be an irrevocable monetary marriage. Even if it is a bad marriage,
the union may still survive longer than many thought because the costs
of divorce are so high. But a bad romance is still fragile, however
large the costs of breaking up. The eurozone is a bad marriage. Can it
become a good one?
A good marriage is one spouses would re-enter even if they had the
choice to start all over again. Surely, many members would refuse to do
so today, for they find themselves inside a nightmare of misery and ill
will. In the fourth quarter of last year, eurozone aggregate gross
domestic product was still 3 per cent below its pre-crisis peak, while
US GDP was 2.4 per cent above it. In the same period, Italian GDP was at
levels last seen in 2000 and at 7.6 per cent below its pre-crisis peak.
Spain’s GDP was 6.3 per cent below the pre-crisis peak, while its
unemployment rate had reached 26 per cent. All the crisis-hit economies,
save for Ireland’s, have been in decline for years. The
Irish economy is essentially stagnant. Even Germany’s GDP was only 1.4
per cent above the pre-crisis peak, its export power weakened by the
decline of its main trading partners.
If all members of the eurozone would rejoin happily today, they would
be extreme masochists. It is debatable whether even Germany is really
better off inside: yes, it has become a champion exporter and runs large
external surpluses, but real wages and incomes have been repressed.
Meanwhile, the political fabric frays in crisis-hit countries. Anger at
home and friction abroad plague both creditors and debtors.
What, then, needs to happen to turn this bad marriage into a good
one? The answer has two elements: manage a return to economic health as
quickly as possible, and introduce reforms that make a repeat of the
disaster improbable. The two are related: the more plausible longer-term
health becomes, the quicker should be today’s recovery.
A return to economic health has three related components: write-offs
of unpayable debt inherited from the past; rebalancing; and financing of
today’s imbalances. In considering how far all this might work, I
assume that the risk-sharing and fiscal transfers associated with
typical federations are not going to happen in the eurozone. The
eurozone will end up more integrated than before, but far less
integrated than Australia, Canada or the US.
On debt write-offs, more will be necessary than what has happened for
Greece. Moreover, the more the burden of adjustment is forced on to
crisis-hit countries via falling prices and wages, the greater the real
burden of debt and the bigger the required write-offs. Debt write-offs
are likely to be needed both for sovereigns and banks. The resistance to
recognising this is immensely strong. But it may be futile.
The journey towards adjustment and renewed growth is even more
important. It is going to be hard and long. Suppose the Spanish and
Italian economies started to grow at 1.5 per cent a year, which I doubt.
It would still take until 2017 or 2018 before they returned to
pre-crisis peaks: 10 lost years. Moreover, it is also unclear what would
drive such growth. Potential supply does not of itself guarantee actual
Fiscal policy is contractionary. Countries suffering from private
sector debt overhangs, such as Spain, are unlikely to see a resurgence
in lending, borrowing and spending in the private sector. External
demand will be weak, largely because many members are adopting
contractionary policies at the same time. Not least because it is far
from clear that the competitiveness of crisis-hit countries has improved
decisively, except in the case of Ireland, as Capital Economics
explains in a recent
note. Indeed, evidence suggests
that Italian external competitiveness is worsening, relative to
Germany’s. Yes, the external account deficits have shrunk. But much of
this is due to the recessions they have suffered.
Meanwhile, the financing from the ECB, though enough to prevent a
sudden collapse into insolvency of weak sovereigns and the banks to
which they are tied, required rapid fiscal tightening. The results have
been dismal. In a recent letter to ministers, Olli Rehn,
the European Commission’s vice-president in charge of economics and
monetary affairs, condemned the International Monetary Fund’s recent
doubts on fiscal multipliers as not “helpful”. This, I take it, is an
indication of heightened sensitivities. Instead of listening to the
advice of a wise marriage counsellor, the authorities have rejected it
Those who believe the eurozone’s trials are now behind it must assume
either an extraordinary economic turnround or a willingness of those
trapped in deep recessions to soldier on, year after grim year. Neither
assumption seems at all plausible. Moreover, prospects for desirable
longer-term reforms – a banking union and enhanced risk sharing – look
quite remote. Far more likely is a union founded on one-sided,
contractionary adjustment. Will the parties live happily ever after or
will this union continue to be characterised by irreconcilable
differences? The answer seems evident, at least to me. If so, this
unhappy story cannot yet be over.
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