Hope springs eternal in the hearts of the European optimists. Despite the fact that Europe is still mired in its longest post-war economic recession and despite every sign that austerity fatigue now characterizes Europe's beleaguered periphery, the optimists cling to the hope that an economic recovery is just around the corner and that somehow Europe will muddle through its economic and political crisis.
More terrible news out of Europe: The euro zone economy has contracted for the sixth consecutive quarter. That's officially the longest recession in the history of the euro, which launched in 1999. Even France and Germany are now getting dragged down.
For a good look at the damage, check out this chart from Philippe Waechter of Natixis Asset Management, which shows that only three of the 17 euro zone nations — Germany, Austria and Belgium — have bigger economies now than they did in 2008. The rest either keep shrinking or have yet to rebound to their pre-recession levels:
The euro zone is mired in a seemingly endless recession, and the European Central Bank is meeting on May 2nd to decide whether to cut interest rates and provide a little stimulus.
Trouble is, that's not an easy decision, as this interesting chart by Benn Steil and Dinah Walker of the Council on Foreign Relations suggests. Different countries within the euro zone are in vastly different economic situations, and ECB head Mario Draghi will have a hard time satisfying everyone:
Cyprus's president says that country's economic crisis is now contained, and it won't need to leave the euro. But even if you believe him, that hardly means Europe is out of the woods. Slovenia was prompting concern last week, and Luxembourg and Malta are also stoking worries. And that's not to mention the biggies Italy and Spain, whose failure would probably spark a worldwide economic crisis.
A new analysis by three economists at BofA Merill Lynch Global Research finds that Europe's major economies could be doomed to sluggish growth for many years to come:
The authors start by pointing out that countries suffering from a recession triggered by a housing bubble typically take a long time to fully recover (five-and-a-half years, on average).
As the entire world started to crumble in 2009, a few countries appeared capable of weathering the storm. Developing countries like China and India, for one thing, managed to keep growing. Australia didn't even have a recession, while Israel barely did and Sweden rebounded quickly.
The Cyprus crisis, it appears, is soooo last week. The new country that's provoking concern is Slovenia. The small former Yugoslav republic—wedged between Italy, Austria, Hungary, and Croatia and best known for its exceptional skiers and Slavoj i ek—had a pretty bad week, with long-term bond yields spiking to 5.4 percent Friday morning amid fears that the country would need a bailout. That's not crisis-level — Cyprus's yields are around 7 percent, for comparison — but it's certainly in the "Danger Zone."
The latest proposal to save Cyprus's economy, "Plan B," has the country nationalizing private pensions and issuing emergency bonds. But even as Cyprus's parliament considers the plan, the "troika" of the European Commission, European Central Bank and International Monetary Fund apparently opposes it. And Russia, the island's other potential savior, is now saying that it won't go for a deal that lacks support from the European Union.
A very helpful comparison from Kevin Drum:
Just to give you an idea of what all the numbers mean, the EU/IMF plan requires Cyprus to come up with about $7.5 billion as its share of the bailout. That's roughly a third of their GDP. To put that into local terms, it would be as if the United States were being asked to pony up $5 trillion. This is about equal to all government spending—federal, state, and local—for an entire year.
No country in the world has ready access to that kind of dough, which is why the original plan relied on taxing bank deposits. There just weren't a lot of other options.
Confused by all the talk of Cyprus? Don't be. Here's the situation in three sentences: The country's banks were using Russian deposits to buy Greek bonds. The Greek bonds went bad, and the Cypriot banks lost a bundle. They now need a bailout from their euro zone partners, but it's tough to convince German taxpayers to pony up if they think the money is really going to Russian oligarchs.
Desmond Lachman is a resident fellow at the American Enterprise Institute and, before that, a managing director and chief emerging market economic strategist at Salomon Smith Barney. He's also been, from the very beginning, one of the most clear-eyed observers of the European crisis. So earlier Wednesday afternoon, I asked him why these mini-crises keep happening. A lightly edited transcript follows.
I understand why Cyprus is rejecting the terms of the European Union's bailout. What I don't understand is why the European Union is offering these terms. Why would they choose to bail out Cyprus in a way that is almost custom-designed to undermine one of their proudest and most important achievements?
Remember that Cyprus bailout we told you about Monday? It might not happen after all.
Reports from Nicosia suggest that the bailout plan — negotiated between the Cypriot government and the so-called "troika" of the European Commission, European Central Bank (ECB), and International Monetary Fund (IMF) — doesn't have the votes to pass that country's unicameral legislature. Update: The budget failed Tuesday afternoon, garnering 0 votes in parliament.
Ezra and Neil discuss the Cyprus bailout proposal that would make bank customers foot much of the bill.
As I explained Monday morning, a substantial portion of the European Commission/European Central Bank/International Monetary Fund bailout is going to be financed by a "haircut" taken from bank deposits in Cyprus. The current policy has 5.8 billion raised from a 6.75 percent levy on bank deposits under 100,000 and a 9.9 percent levy on deposits over that amount. The former levy targets deposits that are insured by the Cypriot government; suffice it to say, you're not supposed to be able to do stuff like this with insured deposits.
This weekend, a group including the European Central Bank (ECB), the European Commission, the International Monetary Fund (IMF) and the government of Cyprus announced that the small island nation was on the brink of crisis, and needed to be bailed out.
But while most previous euro zone bailouts have been financed by rich Northern European countries like Germany and the Netherlands, the Cypriot bailout initially looked to be an entirely different story -- one that happens to involve Russian gangsters. Now that plan has failed and it's anyone's guess what form the next bailout takes. However things go, here's what you need to know.
Last fall, the euro zone settled on a fairly straightforward arrangement to quell its crisis. Member nations would cut their deficits through years of grinding austerity. In return, the European Central Bank would use its power to prevent a run on the bond markets.
Now that deal's being called into question. Yesterday, some 57 percent of Italians cast a vote against further austerity measures in the nation's parliamentary elections. A good portion of the vote went to former prime minister Silvio Berlusconi, who was promising tax cuts rather than increases, and comedian Beppe Grillo, who was advocating a boost in public spending.
This Sunday, millions of voters in Catalonia will go to the polls. And this isn't any ordinary election. Polls indicate that pro-independence parties are poised to win a big majority,which could pave the way for an eventual referendum on whether Catalonia should secede from the rest of Spain.
Catalan nationalism isn't exactly a new force. The region, which borders France, has its own language and has long seen itself as distinct from the rest of the country. But calls for independence have been growing louder during the euro zone debt crisis. Back in September, 1.5 million Catalans took to the streets for a pro-independence rally.
We've been so caught up in the U.S. elections over the past month that we've forgotten to check up on the never-ending debt crisis in Europe. But there have been a couple of worrisome developments that seem to be rattling financial markets this week. Let's see:
1) The European economy is likely grinding through yet another recession. Its GDP shrunk 0.2 percent in the second quarter of the year, and the third-quarter numbers are expected to be weak. Even mighty Germany is no longer immuneto the slowdown, as new data showed that the country's exports and industrial production have been dropping faster than anyone expected.
The Nobel Peace Prize this year went to the European Union, which prompted cackles at a time when the E.U., or at least its common currency, appears on the brink of collapse. “When did Tina Brown start handing out Nobel Peace Prizes?” cracked The Atlantic’s Matt O’Brien. “Nobel committee congratulates Germany on over 70 years without invading France,” quipped University of Denver political scientist Seth Masket.
It’s euro-doom time once again. A general strike in Greece. Protesters flooding the streets of Madrid. Talk of secession in Catalonia. Financial markets are tanking. So what happened? Wasn’t Europe supposed to have fixed itself?
The short answer is that nothing really has happened. Europe’s problems were lurking there all along. They just got papered over temporarily.
In early September, Mario Draghi and the European Central Bank announced a grand plan to come to the aid of euro-zone governments facing unworkably high borrowing costs — countries like Spain and Italy. It seemed like a reasonable enough plan, despite all the potential hitches, and the euro crisis quickly faded from the headlines. Well done.
At long last, the shiny new plan to save Europe is coming together. On Wednesday, Germany’s constitutional court gave its much-awaited okay to the European Stability Mechanism (ESM), a newly created 500 billion ($640 billion) rescue fund for indebted euro zone governments. Until now, that was the big question markan unfavorable court ruling would have brought Angela Merkel’s plan to salvage the euro crashing down.
Of all the dilemmas facing Europe’s leaders, what to do about Greece could prove the most vexing. After two rounds of bailouts, Greece is still struggling to get its deficits under control. So the rest of Europe can either give Greece more time (and money) to solve its debt woes or eject the country from the euro altogether, with all the chaos that might bring.
One of the less commented upon themes of both parties’ conventions was a fear of the U.S. economy being overtaken by China. President Obama bragged that his administration had “stood up to China on behalf of our workers” and railed against education cuts that make it harder to “compete with the scientists and engineers coming out of China.” Mitt Romney attacked Obama’s energy policies, saying his “assault on coal and gas and oil will send energy and manufacturing jobs to China,” while Sen. Rob Portman (R-Ohio) alleged that the administration wasn’t doing enough to fight Chinese currency manipulation.
As anticipated, Mario Draghi, head of the European Central Bank, has announced that he’ll buy up unlimited amounts of Spanish and Italian debt, but only if they agree to fiscal limits, and only with money he gets from selling other investments. My colleague Howard Schneider has the goods:
The bond-buying will have conditions: Countries must agree with European leaders on steps needed to keep their economies competitive, control public debt and fix whatever led them into trouble to begin with. Without such conditionality, Draghi said, the bank would not intervene on a countrys behalf.
The bonds will not be purchased directly from national governments in their primary bond auctions but will be bought from existing investors. That can still have a potentially profound effect on market psychology and interest rates, essentially assuring private bondholders that the central bank wont let a large nation such as Spain or Italy slip into the sort of spiral that forced holders of Greek bonds to accept massive losses.
Welcome to Wonkbook, Ezra Klein and Evan Soltass morning policy news primer. To subscribe by e-mail, click here. Send comments, criticism, or ideas to Wonkbook at Gmail dot com. To read more by Ezra and his team, go to Wonkblog.
RCP Obama vs. Romney:Obama +2.5%; 7-day change: Obama -1.5%.
