Just about everyone outside of Europe’s ruling elite sees the Euro as a train crash in slow motion.
Every day, we open our papers or turn on our screens to be greeted by yet more depressing reports of rising bond yields, squeezed bank lending, austerity measures and slowing growth, but just how bad are things and where is it likely to lead?
Drawing on data in recent articles in the FT and the Economist, the situation looks pretty dire and as to the likely outcome, that depends on whom you ask. Germany’s Angela Merkel would tell you all those struggling states such as Greece, Portugal, Italy and Spain need to do is apply brutal austerity measures and the bond markets will conclude everything is under control and financing cost will drop. The problem with that stance is the markets haven’t bought into the German view of the problem, and so matters have continued to deteriorate. Meanwhile, the financial infrastructure of Europe is freezing solid.
The euro zone and those countries around it that rely on the single currency block for a large chunk of their trade, such as the UK, are going into a recession — if they’re not already there. The probability, if the single currency doesn’t implode, is that it won’t be a long or deep recession, although contraction is in the making, as the Economist explains.
September’s sharp decline in industrial orders is an early sign that companies are cutting back, the magazine says, quoting research at JPMorgan. The world’s largest maker of ball bearings, Swedish SKF, said to be a bellwether of industrial demand, predicted a further softening of investment demand going forward. Consumers are likely to defer big purchases as long as the crisis is unresolved and credit is scarce, the bank said; a drop in demand for capital equipment, durable consumer goods and cars will strike at the euro zone’s industrial heartland, including Germany. GDP could drop by 0.5 percent in Germany next year and up to 2 percent across the EU, according to the FT.
Conditions are ripe for a recession. There is a credit crunch as banks have stopped lending on the wholesale market, tighter fiscal policy as countries desperately apply austerity measures to fend off the bond markets, and a dearth of consumer confidence as unemployment rises and talk of recession becomes widespread. Not only are banks not lending to each other, but investors are wary of lending to banks that have euro zone bonds on their books. Banks are shedding assets both to raise cash and to increase their capital reserves in order to meet EU capital adequacy targets. First to exit are banks’ loans to emerging markets such as those in Eastern Europe and Turkey. The flow of funds back into euros is probably the unseen hand that has been perplexing forex dealers convinced the euro should have collapsed by now.
Fiscal tightening cannot but weaken growth. Neither capital investment nor consumer demand will rise in the early stages of these long-term austerity plans. As consumer confidence spirals downward, a process that is already very evident in the UK, firms will hold leaner stocks, reduce discretionary spending and defer capital projects.
Public reaction to the austerity measures has already resulted in rioting on the streets; the great unknown is whether governments can carry their electorate with them as the cuts bite. Tax receipts will fall as economies, at least in the peripheral states, contract at the same time as welfare payments rise with unemployment, making it harder for states to meet their obligations. The pressure to default and to exit the euro will rise.
So which countries will fall first?
Continued in Part Two.