If any other central bank met following a series of economic reports showing low and falling inflation mixed with stagnant growth, then elected to cut interest rates, you would say, "well yeah, of course they did."
But this was the European Central Bank. The hard-line, inflation-phobic, Germany-based institution that sets monetary policy for the 17-nation euro zone and has been reluctant to do anything that might risk even the eensiest bit of inflation. As a refresher, steeper price increases would be very helpful right about now in allowing the imbalances within Europe to right themselves, but instead the continent is getting the opposite. Inflation has been well below the just-below-2-percent target that the central bank aims for.
Talks begin this week on what will, if it comes to fruition, be the biggest trade deal in the history of the world. After months of comment-taking and framework-setting, the United States and the European Union are ready to start official negotiations over what is formally known as the Transatlantic Trade and Investment Partnership (TTIP). In short: The world's two largest economies are ready to allow the freer flow of commerce between them.
Two years ago, Sen. Patty Murray (D-Wash.) was on the supercommittee, trying to hash out a multi-trillion-dollar deficit reduction package. Three months ago, she was proposing (and, later, passing) $1.85 trillion in additional spending cuts and revenue-raiser.
So it was a little striking to see her using the Senate Budget Committee, which she chairs, to hold a hearing on the negative effects of austerity. This isn't a flip on policy; her budget does, after all, include some stimulus spending. But instead of the usual routine of emphasizing the importance of medium-run deficit reduction, while paying lip service to the need to prevent premature cuts, Murray used the hearing to focus almost exclusively on the latter concern.
The European Union has long prided itself on taking the lead in tackling climate change. But, this week, the continent's flagship program — a cap-and-trade program for carbon-dioxide emissions — came in for criticism after a reform effort failed and the carbon market crashed. So what's the problem? And can it be fixed?
Europe called a mulligan.
Ten days ago, they arrived at a deal to rescue Cyprus in part by taking money out of depositors' accounts in the country's banks. The reaction was an unpleasant one, with the precedent of seizing money from European banks even for small depositors whose deposits are theoretically insured prompting new tremors of worry about the euro currency union.
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.
There is something about the impasse over the fiscal cliff that seems eerily familiar.
The underlying U.S. economy is reasonably sound, and our problems well within our capacity to solve. The open question is whether our political institutions are up to the challenge. The nation's credibility as a global leader is in question.
If you’ve been reading Wonkblog this week, you’ll know it’s very tough to cleanly split the American population between “makers” who fund the government and “takers” who reap its benefits. The percentage of people not paying income tax turns out to be among the worst ways of trying to make that distinction.
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.
What’s happening to the euro right now is, arguably, all part of the grand plan. A reader explains:
I know I’m a little late to the game, but wanted to mention that what Soros called “piecemeal social engineering” is what Jean Monnet [A French diplomat who was a key architect of the effort to begin integrating Europe -- Ezra] called neofunctionalism, or the idea that supranational integration can only occur through the agglomeration of national functions.
In broad strokes, the postwar debate over the European project centered on how countries that just finished destroying each other in war could willingly give portions of their sovereignty to one another. Monnet believed that forming a “United States of Europe,” as Churchill put it, wouldn’t work; the only solution was for European states to gradually build mutual dependency. By surrendering particular activities or segments of their economies to a supranational body, they would bind themselves closer together, and have no choice but to greet future challenges with a united front. Ties would beget more ties and, eventually, common governance to meet a common fate. The Coal and Steel Community was the first step in this chain; the euro was, perhaps, the last.
George Soros’s speech on the euro is getting a lot of attention. Tony Fratto, a CNBC contributor and former treasury secretary, tweets that he’s “never had anything recommended to him more frequently.” Joe Weisenthal, at Business Insider, called it “brilliant.”