For almost a decade after the euro was introduced in 1999, the 17-member currency union enjoyed the benefits. Those in “peripheral” countries like Spain and Portugal were able to borrow money more cheaply to buy goods and build houses. Germany was able to export more stuff to the rest of the continent. Sure, once the financial crisis hit, the awkward structure of the euro zone turned out to be utterly calamitous. But for a spell, the good times were quite good.
At a reception in Ottawa on Wednesday, German Chancellor Angela Merkel said that the euro zone should look to Canada for inspiration on how to deal with its ongoing debt crisis. According to Bloomberg, she hailed Canada’s efforts to trim its deficits and practice fiscal discipline, saying, “This is also the right solution for Europe.”
For the past week, much of Germany has gone on vacation—including Chancellor Angela Merkel—which means that the crisis in the euro zone has been put on temporary hold until Wednesday. Oh, sure, Spain is still in trouble and the continent is mired in recession and it’s not clear whether European Central Bank chief Mario Draghi’s plan to hold the euro zone together will even work. But, for the time being, the panicky headlines have gone into remission.
In 2009, after the U.S. housing bubble popped, Nevada’s economy lay in tatters. Its unemployment rate was soaring past 12 percent. And so, in response, many residents did the only thing they could do. They left. That year, the state’s population shrank for the first time in a century, as former Nevadans fled elsewhere to seek out better economic opportunities in more prosperous states.
Both Paul Murphy and Joseph Cotterill at FT Alphaville aren’t quite so convinced that Mario Draghi’s big policy statement yesterday was a complete and utter flop. True, the European Central Bank (ECB) refrained from using its considerable firepower to bring down borrowing costs for Italy and Spain, as many had hoped. That led to some early panic in the financial markets.
Last week, analysts waxed optimistic about the crisis in Europe after Mario Draghi, the continent’s powerful central banker, said he’d do “whatever it takes” to save the euro from collapse. “Believe me,” he said, “it will be enough.” And financial markets mostly believed him. There was just that nagging question of whether Germany would allow Draghi to act decisively.
Last Thursday, the head of the European Central Bank, Mario Draghi, gave a big, earth-shaking speech in which he promised to do “whatever it takes” to save the euro. Euphoria burst out across the continent. Financial markets went crazy with optimism.
But was any of it justified? According to a new report in Der Spiegel, none of Draghi’s colleagues at the European Central Bank knew he was going to say any such thing. No measures had been discussed. No resolutions agreed to. But the markets reacted as if Draghi had a detailed and decisive plan sitting right there in his back pocket:
It’s been a gruesome week for the euro zone. Spain got blasted by a fusillade of bad economic data. Rumors keep persisting that Greece might get shoved out of the currency union. And the continent’s financial markets have been deteriorating rapidly. Doesn’t anyone have some good news to share?
One person might. On Thursday, the head of the European Central Bank, Mario Draghi, stepped up to the podium and pledged to “do whatever it takes” to save the euro. And that got many market-watchers seriously excited. Because Draghi is one of the few officials who actually does have the power to stanch the bleeding in Europe.
Does Europe need another week full of panic? Not really. But that seems to be on order anyway. Spain’s borrowing costs are already rocketing to unsustainable levels as investors worry that the world’s eleventh-largest economy is mired in endless recession with no chance to ease its debt burden. And, if that wasn’t enough, there’s now renewed chatter that Greece might get kicked out of the euro zone.
Yesterday, some of the indicators in Spain were starting to flash red — a sign that perhaps Europe hadn’t cured its woes after all. Today, we’ve moved to the full-blown crisis phase. Spain’s borrowing costs are rocketing upward and its stock market is getting absolutely crushed. So what happened? How did we go from calm to euro implosion in less than two days?
Is it time to start worrying about Europe once more? On Thursday, Spain found itself struggling to borrow money from investors again. As a result, yields on the country’s 10-year bonds rose to 7 percent. Alarming headlines ensued. It’s that scary number again! So why does 7 percent always put the world on edge?
Spain’s in brutal shape, and its economic woes are hauling down the rest of Europe. Just to review: The country’s in a messy recession, unemployment is hovering at 25 percent, local banks are going bust and need a bailout, and the government faces the daunting prospect of borrowing at least $42 billion this year from skeptical lenders just to stay afloat.
The euro crisis first started roaring in late 2009, when auditors inside the newly elected Greek government discovered that the country had a much—much—bigger deficit than anyone realized. That, in turn, inflamed fears that Greece couldn’t wiggle its way out of its debt trap so long as it was tethered to the euro. It also exposed structural problems within Europe’s currency union. Worries soon spread to Ireland, Portugal, and eventually Italy and Spain. Now the entire global economy is on edge.
Most discussions of friction within the euro zone revolve around Germany. Either mighty Germany lends a hand to stragglers like Spain and Italy, the logic goes, or the euro disintegrates. Somewhat understandably, most Germans aren’t thrilled with this choice.
But it’s worth noting that Germany’s not the only wealthy country in Europe facing this trade-off. Finland is another euro member with sterling credit and low debt. The country is risking as much as 5 percent of its GDP on the euro bailout fund. And some Finnish politicians don’t sound particularly thrilled with the prospect of propping up Spain and Italy indefinitely. Here was the country’s finance minister, Jutta Urpilainen, on Friday:
All week, the financial markets have been euphoric over the proposals that came out of the E.U. summit last Friday. Spanish banks are getting a bailout! Italian bonds are getting bought up! Merkel’s starting to crack! Everybody party!
And so, right on cue, here comes Mario Draghi, president of the European Central Bank, to turn the music down and remind everyone that Europe’s biggest problem is still economic growth. In his speech today, Draghi noted that the outlook for Europe is very dreary indeed:
A somewhat esoteric debate has broken out between the Council on Foreign Relations’ Geoeconomics team and Paul Krugman over Iceland’s performance since the economic crisis. Krugman says it’s done better than the Baltic states of Lithuania, Latvia and Estonia, while the CFR team thinks it’s done worse.
As European leaders strain to hold together the euro zone and prevent it from imploding, there’s a real divide among its biggest countries. Germany has long opposed most of the more sweeping integration measures. But there’s evidence that Germany is slowly losing its clout.
The basic split goes something like this: France, Italy, and Spain all want closer fiscal integration. For the most part, this means that the euro zone as a whole would help its struggling members deal with issues they can’t tackle on their own, from unmanageable government borrowing costs to troubled banks. If Spain’s banking sector goes wobbly because of a housing bubble, the rest of Europe would pitch in — in much the same way that the entire United States helped bail out Texas banks after the savings and loan crisis in the 1980s.
They had to stay up until the bright crack of dawn, but European leaders emerged Friday from their summit in Brussels with a deal to ease the economic crises in Spain and Italy. Financial markets around the world are going crazy, thrilled that the latest euro plan was far bolder than anyone expected. Other analysts are more skeptical. So should we be optimistic or pessimistic about the fate of Europe?
Expectations for the latest euro zone summit in Brussels on Thursday range from low to very low. No one expects it to solve Europe’s problems. And perhaps that’s because everyone’s seen what happened at previous euro summits.
Joe Weisenthal brings us this grim chart from JPMorgan, which shows that the bond markets tend to get jubilant going into big euro zone summits — and then, once the meeting’s over and it’s clear that nothing’s been resolved, the markets panic again:
Another week, another European summit. On Thursday, E.U. leaders will huddle together in Brussels to try and fix the euro zone. And no one has high hopes — financial markets are all tanking Monday because, apparently, they’re already gloomy about the outcome.
Why so much pessimism? One problem is that the leaders of the euro zone’s four biggest economies — Germany’s Angela Merkel, France’s Francois Hollande, Spain’s Mariano Rajoy, and Italy’s Mario Monti — can’t agree on what steps need to be taken to get Europe growing again. This Venn diagram from a new Exane BNP Paribas report (pdf) illustrates.
Rome — It has become the new paradox of European economic policy: There is no saving the euro without saving Italy, and there is no saving Italy without saving the euro.
Which perhaps explains why Mario Monti, Italy’s new, “non-political” prime minister, hosted the leaders of France, Germany and Spain in Rome on Friday as part of his increasingly desperate effort to force a resolution to a euro crisis that is dragging Italy, Europe and possibly the global economy back into recession.
The threat of a credit downgrade to a country typically spurs panic and dire warnings about the impact to national debt markets. But it seems like the market doesn’t always heed the call when ratings agencies actually pull the trigger.
Bloomberg’s own data analysis says that in “about 47 percent of cases, countries’ borrowing costs fall when a rating action suggests they should climb, or they increase even as a change signals a decline.” In other words, whether the market responds to a credit rating change “may be little different that flipping a coin.”
Last August, the euro-zone crisis moved into its “doomsday” phase: Suddenly, it wasn’t just tiny, poor countries such as Greece and Portugal that were collapsing. Massive bedrock economies such as Spain and Italy were also in trouble.
And ever since then, a predictable dance has ensued. Every few weeks, Italy or Spain (or both) will see their bond yields spike to dangerous levels, which means they have to pay more to borrow money and get closer to needing a full bailout from the rest of Europe. In response, euro-zone officials devise some clever half-measure to placate the bond markets. That works for a brief spell, at least until the markets realize that the half-measure is just a half-measure. At that point, Spanish and Italian bond yields spike back up again, prompting the scramble for yet another temporary fix. Repeat ad infinitum.
The results of the Greek elections are in: New Democracy, the conservative “pro-bailout” party, has come in first and appears to have enough support to form a new government.
So what does this mean? In the very short term, it likely means Greece won’t be leaving the euro zone. New Democracy’s leader, Antonis Samaras, basically wants to abide by the terms of the country’s bailout agreement with the rest of Europe. Greece will continue to stick with its austerity program — spending cuts, tax hikes, paring back public-sector jobs. And in return, the “troika” (the European Central Bank, the European Commission, the IMF) will keep sending Greece billions of euros to run its day-to-day operations.
Sunday, Greek voters go to the polls to elect a new government. The outcome of the election could determine whether Greece stays in the euro or not. Which means the fate of Europe — and the global economy — just might hang in the balance. No pressure or anything! Here’s a primer:
Why is Greece’s euro membership at stake? Recall Greece’s basic dilemma: The country racked up many billions of dollars in debt that it can’t repay without help. In February, the European Central Bank, the European Commission, and the IMF (known as the “troika”) agreed to renegotiate Greece’s debts with lenders and give Greece a $170 billion bailout. In return, the Greek government had to agree to a series of spending cuts and tax hikes. These austerity measures are extremely unpopular with voters. Yet if Greece rejects the terms of the bailout, it might have no choice but to default on its debts and leave the euro.
