Euro: Taking No Comfort

The late Milton Friedman famously predicted that the euro would not pass their first economic crisis. The euro, or so the argument went, was doomed from the outset because of the wide spread in economic performance and discipline amongst the member countries. At one hand, we have the highly disciplined but slow growing economies of Germany and the Netherlands and on the other extreme, we have the faster growing but poorly disciplined countries such as Spain and Greece. As the icing to the cake, we also have countries that lack in both departments such as Italy, which make it difficult for the union to ‘gel’ well.

On the spirit of global uncertainty, the recession dynamics are already firmly entrenched, in a context of declining corporate investment and steep labour market deterioration. The deterioration of the labour market has just started in some countries of the Eurozone and the worst is still ahead.

The European approach, at least until now, has been to save the banking system at any cost. A larger part of European debt has to be financed externally and unless there is a material improvement in market conditions, re-financing at such as a massive (estimated more than US$1.5 trillion) is simply a challenge. It is possible that a significant share of the re-financing cost will find its ways to the sovereign balance sheet, ultimately to the tax-payer, and the slow normalization of the credit market will keep a larger fraction of the monetary stimulus not to be fully passed to the final consumers.

I am particularly concern about the widening interest rate differentials between member countries in the Eurozone with regard to the solidity of the single-currency area. This certainly has raised the risk of a collapse of monetary union quite considerably. All these challenges are surfacing as the global economy faces the worst year since World War II. I am becoming increasingly convinced that most of us are underestimating how long it will take to get the global economy firmly back on its feet again.

Another issue, which is potentially even more destabilizing for the euro longer term is the massive liabilities facing Europe as its population ages. Greece is clearly facing the biggest challenge. Public debt, which currently stands at about 95% of GDP, will grow to a whopping 555% of GDP by 2050, if the current pension and social security program is left unchanged. The Greek government is painfully aware of this and was passing one of those new laws, which caused the riots in Athens before Christmas.

The problem, as I have already alluded to, is poor discipline amongst several of the member states. Ever heard of the four PIGS? These economies are often considered the ‘anti-dote’ to the BRIC countries. This less than flattering acronym stands for Portugal, Italy, Greece and Spain – which are all in much deeper trouble than they are prepared to admit.