The truth is that the speech itself is a bit of a slog. The first 1,500 words or so are about Soros’s theory of “reflexivity,” and they’ll probably dissuade all but the most committed readers. Then Soros gets to the bit that’s gotten people excited: A clear explanation of how the euro evolved, and why it is, in essence, a classic bubble. Here’s the key bit:
Europe is a mess. But it’s the type of mess that both the left and the right think validates everything they’ve been saying about what we should -- and shouldn’t -- do here in the U.S. “The right argues we have to cut deficits now or we’ll be like Greece,” says Tom Gallagher, a principal at the Scowcroft Group. “The left argues we can’t cut deficits now or we’ll be like Europe.”
I’m always surprised, in my conversations with conservatives, how often they distill the deficit down to a simple question: Do you really want the United States to go the way of Europe?
Interestingly, I’m now hearing it from liberals, too. Robert Borosage, director of Campaign for America’s Future, warns, “Take a good look at Europe — bloody riots in Athens and Madrid, rising unemployment, spreading poverty and suicide, and a deepening recession — because the current American elite consensus bizarrely wants to drive America down that same path.”
The conservative argument is that unchecked deficits could lead to a bond market crisis, much as they have in Greece. The liberal argument is that austerity could lead to riots, as it has in Greece. Both arguments, I think, miss just how much trouble Europe is in, and how much better shape we’re in.
Some seemed genuinely shocked about the resurgence of Europe’s debt problems. “Wasn’t Europe Fixed?” asked CNBC. But experts say there’s nothing surprising about the recent turn of events, which has soured bond markets in Spain and Italy and set investors on edge, yet again, about the continent’s future.
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.”
Danish PM: ‘In the last two months, we have undertaken more far-reaching decisions than perhaps in the last 50 years’
This morning, I interviewed Helle Thorning-Schmidt, the prime minister of Denmark. For the first six months of 2012, her country will hold the rotating presidency of the European Union, so Thorning-Schmidt has an unusually clear vantage point on the EU’s struggles to overcome its fiscal and economic challenges. The interview was conducted at the Center for American Progress, where Thorning-Schmidt gave a speech on the U.S.-E.U. relationship. A lightly edited transcript of our conversation follows.
Ezra Klein: In your remarks today, you say that Europe is suffering a “crisis of confidence.” Most economists I know say it’s suffering a crisis of growth and debt, and it’s not yet solved. So do you have a different take?
U.S. industrial production has continued to rise in recent months, while Europe’s has plummeted, Thomson Reuters points out. This is not only in spite of the euro zone mess, but perhaps in part, because of it, as the U.S. has partly stepped up to meet global demand while Europe continues to flounder.
That said, the U.S. is hardly in the clear yet: while the blood-letting has been stopped for the moment, few are confident that the latest Greece deal will be a lasting solution to the euro debt crisis, and a real meltdown with global aftershocks could still be on the horizon. And even a more gradual decline in Europe could put a damper on the U.S. recovery.
(h/t Pragmatic Capitalism)
U.S. money-market funds are upping their investments in European banks, the FT reports. This is “a huge sign that the European crisis is ending,” writes Joe Weisenthal. “It’s encouraging but still highly subject to event-driven risks,” Chris Conetta, head of commercial paper at Barclays Capital, tells the FT. I’m going with “it’s too early to tell,” but given that nothing fundamental has changed in Europe, I wouldn’t read too much into this indicator.
I tried for a while to get the term “Euromess” to catch on. Fail. The world seems to have settled on “the European debt crisis” as the accepted term for the run on sovereign bonds that’s bedeviling the euro area. So I gave in and started calling it “the European debt crisis,” too. Now I’m regretting it.
Speaking of things that the European crisis is not about, while I was in Germany, my colleague Robert Samuelson wrote that “Europe’s turmoil is more than a currency crisis and was inevitable, in some form, even if the euro had never been created. It’s ultimately a crisis of the welfare state, which has grown too large to be easily supported economically.”
I don’t think that quite works. Take Germany. They have a pretty big welfare state: pensions, health care, paid vacations, unemployment benefits equal to two-thirds of one’s income. Indeed, the Organization for Economic Cooperation and Development keeps track of social spending — unemployment, old-age pensions, health care, etc — as a percentage of GDP. In 2007, Germany spent 25.2 percent of their GDP on such things. Greece spent 21.3 percent on social policies. Yet Greece is in crisis, and Germany is fine.