Click over to any business or financial site today and you’ll see horrified headlines. Spanish bond yields hit 7 percent! Italy’s are rising too! Europe is doomed! So why is 7 percent such a scary number?
Let’s recall the basic situation: The Spanish government needs to borrow money to fund its day-to-day operations. To do so, it sells (among other things) 10-year bonds. In return for cash from investors, the Spanish government promises to pay a fixed rate of interest — say, 5 percent — every year for 10 years. At the end of that period, the investors get all of their original cash back. When investors are nervous that the government might not repay in full, they demand higher interest rates as a sweetener.
Sorry, optimists. Europe is still in crisis — even after the $125 billion bailout of Spain’s banks over the weekend. So when the European Union holds its next summit on June 28 and 29, they’re going to have to thrash out a more lasting solution.
But what might that entail? European officials have hinted, rather cryptically, that they’re working on a “master plan” to salvage the euro zone. They won’t, however, divulge much in the way of detail. So here’s a rundown of some of the elements that might be in such a plan:
1) A banking union: One of the euro zone’s most urgent crises is the slow-motion bank run occurring across Europe. If you have euros stashed in a Spanish or Greek bank, your deposits are technically insured by the Spanish or Greek governments. But what if those governments themselves run out of money? Or what if those countries decide to leave the euro? Suddenly, your deposits won’t be quite worth as much. So, quite reasonably, depositors in those countries are yanking their euros out of these banks and sending them to safe havens like Germany. And that’s making financial institutions in Greece and Spain even more rickety, which is hurting economic growth and deepening the crisis.
In the past, every time European leaders have huddled together and announced a plan to douse the latest fire in Europe, the financial markets have usually been placated for a brief while — say, a few weeks or months. Then another crisis flares up, and everyone starts panicking again.
Now, though, it seems we only get a few hours of post-bailout euphoria before panic sets in again. On Saturday, euro zone leaders declared they were ready to loan the Spanish government up to $125 billion to prop up the country’s troubled banks. The hope was that this would instill confidence in Spain’s banking sector, stop Spainards from yanking their deposits out, and make everybody more confident in Spain’s overall future.
So you’d like to save the euro zone from total annihilation, would you? Then it might be worth taking a stroll through this new report (pdf) from the analysts at ING, who outline six possible endgames for the euro zone.
The report starts with the premise that fiscal austerity has become, in author Mark Cliffe’s words, “too big to succeed.” At this point, most European countries only seem to be making things worse through big budget cuts and tax hikes. That’s paralyzing economic growth, which is making it harder and harder for countries to rein in their debts. “The required austerity to meet mandated budget deficit targets has become unrealistically large,” ING says.
In the 2000s, both Florida and Spain had large, unsustainable housing bubbles that eventually popped. Since then, however, Florida has largely stabilized. Spain, by contrast, is still reeling from 25 percent unemployment, and its woes are threatening to rip apart the euro. Why the difference?
Paul Krugman points out one big factor: Florida has received billions of dollars in aid from the rest of the United States. The state’s federal tax revenue fell by $25 billion between 2007 and 2010, but Florida didn’t have to make up that entire shortfall with growth-pinching austerity measures, the way Spain now does. Instead, the U.S. Treasury kept paying Florida’s Social Security, Medicare, and Medicaid bills. The federal government also sent an additional $6 billion in unemployment aid and food stamp benefits to Florida between 2007 and 2010.
The fate of the euro — and, perhaps, the global economy — could rest on the elections in Greece on June 17. No pressure or anything. And the Greeks still can’t make up their minds on which way to vote. Polls have been lurching wildly back and forth.
Let’s recall the background. Greece owes a whole bunch of money it can’t repay. In February, the country received a $140 billion bailout from the IMF, the European Central Bank, and the European Commission. In exchange, Greece is supposed to make a bunch of sharp spending cuts. Greek voters don’t like this, given that their country’s economy is already in tatters. But if they don’t accept further austerity, they might not get the bailout. And that could mean a Greek exit from the euro. Possible doom to ensue.
Spain is back in the headlines, threatening to drag down the global economy. The panic started last week, after the country’s fourth-largest bank, Bankia, announced that it needed $23.5 billion in aid. But how did Spain get to this point? Here’s our explainer on the crisis:
Let me guess, Spain is in trouble because its government spent way too much and ran up big deficits, right?
Not exactly. Before the financial crisis hit, Spain was actually running smaller deficits than even Germany. Its public debt was just 27 percent of GDP. Spain was considered a model of fiscal responsibility.
Then how did Spain get into its current mess?
It all started with a housing bubble. During the 2000s, thanks to low interest rates and an influx of foreign capital, Spain had a furious boom in housing construction — houses that, it turned out, the country didn’t really need. Below is a graph of the price-to-rent index in Spain, which gives a sense of the sheer size of the bubble. In 2007, the bubble finally burst. And Spain still isn’t anywhere close to recovering. Economists Cinzia Alcidi and Daniel Gros have estimated that housing prices have fallen 26 percent, but that’s still only about half of the total decline that will ultimately need to happen:
These days, the news about Europe tends to be unrelentingly negative, so here’s something slightly different. The European Union is still on track to meet its climate-change goals under the Kyoto Protocol, according to new data released Wednesday.
Under the Kyoto treaty, 15 European Union countries committed to reducing their overall greenhouse gases 8 percent below 1990 levels by 2012. (The other countries have individual targets, save for Malta and Cyprus.) Even though the continent’s emissions grew in 2010, thanks to a brief economic recovery and a cold winter, the E.U.-15’s emissions are still 11 percent below 1990 levels overall.
There's plenty of data in these charts from the European Environment Agency. Between 1990 and 2012, some countries, like Germany and Denmark, have reduced their carbon emissions by quite a bit, which has offset rises in countries like Spain and Portugal.
Poor Greece. Everyone thinks that Germany is the most industrious of all countries and Greece is the laziest. Everyone, that is, except the Greeks, who think of themselves as the busiest of all bumblebees. So who’s actually correct here?
Lately, there’s been lots of debate in Europe over whether the broken euro zone needs some sort of “eurobond” to alleviate the continent’s debt woes. French president Francois Hollande has made this one of his top priorities. Yet the most recent E.U. summit ended without much progress on the topic. So what are eurobonds? And would they actually work?
The Guardian has a handy primer on the concept. The basic idea is that, right now, lenders and investors are nervous that a bunch of individual countries on the euro — from Spain to Portugal to Greece — might not repay their debts. So the cost of borrowing money for those countries has been spiking at various points. (Spain is the latest casualty.) That, in turn, makes their debt crises even worse, which raises the risk of a horrible death spiral, and so on.
The logic behind eurobonds is that, rather than individual countries trying to borrow money on their own, the entire continent would borrow money together, as a unit. Spain and Greece would, in effect, pay the same interest rates on their debts as France and Germany do. Since the euro zone as a whole is large and rich, that would calm the panic over individual countries. And troubled nations would get a bailout. If Portugal only had to pay the average interest rate of euro members, its annual debt payments would fall by €15 billion, or 9 percent of its GDP.
Why did Europe go from bad to total horrific panic in the last year? There are all sorts of theories: weak growth, the impact of austerity, missteps by central bank bureaucrats. But here’s another scapegoat offered up by the International Energy Agency: Europe’s soaring oil bill.
The IEA laid out some eye-catching numbers on Thursday: Between 2000 and 2010, Europe spent an average of $182 billion per year on oil. Then, in 2011, due in part to a civil war in Libya, Europe spent a record $488 billion on crude. In 2012, thanks to tight global supplies in the first half of the year and tensions with Iran, the continent is expected to spend well over $500 billion. To put that in context, the total debt of Greece, which has everyone sweating, is about $370 billion.
We’ve noted before that most countries in Europe are engaged in “austerity” — defined as some mix of spending cuts and tax increases. But what’s the actual mix?
Here’s one helpful graph from the OECD’s latest Economic Outlook. It shows the projected change in the “primary balance” of the world’s wealthiest countries between 2011 and 2013. (This is the deficit picture after excluding net interest payments on the debt.*)
Some countries, like Italy, are trying to consolidate their budgets primarily through revenue increases. Others, like Spain and Greece, seem to be relying far more heavily on spending cuts:
Recall the reasons for the current euro panic: Greece is getting bailed out and, in return, it’s supposed to cut spending and raise taxes even further. But Greek voters don’t enjoy this austerity and are rebelling against politicians who agree to the deal. So Germany’s now hinting that Greece might get booted from the euro. Disaster, right?
Well, perhaps not. Lately there have been signs that this situation won’t end in total apocalypse, after all. Kate McKenzie points to a new poll suggesting that Greek voters are slowly turning away from Syriza, the leading leftist party that’s threatening to rip up the bailout agreement (and hence risk a Greek exit from the euro). The Greek elections are on June 17. If voters turn away from Syriza and end up reelecting the two parties that support the bailout-for-austerity agreement, then Greece has a somewhat better chance of staying in the euro.
There’s been lots of discussion lately on whether Greece should exit the euro. Sure, advocates say, in the short term the country might face even more austerity and a crushing recession. But in the long run, Greece would be free to grow. Here’s Arvind Subramanian making that case:
Just look at what happened to the countries that defaulted and devalued during the financial crises of the 1990s. They all initially suffered severe contractions. But the recessions lasted only one or two years. Then came the rebound. South Korea posted nine years of growth averaging nearly 6 percent. Indonesia, which experienced a wave of defaults that toppled nearly every bank in the entire system, registered growth above 5 percent for a similar period; Argentina close to 8 percent; and Russia above 7 percent. The historical record shows clearly that there is life after financial crises.
Let’s say you were an ordinary person living in Greece and had a stash of euros deposited in your local bank. You’ve been watching all the political chaos unfold on TV and listening to chatter about how Greece might have to exit the euro altogether. What would you do?
Why, you’d take your euros out of your local Greek bank and put them someplace safe — say, in a German bank. No sense risking the prospect that the Greek government could leave the euro zone and replace all your hard-earned money with some less-valuable drachmas.
