Medicine for Europe’s Sinking South
Greece has long been an accident waiting to happen due to heavy public debt and lack of competitiveness. But its problems are not unique. On their resolution rides the fate of its neighbours, the eurozone and perhaps the European Union itself.
Fiscal incontinence and uncompetitiveness are interlinked across southern Europe. Euro accession and bull-market “convergence trades” pushed the bond yields of Portugal, Italy, Greece and Spain towards German bunds. The ensuing credit boom supported consumption but papered over wage inflation that outstripped productivity growth and priced Greece out of traditional export markets.
Excessive bureaucracy and rigidities in labour, product and service markets, meanwhile, discouraged investment in high value added sectors, despite wages well below the EU average. The resulting noxious mix of large current account and budget deficits led to rising foreign debt. Dramatic euro appreciation in 2008-09 compounded these problems.
As bond yields rise, Greece and its peers face difficult choices. The best course would be to follow Ireland, Hungary and Latvia with a credible fiscal plan heavy on spending cuts that government can control, rather than tax hikes and loophole closures that depend on historically weak compliance. This could achieve an internal devaluation with deep real wage cuts and structural reforms to boost competitiveness, as Germany has since unification.
The easy option would be to resort to financial engineering and fiscal fudges, delaying adjustment. In this scenario market access would eventually be lost, perhaps by mid-2010. Greece would then have to turn to other member states for direct loans (denied – at least so far); to the International Monetary Fund (ruled out – so far); or to non-traditional creditors, say China (denied). Alternatively, it could devalue, default and re-denominate liabilities into a “new drachma,” à la Argentina (unthinkable).
A credible austerity plan would restore solidarity with EU countries that are adjusting, improve the rhetoric of the European Central Bank and key member states, and bring Greek bond spreads back to earth. This approach is working in Ireland – spreads exploded as public debt ballooned to save its banks, but came back in as public spending was cut by 20 per cent. But it is no cakewalk: Portugal has been deflating to boost competitiveness for a decade. Harsh medicine is best ingested quickly.
Greece’s adjustment would ideally be backed by a large IMF programme to prevent a run on public debt and banks during the tough times ahead. In a Europe-only plan, the European Commission would monitor adjustment and the ECB would lend. Neither has imposed conditionality on members, which is what the IMF does for a living. The IMF is ruled out because it would signal weakness. But an EU-only plan may be seen as a fudge by interested parties, given the risks to Europe of failure.
Failure to take the tough decisions necessary would draw attention to an uncomfortable historical truth: that no currency union has survived without a fiscal and political union. The contrast between the eurozone and the US would become ever starker. Many US states are also in fiscal crisis, but local problems can be solved at a federal level. Should transfers fail to do the trick, a chapter of the bankruptcy code is devoted to sub-federal governments. The eurozone lacks such burden-sharing mechanisms.
The story of the other eurozone stragglers is different in degree but not principle. All are highly leveraged – the fundamental source of financial contagion. Spain, like Ireland, has a massive contingent public liability in its banking sector, arising from mortgage debt. Its growth model – residential construction driven by a house price boom – is defunct. Spain too needs fiscal consolidation and structural reform to restore debt sustainability, reinvigorate growth and reduce its 20 per cent unemployment rate. Italy’s government is highly leveraged so it too must cut spending and regain competitiveness. Portugal urgently needs structural reform to restore economic dynamism and fiscal health.
Greece, then, is the front line of a wider battle to stay on the path demanded by European Monetary Union. The political commitment to the eurozone of every country that has come under the gun is unwavering – witness Ireland’s deep budget cuts; Portugal’s painful deflation; the sharp adjustment of aspirants such as Latvia or Hungary. Lack of political and fiscal union, limited labour mobility but free capital movement make such adjustments critical to the long-term viability of the eurozone.
Ideally, formal rules for fiscal burden-sharing should be developed to give teeth to no-bailout clauses, such as debt restructuring mechanisms for eurozone sovereigns. Otherwise, doubts about EMU sustainability will return in every downturn. Sooner or later, these doubts will be validated.
