Serious Problems Emerge For The F-UK-DE Group of Countries

Well, I for one can’t help thinking that it’s now well time we all stopped getting carried away with the use of so many acronyms. Not only may one man’s meat easily prove to be another’s poison, it may even be that for some the entire meal will be so distasteful as to prove totally indigestible. And so it is with the latest set of proposals to appear on the table hastily erected to find the “cure all” for the eurozone’s many ills.

Daniel Gros, in a well meaning, but I feel fatally flawed, move to get us all away from talking about some of the members of our own community as PIGS, has decided to tell us, that they are not pigs at all, they are merely GIPSYs. Of course, depending on which way you look at it, such forms of reference could be taken as a compliment (”you sure do eat like a pig”), or not, but with due regard with the kind of controversy which has been provoked by the arrival of large numbers of Roma in Italy, perhaps it may not be the best move to get debate going to start by telling the countries which lie of Europe’s periphery that the best way to conceptualise them is as a bunch of “gitanos”. Nor is it the nest way to tell the members of core Europe that they way things stand they are essentially F-UK-DE. But there it is. That’s just how things are these days.

Now, to take us back a bit nearer to reality, in fact Daniel, in his ill-named Working Paper “Adjustment Difficulties in the GIPSY Club“, actually does get to the heart of some very important matters, and really I thoroughly recommend everyone to read it from start to finish. The core of Daniel’s argument is, I feel, the extraordinarily obvious point that the kind of fiscal adjustment being proposed for some of the peripheral countries is going to have one, and only one immediate consequence: these countries are going to be sent off to the outer darkness of very, very (see his numbers) sharp GDP contractions, and these contractions run the risk of precipitating pre-Argentina 2000 type situations in the countries involved, whereby the contractions in nominal GDP are so large that they effectively take away with the one hand what was given (in the form of sacrifice) with the other, and lead to a seemingly endless spiral of increases in the debt to GDP ratios, which lead to ever deeper short term fiscal cuts, and ever stronger contractions, etc, etc.

As Daniel argues, the only way to restore competitiveness, and avoid the dreaded Argentine spiral is to carry out some form of internal devaluation:

“What can Greece do to escape the ‘Argentine’ vicious circle of higher risk premia and a worsening economic outlook? The only way to minimise the cost of the external and fiscal adjustments that are required to… make the situation sustainable is to make Greece more competitive and thus stimulate exports.”

“This can be achieved only by an across-the-board reduction of wages (or rather labour costs) in the private sector of between 10 and 20%. Cuts in wages of this order of magnitude will encounter fierce popular resistance. They could come about either at the end of an extremely painful process when unemployment has reached peaks never seen before or they could come much earlier as the result of an overarching national agreement in which the government, opposition parties and the social partners agree on what is needed in the light of present circumstances. Greece thus needs a concerted effort at the national level not just a government that pushes austerity measures through Parliament.”

So Why Are The Other F-UK-De?

The problem is, conceptualising this situation as one group of fiscally derelict countries having to be controlled by another group of upright and competitive ones does not give us a complete picture of the mess we are all in, as Gideon Rachman eloquently argues in his Dr Schäuble’s Torture Chamber post:

Behind the careful bureaucratic language, Schauble makes some amazing claims and proposals. Here are just a few.

“All eurozone members must return to adherence to the stability and growth pact as rapidly as possible.” This is just hypocrisy. I was living in Brussels when the pact was gutted the first time – because Germany and France were unable to keep within the 3% deficit limit.

Schauble also seems keen to resurrect the main feature that made the stability and growth pact lack credibility in the first place: the notion that countries that are running out of money need to be shocked back onto the path of virtue and prudence by being fined – a move that would obviously worsen their financial plight.

Basically, as Rachman argues, we all need to calm down a bit here, and get things rather more in perspective. In the first place the Eurozone’s economies – as I keep arguing day in and day out – are all roped together via the system of current account deficits and surpluses.