And that’s exactly what a lot of Greeks have been doing these past two years, withdrawing about €2 to €3 billion worth of euros from the country each month. Lately, though, these withdrawals have been accelerating. A lot. On Monday, Greek depositors took out some €700 million in a single day, sending their euros elsewhere for safekeeping. It’s a smart move by those individuals. The problem, though, is that if everyone in Greece does this, it could inadvertently get Greece kicked out of the euro.
Ever since the Greeks went to the polls on May 6, the country has been gripped by political paralysis. The Greek parliament can’t form a new government, and Greece now faces the risk of being booted from the euro zone — with potentially horrific consequences. Here’s a look at how Greece reached this point and whether there’s any way out of this mess.
What, exactly, are Greek politicians bickering about these days?
Recall Greece’s basic problem: The country racked up many billions of dollars in debt that it can’t repay without help, and the Greek government doesn’t have enough cash to cover all of its own obligations. In February, the European Central Bank, the European Commission, and the IMF (known as the “troika”) agreed to renegotiate Greece’s debts with lenders and give Greece a €130 billion ($170 billion) bailout. In return, Greece agreed to shrink its deficits with a series of spending cuts and tax hikes.
Here’s the dilemma: These austerity measures are spectacularly unpopular, and Greek voters keep punishing any party that tries to implement them. That puts the whole bailout deal at risk. Under the terms of the deal, the Greek government is supposed to pass an additional €11 billion in spending cuts this summer before it receives its next bailout payment of €31 billion. If those cuts don’t happen, Greece won’t get its bailout money. It will then default on its debts, and the country would likely have to leave the euro. That could be bad.
The latest salvo in the debate over austerity in Europe is to… imply there hasn’t been much austerity at all. At National Review, Veronique de Rugy posts a chart suggesting that if you don’t adjust for inflation and don’t count tax increases, there’s only been a bit of budget-cutting.
But this seems to misunderstand what austerity is. It’s not all about spending cuts. So let’s back up for a second. The standard Keynesian prescription for countries that are stuck in a deep economic slump — and this seems to describe much of Europe — is to actively increase deficits through more spending or tax cuts. Instead, most countries in the euro zone have done the opposite. They’ve been cutting spending and hiking taxes while the economy’s still weak. This is austerity. The typical criticism is that pursuing austerity during a downturn hurts economic growth — and, as such, makes it even harder to get debt burdens under control.
Roughly speaking, here’s the euro zone’s current approach to its debt crisis: Individual countries are pursuing austerity measures to shrink their budget deficits. There’s a bailout fund for countries in truly terrible shape, such as Greece and Portgual. And the European Central Bank is propping up the continent’s rickety banks. Basically, muddle through and hope for the best.
But muddling through doesn’t seem to be working. Voters are now revolting against austerity, especially as the euro zone slides into yet another recession. Countries like Spain are finding that austerity is hurting growth and making deficits harder, not easier, to control. The bailout fund isn’t big enough to prop up countries like Italy and Spain if they run into serious trouble borrowing money. And many poorer euro zone countries are finding it difficult to grow and reduce their trade imbalances so long as they’re yoked to a single currency and a central bank that can’t cater to everyone’s needs.
So many observers are wondering whether Europe will shift course now that France’s newly elected president, Francois Hollande, has called for a change. But what else could Europe do? Here’s a list of six policies that various experts have suggested that the euro zone might consider instead:
Europeans are rebelling against austerity. That’s the read on Sunday’s elections in Greece and France. But why do voters loathe austerity? Perhaps because, as economists have found, efforts to rein in budget deficits can take a wrenching toll on living standards, especially in a recession.
In a recent paper for the International Monetary Fund, Laurence Ball, Daniel Leigh and Prakash Loungani looked at 173 episodes of fiscal austerity over the past 30 years. These were countries that, for one reason or another, cut spending and/or raised taxes to shrink their budget deficits. And the results were typically painful: Austerity, the IMF paper found, “lowers incomes in the short term, with wage-earners taking more of a hit than others; it also raises unemployment, particularly long-term unemployment.”
The original idea for the European Monetary Union was a bit odd. Here you had a bunch of very different countries — from Germany to Greece to Ireland — yoked together under a single currency, the euro. It sounded more like a reality show than an economic policy. And it hasn’t turned out well.
Via FT Alphaville, this amusing research note from J.P. Morgan’s Michael Cembalest illustrates just how bizarre the euro zone concept was in the first place. Cembalest looked at several proposed monetary unions across history and measured how “different” the countries within them were. As it turns out, the euro zone is the most implausible currency union of them all. It would be slightly more realistic, in fact, to bind together all the countries in the world that began with the letter “M”:
It’s no secret that France is further to the left than the United States. But listening to some of the rhetoric from the French presidential election can underscore how vast the gulf really is. Here are five things that it’s hard to imagine a major-party American candidate saying:
1) Unadulterated bashing of the financial industry. Here was Francois Hollande, the Socialist presidential front-runner in France, back in January: “Let me tell you who my rival is. It does not bear a name or have a face, it’s the finance industry. In the past twenty years, the financial industry has taken control of our societies, of our lives and threatens our states.” In London the following month, this was Hollande’s way of dialing back his speech in a talk with investors: “I am not dangerous… [still], there must be regulation everywhere.”
In normal years, a presidential election in France wouldn’t garner much interest here in the United States. But this isn’t a normal year. The euro zone is lurching from crisis to crisis, and France, the continent’s second-largest economy, will need to play a crucial role in fixing things.
The current front-runner in the French race, Francois Hollande of the Socialist party, has vowed to renegotiate the treaties that bind the euro zone together, arguing that the current focus on austerity is counterproductive. His main opponent, incumbent president Nicolas Sarkozy, argues that Hollande is threatening to undermine the entire euro zone project. The first round of the French election is Sunday, April 22, and the top two candidates will compete in a run-off on May 6. Some observers fear that if Hollande wins, investors in Europe will get spooked, which could, in turn, ripple out to our economy, and even to our election.
To get a better sense of the stakes involved, I called up Arthur Goldhammer, who is currently at Harvard’s Center for European Studies, and who has been following the twists and turns of the election closely over at his excellent French Politics blog.
Spain is threatening to throw the global economy into turmoil yet again. Earlier Monday, the country’s borrowing costs spiked: Spanish bond yields are back up above 6 percent, perilously close to the level at which Greece, Portugal and Ireland all needed financial bailouts.
Spain’s problems, many analysts say, aren’t primarily about deficits. As economist Paul Krugman points out, Spain was actually handling its budget and debt burden more responsibly than even Germany before the 2007 financial crisis hit. But the euro zone is forcing Spain to act as if its chief problem is deficits, pushing the country into a counterproductive cycle of austerity that’s hurting Spain’s economy and ensuring, as Wolfgang Munchau writes in the Financial Times, that “Spain will miss the target, or the Spanish government will have to fire so many nurses and teachers that the result will be a political insurrection.”
Just when we thought the euro crisis had subsided for a bit, Spain is bursting back up as a trouble spot. On Wednesday, Prime Minister Mariano Rajoy said the country is “facing an economic situation of extreme difficulty.” Spain is struggling to borrow money and can’t hit its deficit targets.
Why is Spain in so much trouble? The country is still mired in what the Financial Times’ Gavyn Davies calls “the austerity trap.” Last year, the country was supposed to whittle its budget deficit down from 9.3 percent of GDP to around 6 percent. Spain whiffed on that goal by a lot — its final deficit ended up being about 8.5 percent of GDP. In part that’s because economic growth was so poor, and in part it’s because regional governments were hesitant to cut spending sharply enough to hit the targets. (Madrid has only limited control over the provinces in this regard.)
The European Union is the world’s largest source of foreign aid. So when the E.U.’s hurting, a bunch of poorer countries start hurting, too.
A new report from the OECD finds that the euro debt crisis took its toll. Among wealthy countries, foreign assistance dropped 2.7 percent in 2011.
Not surprisingly, euro zone countries that have been hit hardest by the euro’s problems have become far more reluctant to donate abroad. Spain’s “official development assistance” dropped 32.7 percent last year. Greece’s plunged 39.3 percent. Belgium’s fell 13.3 percent. Among countries plagued by debt woes, only Italy managed to become more generous to the rest of the world, boosting aid by 33 percent, thanks to a rise in debt-forgiveness grants and “an upsurge in refugee arrivals from North Africa” after the civil war in Libya. (Although see here for a longer look at how Libya’s refugees in Italy have fared — it’s not always an uplifting story).
Over the past year, Germany has been pressuring its fellow euro-zone nations to axe their budget deficits — even if that’s not the sort of thing that, say, the IMF would recommend doing during an economic downturn. But how well is Germany following its own austerity program?
Not very well, reports Der Spiegel. Germany has enacted fewer than half of the spending cuts proposed by Angela Merkel’s coalition government: “Calculations made by the influential Cologne Institute for Economic Research indicate that only €4.7 billion ($6.16 billion) of the €11.2 billion in austerity measures stipulated by the savings package actually took shape in 2011. The government is also falling behind on its targets for this year. Of the originally planned €19.1 billion in savings, less than half has been implemented.”
News sites everywhere are blaring scary headlines like: “Greece Deal Triggers $3 Billion in Default Swaps” Markets even lurched for a bit on the news. So what exactly is going on in Greece?
Planet Money’s Jacob Goldstein has a nice, simplified explanation. Over the past few weeks, Greece has been working to restructure its debt — the people holding Greek bonds will get repaid far less than they were originally owed. And there was a lingering question about whether the people who’d bought insurance on these bonds (in the event of a Greek default) would get their insurance money. Today, the committee that decides these things pronounced that, yes, they will.
There’s about $3 billion at stake here, and Goldstein says “it seems unlikely that the payouts will cause much trouble in the financial system.” More detail from Felix Salmon here.