Nouriel Roubini is chairman and Arnab Das head of market research at Roubini Global Economics
12 Responses to “Medicine for Europe’s Sinking South”
PeterJB • February 2nd, 2010 at 5:15 pm
Housing in the ‘house of cards’ model and the continuing Global Economic Collapse and the ‘house of fools model’:From Mish, this day:http://globaleconomicanalysis.blogspot.com/“Today the Reserve Bank of Australia (RBA) unexpectedly held interest rates at 3.75%. No doubt this was in fear of the Australia’s enormous housing bubble that exceeds the height of the bubble that long ago burst in the US. 20 economists predicted the RBA would hike. Not a single one predicted anything else.”Appears that ‘quick-draw’ Glen Stevens, the Head of Reserve Bank of Australia (RBA) has been caught short yet again in his own style of the knee-jerking of interest rates to PC expectations of the faith-based economic model and lack of comprehension of all things economic… no surprises here, at all!At least he is consistent! LOLCommercial Property ‘For Lease’ signs everywhere, I repeat, everywhere and growing daily – as the norm! Ubiquitous and pervasive comes to mind.And, despite all the “just wonderful” growth and wondrous future (at their hand) rhetoric from “leadership” and all that that hangs off it, there is that dry hallowed hollow pre-eminent tight gut feeling, dominating all events domestic and er, international related to growth of economic activities. Like the dawn before the coming of the Grim Reeper – http://fineartamerica.com/images-medium/grim-reaper – k a t i e – a l f o n s i . j p gJust part of the dynamic. I am always amused when “leadership” quickly claim to be the cause of “good-times” and always more faster to deflect and deny responsibility for crises which, as we all know, are only that which they do – and do exceptionally well! LOLThis is a “leadership” crisis!Ho hum
PeterJB • February 2nd, 2010 at 5:19 pm
Oh?”Another Great Depression may have been averted but the crisis is far from over.”Indeed, and perhaps so but it is time to welcome the coming Dark Age, er, for some, which will indeed arrive, er, soon.It may be time to bet just who those “handcuffs” will fit;-)> ?? but this will be the wrong way to go as THE focus.Ho hum
PeterJB • February 2nd, 2010 at 5:30 pm
Definitions FYI: The Human Attributes which are shared with other emergent phenomenon, all which are correctly classified as “life’.. Courage is to be human. Hope is human insight. Sanity is scepticism. Reason is accord. Accord is just logicAnd, the above are all missing from our “leadership” and all that hangs off it, today! Of course I speak generally and collectively;-)>Ho hum
Guest • February 2nd, 2010 at 10:27 pm
OFF TOPIC??this is not fear-mongering, just facts sharingi have followed this “story” for 1-2 weeks now and people are oblivious of it..this is from a well known tinfoil site, but nothin is tinfoil about this….http://www.abovetopsecret.com/forum/thread422630/pg537read the last 20-30 pageskeyword:- viggo, gama, papa, the road, bbbrrrrr
crash866 • February 3rd, 2010 at 9:37 am
Interested but link does not work???
Free Tibet • February 3rd, 2010 at 10:44 am
Professor, I love ya, but you’re losing me. I can’t tell how much of what you write above is specific to Greece and how much you believe applies to southern Europe in general.
“…fiscal incontinence and uncompetitiveness are interlinked across southern Europe”.
Yes, but the reasons are different in each case and in no case – with the possible exception of Greece (of which I would not know) – is it caused by:
“… wage inflation that outstripped productivity growth and priced Greece out of traditional export markets.”
So, there is my confusion. You may be referring specifically to Greece. AlI I know about Greece is that it’s inconsequential (~2% EC GDP). So, you may be right about Greek uncompetiveness. However, even if wage inflation in Spain & Italy or Portugal have outstripped productivity that isn’t what has hurt those economies. Spain overbuilt. As you say, residential construction is defunct. There was a time when it looked like every German and every Scandinavian would retire to the Spanish coast. Now it looks like maybe not. That malinvestment must be worked out of their economy. Just as it must be in the US.And Italy, come sapete più di me, has been dependent on small family businesses with very specialized markets. Globalization has been harder on Italy that probably any other place. Italy has lost its market to cheap foreign goods.And Portugal has been deflating? Not sure how you justify that. It surely hasn’t been apparent to me. All I’ve seen was growth (based in some measure on EC subsidies).To be brief, Italy lost its market, Spain approached the wrong market, and Portugal never got its feet on the ground before all their markets collapsed.What is UNTHINKABLE is what you (and that fool Edward Hugh and his compañero) euphemistically call “internal devaluation” which means balancing this past malinvestment and govt. expenditures on the backs of labor. Just labor. Labor alone will not be able to make that adjustment and if it were attempted will lead to further hardships in those economies and probably to what you yourself hold to be the unthinkable situation of a break up of the monetary union.
