Wednesday 21 March 2018

Germany should look over the brink and shudder with fright

Today is Thanksgiving and, in the United States, a Congressional 'super committee' charged with finding $1.5 trillion in deficit-reduction measures failed to meet its deadline. There was a lot of recrimination and markets sagged but, in truth, the fallout will not disturb too many turkey dinners.

The issue is already disappearing from the headlines. In Europe, however, the crisis spreads inexorably on and the turkeys are running amok.

Three big differences between the budgetary problems in Europe and the US tell a lot about the nature and danger of the euro crisis:

First, the US had a safety net in place in case negotiations failed. The Budget Control Act of 2011 will now set in motion a series of mandatory across-the-board spending cuts to secure the necessary adjustment over 10 years.

The mandatory cuts may not be to the liking of many politicians but they would satisfy rating agencies.

Europe has no safety net. The only possible candidate for this role is the ECB but it steadfastly refuses to accept the part, even while it makes regular cameo appearances in the bond markets.

It spends all of its time describing what it cannot do instead of seriously considering what it might. And this only succeeds in making the situation seem more dangerous; scaring the markets with the prospect of a complete collapse and making the task confronting each and every country more difficult.

So, the US had the foresight to bind itself to a solution, however imperfect. Europe is preoccupied with ruling out a solution, however necessary.

Second, the US has identified and confronted its problems and the mandatory cuts are quantified according to a credible annual timetable. Everybody knows what is supposed to happen.


Policymakers in Euroland, meanwhile, are fascinated with preventing problems from arising in the future and make frequent proposals on how budget deficits would be monitored and controlled under a new regime.

Brussels made another valiant foray into this territory yesterday. But such proposals, even if they could eventually lead to Eurobonds being issued or to a measured ECB intervention, are completely unrelated to the current impasse. There is no credible plan to deal with the urgent debt and banking problems that afflict us now.

So, the US has set a target for the future and charted a path to it. Europe dreams of a better world but has no idea how to get there.

And the third difference between the US and Europe arises as a result of the first two -- interest rates on government debt in the US are at record lows and steady while interest rates on the government debt of more and more European countries are rising to unsustainable levels.

This is because the problem in the US is identified and under control while the problem in Europe is elusive and growing.

Recent macro-economic data for the US have been better than expected while growth rates in Europe are constantly marked down.

Angela Merkel continues to argue that problems in the eurozone spring from fiscal laxity in individual countries but, as the legion of supposed miscreants continues to grow, this explanation is ever less credible.

Why do markets suddenly alight and put pressure on countries that are trying to put their books in order? The answer, of course, is because the prospects of a safety net being in place look increasingly dim and the consequences of a slip are ever more frightening. Therefore, the benchmark for fiscal probity continues to rise and, as it does, it disqualifies more countries.

This is a systemic crisis, not a set of isolated problems, and it must be confronted with a euro-wide solution.

But time is running out and individual countries must have prepared their own fall-back plans by now, their disaster strategies.

Doomsday scenario

As mentioned previously in this column, Ireland would be in a better position than most in a doomsday scenario because our banking system is a net debtor on international markets -- it owes more than it is owed.

Therefore, Ireland could close its banking system to the outside world in the event of a financial collapse -- as Iceland did in 2008 -- and continue to serve the domestic economy until a more permanent solution is worked out.

This path is not suggested lightly, but it could get Ireland through a European banking crash; which is the ultimate nightmare.

And, in these circumstances, countries with banking systems that are net international creditors have more to worry about.

A banking crash would leave their assets impaired and their governments would have to quickly plug the gap. Iceland's defensive measures fuelled a bank run in the United Kingdom.

So, as bond yields in Spain and Italy sit just below the 7pc trigger point, and Ms Merkel talks of treaty changes and the impossibility of issuing eurobonds or hatching a plan that would fully engage the ECB, somebody in her cabinet should have a look over the brink.

German and ECB brinksmanship, aimed at putting pressure on problem countries to introduce reforms, is beginning to turn back on the creditor nations. And Europe is walking a very high wire.

Gary O'Callaghan is Professor of Economics at Dubrovnik International University. He was a member of the staff of the IMF and has advised numerous governments on macroeconomic policies.

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