1. An awful political
background
Since the financial
crisis started in 2007, 8 elections in Europe
have driven incumbent parties out of business. Whether justified or not, it
shows how the European population is disgruntled by a generation of politicians
whose lack of courage led to the current over-indebtedness mess (N.B. voters
share the responsibility by voting for the same politicians they despite now).
For a couple of years I have written that Greece could not
be saved and I strongly believe that European
politicians did not give a damn about Greece to solve the crisis, and were solely interested in insulating their
banks from a Greek default: to succeed, (1) time needed to be garnered
(hence the succession of costly bailouts) and (2) the ECB involved by buying
sovereign debt from banks and extending unlimited liquidities; banks used these
liquidities to buy more European sovereign debt (the 3 years EUR 1 trillion
LTRO is meant (1) to provide some breezing space for deficit prone Southern
European countries –France included- and (2) give a free return to banks to
strengthen their balance sheet in the turn of 2-4% i.e. EUR 20-40 bn a year, a
disgrace– as a side comment, none of the executives of European banks
benefiting from the ECB largess should get any bonus since the profitability of
banks has nothing to do with managerial acumen, and should in fact, for many of
them, be bankrupt; as I have advocating for so many years banks’ executives and
theirs boards should have been fired: what shareholders are waiting for?).
Greece
will again go the poll in June and I do not see why results would favor a corrupt
and incompetent political arena which has ruled Greece for 30 years, and all poll
are giving the extreme left SIRYZA party a large lead. Despite disguised
threats to the Greek electorate (80% want to remain within the EZ but with no
austerity but an open check book from the Germans – they are living in Cuckoo
land) from policy makers about a possible exit from the EZ (if your vote is
wrong i.e. you do not abide by our integrationist rules, then it will be a
disaster for you and no more money from us), the PASOK and the so-called
liberals will be out of business for good, hopefully. The trick is to propose
at the same time a referendum about the exit of Greece from the EZ which would
end up in a rather strange situation where the majority would vote for an
anti-austerity parliament and at the same time vote again the exit from the
euro whilst bailouts are linked to austerity; the discussions about adding
growth to austerity are fine but will not address the roots of the problem:
lack of competitiveness.
After the failure of economic convergence within the EZ, we
are witnessing Greece’s standard
of living fast converging not with Northern Europe but with its European
neighbors, Romania and Bulgaria!
For the time being, Greece got its EUR 4.2 bn rescue payment
from Europe last week (add EUR 1.6 bn if the IMF disburses its part of the
deal) that will cover its liquidity needs for June and probably until late July
since Greece has hardly any repayment due in July.
Parliamentary elections in France, also taking place in June,
will see the current Sarkozyst party (UMP) lose a considerable number of seats pending
unofficial local agreements with the FN, Mrs. Le Pen populist party. The socialist party will win the elections,
the question being by which margin: if their victory is large enough, after
gaining control of the Senate in September 2011 for the first time under the Vth Republic, they could hold 2/3 of the
congress (Senate + Parliament gathering) to modify the constitution as they
wish.
Germany’s Chancellor Angela Merkel registered a strong defeat in North
Rhine-Westphalia state election in May, the most populated region. However the
increased lead for the SPD (the center left) does not mean that this will end
the austerity imposed onto Southern Europe since it is the SPD that enshrined
budget balance in the Constitution: Germans will not agree to finance ad vitam
aeternam Southern Europe for the sake of “peace and the European construction”,
which is the dogmatic and untrue eurocratic motto.
2. An awful economic
background
Economic forecasts for
2012 and 2013 are between bad and disastrous for Club Med countries (the
IMF is less confident than the EC, and private forecasters are even more
pessimistic), and downward revisions will crawl along the year and next.
