Another front page article in today’s New York Times attempts to explain why the economic and financial crises in the Euro nations are not resolved. Like too many US media discussions, it skips between several issues, related to be sure, but without sorting out which set of facts goes with which issue. These connections matter.
We see this jumble in the title, Even as Governments Act, Time Runs Short for Euro, and again near the top of the piece by Kulish and Erlanger, who begin by noting the resignation of Italy’s Berlusconi. As in Greece, Italy’s leader has been replaced by a supposedly competent “technocrat.” What do they mean?
Both there and in Greece, jumbled parliaments came together with urgency to install more technocratic governments that are committed to delivering the difficult reforms and austerity measures demanded by the European Union, the European Central Bank and the International Monetary Fund.
Despite those drastic and tangible steps, though, there is a host of problems that could quickly overwhelm Europe’s progress.
Looming over all the discussions of reform and financing mechanisms is the slowdown in the Continent’s already anemic growth rate, to 0.5 percent in 2012, and even the threat of a double-dip recession, the European Commission said in a forecast for the euro zone last week.
That calls into doubt the adequacy of the euro zone’s latest attempt to placate the markets, the lagging effort to bolster the $605 billion European Financial Stability Facility to $1.4 trillion or to find other funding. The task will become that much harder in a recessionary environment, especially as France’s credibility with investors begins to decline.
The title implies that even though new government leaders are now working to solve the problems, their solutions may not come fast enough. The article reinforces that message by implying the new leaders are presumably competent — because they’re “technocrats.” However, “despite” being “committed” to the necessary solutions — “reforms and austerity” — that may not be enough. The reporters then suggest the new leaders’ austerity commitment is at risk because Europe will likely suffer minimal growth or another recession, and that will undermine the austerity measures and the adequacy of the bailout fund.
That discussion is typical of US coverage, but I think it’s a confused mess and mostly backwards.
There appear to be multiple, simultaneous and related problems going on, so it’s important to sort them out. For example . . .
First, there is a massive and dangerous bank run going on, based on fears that weaker Euro nations will not be able to cover their sovereign debts. As the market demands higher and higher interest on their bonds, those nations can’t indefinitely afford to borrow or issue new bonds to roll over their existing debt. Their own banks, banks in other nations, and other private lenders own sovereign debts in the form of bonds issued by Greece, Italy, Spain and so on, and all of those creditors are trying to sell those bonds to minimize their own losses — hence the run.
If the run continues, it could create insolvency – “self fulfilling” as Krugman calls it — for some countries — Greece already, Italy next, then others — so that none of them could borrow to keep going. The Euro-based economy would crash, and everyone who trades with them, including the US, would take a huge hit in turn. It could cause a new recession here.
So the first priority is to stop the run. That has to be done immediately. They’ve been applying bandaids to a hemorrhaging wound, and that can’t last. The so-called “bailout” mechanism was supposed to stop the run, but its funding depends on Euro governments putting up enough funds to stop runs not just on Greece but on Italy and perhaps beyond. Acting individually, the Euro nations can’t or won’t make enough commitments, so creditors conclude the fund is inadequate and the immediate crisis — the run — continues.
Now let’s assume a can opener. In theory, many economists now say, the European Central Bank could stop the run by acting as the “lender of last resort” to backstop all Euro nation sovereign debt. That’s one of the things a central banker of a real union is supposed to do. It’s what Ben Bernanke and the Federal Reserve did in 2008-2009 and would do again here (and Ben included foreign banks too). If this happened in Europe, economists tell us, the bank run would end, because creditors would know that the central bank stands behind Euro nation debts, so their value would not disappear, and the panic selling would stop.
That’s just the first problem. Even if the ECB dropped its refusal, demanded by the Germans and other creditor nations, to perform this necessary function, there would still be a major economic problem in most of Europe. That problem is the absence of economic growth and the corresponding problems of high unemployment, which in turn reduce government revenues and increase safety net spending. Here’s where the Times story and many others get the problems and solutions mixed up.
The common story is that all Euro nations need to radically reduce their debts and annual deficits so that concerns about each sovereign debt’s value collapsing (via default) would lessen. The ECB, the IMF, and the financial directors of the larger European Union together insist that all Euro nations impose severe austerity on their respective budgets and populations to achieve the goal of lowering sovereign debt. But that one size fits none solution is a principal cause of the problem of no growth and high unemployment across the Euro region. Austerity is strangling the weaker economies and pushing the stronger ones into zero growth or recession, and that in turn is making deficits worse.
Euro nations thus need selective policies to stimulate growth and lower unemployment, and you can’t do that with austerity on everyone. Having competent technocrats committed to austerity in Italy or Greece doesn’t address this problem, and it’s not a substitute for a competent ECB playing the lender of last resort; it may even make it worse. And ignoring popular and entirely justifiable opposition to aspects of austerity is seriously undermining democracy and legitimacy.
Not all Euro nations have the same options for stimulating growth. Greece appears to have almost none acting on its own — it can’t borrow and it doesn’t have enough to export that others want to buy – but that’s not true for Italy, which does have competitive industries that can support economic growth. Growing exports would help, but more budget austerity when they’re already in primary balance (though they have large total debts) would not help them much. It only makes the economic downturn worse.
More important, Germany (as well as the UK and other Northern countries) has considerable capacity to expand its government and/or domestic spending, and that in turn would not only boost their own economies but provide larger markets for Italy, Spain and others who need to sell more. So some austerity may be unavoidable for some — but they also need a huge debt restructuring and more aid — but others with more capacity don’t need it and should be doing the opposite, expanding their economies. The supposedly competent technocrats, all connected to the UCB and “austerians,” oppose this.
Similarly, the concern that stimulus policies, or aggressive lending or money creation by the central bank would cause inflation are overly simplistic. When the problem is excessive debt, some inflation is a good idea. And it’s better for some nations than for others. So many economists have suggested stimulative monetary policies that would deliberately increase inflation. The average inflation for all would be higher than currently allowed by the ECB’s restrictive policies. But more important, the higher average would keep inflation from being too low in the debtor nations who need inflation.
This explanation is already too long, and it too risks being too simple. For deailed technocratic solutions, try Roubini. But it should be clearer than the confused, jumbled mess we keep getting from much of our media. And right now, with our own Congress drawing the wrong conclusions from Europe and hopelessly preoccupied with a phony debt crisis when there is no such crisis here, we could use a lot less confusion on these topics.
More on the daunting task facing the new Italian PM, from Gavyn Davies, The Italian Job, Financial Times