This is a point France’s finance minister Christine Lagarde draws attention to in an interview in this morning’s Financial Times. As M. Lagarde says:

“[Could] those with surpluses do a little something? It takes two to tango,” she said in an interview with the Financial Times. “It cannot just be about enforcing deficit principles.”

“Clearly Germany has done an awfully good job in the last 10 years or so, improving competitiveness, putting very high pressure on its labour costs. When you look at unit labour costs to Germany, they have done a tremendous job in that respect. I’m not sure it is a sustainable model for the long term and for the whole of the group. Clearly we need better convergence.”

Well, let’s leave aside today the issue of whether or not convergence is a realistic (or even a possible) objective for Europe’s economies given the large demographic mismatches between countries, but still, Lagarde is on to something. What we don’t have is a situation where on the one hand we have everything for the best in the best of all possible worlds, while on the other we have a group of slouchers and forgers. This kind of thing makes for nice headlines, but it is far from corresponding to reality.

Another reason the F-UK-De group are in trouble if the GIPSYs wander off to the outer darkness, is that they will have issues to resolve in their banking systems, as the chart below reveals. German banks may have little exposure to Greek debt, but their exposure to Spain and Ireland is enormous.

In fact, the massive exposure of German and French banks to Portugal, Ireland, Greece and Spain offers part of the explanation as to why Europe’s biggest economies have been steadily moving to rescue their southern neighbors in recent days, according to a recent report from Societe General entitled “Shotgun Greek Wedding.” According to the report banks in Germany and France alone have a combined exposure of $119 billion to Greece and $909 billion to the four countries, according to data from the Bank for International Settlements. Overall, European banks have $253 billion in Greece and $2.1 trillion in the four countries collectively referred to as the “PIGS”.

“The exposure is enormous,” said Klaus Baader, co-chief European economist at Societe Generale in London. “The crisis in Greece isn’t Greece’s problem alone but a concrete problem for Europe’s whole banking sector. That explains the interest of finance ministers in stabilizing the situation.”

Defining Moment?

Gideon Rachman admitted that this one felt like a significant moment to him, and I am inclined to agree. We have two proposals on the table, and neither of them will work. In the first place simply treating the problem on Europe’s periphery as an essentially fiscal one will not return these countries to competitiveness, and will simply precipitate GDP contractions, and deflationary spirals, that will lead inexorably towards failure, default, and possibly exit from the Eurozone (which, in fact, Herr Schäuble seems to feel would be an acceptable outcome to all this).

On the other hand, A Germany (or a Japan) which is not able to maintain a substantial external surplus (which is the only way a country with their kind of demographic profile can attain headline GDP growth, since internal demand is long gone as a “driver”) since without a surplus and without GDP growth the implicit liabilities of ageing populations (via health and pension commitments) will become unpayable, leading to default (or a huge slashing of public welfare commitments) in these countries too.

Wolfgang Munchau also seems to think it is decision time. As he argues in his Op-Ed in today’s FT, “Shrink the eurozone, or create a fiscal union“. I know which side I am on. As Joaquín Almunia once argued, people would need to be crazy to leave the Eurozone. So let’s get on with it, and go climb that hill which lies out there in front of us.

Edward Hugh also blogs at A Fistful of Euros.

  1. Element says

    Verbatim quote from ABC TV’s Inside Business, Feb 28th, 2010.

    Alan Koehler: So what are the odds of a double dip in Europe, do you think?

    OECD Deputy Director of Financial and Enterprise Affairs, Adrian Blundell Wignall (formerly Reserve Bank of Australia): Well I think ah, the…the odds of a double dip recession are, er, you know, have been er, quite high for some time. I mean there’s been er, umm, the big problem in this crisis is that the problems in the banking system have … not … been solved.