Pressured by Germany and other northern European states to rein its budget, Greece experienced a sharp fiscal contraction last year that proved brutal to the country’s economy without ultimately helping its long-term deficit problem. Moody’s economist Tu Packard surveyed the damage in a new research note:
Once upon a time, the big worry was that the euro zone would implode and spark a global financial panic. But Jacob Funk Kirkegaard lists several reasons why that’s no longer likely to happen — at least not until after this year’s U.S. elections:
[T]he looming risk of a “European Lehman moment,” in which a large European bank would suddenly collapse and cause widespread systemic turmoil — and possibly have required a federal bailout of another US bank — has been dispelled for the foreseeable future. No large European bank is going to go bust... as long as it enjoys the benefits of the ECB’s long-term liquidity injections. This fact takes us well beyond November 2012. As a result, neither the Fed nor the Treasury needs to worry about an intervention that would be exceedingly unpopular.
There’s still plenty that could go wrong in Europe. Greece, say, could refuse to follow the IMF’s austerity plan and leave the euro. But even that wouldn’t happen until November or later.
Over at the Oil Drum, Gail Tverberg argues that Europe is getting hammered by soaring oil prices harder than just about anywhere else. Not good news for a continent already mired in recession. And the graph below is especially striking — the euro zone countries with the worst trade imbalances (and, not coincidentally, the worst debt crises) are also particularly dependent on foreign oil and gas:
Indeed, some experts have suggested that rising oil prices could have been an underappreciated contributor to the euro zone mess in the first place. In a paper for Nature, James Murray and David King detailed how steadily rising crude prices worsened Italy’s trade imbalances in the run-up to the country’s debt crisis: “Despite a decrease in imports of 388,000 barrels per day compared with 1999, Italy now spends about $55 billion a year on imported oil, up from $12 billion in 1999. That difference is close to the current annual trade deficit.”
Late Monday night, the euro zone agreed to a $170 billion bailout package for Greece in exchange for certain budgetary oversight measures and economic reforms. We asked a group of experts and economists to weigh in on the deal — and whether it’s enough to hold Greece — and Europe — together. Here are their reactions:
Kevin Featherstone, professor of contemporary Greek studies at the London School of Economics:
“Will the deal work? With this deal, Greece has only overcome the first of several hurdles. It remains to be seen whether the package will continue to be challenged by strikes and protests. Even then, there must be questions as to whether the necessary structural reforms can be implemented in a full and effective manner by an underperforming administrative system.
“At the same time, it is very important to question the content and schedule of the package being imposed on Greece by the Troika [the International Monetary Fund, European Commission and European Central Bank]. It stresses clumsy across the board cuts calibrated by fiscal constraints, rather than a coherent set of choices that might lead Greece towards a better model. In this sense, the package is too closely set to appease the insularity of foreign voters, rather than to achieve the shared interest of returning Greece to growth and putting the euro-zone on a more solid basis. In time, this bias will need to be adjusted.”
How badly is Greece hurting from its debt woes and onslaught of austerity? One World Bank official tells the paper Ekathimerini that the country is on pace to suffer the worst economic contraction in the postwar era. “On the current path — which is not sustainable in my view — we may very well see Greek GDP go down 25 to 30 percent, which would be historically unprecedented,” said Uri Dadush, a former World Bank official.
Zero Hedge says it is:
And it does look terrifying. Spain’s youth unemployment rate is 51.4 percent! Greece’s is nearly there. Isn’t that the sort of that leads to war and destruction? Perhaps, though there’s a key caveat missing here: Spain’s youth unemployment rate is only calculated among those youths actually looking for work. As the European Commission explains, the vast majority of kids that age are still in school. That means only about 17.8 percent of all Spanish youths aged 16-24 are jobless and not in school. (In Greece, it’s 10 percent of all youths; across the euro area as a whole, it’s 8.7 percent.) Those are still terrible numbers, albeit somewhat less apocalyptic.
It’s been awhile since we looked at the mess in Europe, but this is a big week. European leaders are meeting in Brussels to adopt a new deficit treaty. And depending on whom you ask, talks over Greek debt restructuring are either progressing nicely — or threatening the continent. Here’s a rundown:
What will the new EU treaty do? The details are still getting thrashed out, but at a basic level, the new treaty will force euro zone governments to keep their overall debt burdens below 60 percent of gross domestic product and their yearly deficits under 3 percent. (Ideally, they’re supposed to keep their annual “structural deficits”—what’s left over when you discount the effects of recessions and booms—at 0.5 percent.) If countries break these rules, they’ll get hit with big sanctions. You can see a draft of the treaty here .
The World Bank is waxing increasingly pessimistic about 2012, predicting that the world’s economy will now grow more slowly than it did last year. But the real worry is what happens if a full-blown crisis erupts in Europe. Ryan Avent parses the consequences:
The authors of the [World Bank] report game out two potential downside scenarios to the baseline forecast. One, a "small contained crisis", projects the impact of a serious credit squeeze on one or two small euro-area economies, resulting in a decline in their output similar to that already experienced in Greece. In that case, the world economy would grow by 1.7 percentage points less than forecast, for a net expansion of just 0.8%. In the other case, the credit squeeze impacts two larger euro economies (like, oh, Spain and Italy). In that event, the World Bank says, the euro-zone economy is likely to contract by nearly 6% in 2012, and the world economy will fall back into recession.
This has been expected all day, but it’s finally hit. Standard & Poor’s is downgrading the credit rating of France, Austria, Italy, and Spain by one notch. (Germany escaped unscathed.) Here’s the full statement.
Potentially the most significant move here is the downgrade of France and Austria from AAA to AA+. That means only four of the six member states propping up the €440 billion European Financial Stability Facility (EFSF), which is supposed to help shield Europe’s core members from contagion, are now rated AAA. Already, the bailout fund is running perilously low on resources, having committed most of its money to Greece, Ireland, and Portugal, and the fund is considered much too small to protect Italy and Spain from further market turmoil. To make things even more complicated, S&P is warning that it could soon downgrade the EFSF as well.
The crisis in Europe hasn’t been terrible for everyone. Reuters reports that, according to one anti-crime group, the Mafia is now Italy’s largest “bank,” lending out some $179 billion each year, more than any other financial institution in the country:
Old style gangsters handing out cash in bars and pool halls had been replaced by apparently respectable bankers, lawyers or notaries, the report said. “This is extortion with a clean face,” it added. “Through their professions, they know the mechanisms of the legal credit market and they often know the financial position of their victims perfectly.”
Italy recently set up a special commission, headed by statistics bureau chief Enrico Giovannini, to see if the country’s lawmakers and government workers were overpaid by European standards. The commission’s initial report is now out, and, while exact comparisons are difficult, it does seem like Italian politicians make a whole lot more than their counterparts elsewhere — as much as 60 percent more than the European average. They don’t, however, make much more than U.S. politicians.
For instance, the reports says that a lawmaker in Italy’s lower Chamber of Deputies gets a monthly base salary of about $14,735 (€11,283), compared with $11,105 (€8,503) a month in the Netherlands and a mere $3,675 (€2,814) a month in Spain.
Just for thrills, I put together a bar chart below comparing annual base salaries for parliamentarians in the lower houses of different European countries — adding in members of the U.S. House of Representatives (who make $174,000 a year).
“Without intervention … Europe’s climate policy is over. It will put Europe back in the dark ages.” That’s energy analyst Sanjeev Kumar commenting on one of the lesser-discussed victims of the euro crisis — namely, that Europe’s cap-and-trade system for heat-trapping greenhouse gases is on the verge of collapse, thanks to flawed design, low permit prices and a brutal recession.
Yesterday, Italian 10-year bond yields quivered above 7 percent yet again. Many analysts have deemed this level intolerable: basically, the amount that Italy has to pay to borrow money has risen so high that the cost of servicing the country’s debt threatens to increase far more quickly than its GDP. That, in turn, means Italy’s debt load would eventually spiral out of control. Bad news.
So how can we tell when countries hit this point of no return on their debt? A new report from Moody’s Analytics tries to measure the concept of “fiscal space” — how much room a country has before its debt becomes unsustainable. The nickel version is that the United States seems to be in no immediate fiscal danger. But a couple of crucial countries in Europe are inching perilously close to the red zone (the zone where Greece, Italy, Portugal, and Ireland are all currently residing). Which, as Ryan Avent points out, means we could very well be heading for yet another flare-up of the euro crisis as soon as European countries resume auctioning off debt early next year.
As part of Friday’s plan to save the euro, member states now have to wrestle their “structural deficits” (what their deficits would be without a boom or recession) to 0.5 percent of GDP. What’s more, the nations need to start hacking down their public debt drastically — each year, reducing debts by one-twentieth of the difference between their current debt-to-GDP ratio and the target of 60 percent. That all sounds complicated, but the bottom line, for many analysts, is that this is going to prove extremely difficult to pull off.
We keeping hearing that a breakup of the euro zone is “unthinkable.” But a number of analysts have decided the situation in Europe looks scary enough that they should at least start pondering it. Already we’ve seen UBS Investment Research depict a doomsday scenario for a euro crack-up. And now the financial analysts at ING have written their own assessment (PDF) offering up all sorts of graphs on how a Greece exit or a total euro breakup would hurt different countries in Europe:
Perhaps it’s worth noting that just as Americans aren’t happy with German policymakers right now, Germans aren’t too impressed by America’s policymakers. This was a common theme in my conversations with German policymakers: The financial crisis was largely America’s fault. The debt-ceiling debacle convinced the world our political system has gone nuts. Our long-term deficits are appalling. We’re too focused on stimulus. The Federal Reserve is pumping so much liquidity into the market that we’re almost assured future bubbles or higher inflation. We’re obsessed with short-term problems and have lost sight of our long-term challenges.
Germans think, in other words, that we’re too much like us, and not enough like them. Which is sort of true. But at the same time, the Germans are too much like Germans and too little like, well, us.
Here’s how onlookers thought this week’s European summit might play out: The euro zone nations would tentatively agree to a new fiscal measures to rein in their debts. And then the European Central Bank would step in with its gigantic firehose and put out the market conflagrations that are threatening countries like Spain and Italy. ECB President Mario Draghi hinted as much last week when he said that “other elements might follow” the new government reforms. As Martin Wolf notes, the markets seemed to interpret that as a sign that the central bank would intervene to cap borrowing costs for troubled euro nations.
But in his press conference today, Draghi appeared to dash those hopes. Draghi told reporters that “the ECB’s governing council has never discussed setting limits for bond yields or bond spreads for euro-zone debt.” In other words: the central bank action that was supposed to make the euro zone deal work hasn’t even been under discussion. Not surprisingly, the euro, which had risen on the news that the ECB was cutting rates to bolster growth in Europe, immediately plunged. Italian and Spanish bond yields are spiking uncomfortably once again.
