Why the Euro Crisis Is Nowhere Near Being Over

Bailouts and easy money won't be able to resolve the structural problems of the euro zone, and increasing austerity won't fix things either.

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DOMINIQUE FAGET / AFP / Getty Images

Spaniards attend a demonstration organized by "indignant" protesters, who rally against a system they say deprives citizens of a voice in the crisis, near the parliament building in Madrid on Sept. 29, 2012

It’s astonishing, but everyone is behaving as though the euro crisis were over. Long-term bond yields are bellwethers of investor confidence. And over the past few months, yields on 10-year Spanish bonds have fallen from 7.5% to 6%, while those on similar Italian issues have dropped to 5%. The U.S. stock market seems equally upbeat. The S&P 500 finished the third quarter last week at its highest level in more than four years. Share prices are shrugging off not only the likelihood of an economic slump in 2013, but also the possibility that a crisis in the euro zone could send shock waves throughout the global banking system.

Something seems very wrong with this picture — at least to me. Focus only on the European elite, and everything may appear under control. The May election of Socialist François Hollande to replace Nicolas Sarkozy as President of France has shifted European finances in the direction of easy money. The ruling three weeks ago by Germany’s Constitutional Court removed the biggest remaining stumbling block for future bailouts in the euro zone. And German Chancellor Angela Merkel has also softened on financial questions, declaring last Thursday, “We will continue to do everything necessary to develop the economic and currency union so that it is stabilized permanently.”

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But as soon as you turn from the elites’ self-congratulation to stories about people in the streets, you get a very different impression. Formerly middle-class Spaniards are scrounging for food in dumpsters. Greeks are rioting when they are not engaged in neofascist marches. Rich French people are thinking about leaving their country because of staggering new income tax rates. And former Italian Prime Minister Silvio Berlusconi — the “bunga bunga” man — is mulling a return to office by running against German oppression.

Everything can be straightened out, according to advocates of easy money, if enough cash is handed around by European financial institutions. “If Germany really wants to save the euro, it should let the European Central Bank do what’s necessary to rescue the debtor nations — and it should do so without demanding more pointless pain,” writes Paul Krugman in the New York Times. “The continued survival of the euro is assured,” writes George Soros in the New York Review of Books, although more ominously he adds: “The line of least resistance leads not to the immediate breakup of the euro but to the indefinite extension of the crisis.”

An indefinite extension of the crisis is precisely what appears to be in store. By lowering the cost of borrowing, expansive monetary policies do indeed reduce the short-term financial pressures on heavily indebted countries. But in my view, three long-term problems remain that have no easy solution.

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First, countries can’t easily escape the consequences of past mismanagement. Greece, Italy and Portugal are all projected to run what are called primary budget surpluses next year. That means that their governments will take in more money than they spend, if you don’t count interest payments. In other words, they would now be in great financial shape, thanks to all their belt-tightening, if it weren’t for the burden of the debt they accumulated in the past. By contrast, the U.S. primary deficit is still a whopping 6% of GDP, significantly higher than that of every country in the euro zone. If weak European countries have to pay off all their past debts at the same time that they are running primary budget surpluses, they will face a very long period of austerity indeed.

The second problem is that over the past decade, the euro has created a severe misalignment in labor costs (after adjustment for differences in productivity). Labor costs in weak countries are as much as 20% higher than those in Germany. Part of the reason for the gap is that those countries let wages and benefits rise too fast in past years, and another part is the result of subpar gains in productivity. There are three possible fantasy solutions: everyone could leave the euro and then rejoin it at new exchange rates that equalized costs; everyone in high-cost countries could agree to 20% wage cuts; or a massive wave of new investment could boost productivity. None of those things is particularly likely. More realistically, countries with overpriced labor have a choice between simply leaving the euro zone or preparing for years of austerity that slowly grinds down their labor costs.

The third problem is that perpetual austerity is not only intolerable, it is also ineffective. Occasional protests that result in some broken shop windows are one thing. But current demonstrations in Europe against stringent austerity policies reflect the unraveling of the social fabric itself. What is worse, there is little chance that such policies can solve Europe’s financial problems within a reasonable time frame. There is simply too much debt to pay down and too many accumulated structural problems. Moreover, if austerity pushes countries into recession, their shrinking economies will actually become less capable of hitting financial targets.

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There is, in short, no straightforward solution. At best, a careful balance will have to be maintained between, on one hand, the financial stringency required to chip away at debt while bringing European labor costs into better alignment and, on the other, the basic needs of the people who will suffer in the process. Europe is still immensely wealthy, and there is no reason to believe that today’s problems will necessarily end in catastrophe. However, the current level of complacent optimism seems somewhat naive. There figures to be a lot more mess to wade through before the euro crisis is truly over.

19 comments
blub blubber
blub blubber

Be glad... as long as the Euro is effed, there is no inflation in the $ zone... Good for everyone (except Spain etc.).

boonteetan
boonteetan

The Eurozone unemployment rate stands at 11.4%, with Spain near an awesome 25%. The situation is getting worse and recession raising its ugly head ever higher, despite all the desperate effort to revive the economy. 

There is no panacea, short of enduring a much less lavish and flamboyant lifestyle for years. Are Europeans willing?   (btt1943, vzc1943)

paul.abbotson
paul.abbotson

@boonteetan Apparently the golden banking boys are not willing and supported in their greed by the UK government.

kishorashah
kishorashah

The lesson this crisis has imparted is

" Govt spending with borrowings is nothing less than future revenue spent today."

