The euro zone double dip is almost here

The OECD has warned that the economic outlook in developed economies has become significantly worse. The organization now expects a measly 0.3% growth in Q4, as close to recession as could be possible. The OECD has urged central banks to keep policy rates low and to stand ready for further easing.

In the euro zone, the situation is much worse as the sovereign debt crisis bears down with full force. The euro acts as a gold standard for individual euro zone members. As with the gold standard, euro zone members abdicated currency sovereignty in order to benefit from the price stability of the currency tie. Individual euro zone sovereign states are now currency users with limited policy space, meaning that a recession must be met with the deflationay response of pro-cyclical fiscal policy (budget cuts and tax increases).

Over the medium-term, this decreases demand and reduces economic growth. In a credit crisis, when private sector debt levels are high, debt deflationary forces of reduced output can lead to falling asset prices, debt distress, deflation and depression.

I see the procyclicality as one of the structural flaws of the euro zone; there is no federal agent to do counter procyclical budgeting during a recession. Thus, the euro zone business cycle will invariably be volatile, making current account imbalances a lightening rod for intra-European recrimination.

As I wrote when the sovereign debt crisis was beginning, Spain’s debt woes and Germany’s intransigence lead to double dip (Spain representing the euro zone periphery writ large):

If Spain is forced to run austerity measures as seems likely, in stage two, this shifts their government deficit markedly down. Given Spain’s poor labour competitiveness, sticky wage prices and inability to depreciate the currency, all of the adjustment falls onto the private sector in the form of reduced net savings (which could include larger debt burdens). But, the thing to realize is that total GDP in Spain is lower in this scenario, which means total imports are lower, which means Germany’s total export volume is lower. This is a deflationary scenario.

And indeed, the OECD expects Germany to suffer most:

The German economy could contract by 1.4% in October to December, the Organisation for Economic Co-operation and Development (OECD) has warned.

The OECD said Germany could be most affected by a downturn in global trade, but said high uncertainty surrounded all its latest estimates for the G7 group of the world’s largest economies.

This does not augur well for the euro zone. In the past few months, I have become negative on the euro zone’s chances of survival. I no longer believe the political imperatives for the euro zone will be enough to overcome the politics of this next downturn. I will have more to say on this subject in a separate post.

  1. Buddy Rojek says

    The Trillion dollar question is “What do the German Voters think?”

    If you are German can you please provide insights, and examples of German articles, polls etc, I can translate.

    1. Detlef says

      The German voters are concerned, scared, furious and have lost some trust in the ability of politicians to solve this crisis. They also don´t believe that emergency funds or eurobonds will work.

      See, quite a few of the German (and European) politicians in power today were already (influential) politicians 10-15 years ago when the Euro treaty was created. Both in the government parties and in the opposition parties. They all told us not to worry when the Euro was introduced (even though a majority of Germans were skeptical back then) and pointed for example to the no-bail out clause in the treaty. They disregarded warnings by economists. They nodded when Greece was admitted into the Eurozone even though there were already clear hints that the budget numbers were fudged.

      And now the very same politicians disregard such clauses, tell us that there is no alternative and promise us that this time they know what they´re doing. Oh, and they try to scare us by telling us that this is a question of war or peace.
      That doesn´t exactly inspire trust. :)

      Germany entered the Euro when we were still struggling with the aftermaths of German reunification (with its accompanying huge costs). The 2000s mostly saw stagnant wages (after inflation). At the same time taxes like the VAT were raised from 16 to 19%, there were cuts in the social safety net (Hartz IV laws), cuts in government services, all in the name of balancing the federal budget. And when wages finally started to rise a bit and the budget was balanced we´ve got the financial crash.

      So German experiences during the 2000s were mostly ones of sacrifices. And now we´re asked to sacrifice again to rescue some Eurozone countries (in reality banks). And understandably enough Germans aren´t happy.

      Just to illustrate the point. In 2010 there were discussions for months on end if the monthly Hartz IV welfare payment could be raised by Euro 5 per month. If the federal budget could afford that. And that was less than Euro 300 million per year. Now we´re talking about Euro 200 billion for the new Eurozone rescue fund and the German parliament is told to hurry. We can barely afford Euro 300 million for the poorest in Germany but we can easily afford/risk Euro 200 for the Eurozone?
      German voters are scratching their heads…

      Still, I notice that bail out candidates are treated differently in the German media and public opinion. There is practically no discussion/controversy about Ireland for example.

      There is a lot of controversy about Greece.
      Fudging the budget numbers by both conservative and socialist Greek governments for years. Tax evasion, fraud, corruption. Will that change?
      People are wondering if in case of Greece is this a one-time action or a hole without bottom (is that the right term in English?).

      Italy too got a bit of negative German media attention lately. Berlusconi announces measures to balance the budget. The ECB in reaction buys Italian bonds to lower the interest rate. Berlusconi then announces that an additional tax on rich people (which was included in the budget measures) wasn´t needed. I understand that it´s now back?

