After half a decade from the financial crisis, the United States is recovering, but Europe is suffering from a lost decade. Why?
In the 2nd quarter, the U.S. economy grew at a seasonally adjusted annual rate of 4 percent, surpassing expectations.
In the same time period, economic growth in the Euro zone slowed to a halt (0.2%), well before the impact of the sanctions imposed on and by Russia over Ukraine. Germany’s economy contracted (-0.6%), France’s continued to stagnate (-0.1%) and Italy’s took a dive (-0.8%).
How did this new status quo come about?
US: Looking better, but fragile
In the United States, real GDP growth showed resilience last year (1.9%), while inflation remained below 2 percent (1.5%). In the ongoing year, the 1st quarter was far weaker than expected (-2.9%) and caused downgrades as the projected annual growth was re-estimated to less than 2 percent.
However, economic indicators for the 2nd half of the year tell a story of recovery and the outlook for 2015 is optimistically seen as almost 2.5-3 percent.
Mid-term elections will ensue in fall 2014 and presidential elections in 2016. If Democrats want to keep the White House and the Congress, U.S. economy must look strong – at least through the two elections.
The Federal Reserve is likely to end the large-scale debt purchases around October. As a result, the debate has begun when the rate hikes will follow.
The Fed chief Janet Yellen is determined not to raise the policy rates too early and risk hurting the U.S. recovery, which remains fragile. For now, the hikes are expected by mid-2015.
However, Yellen is also a consensus leader and as labor markets are improving, several Fed board members would like to raise borrowing costs sooner; the “hawks” already in the late fall. In the recent Jackson Hole summit, Yellen presented herself between the “hawks” and the “doves,” however.
If the rates are hiked too early, U.S. recovery could be threatened and the spillovers would be negative from Europe to China.
Euro zone: From contraction to stagnation
In the Euro zone, real GDP growth contracted last year and shrank in the ongoing 2nd quarter, while inflation plunged to a 4.5 year low.
Europe’s core economies performed dismally. In Germany, foreign trade and investment were the weak spots. The country could still achieve close to 2 percent growth in 2014-2016 until growth is likely to decelerate to 1.5 percent by late decade.
In France, President François Hollande has already pledged EUR 30 billion in tax breaks and hopes to cut public spending by EUR 50 billion by 2017.
Nevertheless, French growth stayed in 0.1-0.2 percent in the 1st quarter. Fiscal austerity and falling consumer confidence are preventing domestic demand from rebounding, while investment and jobs linger in the private sector. Pierre Gattaz, head of the largest employers union, has called the economic situation “catastrophic.”
As France is at a standstill, Paris has all but scrapped the target to shrink its deficit. Before his resignation Prime Minister Manuel Valls intensified reforms, which in April included additional EUR 11 billion in tax cuts for companies and households. This is how the reform-minded Valls reshuffled a new government without his left-wing economy minister Arnaud Montebourg, as well as the ministers of culture and education, who have blasted both Chancellor Merkel’s austerity doctrine and President Hollande’s economic policy.
By replacing Montebourg with the ex-banker Emmanuel Macron, who helped to draw up Hollande’s pro-business agenda, both Valls and Hollande need results fast. The new stance is to avoid an explicit confrontation with Germany, but to redefine austerity vis-à-vis budgetary reforms. As a result, Paris hopes to soften Euro zone budget rules already next month.
The timing is favorable. After all, Italy has fallen back into recession. To sustain his bold economic reforms, Prime Minister Matteo Renzi now needs a whopping EUR 32 billion to overhaul the labor market, EUR 18 billion for unemployment benefits and EUR 13 billion for infrastructure projects.
While better performance is likely to ensue later in 2014 and thereafter, growth will linger. Indeed, Italy and France are coping with similar ailments. In both, fiscal adjustment is strangling domestic demand, while exports suffer from deindustrialization, erosion of competitiveness and the strong euro.
In 2014, the Euro zone’s growth is expected to increase to 1 percent but the recovery is fragile and downside risks have grown elevated. The aging Europe is breathing heavily before stumbling up – or falling further down.
In America, polarized economic growth has endured for three decades. Ferguson, Missouri is just the tip of the iceberg. However, if Washington can avoid its political stalemates, U.S. growth may accelerate to 2 percent growth in 2014 and could remain around 2.5 percent through the rest of the decade.
It was the plunging consumption and the subprime-market abuses that initiated the crisis in America in fall 2008. Despite improving wages, it remains the weakened consumption and slower home-price appreciation that continue to penalize growth, along with the aging population and other secular forces. Further, premature rate hike expectations could cause new economic uncertainty and market volatility.
In 2014, the Euro zone growth rate will linger at close to 1 percent and it could remain at less than 1.5 percent through the rest of the decade. As the European Central Bank chief Mario Draghi recently alluded, persistent disinflation is driving the ECB away from strict austerity policy. The inconvenient truth is that this happens half a decade too late. Unemployment rate remains 11.5 percent and prohibitively high in Greece (27%) and Spain (25%), respectively.
Today, even successful performers, such as Germany, are no longer immune to adverse turns, and others, such as Finland, are navigating to uncertainty.
Original version published by the EUobserver on August 28, 2014
WHY AMERICA IS RECOVERING, BUT EUROPE IS NOT
Part II: U.S. Crisis Success Versus European Failure – and the Russian Sanctions Threat
By Dan Steinbock
It is the differences in the way the United States and Europe tackled the global financial crisis that explains why the U.S. economy is recovering, whereas the Eurozone is amid a lost decade.