“…a chapter of the [US] bankruptcy code is devoted to sub-federal governments.”
Get real! Bankruptcy law can’t resolve a TBTF bank and you think it can resolve Calif?
Morbid • February 3rd, 2010 at 12:33 pm
U.S. May Lose 824,000 Jobs as Employment Data RevisedCan you say MANIPULATE!
Morbid • February 3rd, 2010 at 2:59 pm
For some reason the new forum is adding some unexpected characters in posted links. I have found that if you use the allowed html tags you can avoid this problem. See following examplea href=(Add http link here)>TitleIn front of the a there should be < and after Title there should be <followed by a>
Guest • February 3rd, 2010 at 7:34 pm
MA • February 4th, 2010 at 10:01 am
Anybody catch Nassim Taleb’s comment about shorting T’s??? …and the comment about Larry Summer’s role????Nouriel… where do you stand? You have affiliations with both of these guys… don’t you? Is there some sort of tension?My personal advice… DO NOT LISTEN TO TALEB!!!IS HE INSANE? Short treasuries?In essence, that’s what the repo market already does, but shorting treasuries is a potentially catastrophic recommendation! Sure, we all know rates will rise, so in theory it makes sense… but like I said last year when the TPMG placed new fines for treasury fails, there would be potential for market shortages. Going and shorting this market would in turn create real market shortages, and potentially freezing up the most liquid market in the world!!!…while at the same time, incurring a fine (EVERY DAY) that is greater percentage-wise then the spread on the rate increase. To boot, in freezing that market, you wind up increasing the value of that T since its demand increases.PLEASE, PLEASE, PLEASE someone find out more about what Taleb said, and see if there is something I am missing?From my article last year, I talked about this: http://www.roubini.com/usmonitor/256591/where_is_superman___is_he____deep_captured____In specific, this is what I said:Naked Short Selling vs The US GovernmentOne has to wonder how the entire financial community was able to deny this practices existence. It is comical to see the captured regulatory agencies scurry to put in place safeguards to protect against something they swore up to 6 months ago didn’t exist.It has gone so far that the US Treasury is set to make a massive industry change on May 1st. On the 1st the TPMG (The Treasury Market Practices Group) will put into affect a sizeable charge on failed deliveries of US Treasuries. Although they may deny this as their main reason for the charge, I will be willing to stand out on a ledge and state that I believe this is a move by the treasury to essentially protect themselves against the naked Short Selling equivalent of US Treasuries. It is a move to protect the “quality” of the asset, because they can NOT afford to have these securities subject to potential manipulations. That would rock the foundation of its status as a “flight to quality” and bring about a potential collapse.Sure they may say this isn’t the case, and that they are just trying to free up liquidity, but the fact is that the broker dealers know that with rates so low, it is cheaper to fail on a delivery, rather then pay the cost of borrowing the collateral for the repos they finance themselves with. (This move by the TPMG could become dangerous as they may actually cause market shortages in the long run?)Don’t believe me??? Here are their words along with the website to check out the changes that go into effect this week:“Market participants with large short positions should make deliveries in good faith. Market participants with a particularly large short position in an issue should ensure that they are making a good faith attempt to borrow needed securities in order to make timely delivery of securities. Market participants should avoid the practice of “strategic fails”—that is, the practice of selling short a security in the repo market at or near zero percent with little expectation of being able to obtain the security to make timely delivery.”www.newyorkfed.org/tmpg.WOW!!! This is a pretty amazing about face for the practice of Naked Short Selling that didn’t exist just six months ago!!!All the best,Miss America
Guest • February 4th, 2010 at 8:53 pm
“I don’t need to out-run the tiger. I need to out-run you!”-the USA said to Europe in 2008
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