As the table below exemplifies, GDP will turn negative this year and more deeply so in 2013, with
hardly any EU country escaping, the EZ
being more affected, and within the EZ, Southern
Europe the most
In the case of France, the new President, François
Hollande, based his economic program on official, and as usual over-optimistic,
growth forecasts of 0.7% in 2012, 1.75% in 2013 and 2% until 2016, whilst the
country will be in negative territory in 2012 and 2013 at least. Add a Greek
default and you get an asset that becomes a straight loss in the turn of EUR 15
bn from the first bailout already paid plus any recapitalization of the ECB.
France’s
deficit will not be reduced back to the 3% Maastricht criteria in 2016 and its debt will
continue on its upwards trajectory. Expect 2 notch rating downgrade within 12
months.
Like other Europeans,
the standard of living of French citizens will keep up contracting.
The key issue of low
competitiveness is structural, and economic, social and tax reforms are not
addressed. Policy makers have focused for too long on what they thought,
incompetently or dogmatically, were liquidity issues.
3. The choice
This foolish blindness is leading to one of two tough choices: internal or external devaluation to quickly
regain competitiveness.
Let’s come back to my preferred equation:
PIB = Public spending
+ private spending + commercial balance
The World has huge
imbalances which result from demand led economies (USA for example) whose consumption is satisfied by export driven economies (China for
example), and these imbalances must be
corrected to go back to some economic and financial normality.
Looking at the equation, and taking into account the state
of debt and budget deficits in demand driven economies in the West, they MUST shift their focus to improving
their trade balance, and export driven countries MUST stimulate domestic demand.
There are two ways to
improve the trade and services balance: either increase exports or reduce
imports or a combination of the two.
To increase export
one needs to propose goods that others want to buy by focusing on added value
products (there is no way to be competitive for goods very elastic to prices) or
unique goods and improve competitiveness.
Wage and social costs are the items a country controls which impact
productivity and no Club Med country will escape harsh austerity. Energy is
also quite important and must be addressed (the USA is thriving in becoming
self sufficient again in the years ahead thank to technology which allows shale
oil and gas recovery – this will all also have a substantial positive impact on
the US trade balance).
To reduce imports, goods
must become too expensive for consumers or find the same ones locally at
attractive prices. This can be achieved
via custom tariff and/or other tricks or via unfavorable exchange rates.
Therefore, taking
the extreme case of Greece
(but it is valid for Spain, Italy, France, etc.), to rebalance the economy and improve the terms of trade, the choice is between
external or internal devaluation.
External devaluation
corresponds to the exit from the fixed exchange rate mechanism (the euro)
where the Drachma will loose 50-70% of its new parity with the euro (or DM)
leading to much higher imported goods thus lowering consumption and more
importantly lowering imports; this assumes that the goods and services needed will
be substituted with locally produced ones, otherwise the country will continue
impoverishing itself. The terms of trade for exports will also dramatically
improve, assuming Greece
will produce goods other countries want to buy. For the country not to crumble
under debt servicing, this will be accompanied
with a debt default (restructuring, straight default, inflating the debt
away, you name it). Competitive exchange
rate devaluation has always been and still is an economic policy tool (see
the US and China manipulating their currencies
at will).
Internal devaluation
is where countries have chosen austerity without currency devaluation: the only
adjustable variable is real wages and social benefits which must be reduced and
this must be equivalent to a currency devaluation. The terms of trade will
not improve and trade imbalances will remain. Debt servicing becomes
unsustainable by eating a rising portion of taxes collected. This can only work
with fiscal transfers from other countries if a social collapse is to be
avoided, i.e. Germany
continuing paying.
Whatever the course
of action followed, the standard of living of Europeans will continue to fall
for years if not for a decade. However, the internal devaluation
route, if followed, would end up very nastily.
I will never
sufficiently outline the need for Europe to focus on innovation (strength
of the US which also explains why I am more positive on the US economic
prospects than the European one) and
demographics, an other factor of economic growth: spending money in these areas
instead of Greece et al. would have been more beneficial to European growth
long term.
Source:
Capital Economics: European Economic Outlook Q2 2012
http://www.capitaleconomics.com/
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