    Um, you know, they’ve been hidden by changes in accounting rules, to some extent, er, but if people ask me, what…? Why does this thing appear to have gone relatively smoothly, compared to what you might have thought? A big part of that is because many of what people call ‘toxic assets’ has been put on to the balance sheet of the Federal Reserve, and on the balance sheet of the European Central Bank. And if that wasn’t there, you know, that is basically taking the assets-the bad assets-as collateral for loans, from the cental banks to these, er, to these banks. Well, they have to be paid back, and the question is, if you put that collateral back to them, what would their situation be?

    Er, that’s why credit is NOT supporting this recovery. So if you look at in a fiscal policy, in zero rates, well, it’s pushing on a string. With zero rates you’ve got fiscal policy very supportive, and of course fiscal policy dollar-for-dollar expands GDP, but credit is going south, in erm, in North America, and in Europe, and in, er in a global sense. You know, Australia is a very different story, but er, but overseas, in the northern hemisphere, credit is NOT supporting this recovery.

    And therefore, the question about what happens, as we go into 2011, in terms of whether GDP double dips again, is something that really policy makers DO have to deal with. It would be foolish to say that was not a risk, of course, it’s a risk.

    Alan Koehler: … um sounds like you think it’s a probability?

    Adrian Blundell Wignall: Well I, you know, it’s, you can’t, you can’t sort of make a uni-variate sort of forecast without knowing what policy makers are going to… I mean, is there a, is there a, … a way to get through all this with sub-trend growth and a muddling through kind of thing? Well, of course there is.

    Um, you know, there are a lot of things you have to do, to do that.

    Er, as I said before, there are a lot, a lot of icebergs in front of the ship here, and can this ship er, sort of get through the icebergs? Well, of course it can. But the chance of hitting one is quite high, as well. So that’s why, you know, you can’t say that …you realise that you have to know what policy makers will do. And what the actual… will they do the right things, to the, … to make the path of the ship through the icebergs, ah, relatively …, er, relatively safe-or not.

    And ah, and I think that’s the key issue.

    So yes, there’s a bi… [nods his head and realises he almost said the “big” word] – um, a good chance of a double dip, but it’s not impossible that you can get through, with the right policy actions.

    Overall Wignell is far less convinced that “the worst is behind us”, as the White House pretends. Indeed he’s making it clear that the really dangerous part of the GFC is only now about to begin, due to the lack of any policy resolution to actually fix anything, with multiple opportunities popping up for things to go badly wrong. Let’s face it, the chances that so many necessary complicated policy moves, all being more or less in the right direction, in the right order, with the right timing … is lowish. No?

    The enduring weakness and slowness of recovery in such a debt-stressed (soon to be high taxed) situation, simply means we are exposed to the unforeseen effects and dangers longer.

    Or as Hans Hoogervorst, the Dutch Financial Markets Regulator said in advice he gave to Reserve Bank of Australia Governor Glenn Stevens, on March 1st, 2010, within a public discussion;

    “… Prepare…for…a very…difficult economic time…which you will not be able to continue to escape.” (choosing his words very carefully)

    Politicians (and bankers) have a dreadful record in this situation. Neither of them directly feel the pain when the economy goes bad. Maybe they suffer a dislocated ego or a blemish on the memoir, but little personal financial pain, no smashed home budget, no family dislocation, or insecurity. So how motivated will a politician really be to get it right, or to not give up the fight before it’s properly begun?

    Politicians (and bankers) are NOT as a collective, changing course for the icebergs. They are just trying to increase speed while ignoring the damage to the bow, and ignoring the flooding occurring, due to the iceberg we already hit.

    The unfolding effect of the first iceberg is only now beginning to show.

    We are only at the stage of kicking the ice off the deck and preparing to get steaming again. But the ship’s engineer has now reported that the pumps can not cope with the flooding, so the captain has ordered that all the fire hoses be directed into the bow compartments to try and push the ocean back out, via increasing the water pressure.

    I would never have thought of doing something like that. We are in good hands.

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