One noteworthy tidbit here is that Greece’s government spending, as a percentage of GDP, isn’t all that much higher than Germany’s (48.05 percent versus 45.79 percent). On the other hand, Greece’s tax revenues are grossly inadequate, which helps explain why the country is now insolvent. Meanwhile, Finland is one of the highest-spending European countries of all (53.89 percent of GDP) but has found a way to live within its means and keep its debt burden manageable.
Back in August, Standard & Poor’s downgraded the United States’ credit rating after the debt-ceiling fight and. . .nothing happened. Investors kept rushing to buy up U.S. debt anyway, in part because disruptions in the rest of the world made those periodic spats in Congress look sane and sound by comparison. Now S&P is intervening in Europe, announcing that 15 euro-area nations (save for the already-on-notice Greece and Cyprus) are all being reviewed for a possible downgrade, depending on what sort of deal to save the euro zone emerges this week. Might S&P make more of a difference here?
The markets looked awfully giddy today. Stocks were up in Europe. Italy’s once-terrifyingly-high borrowing costs were tumbling. So should we interpret today’s rally as a sign that Europe’s leaders might just get this euro crisis under control? Perhaps, although there are still plenty of reasons to think that Europe’s nowhere near a lasting solution to its woes.
First, a recap of what happened today: As the Financial Times describes, France and Germany reached a tentative agreement to impose mandatory limits on the budget deficits of European Union countries, a process that would require more centralized oversight. A “golden rule” would limit deficits of euro nations to no higher than 3 percent. Of course, the E.U. already had a rule like that, and countries violated it all the time. This time around, though, truant nations would face automatic sanctions — unless a qualified majority of governments voted to overturn the fine. This treaty change still has to be agreed by, at the very least, all 17 euro-zone members.
Why are European nations faced with such high debt loads? The story tends to vary quite a bit for each country. Alex Harrowell over at Fistful of Euros points to a recent chart from the International Monetary Fund breaking down the sources of the increase in public debt for Germany, Italy, France, and the United Kingdom since the global slowdown began in 2007:
Notice that Germany spent, by far, the most in bailing out the banks — that’s the big yellow square — and also carried out the largest stimulus program (the red square) of any of the countries listed, reaching 5 percent of GDP. Note, too, that Germany’s public debt has ballooned far more since 2007 than Italy’s or France’s. Yet Germany has also had the strongest recovery from the recession, which is why its revenues, shown in blue, have increased over time. Growth matters, a lot.
American commentary on the euro zone crisis often insinuates that German leaders are being wildly unreasonable in holding up many of the proposed solutions favored by economists. Why won’t Angela Merkel just let the European Central Bank backstop Spanish and Italian debt? And what’s wrong with eurobonds? Sure, they could entail a German-financed bailout of irresponsible neighbors, but a bailout would still be cheaper than the consequences of having Greece — or even Germany — leave the euro. So why are they being so stubborn?
Tyler Cowen has a thoughtful post at Marginal Revolution trying to see things from the German perspective. Among other points, he notes that Germany has some experience in standing firm in the face of expert carping after the fall of the Berlin Wall. “We” — meaning the Germans — “did a deal with East Germany, and the terms of that deal violated a lot of precepts of economic theory,” Cowen writes. “It even included an overvalued currency for the poorer region and a long period of adjustment. Yet we insisted up front that all dealings be done on the terms of the more successful region and culture, with very little compromise. This transition, for all of its short-term flaws, will go down in the history books as a great long-run success.”
Fair enough. But it’s worth thinking through whether German reunification is really such a good model for European integration.
The European debt crisis can easily feel like an unwieldy, unmanageable mess of complex jargon and financial terms. Here’s Wonkblog’s explanation of what’s happening across the Atlantic Ocean with the help of eight key graphs:
The place to start with the European debt crisis is, well, with European debt. Put simply, the crisis in the euro zone is that the market doesn’t trust that Greece, Italy, Spain, Ireland and Portugal can pay back their debts, and so they don’t want to lend them more money except at exorbitant rates.
But to understand how Europe got into this mess, how countries like Greece managed to borrow so much money that they couldn’t pay it all back, you need to see this graph from the Organization for Economic Development and Cooperation (OECD). On the right side, you’re seeing the story everyone already knows: The market is charging Southern European countries a lot to borrow. But look at the left side. As recently as 2008, the market was lending to Greece and Germany at pretty much the exact same price. The assumption was that the euro could never break up, and thus everyone in it was as safe a bet as the safest, biggest economy on the euro: Germany.
The latest twist in the euro zone crisis is that Europe’s leaders are now asking the International Monetary Fund to step in and help supplement their bailout efforts for countries in debt crisis. So how would this work? Would it work? Here’s a quick way to think about it.
Recall what’s at the root of the current market panic. Italy and Spain need to refinance roughly €1 trillion in debt over the next three years (and that’s before any additional borrowing they might do). Investors are nervous about lending money to either country and are demanding unsustainably high rates. That, in turn, makes it ever less likely that Italy and Spain can repay their debts. Voila, crisis! So it would help to have some sort of “lender of last resort” to help out countries like Italy and Spain that are having trouble raising money on the world market.
As my colleague Neil Irwin reports this morning, major central banks announced a new strategy this morning to halt Europe’s financial woes from undermining the global economy. Here are five things to know about what happened this morning:
1. The big ticket item: swaps to increase liquidity. One key challenge facing banks right now, particularly those in Europe, is liquidity: Making sure they have enough credit to meet their lending obligations. That’s exactly the issue that the Federal Reserve, along with five other central banks, is tackling today. They’re lowering the costs of moving money from the Federal Reserve to other central banks through what are called “liquidity swap lines.” “In effect,” Irwin explains, “the Fed is handing over money to other global central banks—now at a lower rate than in the past—and those central banks, in turn, lend the dollars to banks in their countries that are facing difficulties funding themselves.”
In early-September, UBS published an analysis (pdf) of what would happen if any countries decided to actually try and leave the Eurozone. Their basic argument is that however bad you think that would be for Europe, it’s likely to actually be much, much worse, with consequences that are both further reaching and more chaotic than a cursory assessment of the situation would suggest. It is, unfortunately, a very convincing paper. Here are the parts I found particularly interesting.
-- “The economic cost is, in many ways, the least of the concerns investors should have about a break-up. Fragmentation of the Euro would incur political costs. Europe’s ‘soft power’ influence internationally would cease (as the concept of ‘Europe’ as an integrated polity becomes meaningless).”
-- “The Euro should not exist. More specifically, the Euro as it is currently constituted with its current structure and current membership – should not exist. This Euro creates more economic costs than benefits for at least some of its members – a fact that has become painfully obvious to some of its participants in recent years.”
Right now, the European countries facing debt crises are all being told the same thing: Austerity is the answer! Cut spending, raise taxes, pay off your debts. Now. The pitfall, of course, is that austerity measures could trample the already-fragile growth in places like Italy and Spain, which will, in turn, just exacerbate their short-term debt problems. As an example, the OECD is predicting that Britain’s austerity experiment could push the country into recession, which might, in turn, lead to a higher debt-to-GDP ratio than before the Cameron government began slashing.
So here’s a question: Why don’t countries like Spain or Italy or France try to do what the Obama administration has proposed in the United States? Enact some stimulus this year, while the economy’s weak, and then cut future spending. Avert a recession now, austerity later. This is what the IMF has recommended, after all. Why wouldn’t that placate the bond markets? One problem, says Joe Gagnon of the Peterson Institute for International Economics, is that the structure of European political institutions make these sort of timed cuts a lot more difficult.
Yesterday, the OECD announced that it expects the euro zone to grow just 0.2 percent next year, while the United States would grow a slightly more healthy 2 percent. Tim Duy thinks this is way too optimistic on both fronts. Already, there are signs that manufacturing in Europe is imploding — new industrial orders plunged 6.4 percent in September — and it’s unlikely that the U.S. can escape the downward drag. Duy posts a chart showing just how closely tied together the fates of the U.S. and European economies have been.
Notice that ominous blue drop at the end for European orders. Doesn’t bode well for the United States. Meanwhile, an earlier analysis from Citigroup had found that U.S. and Europe GDP growth have become increasingly correlated.
Imagine that Greece, Portugal, Ireland and Spain left the euro tomorrow. Somehow they did it so cleanly, so smoothly, that there wasn’t a financial run. Would that be good for Germany? No, it would be very bad for Germany.
Putting the desire Germany has, and the effort it’s put into creating and leading the euro zone, if the weaker economies leave the euro, then, as Gavyn Davies says, the value of the euro will rise. And that would mean Germany’s exports become less competitive, dealing a blow to its economy. And in the real world, Greece and Portugal and Ireland and Spain would be dealing with huge financial crises, and the United States would likely be back in recession, and the crisis would be battering China’s economy. So at the same time as Germany’s exports are becoming more expensive, global demand for exports would be falling. Bad, bad, bad for Germany.
The warnings on Europe sound extra-apocalyptic this week. “The eurozone really only has days to avoid collapse,” blares the headline on Wolfgang Münchau’s column. And, while European leaders are frantically thrashing out plans for further fiscal union to save the euro, German Chancellor Angela Merkel is still resisting sweeping reform measures. As my colleagues Michael Birnbaum and Anthony Faiola report, “investors and world leaders alike hang on Merkel’s every word, searching for a hint that her resistance is simply a bluff to scare countries into behaving more like hers.”
And maybe Merkel is just bluffing. But plenty of observers seem freaked out enough to start asking the question no one wants to ask: What would a breakup of the euro zone actually look like? The FT’s Gavyn Davies runs through some likely scenarios. Maybe a few periphery countries like Greece and Ireland decide to exit the euro zone, default on their debts, and revert back to their old, devalued currencies in order to start afresh. Or, alternatively, maybe financially stable countries like Germany and the Netherlands decide to leave the euro, bid their troubled neighbors adieu, and form their own, smaller currency zone.
These sorts of scenarios are no longer unthinkable. But a recent report suggests that either move would be far more painful than most people seem to realize. Indeed, a crack-up could prove far more costly to Germany than a bailout of its neighbors.