To bring this across the Atlantic, you could argue that the United States’s debt burden is the product of an insufficiently large welfare state — at least with regard to health care. To see a stark illustration of that thesis, head to the Web site of the Organization of Economic Cooperation and Development and download their health-care statistics for Canada and the United States.
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.
In the American press, the European negotiations tend to get boiled down to a simple equation: Northern Europe wants to impose job-crushing austerity on Southern Europe, Southern Europe wants undeserved subsidies from Northern Europe. But it’s an equation with no answer: Too much austerity, and Southern Europe can’t grow, which means it can’t pay its debts. And though bailouts are nice for the recipients, they’re not a permanent solution, either. The only permanent solution is growth.
But one dimension of the European negotiations that hasn’t received much attention are the labor market reforms -- reforms that are meant to accelerate growth. One American policymaker in Europe speculated to me that that’s because we’re used to arguments over deficits, but we don’t really have a context for understanding “how weird the labor markets and regulations in Southern Europe are.”
In 2007, the BBC ran a story with the headline “Ireland: An EU Success Story.” But the point wasn’t simply that Ireland had done well. It was that Ireland had done well that their continued interest in the European Union served as a critical endorsement of the continent’s generational project.
And that wasn’t just the judgment of the Europeans. Ireland was touted here, too. Their low-tax, pro-business economic policies were considered a rare triumph for free market ideals in Europe. In October 2008, Sen. John McCain told conservative TV host Sean Hannity, “You’re going to go on my first overseas trip. And I think it might be to Ireland.”
Or consider this August Wall Street Journal article on Italy: “As fears mount that Italy could be sucked into the vortex of the euro-zone debt crisis, consider this: The country’s public finances are among the strongest in the European Union.” Yes, even now, Italy is running a primary surplus. They have made many mistakes in the past, but so have we, and we haven’t made the tough decisions to work our way back to a primary surplus yet. (Nor, I hasten to add, should we make our way back to a primary surplus yet.)
Austan Goolsbee is the former director of President Obama’s Council of Economic Advisers and an economics professors at Chicago University’s Booth School of Business. On Monday, he published an op-ed on the crisis in Europe that made some provocative points, so I asked him to expand on them in an interview. I think it’s fair to say that Goolsbee is not an optimist when it comes to the euro. The problem, he says, is that even if you recapitalize the banks and end the runs on government debt, you haven’t solved the region’s growth problem. A lightly edited transcript follows.
Ezra Klein: You wrote that “Germany’s currency has been to Southern Europe what China’s has been to the U.S.” Unpack that a bit.
Austan Goolsbee: Germany’s productivity has gone way up. Normally, that would mean their currency appreciates, which lessens the advantage that gives their economy [in exports]. But unlike virtually every other advanced country in the world, the manufacturing share of output in Germany has risen over the last 20 years. And part of the explanation is that, just as in China, Germany has an export-oriented growth strategy fueled by a currency that’s undervalued. But that undervalued currency has been at the expense of Southern Europe. And the main point of the piece is that there’s no obvious way for Southern Europe to grow, and if they can’t grow, they can’t balance their budgets no matter how much austerity they engage in.
EK: Sebastian Mallaby wrote that between August 2009 and May 2011, German exports jumped 18 percent. If they hadn’t been in the euro, they would have only risen by eight percent. So Mallaby’s take was that one way to view the issue is that the euro has been making Germany richer and now they need to share that wealth.
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.”
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.
Here’s how it was supposed to go: Greece first. Then, perhaps, Portugal and Ireland. If things got really bad, Spain. If the world -- or, more precisely, the euro -- was coming to an end, Italy. It was not supposed to go Greece and then Italy. No one was prepared for that. The markets weren’t prepared for that.
And so the markets are falling. The Dow is down 290 points. The Stoxx 50, a blue-chip index for the euro zone, is down 2.5 percent. Italy’s borrowing costs have skyrocketed. The Euro has plunged.
