Last summer, Washington’s indecision pushed America close to an edge. In the past few weeks, indecision in Brussels, ECB and major European capitals has pushed the euro zone closer to ‘catastrophic risk.’ Policy reversals are needed urgently.
The world economy is facing bleak prospects in the medium-term. Conceivably, the drift toward a new global recession could be avoided, but only with credible and sustained success in the euro zone.
After a brief visit in Europe, it is hard to avoid the conclusion that it is only prudent to keep expectations in check. Clearly, the problems are not restricted to the so-called PIIGS, peripheral Europe, or the ‘Club Med.’
In reality, the European problems are pervasive and systemic, extending from small and fragile economies to the core of the region. Nor are they limited to the euro zone, as evidenced by the riots, polarization and stagnation in the United Kingdom – the Swiss currency struggles, the Swedish debate over growth prospects in the medium-term.
Overcoming the euro zone challenges is not impossible; but it is exceedingly difficult, highly complicated and requires relatively long-term cooperative efforts.
Requirements of “comprehensive solutions”
Despite on-and-off market hopes, the sustained vitality of the euro zone is predicated on appropriate fiscal and monetary policies, sensible debt restructuring and adequate liquidity facility, recapitalization of systemically critical banks and cleaning of the toxic assets at the European Central Bank (ECB), as well as structural reforms in competitiveness and innovation.
Attacking one of the challenges will not suffice. Each and all must be overcome. And that’s why the challenge seems so overwhelming.
Brussels has only a few weeks to come up with a “comprehensive” solution. It is impossible to predict the future, but it is possible to outline seven conditions that are vital to the Eurozone’s sustained success.
For almost two years, the euro zone leaders in Brussels and the ECB have refused to acknowledge the severity of the problems, especially the need for the restructuring of Greek debt and the creation of euro bonds. Now both are on the table, but precious time has been lost. Moreover, the proposed measures remain inadequate. Most probably, Greece needs a 50% haircut for private creditors.
A managed debt restructuring in Greece is not a question of principle, just a matter of time. Neither can Portugal or Ireland escape substantial haircuts. The debt problems in the Eurozone are systemic.
Recently, German Chancellor Angela Merkel said euro-region leaders must erect a firewall around Greece to avert a cascade of market attacks on other European states. That, however, requires adequate liquidity facility.
In the euro zone, liquidity support is vital for many euro nations. But the proposed changes to the stability facility (EFSF) are grossly inadequate. The current EUR 750 billion facility – EUR 440 billion by EFSF, EUR 60 billion by European Commission and EUR 250 billion by the IMF – will not deter runs on Italy or Spain. More importantly, even if the EFSF were to be doubled or tripled, that will not save the “too big to fail” major economies in the euro zone.
More importantly, the eurozone/IMF projections of the euro banks’ capital needs ignore the massive losses that these banks will accrue from debt restructurings. As a result, recapitalization of the systemically critical banks is unavoidable.
Then, there is the question mark of the ECB. Since the onset of the global crisis, the ECB has embraced trillions of dollars of questionable debt. The ECB toxic assets must still be defused. As ECB chief Jean-Claude Trichet will be retiring on November 1, ECB hopes to defer the task; that is possible but will add to final costs.
Unfortunately, overcoming the challenges of restructuring, liquidity, recapitalization and the ECB will not suffice. The euro zone also needs right fiscal and monetary policy, and structural reforms.
Since fall 2008, the leading euro economies have engaged in severe front-load austerity measures and promises of long-term fiscal support. That has been precisely wrong. In current conditions, neither bastard Keynesianism nor Ebenezer Scrooge doctrines of austerity will do. Instead, they should ensure short-term fiscal support, in order to boost recovery, and credible, long-term back-load austerity, in order to sustain growth.
In the aftermath of the global crisis, the traditional instruments of monetary policy have been exhausted in the Eurozone. Hyper-concerned with inflation, the European Central Bank (ECB), led by Trichet, was initially all too fast to hike the rates. In contrast, the euro zone despairs for monetary easing, particularly credit for small and medium-size enterprises which are critical to employment.
In the absence of growth, finally, resolving debt dilemmas is inadequate. In order to sustain their strategic strengths, the Eurozone nations need structural reforms in competitiveness and innovation, in order to sustain their competitive leadership.
$8 trillion lost – before the recent market decline
In the past few weeks, the world economy has taken a dangerous turn. As advanced economies are struggling amidst potentially devastating debt crises, large emerging economies are coping with growth pains.
The centrifugal pressures are reflected by the state of major exchanges, as evidenced by the plunge of combined domestic market caps of regulated exchanges worldwide.
Last April, the 50+ major stock markets worldwide peaked at $59.2 trillion. Since then, markets have lost almost $8 trillion. While markets have plunged in all regions, the losses have not been equal across core regions.
In Asia, the markets have declined over 8% since the peak in April. In the United States, the plunge has been much steeper; almost 14.3%. In the same period, however, Europe’s decline has been more than twice as deep as in Asia – over 17%.
These declines occurred before the recent market turmoil, fueled by the euro zone. In the absence of right policies, the current volatility is just a prelude for what is to come.
13 Responses to “Postcard From Europe: Overwhelming Challenges in the Euro Zone”
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