      Anyway such actions don´t inspire confidence in German voters. They´re wondering if they´re asked to permanently transfer money to governments like that?
      Money which won´t be used to rescue and build-up a country so that it won´t need it in the future. But money which will be used inside the country to help the popularity of some politicians.

      Don´t misunderstand me. Even a one time bail out isn´t popular in Germany, it just might be tolerated. The real scare for most Germans is that this might become a permanent fixture.

      (Note: This is just my personal impression on how most German voters see things. I share some of it but not all. For example I don´t see how more and more austerity is supposed to lead to more economic growth.)

      “90% of Germans polled by Emnid don´t believe that the financial crisis can be solved with ever larger European rescue funds. 80% demand that the Bundestag, the German parliament should have to agree every time Germany is asked to to raise its loan guarantees or money transfers.”
      (That poll was done before the German Constitutional Court published its decision.)

      “76% of Germans polled by Emnid are against the introduction of eurobonds as a solution to the financial crisis. Only 15% support such a move.

      46% believe that the German government is doing the right things, 49% disagree.”

      1. Buddy Rojek says

        Thankyou Detlef. In 20 years of reading financial news I have never read this perspective. For me this is the most profound insight I have read. I had a gut feel the Germans will vote against this in the long run, therefore I feel the Euro is doomed in the long term.. The question is like in all Democracies, is: Are the German Voters smart enough to see the smoke and mirrors, or will they be guided by fear and apathy?, like the USA, UK and Australia .

      2. Dave Holden says

        Thanks for the insight Detlef.

        “Just to illustrate the point. In 2010 there were discussions for months on end if the monthly Hartz IV welfare payment could be raised by Euro 5 per month. If the federal budget could afford that. And that was less than Euro 300 million per year. Now we´re talking about Euro 200 billion for the new Eurozone rescue fund and the German parliament is told to hurry. We can barely afford Euro 300 million for the poorest in Germany but we can easily afford/risk Euro 200 for the Eurozone?
        German voters are scratching their heads…”

        It’s exactly this kind of thing that destroys political capital and leads to the disillusionment of voters.

        Of course much of this has little to do with profligate governments and a lot to do with a corrupt financial system. If you really want to make your blood boil take a read of this

  2. Dave Holden says

    Over the last decade or so the eurocracy have created two deficits, a democratic one and a financial one. They’re now faced with increasing the former (possibly to breaking point) to contain the latter. What worries me is that they don’t realise that the former is the more dangerous.

    1. Edward Harrison says

      Europeans want more accountability. But getting it during a crisis is going to lead to a lot of people saying no mas. As a result, soon the bailouts will end, the defaults will begin and then we will see where the political will is then. I am a lot less optimistic.

      1. Dave Holden says

        Really, there wasn’t any optimism in my comment. The failure is that there was no getting political accountability outside of a crisis. The political elite set themselves a trajectory and rode it on the wave of easy money and bullied electorates. A cynic might think that they knew that at some point a crunch would come requiring a fiscal and or debt union, this being their ultimate aim, but I wouldn’t credit them with being that bright.

        I take your point on political will, I think it’s important however to distinguish between incumbent political will and current democratic will. I suspect there is now a great deal of incumbent political will for some kind of fiscal/debt union. I think it’s clear that at least on behalf of the “creditor” nations current democratic will is very much against, which from a purely economic sense of course isn’t rational but the EU “states” relations with each other are a long way away from that of the US “states” relations with each other.

        But yes if the “bailouts” stop the dynamics of the democratic will vs political will, will lets just say be unpredictable.

        1. Detlef says

          And that is the major political problem right now.

          In Germany all major parties supported the introduction of the Euro. While a majority of Germans were skeptical to say it politely.

          The political elite disregarded the will of the voters back then. While telling them that what is happening now could never happen.
          Now that it happened why should German voters believe those politicians again? This time they know what they´re doing?

          It´s one thing to be able to point to a referendum and say: “You voted for it. Now let´s rescue it.”
          It´s quite another thing to say: “We forced it on you. We messed up. Now we´ll force a fiscal/debt union on you.”

          I´ve read newspaper articles here in Germany than a party like the “True Finns” with a charismatic leader easily would get 10-20% of the votes at least.

          And it´s not only about Germany.
          Voters in the Netherlands, Finland or Austria for example are also “unhappy”.

          It´s one thing to rescue a Eurozone member country once. It´s quite another thing to rescue Greece or an Italy governed by Berlusconi. In those cases I fear rescue might mean money transfers year after year. Without any hope for improvement.

          1. Dave Holden says

            “It´s quite another thing to rescue Greece or an Italy governed by Berlusconi.”

            Now that is a frightening thought!

          2. Edward Harrison says

            I was at a Dutch-Brazilian wedding this past weekend and I saw a lot of old buddies from Holland there. Some were very negative about the bailouts and I think you are right that the mood in the Netherlands is similar to that in Germany.

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