The Eurozone has saved itself from oblivion with a massive E750bn aid package. So why is the Euro still weak and why, after a brief surge, are the markets not rejoicing? Surely the risk of a Greek default and the possible resulting contagion to Portugal and Spain was solved by the ECB/IMF loan package – right? Well no not completely. It has certainly shifted the cost of failure to keep the Greek economy afloat from the private sector and banks to the governments of Europe, but what now? Greece already faced civil unrest at the prospect of having to cut services and the public sector wage bill. Even as the country was on the edge of the abyss, workers were on the streets fighting police as if the country’s economic problems were not their problems. Now with the pressure off what incentive is there for Greece to solve it’s vastly inflated national debt? Unlike Ireland who also faced a potential run on its bond market and responded with a widely supported but crushing austerity package, Greece seems to feel this is someone else’s problem and it is unfair to expect them to solve it. As the following graph courtesy of the Financial Times shows, Portugal, Spain and Ireland have all devised and implemented credible debt reduction programs.
Not surprisingly we have not heard much if anything about Ireland as a possible defaulter over recent months. The Irish are understandably unhappy with the austerity measures imposed but they appear to be accepting them stoically as a collective price that has to be paid. Public sector workers have accepted pay cuts rather than massive layoffs in the spirit that this is a problem they have to work through together according to this article.
But for the rescue package to be successful, Eurozone growth will have to return. Yet as the FT points out in a different report, although Portugal, Spain, Greece and Ireland together represent only 15% of the Eurozone economy; Germany accounts for 25% alone. But 15% is not negligible. As Deutsche Bank notes, pre-2008 growth in periphery countries was faster than in the core economies. It predicts that, without that boost from the periphery, Eurozone growth will converge to the pace of Germany, France and Italy, of about 1.5% yearly. Even that may be optimistic if Germany cannot expand domestic demand. With so much of Greece, Portugal and Spain’s economic activity depending on demand from other Eurozone countries slow growth that will hardly support growth at home particularly as funding is being sucked out of the economy by the need to reduce public expenditure. Eurostat is still predicting modest growth (<+1%) from Portugal and Spain next year and a modest contraction (<-1%) for Greece. This seems optimistic if deficit reduction programs are to be effective domestic spending will have to be slashed in an anti Keynesian drive. So with growth among the countries main trading partners in the Eurozone weak where is the counterbalancing export demand going to come from?
It seems growth is going to be slow to come back in Europe as a whole both inside and outside the Eurozone. Britain’s new government needs to push through a credible and effective deficit reduction program in the next 100 days before the markets lose patience. Of all European countries with unsustainable deficit levels only Britain, paralyzed by its general election has failed to put forward a plan to address it. So far demand for government gilts (bonds) have been strong and borrowing rates low but that won’t last forever. Fortunately the 25% devaluation of the pound over the last 18 months is finally feeding through into strong export growth and a surge in manufacturing activity, but at 3+% inflation is still at the upper limits of acceptability and a weak pound won’t help input costs.
The question marks that remain regarding the short-term efficacy of deficit reduction efforts in the Club Med economies and drag on growth from the long-term subsidy cost to the larger core economies will continue to reduce global growth and weigh on metal prices. This is probably not the end of the Eurozone sovereign debt crisis, as a source of uncertainty and volatility it has some way to run.