At first glance, it might seem odd that Italy’s debt woes are threatening to torpedo all of Europe. The country’s current finances, after all, are fairly sound: in 2011, Italy will take in more in taxes than it spends, building up a primary surplus of about 0.8 percent of GDP. The problem, alas, is that Italy is paying for the profligate ways of governments long since booted out of office. When you include interest payments for the debt that Italy accumulated over the years — reaching some 4.8 percent of GDP per year, the second-highest in Europe after Greece — then the country is in real trouble.
That means Italy needs either to grow its way out of debt (hard to do right now) or run up even bigger surpluses, either by cutting spending or raising taxes. And that sort of grueling austerity could hurt Italy’s economy even further, worsening the problem. A more appealing possibility is for Italy to crack down on rampant tax cheating in the country. My Washington Post colleague Anthony Faiola has a great exploration of Italy’s untaxed “shadow economy” today, with this striking stat:
There was a fair bit of commentary in the financial press yesterday about the fact that Germany’s borrowing costs had risen, for a brief spell, above Britain’s. That doesn’t happen very often — Germany has long been deemed a slightly safer place to invest than Britain (although both countries are considered very sound in the grand scheme of things). Was that a sign of impending doom in Europe? Or are people reading too much into blips in the market?
For the past year, Germany has been Europe’s seemingly unshakeable anchor. Ireland’s debt looking dodgy? Greece’s? Italy’s? No problem. Investors were always happy to buy up nice, safe German bonds. Until today.
Der Speigel summarizes: “At an auction on Wednesday of the country’s 10-year bonds, one-third went unsold. ... The federal government had initially intended to sell bond issues worth some €6 billion (around $8 billion), but managed to garner just €3.89 billion.” Or, if you prefer your bond-market summaries pithy and apocalyptic, here’s Marc Ostwald, a strategist at Monument Securities in London: “It is a complete and utter disaster.”
So what happened? Perhaps investors are freaking out about the long-term future of the euro. Alternatively, FT’s Neil Hume rattles off some possibly benign technical explanations for Germany’s mishap. Meanwhile, Kathleen Brooks, research director at Forex.com, suggests yet another reading: “The bond market is staging a buyers strike, essentially trying to push Germany to take action.” In other words, investors are screaming at German leaders to use their considerable clout and resources to save the euro zone before it disintegrates. But will they? Can they?
No one at the Republican debate last night discussed the ongoing debt crisis in Europe. Indeed, the topic hasn’t gotten much play in any of the GOP debates. Moderators don’t want to ask about it. Candidates don’t want to formulate views on it. But the prospect of a euro zone implosion is a huge, alarming pitfall — not just for Europe, but for the United States as well.
Take a peek at the debt-to-GDP ratios of various euro zone countries and you’ll notice a wide disparity. Greece’s debt is a whopping 144.9 percent of its economy. Italy’s is 118.4 percent. Seems unsustainable. But looking further down the list, a country like Finland’s debt sits at just 48.3 percent of GDP. In fact, if you look at the euro zone as a whole, the continent’s debt is a manageable 85 percent of GDP, less than that of the United States.
That’s partly why some economists have argued that if all of the euro zone countries simply banded together and issued one common euro bond, they could placate nervous investors and put a stop to the ongoing market convulsions that are threatening to rip apart the euro right now. In essence, wealthy, stable countries that currently enjoy low borrowing costs, like Germany, would be subsidizing countries like Greece and Italy by helping to back their debt. (As Wolfgang Münchau has observed, this isn’t all that different from having the European Central Bank aggressively buy up the bonds of various E.U. countries to keep their borrowing costs down, but the ECB seems to be shying away from the latter option.)
To get a sense of how much leverage Germany has over the rest of Europe, check out the wild goings-on in Ireland. As the Daily Mirror reported, Irish parliamentarians are livid over the news that German lawmakers got to pore over Ireland’s new budget before they did. But that was all part of the deal to bail out Ireland earlier this year: “Germany now has the right to be fully informed about bailout countries’ progress before new tranches of funds are paid out.” Or, as the Daily Mirror’s headline screams, “GERMANY IS OUR NEW MASTER.”
And yet, Germany doesn’t exactly seem thrilled at the prospect of further bailouts and expanded schoolmarm duties. German Chancellor Angela Merkel is still refusing to allow the European Central Bank to act aggressively to calm the debt crisis in Italy and Spain. That, in turn, has market analysts freaked. Deutsche Bank’s Jim Reid noted today that it’s impossible to tell whether Merkel is bluffing — to induce reforms in Spain and Italy — or not. (Hey, isn’t that the point of a good bluff?) “If you don’t think Merkel’s tone will change,” writes Reid, “then our investment advice is to dig a hole in the ground and hide.”
Before I say anything substantive about Economania, the European Central Bank’s online monetary-policy game, I’d like us all to take a moment and simply look at the picture that the game begins with:
More substantively, the game inadvertently says a lot about how the ECB understands its job. While you’re playing, it tracks production growth, the money supply, inflation, and unemployment. But when you finish, you’re judged on only one thing: the inflation rate.
It’s not just Italy anymore. Spain’s borrowing costs are rising. French bond yields keep ticking ominously upward. The market conflagration is threatening to spread to all of Europe. Yet European leaders — especially German Chancellor Angela Merkel — still refuse to give their blessing to the European Central Bank to fire up the printing presses and start guaranteeing the debts of sovereign countries. Instead, E.U. officials have now resorted to dreaming up convoluted bailout schemes.
At this point, a wide range of economists agree that any plan to avert a breakup of the euro zone will have to involve the European Central Bank stepping up and pledging to backstop the debt of countries like Italy and Spain. Those calls have only grown louder this week, as the bond market went haywire and the contagion spread to once-safe countries like France.
And yet… European officials keep insisting that the ECB isn’t legally allowed to play savior. On Tuesday, the head of Germany’s Bundesbank called it a violation of European law. The Wall Street Journal argued Wednesday that the European Union’s founding treaty would need to be revamped before the ECB could act as a lender of last resort to countries like Italy. So is this true? Could Europe really melt down because of a few legal niceties?
With the crisis in Europe still raging, analysts are frantically trying to game out what a euro zone implosion would mean for the United States. Yesterday, the Federal Reserve Bank of San Francisco put out a research note pegging the odds of a U.S. economic contraction in early 2012 at “greater than 50%,” noting that a European sovereign debt default (Greece, say) would very likely plunge us into recession.
Part of the reason for that is that Europe is one of our major trading partners — accounting for about one-fifth of U.S. exports. Over at Real Time Economics, Josh Mitchell put together a handy chart, using Wells Fargo data, showing which states export the most goods to Europe, and hence would get hit hardest by a Europe slump:
No surprise, the crisis in Europe is still with us. Over the weekend, there was some airy optimism that the new technocratic government in Italy, led by economist Mario Monti, might be able to mop up the debt mess that Silvio Berlusconi left behind. But this morning, the markets remain unappeased. Investors once again appear gloomy about the fate of Italy — yields on five-year bonds at a recent auction rose to record highs. And that, in turn, portends gloom for Europe. But why is this happening?
One big reason for pessimism is that Italy faces some serious structural problems that won’t go away with a new leader, however wonky and competent he might be. Gavyn Davies’ has a nice breakdown of Italy’s debt challenges over at the Financial Times. To prevent an implosion, Italy first needs some deep-pocketed entity to backstop its debt, placate the markets, and give Italy time and space to carry out longer reforms. Yet the deepest-pocketed entity around, the European Central Bank, seems unwilling to play this role.
Right now, the great hope in Europe is that a team of bloodless wonks can parachute in to save Italy and Greece. Italy may get a former top-ranking E.U. commissioner — Mario Monti — to replace the scandal-ridden Silvio Berlusconi. Greece is getting a former vice president of the European Central Bank, Lucas Papademos, to head up a unity government until the next elections. The theory is that Italy’s and Greece’s problems are largely leadership-driven. Toss out the stubborn rulers who were unwilling to make tough decisions. Bring in the nerdy technocrats. What could go wrong?
After weeks of dire warnings about a euro collapse, Thursday felt a little less like doomsday. Italian bond yields have slipped back down below 7 percent. Greece has settled on a new prime minister. And, in the United States, stocks rallied as immediate concerns about Europe eased.
Few economists are ready to predict an easy end to the European debt crisis. “It’s very difficult to see happy outcomes,” says Desmond Lachmann, a former deputy director of the International Monetary Fund. But some do say that a least-bad outcome is at least possible.
With Italy’s debt crisis still smoldering, analysts are insisting that only the European Central Bank can quell the ongoing market panic over Europe’s troubled countries. “We think ECB needs to step up to the plate,” warned Barclay’s Capital. There’s just one teensy hurdle. In recent weeks, ECB officials have actually become less willing to embrace this savior role. “Clearly it is not the task of the central bank to intervene,” wrote board member Peter Praet on Thursday. So what gives? Can the ECB really stop the carnage? And if so, why won’t it?
Recall the reasons why markets are freaking right now. Members of the euro zone all issue debt in a currency they don’t control — i.e., the euro. So countries like Italy can’t always guarantee to bondholders that they’ll have enough money to pay up when the bills come due. At the moment, investors are fretting that they won’t get repaid and are demanding ever-higher interest rates to lend Italy money. That, in turn, makes Italy’s debt problems more unmanageable and causes markets to freak out further. Repeat until doomsday.
Fortunately, there is an entity with an unlimited supply of euros — the European Central Bank. All the ECB has to do, argues Paul De Grauwe, an economist at Belgium’s University of Leuven, is announce that it’s going to do everything in its power to intervene in the bond market and that it won’t stop until Italy’s borrowing costs settle back to manageable levels. (Right now, the ECB only engages in sporadic, temporary purchases, while harrumphing that it would prefer not to intervene at all.) In theory, that should calm the markets, giving Italy space to carry out longer-term reforms. So why doesn’t the ECB do this?
Italy isn’t just any country. It’s the euro zone’s third-largest economy. It’s the world’s eighth-largest economy. The country’s rapidly worsening debt woes are threatening to drag down all of Europe. And here’s the scary part: European leaders still can’t quite agree on how to save Italy from implosion. “Financial assistance is not in the cards,” one official told Reuters late on Wednesday.
