Wall Street Journal Europe
September 20, 2010
by Irwin Stelzer
If you can't solve a really important problem, create one that you can solve. So while the eurocracy fiddles with charges and countercharges of Nazi-ism over the issue of sending gypsies home, the economy burns. And not because it is overheating.
"Europe lags other major regions of the world in terms of economic recovery…" Although it is still growing slowly, continues the report of the Economic Group at Wells Fargo Securities, "the recovery in the euro zone is hardly self-sustaining at present…" David Owen, chief European financial economist for Jeffries International concurs, "We have had more evidence of activity in much of the EU losing some momentum… hardly surprising… given much of the growth seen in Q2 was inventory led." To which Goldman Sachs adds that "the softening global demand environment creates headwinds for exports."
Industrial production in the euro zone does not seem to be growing, after a Germany-driven period of growth in the first half of the year. The optimism engendered by that growth has also faded. The index of expectations for the German economy—based on a survey of financial analysts—dropped 18 points into negative territory in September, the largest drop in close to two years.
There are multiple reasons for the replacement of first-half euphoria with gloom. Perhaps most important is the market's expectation that if Greece falls the other peripheral dominoes, with Spain a possible exception, will follow. Consider the argument mounted by Greek finance minister George Papaconstantinou to support his position that Greece will not have to restructure its €300 billion ($390 billion) debt. "If Greece restructures, why on earth would people invest in other peripheral economies?"
Indeed, why on earth would they? Mr. Papaconstantinou assumes that in order to avoid such a catastrophic "break to the unity of the euro zone", the Brussels cavalry, flush with German money, will ride to the rescue, with help from the International Monetary Fund if Greece remains effectively locked out of financial markets by the more-than 11% interest rate investors are demanding on Greece's 10-year bonds in anticipation of a 30% "haircut" on Greek debt.
Note first the concession that as Greece goes, so go the periphery countries, and as they go so goes the euro zone. Hence, "Save us or else…"
There is truth in that argument. A default by Greece would certainly increase the pressure on Ireland, which has been hit by a report from Barclays Capital suggesting that Ireland might have to call on the EU and the IMF for a bail-out; a radio interview by Taoiseach [prime minister] Brian Cowen, after which he was forced to deny being drunk or hungover, but who says that in the future he "will be a bit more cautious in terms of that aspect of how I conduct my social life"; and figures showing that even if the cost of bank bail-outs is excluded Ireland's fiscal deficit will hit 11.6% this year.
Yields on Irish 10-year bonds, at 6.17%, are almost four percentage above bunds and at their highest level since the euro was launched in 1999, which suggests that Ireland will pay a fancy premium at tomorrow's auction of four- and eight-year bonds.
The struggles of Greece and Ireland are not the only reason that sentiment has turned sour. It is becoming increasingly clear that more than a few euro-zone banks have not confronted the bad debts still on their balance sheets. Ireland's banking sector is essentially insolvent, loaded down with loans to property developers who cannot repay. Any doubts that German banks are undercapitalized were dispelled when they fought to water down the new and not-so-very-demanding Basel III capital requirements. Worse still, any confidence generated by the recent stress tests is fast dissipating. It turns out that an unknown number of the 91 banks tested excluded holdings of certain sovereign bonds from their reports to regulators, to the tune of billions of euros. It seems that regulators were eager to demonstrate that Europe's banking systems are in good shape, and jiggered the reporting rules accordingly.
All of this has the eurocracy in a quandary. Jean-Claude Trichet, president of the European Central Bank, continues to insist that the path to sustainable growth lies in ever-more austerity to restore business confidence. The Organization for Economic Co-operation and Development, until recently in agreement with Mr. Trichet's prescription, has studied new data, decided that the EU economy is slowing at a pace that "is somewhat more pronounced than previously anticipated," and that with 24% of people in OECD countries out of work for a year or more, less emphasis should be placed on austerity and more on stimulating growth—a position in line with that of President Barack Obama and Britain's opposition Labour Party.
All very confusing. But one thing is clear: the peripheral countries and Europe's banks are going to have to raise money on terms that are, to put it mildly, unlikely to contribute to rapid growth.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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