Time to ensure that all new borrowings must (restrictively) be used for creating assets for coming generations.

pendragon05
pendragon05

The present state of Europe is proof positive why Socialism is a failure on every level.

If nobody works, nobody pays into the system, money runs out way sooner than later.

paul.abbotson
paul.abbotson

@pendragon05  

True I cannot argue with that but neo-conservative capitalsin sparked the  world crisis with the prime loan  debacle. We do not need either unfettered socialism or  unfettered capitalism, but should seek to   find a pragmatic middle way not based on political ideology of any kind  but on the fact  that we do live by choice  in a human society and act accordingly in an intelligent  and responsible way. There is much to support my view the we shoudl scrap  all social security schemes, including hand outs to corporate an banking welfare bums  as a a useless waste of money and adopt instead  a comprehensive single purpose  scheme  based on the  the guarantteed  household income concept/ This concept, which I do no have enough space to describe in detail,  can  only work if it is universal and well understood bu those who administer it.  We cannot  abolish the  poor among us anymore than we can or should   abolish the super rich but at least make life liveable and enjoyable for the majority of working households and help those others who  cannot help themselves as a result of  physical or mental handicaps. The abolition of misery rather  than  a guarantee of  a lazy life of luxury is the goal.. Throughot  history, ancient and modern,  the rich need the vast majority  otherwise they would not be  rich and  they are as much dependent on society as the homeless poor at the bottom  of the pile..


Peter Palfrei
Peter Palfrei

Socialism works for as long as the base of its economic model focuses on creating jobs for everyone by means of state-private joint venture enterprises instead of handing out monetary assistance.

Money is a means of retribution, retribution for something. Being an idle citizen is not enough to receive state money on a monthly basis.

Talendria
Talendria

I think it's simply a case of give an inch, take a mile.  The social safety net was designed to save people from Dickensian poverty, and in that it's been very successful.  But like everything else in this world it's been corrupted by greed.  Somewhere along the way people forgot that the grand purpose of life is struggle and redemption, not complacency and failure.

William Livingston
William Livingston

"Time" offers a four free issues bait to those whom it hopes to get to subscribe to it, but "Time's editors fail to realize that many Americans have have given up on the Leftist propaganda the MSM attempts to spread under the guise of what it calls the "news."

I wouldn't permit my house to be contaminated by "Time's" lies even should the magazine pay me its subscription price to accept it.  IOW, I wouldn't let "Time" in my house were I paid $50. to accept it free-of-charge.  The same applies to "Newsweek."

Joe
Joe

Europe needs about $3 trillion. The US needs about $4 trillion.

Such amounts cannot be found in European pockets. They can only be found in two other places: Chinese surpluses, or Mid East reserves.

But China won't part with its money unless it gets clear title in return-- which neither Europe nor the US will accept.

So the only outcome must be a steep reduction in oil prices, perhaps as much as 50-60%.

Europe consumes about $800 billion of oil a year. The US, about $900 billion.

A 60% price cut is about half a $trillion in saves for each. It will make the Western economies boom. 

But of course, it will export the recession to the east: Saudi Arabia, Iran, Russia.

But they don't vote here, do they?

dru_down
dru_down

What nonsense.

Like any individual debtor, the answer here is reorganization of debt. 

Rodger Malcolm Mitchell
Rodger Malcolm Mitchell

"By contrast, the U.S. primary deficit is still a whopping 6% of GDP, significantly higher than that of every country in the euro zone. "

The U.S. is Monetarily Sovereign, so can pay any bills of any size any time.  The euro nations are monetarily NON-sovereign -- like our states, counties and cities -- so cannot pay their bills.

Those who do not understand the difference do not understand economics.

Nonaffiliated
Nonaffiliated

It's not quite that easy for the USA.  Sure, we can create new money to pay any bill, but when you do enough of that, your currency loses value (inflation) and you have to pay higher interest rates on your debt (which rolls over periodically).  The higher these interest rates go, the larger your deficit, the more money you have to print, the higher the interest rates go.  The whole time, the purchasing power of Joe Citizen's paycheck is shrinking through inflation, retirement funds lose value, and there's more burden on the safety net.  It's not a path you want to go down.

JJCobas
JJCobas

I am Spanish. It is not true that "Formerly middle-class Spaniards are scrounging for food in dumpsters". The article form NYT is simply a caricature.

I recommend this vision from a US writer who lives in Barcelona:

http://www.psmag.com/blogs/the...

snowleopard (cat folk gallery)
snowleopard (cat folk gallery)

As an outsider looking into the EuroZone, I have to ask, what is to prevent the Eurozone and the European Union from simply breaking apart one portion at a time under the social and economical strains it is being subjected to?

If Greece or other member nations withdraw from the EU, what becomes of the other nations and the economic ties between them?

The reason I ask of the Europeans and those familiar with the EU and EuroZone is that I see my own nation headed down the same path within a few years if the ship of state is not set on another path and soon.

Nonaffiliated
Nonaffiliated

If a nation leaves the Eurozone, will it pay back its debts in Euros or some new (depreciated) currency?  If they have to pay back in Euros, they haven't gained much.  If they pay back in new currency, lots of banks that loaned them Euros would be in trouble.   If they don't pay back at all...well, that's even worse.

Talendria
Talendria

United we stand; divided we fall.