The calm before the eurozone’s next big storm. A LITTLE more than a year ago, the eurozone, faced with growing fears of a Greek exit and unsustainably high borrowing costs for Italy and Spain, appeared to be on the brink of collapse. Today, the risk that the monetary union could disintegrate has diminished — but the factors that fuelled it remain unaddressed. But beneath the surface calm of lower spreads and lower tail risks, the eurozone’s fundamental problems remain unresolved. For starters, potential growth is still too low in most of the periphery, given ageing populations and low productivity growth, while actual growth — even once the periphery exits the recession next year — will remain at less than 1% for the next few years, implying that unemployment rates will remain high. Meanwhile, levels of private and public debt — both domestic and foreign — are still too high and they continue to rise as a share of gross domestic product because of slow or nonexistent output growth. This means that the issue of medium-term sustainability remains unresolved. At the same time, the loss of competitiveness has been only partly reversed, with most of the improvement in external balances being cyclical rather than structural. The recession in the periphery has caused imports there to collapse, but lower unit labour costs have not boosted exports enough. The euro is still too strong, limiting the improvement in competitiveness needed to boost net exports in the face of weak domestic demand. Finally, while the fiscal drag on growth is now less, it is still a drag. And its effects are amplified in the periphery by a credit crunch, as undercapitalised banks deleverage by selling assets and shrinking their loan portfolios. The larger problem is that progress toward banking, fiscal, economic and political union has been too slow. Indeed, there has been no progress on the latter three, while progress on the banking union has been limited. Germany is resisting the risk-sharing elements of such a union: common deposit insurance, a common fund to wind up insolvent banks, and direct equity recapitalisation of banks by the European Stability Mechanism. Germany fears that risk-sharing would become risk-shifting, and that any form of fiscal union would likewise turn into a "transfer union", with the rich core permanently subsidising the poorer periphery. At the same time, the entire regulatory process for the financial sector is procyclical. The new Basel 3 capital-adequacy ratios, the European Central Bank’s (ECB’s) upcoming asset-quality review and stress tests, and even the European Union’s competition rules all imply that banks will have to focus on raising capital — and thus not providing the financing needed for economic growth. Moreover, the ECB is unwilling to be creative in pursuing policies that would ameliorate the credit crunch. Unlike the US Federal Reserve and the Bank of Japan, it is not engaging in quantitative easing; and its "forward guidance" that it will keep interest rates low is not credible. On the contrary, interest rates remain too high and the euro too strong to kick-start faster economic growth in the eurozone. In the meantime, austerity fatigue is rising in the periphery. The Italian government is on the verge of collapsing; the Greek government is under strain as it seeks further budget cuts; and the Portuguese and Spanish governments are having a hard time achieving even the looser fiscal targets set by their creditors. And bail-out fatigue is emerging in the eurozone core. In Germany, the next coalition government looks set to include the Social Democrats, who are pushing for a bail-in of the banks’ private creditors, which would only worsen the Balkanisation of the eurozone’s banking system; and populist parties throughout the core are pushing against bail-outs. So far, the bargain between the core and the periphery has held up: the periphery continues austerity while the core provides financing. But the political strains may soon reach a breaking point, with populist anti-austerity parties in the periphery and populist anti-euro and antibail-out parties in the core possibly gaining the upper hand in next year’s European Parliament elections. If that happens, a renewed bout of financial turbulence would weaken the eurozone’s fragile economic recovery. The calm that has prevailed in eurozone financial markets for most of the past year would turn out to be only a temporary respite between storms. • Roubini is professor of economics at the Stern School of Business at New York University. © Project Syndicate, 2013.
Posted on: Fri, 04 Oct 2013 05:50:03 +0000
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