It’s not an easy problem, after all. Italy’s public debt currently amounts to some 1.9 trillion euros — far too large for the country to be bailed out by the European Financial Stability Facility or by the IMF. At best, some economists say, those institutions might be able to keep Italy afloat for a few months. (The European Central Bank could also step up its purchases of Italian debt.) But no one knows how long that relief would last. Italy has more than 150 billion euros worth of debt coming due between February and April. Even if it can survive its short-term woes, it’s unclear whether the country can sort itself out before then.
Italian prime minister Silvio Berlusconi announced Tuesday that he will resign after the country passes a budget. Greece wants to form a unity government after its own prime minister, George Papandreou, announced this week that he would leave office. But that nation — facing a debt crisis --is struggling with political roadblocks. The Euromess used to be seen as a fairly straightforward economic problem. Now it’s mutated into a political problem, too.
The focus shifts from Greece to Italy, where financial instability mounts. The country’s borrowing costs hit new highs. Financial markets perked up this morning when rumors circulated that Silvio Berlusconi’s resignation was imminent. But when Berlusconi made clear he wasn’t going anywhere— both in the press and on his Facebook page — markets dropped back down. Berlusconi isn’t out of the woods yet: He faces a no confidence vote in the Italian parliament next week. By one economist’s estimate, Berlusconi’s rule has already cost Italy 20 billion euro.
Earlier this morning, financial markets perked up over rumors that Italian Premier Silvio Berlusconi might soon resign. Stocks rose briefly, and Italy’s borrowing costs eased. But then Berlusconi huffed that he wasn’t going anywhere and markets got depressed again. So what gives? Do the markets really think Berlusconi is that big a drag on Italy?
Actually, yes. Tito Boeri, an economist at the University of Bocconi in Milan, devised a clever way of showing just how much Berlusconi’s antics are weighing Italy down. Boeri compared the borrowing costs of both Spain and Italy — two countries in similar predicaments since Europe’s debt crisis began — by looking at their bond spreads vis-à-vis German bonds. Boeri found that Italy’s position relative to Spain has noticeably worsened every time new Berlusconi-related scandals have emerged. What’s more, Berlusconi’s announcement of a new budget package on Aug. 8 had no effect on Italy’s standing — suggesting that the prime minister no longer has any credibility with the markets.
All told, Boeri concluded, by driving up the country’s borrowing costs far above even Spain’s, Berlusconi’s government has imposed a €20 billion “tax” on Italy through mismanagement alone.
At the G-20 summit in Cannes on Friday, President Obama claimed that the leaders had made “important progress” in stabilizing the global economy, although the United States declined to pledge money for Europe’s bailout fund. Meanwhile, Europeans across the continent are trying to suss out what a Greek exit from the euro would mean for their own countries. (On Friday evening, the Greek parliament will hold a confidence vote for Prime Minister George Papandreou.)
Most of the focus in the Greek debt crisis has centered on Greek
prime minister George Papandreou. After all, he was the guy who threw the entire European bailout deal into disarray by calling for a referendum. And later today, he faces a no-confidence vote in the Greek parliament.
But economist Daniel Gros at the Centre for European Policy Studies, says our eagle-eyed focus could be misguided: if we want to understand the future of the European debt crisis, we ought to be watching Greece’s banks rather than its political leadership. “It’s difficult to get good data,” he says. “But I’m trying to watch the Greek banking system to see whether there’s a rush to withdraw deposits. Right now, it’s been surprisingly slow. but if it accelerates that could spell the end.”
Greek prime minister George Papandreou kicked off today by backing away from the referendum on the European bailout that he proposed just two days ago. And in a speech to the Greek parliament, the country’s finance minister echoed that message, saying the bailout should be categorically ruled out. But it’s not a done deal yet: to avert a referendum, it appears that Papandreou must go through negotiations with his opposition party. Obama called solving the European debt crisis the “most important” task at hand for the G20 summit, underway now in France. At least the markets are reassured that the referendum appears to be off: they spiked today.
The political situation in Greece remains incredibly unstable and in
flux. But for the time being, the most likely path forward looks like it won’t involve a Greek referendum on the European bailout package. Instead, Greek Prime Minister George Papandreou is said to be working on a coalition government that could accept the bailout, no popular vote required.
Economist Michael Arghyrou has been writing extensively on the Greek debt crisis from his post at Cardiff University in Britain. Today he headed to Greece and, in an interview from Athens, he shared his perspective of what things look like on the ground, how a coalition government could help create stability and what a Greek exit from the euro zone would mean. What follows is a transcript of our discussion, edited for length and content:
Sarah Kliff: What’s the feeling on the ground in Athens right now?
Michael Arghyrou: What feels most likely right now is we’re going to see elections, and that will happen in the next 20 to 30 days. From those elections, I’d expect there will be no single party government, so we’ll have a coalition government. It’s still not very clear what will happen if the prime minister loses the vote of confidence tomorrow, whether his party will remain united. There are some who seem willing to form a coalition with the center right.
There’s a lot of speculation right now about whether or not Greek Prime Minister George Papandreou will resign. Hours ago, numerous news organizations reported that he would. Now, top officials are telling reporters that he won’t. And all of that could change as Papandreou continues to meet with his cabinet in Athens.
Tracking these developments so closely might be missing the forest for the trees a little bit: Whether or not Papandreou resigns this morning, a lot of the developments that could play out over the next few days leave us with the same practical outcome.
As the European debt crisis unfolds, Wonkblog will be posting an afternoon round up of the latest developments from across the Atlantic. Today’s edition:
Today in EuroMess, the story moved from Athens to Cannes, where international leaders convened for the annual G20 summit. The meeting doesn’t start until Thursday, but attendees are not wasting any time: French president Nicholas Sarkozy and German chancellor Angela Merkel held an emergency meeting this afternoon with Greek prime minister George Papandreou. They urged him to “make up his mind fast” on whether Greece would leave the euro.
It’s hard to find an economist with a good solution to the unfolding debt crisis in Europe. “You’re choosing between very difficult alternatives,” says the London School of Economics’ Kevin Featherstone. “There are no good options left.” What’s not hard, however, is finding an expert who can rattle off the many ways that the Greek debt crisis could end up damaging the European Union. Here are three potential doomsday scenarios to worry about in the coming months:
If there’s one word that describes Europe right now, it’s
uncertainty. Yesterday, Greek Prime Minister George Papandreou called for a referendum on the bailout deal crafted by European leaders. That deal would have absolved Greece of much of its private debt, but also would impose unpopular austerity measures on the nation. Markets, which jumped last week at news of a deal, declined again. Much still remains in flux, so here are five things to watch as events unfold across the Atlantic this morning:
1. What happens at the G20 summit in Cannes? All eyes are on Southern France this morning as international leaders make their way to a long-planned G20 summit. The conference pulls together industrialized and developing economies to, as my colleague Howard Schneider puts it, “compare notes on the world economy.” When the meeting opens tomorrow, a lot of that note comparing will no doubt focus on Greece. This will be the first meeting of many key European leaders, including French president Nicholas Sarkozy and German Chancellor Angela Merkel, since Greek announced its referendum. It will also bring a few, key international players, including the United States and China, into the room.
In May of 2010, I spoke with Desmond Lachman, a resident fellow at the American Enterprise Institute, about the growing crisis in Greece. Lachmann, a former managing director and chief emerging market economic strategist at Salomon Smith Barney and deputy director in the International Monetary Fund’s Policy Development and Review Department, was not optimistic. I called him back today to see how he was feeling now. His answers weren’t comforting. A lightly edited transcript of our conversation follows.
Ezra Klein: A bit over a year ago, when we first spoke, you said Greece was like Bear Stearns, and behind it were a lot of potential Lehmans. Have you become more optimistic since then?
Desmond Lachman: No. What has occurred over the past year is that the situation with Greece has clearly been untenable. It is only a matter of time till Greece has a hard default. Since then we have had real problems in Portugal and Ireland. But what is of most concern is the crisis has spread to Italy and Spain, and even the French banks have trouble funding themselves. This isn’t just the European periphery. It’s the heart of the European banking system and the whole European experiment. What makes matters worse is that the American, French and German economies are slowing. That means that if the troubled countries in the periphery had any chance to export their way out of their problems before, they don’t have that option now.
EK: And if some of these dominoes fall, how bad are things likely to get?
All week, we’ll be interviewing experts on the European debt crisis. First up is Barry Eichengreen, professor of economics and political science at the University of California at Berkeley. Compared with some other experts you’ll hear from in this series, he is relatively optimistic about the future of the European Union. (The transcript has been lightly edited for length and clarity.)
Brad Plumer: Markets seem to be reacting positively to the recent steps European leaders have been taking to stabilize the debt crisis there. Is that optimism well-placed or no?
Barry Eichengreen: The markets reacted positively at the beginning of the week because they heard that European policymakers were finally beginning to address the relevant issues. Those issues included: strengthening weak banks by injecting the capital necessary; the need to acknowledge and act upon the fact that Greece is insolvent; and the need to ring-fence other European countries once Greece’s debt was meaningfully restructured. There was the announcement that the 15 banks identified as problem banks in the latest stress tests would get more capital. And there were hints from European policymakers that Greece bondholders would have to take serious haircuts, as opposed to the cosmetic haircuts that they’d been subjected to on July 21. There was also talk of leveraging the European Financial Stability Facility (EFSF) to give it the firepower needed to ring-fence other European countries. That was all good news.
The bad news is that markets got carried away. There was some commentary on this side of the Atlantic, which was not adequately informed by an understanding of European politics, that led investors to believe this would all happen tomorrow. In reality, it will take some months. These steps won’t get done without considerable negotiation, infighting, and posturing by various politicians. The idea that this period of high uncertainty is over is naive. We’re in for a couple more months of volatility at least.
BP: So what are the big hurdles standing in the way of resolving the crisis?
It seems increasingly clear that the most important story right now for the American economy, and arguably for the American political system, is what happens in Europe over the next few days and weeks. So here at Wonkblog, we’re going to try to get you — and ourselves — up to speed with a series of interviews and articles on the EuroMess: what it is, what needs to be done, what’s likely to happen, and how it may affect us. We’re also going to try to pull together a primer with some of the best journalism on the topic, so if you’ve read a piece that you found particularly clear or illuminating, leave a pointer to it in the comments.