Why U.S. crisis policies worked
In the United States, the global financial crisis was unleashed by real estate markets and the financial sector, which caused a dramatic contraction and massive mass unemployment.
But even as the Obama administration and the Congress initiated deleveraging and tried to repair the devastation of the subprime markets and the colossal excesses of the too-big-to-fail banks, Washington used substantial fiscal adjustment as a cushion.
The administration’s stimulus package, which was later revised to $831 billion, included spending in infrastructure, health and energy, federal tax incentives, expansion of unemployment benefits and other social welfare provisions. It boosted innovation and supported competitiveness.
Meanwhile, the Federal Reserve, in just weeks, subverted monetary policies that had endured three decades. Under Ben Bernanke, the Fed reduced the federal funds rate to 0-0.25% in fall 2008 and, since that proved inadequate it turned to non-standard monetary instruments, including rounds of massive large-scale asset purchases.
Most importantly, the United States did not suffer from “institutional deficits.” Through the crisis, it was able to rely on common fiscal and monetary policy. When one state got into trouble, it could turn to others for support. Of course, the crisis supported some states and hurt others, but the common institutions worked.
Then, there were the advantages associated with the U.S. dollar. In fall 2008, it translated to 0.80 euro; today, it amounts to 0.74 euro. Currently productivity is increasing 20 percent faster in the U.S. than in Europe. Yet, U.S. dollar remains 25 percent behind euro.
Mysterious are the ways of the currency markets.
Why European crisis policies did not work
When the 2008/9 crisis hit Europe, the core economies relied on their generous social models, but structural challenges were set aside. That ensured a timeout but boosted threats. In spring 2010, the crisis was still seen as a liquidity issue and a banking crisis. So Brussels launched its EUR 770 billion “shock and awe” rescue package to stabilize the Euro zone.
As the consensus view grouped behind Brussels, I argued that the rescue package was inadequate and the austerity policy too strict. Further, it ignored multiple other crisis points. And it was likely to result in demonstrations and violence in Southern Europe. That’s what followed as smaller economies – Greece, Portugal, and Ireland – were swept by deep contractions.
In Brussels, the crisis economies were seen as “exceptions” until the Euro zone crisis deepened in Spain, Italy, and even France. At the same time, the European Central Bank (ECB), led by its then-chief Jean-Claude Trichet, moved too slowly and hiked rates instead of cutting them. When the ECB finally reversed its approach, precious time and millions of jobs had been lost.
Subsequently, Trichet’s successor, Mario Draghi, cut the rates and pledged to defend euro “at any cost.” Markets stabilized, but not without huge bailout packages, which divided the Euro zone.
As Barroso and his commissioners began to argue that “the worst was over,” Brussels hoped to reinforce the trust in euro and the EU and deter the rise of the euro-skeptics. But hollow promises resulted in a reverse outcome.
What’s worse, both Brussels and the core economies failed to provide adequate fiscal adjustment amidst the global crisis and the onset of the Euro zone debt crisis, which made bad mass unemployment a lot worse and continues to penalize demand and investment. Further, neither liquidity support nor recapitalization of the major banks has mitigated the worst insolvency risks in the region.
Unlike in the U.S., many European economies, including the Nordic ones, also continued to cut their innovation investments, thus making themselves even more vulnerable in the future.
As the crisis spread to Italy and Spain, which together account for almost 30 percent of the Euro zone economy, bailout packages could no longer be used. Rather, structural reforms became vital but since they were seen as a political suicide, delays replaced urgency.
Meanwhile, euro has been a heavy burden in the Euro zone. Although Europe remains significantly behind the U.S. in productivity growth, the euro was to 1.45 in fall 2008 and 1.34 today – a third higher than the U.S. dollar.
How has deleveraging succeeded? Well, it hasn´t. General government gross debt as percentage of the Euro zone GDP soared from 70 percent to 93 percent in 2013. In Italy, the ratio has increased by a third to 133 percent. In Spain, it more than doubled to 94 percent; in France, by a fourth to 94 percent. In small crisis economies, the debt – Greece (175%), Portugal (129%) – remains at threat levels.
Perhaps it is not coincidental that the Euro zone is “changing” its budget accounting method, while Italy is postponing the release of its fall budget.
The Russian sanctions threat
But it is the sanctions on and by Russia that pose the greatest downside risk to Europe, Russia´s greatest trade partner.
Last year more than 50 percent of Russia’s exports of goods went to EU countries, where Russia also purchased almost 50 percent of its imports. In the financial sector, European banks had some 75 percent of Russia’s foreign bank loans in late 2013.
It is for this reason that Germany’s Chancellor Angela Merkel recently rushed to Kiev to pave the way for peace talks between president Putin and Ukrainian president Petro Poroshenko.
Her balancing act was designed to sustain Europe’s positive economic development, despite sanctions. While Moscow does not want to see Ukraine in NATO, Merkel indicated that she did not see “membership” on the agenda but that Kiev could continue its “co-operation” with Nato.
Then came reports from Kiev suggesting a “Russian invasion” is under way.
As the eurozone core economies – Germany, France, and Italy – began to ponder extra sanctions on Russia, NATO said Ukraine can pursue membership. As Merkel’s cautious recalibration was undermined by real and alleged events, EU leaders opted to wait how Russia will respond to Poroshenko’s new “peace plan.”
If the West will tighten current sanctions incrementally, global economic prospects remain tolerable. If, however, the West takes the sanctions to still another level, the downside risks could push Europe into a triple-dip recession – and the weakest euro countries into the shadow of the abyss.
Original version published by the EUobserver on September 1, 2014