The problem, put simply, is that Italy is both too big to fail and too big to save. It’s the eighth-largest economy in the world. At $2 trillion, it’s about seven times as large as Greece’s $300 billion economy. France and Germany’s banks alone have $600 billion in exposure to Italian debt. But Barclay’s says Italy is “now mathematically beyond the point of no return.” Silvio Berlusconi might be out, but changing governments does not change arithmetic. And so the question is simple, and stark: If there wasn’t the will to really save Greece, where would the will -- and the money -- come from to save Italy?
The answer that’s so troubling the markets right now is that it perhaps won’t come at all. Market participants and commentators are increasingly thinking the unthinkable: Perhaps this really is the end of the euro. “If policymakers had understood two decades ago what they know now,” writes Martin Wolf in the Financial Times, “they would never have launched the single currency. Only fear of the consequences of a break-up is now keeping it together. The question is whether that will be enough. I suspect the answer is, no.”
Tiny Slovakia on Tuesday defied its mightier neighbors and rejected an expanded rescue fund to save Europe’s ailing nations and troubled banks, effectively holding ransom the region’s plan to fend off a broader economic crisis.
The “no” vote after a marathon session of parliament in the sleepy Slovak capital of Bratislava threw up yet another stumbling block in Europe’s haphazard crusade to staunch a debt crisis that is threatening the global financial system. The Slovaks were scrambling late Tuesday to rearrange a new vote after the government there became the first to fall in Europe over opposition to bailouts.
From FT Alphaville:
Rather than debating if there will be a recession in Europe, economists are now trying to figure what it will look like and how long it will last.
Yikes. The Venn diagram atop the post, incidentally, is Paul Krugman’s one-graphic explanation of the Euromess. Looks about right to me.
Carmen Reinhart is co-author of ‘This Time is Different,’ the seminal history on financial crises, and a fellow at the Peterson Institute for International Economics. She is also not particularly surprised to see our financial crisis being followed by a massive sovereign-debt crisis. in an interview yesterday, she explained why.
Ezra Klein: There’s one interpretation of the events in Europe, which you often hear from the Obama administration, in which they’re presented as “bad luck.” But one of the lessons I took from your book on financial crises is that aftershocks like this are more predictable than that. It’s more like someone with a weakened immune system catching pneumonia. That’s not bad luck so much as it is a symptom of the underlying problem.
Carmen Reinhart: The immune system metaphor is very much how I view it. We do have a weak immune system. Our ability to withstand shocks is completely different than in quote-unquote more normal circumstances. But it’s not bad luck. Ireland is in a precarious situation for different reasons than Greece. But it wasn’t bad luck that got their gross external debt to 1,000 percent of GDP. It was a bet that things would continue to go well for a prolonged period of time.
EK: One element of your work has been to look separately at financial crises, sovereign-debt crises, currency crises, and various other forms of global economic misery. So what separates or connects a sovereign-debt crisis like the one we’re seeing in Greece from a financial crisis like the one we had here?
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.
(This article by Dylan Matthews originally published on August 5th, 2011. But with Europe’s crises nearing a tipping point, it’s worth republishing today. The main update since August 5th is that everything is worse now than it was then. --Ezra)
Since the financial crisis hit in 2008, a wave of debt crises have swept the European Union, threatening various countries with default and putting the future of the euro in danger. Here’s what's happened, by country.
Greece: Greece had a debt load of over 100 percent of GDP in 2001, when it joined the euro. But joining the euro lowered interest rates on its debt, because the bond markets no longer worried about inflation or a devalued currency. The result was an economic boom fueled by low interest rates, and ever-increasing debt due to a lower cost of borrowing. Greece hired Wall Street firms, most notably Goldman Sachs, to help hide its debt so as not to run afoul of E.U. rules. In October 2009, the conservative government was voted out, and the new socialist government announced that deficits were more than double previous estimates. Greek debt was immediately downgraded. The situation worsened in February 2010, when institutional bondholders started selling off Greek debt and ratings agencies kept downgrading it. Greece responded with a round of austerity measures.