I detect a somewhat more hopeful stance in this report on the eurozone’s prospects compared to earlier S&P reports. There’s more than a glimmer of hope in the report’s introduction:
The eurozone should gradually climb out of its mild recession in the second half of this year and into 2013, in Standard & Poor’s opinion. We think core countries will lead the way, with other member countries delivering diverging performances. Under our baseline forecast for 2012-2013, which we updated at the end of 2011, we project flat GDP for the eurozone as a whole in 2012 and 1% growth in 2013.
We acknowledge, however, that risks of a steeper downturn this year have risen. We currently assign a 60% probability to our baseline forecast, versus 40% for our alternative forecast of a true double dip, which would have a particularly adverse impact in countries like Spain, Portugal, and Italy. We believe three main factors will determine the depth of the eurozone’s downturn:
How demand from emerging markets holds up in the coming quarters;
How European consumers react to renewed uncertainties, such as rising unemployment and concerns about the sovereign debt crisis; and
How European governments and especially the European Central Bank (ECB) rekindle investor confidence in capital markets in the next few quarters.
Still, we think the scale continues to tilt in favor of a mild recession and a gradual return to growth, taking into account potential growth in emerging market demand, resilient consumer demand in the core countries, and somewhat restored investor confidence.
The Economist isn’t impressed with the past week’s speculation in some quarters that Europe’s leaders had at long last put together a a plan to save the euro. It cites three reasons for being skeptical:
First, for all the breathless headlines from the IMF/World Bank meetings in Washington, DC, Europe’s leaders are a long way from a deal on how to save the euro. The best that can be said is that they now have a plan to have a plan, probably by early November.
Second, even if a catastrophe in Europe is avoided, the prospects for the world economy are darkening, as the rich world’s fiscal austerity intensifies and slowing emerging economies provide less of a cushion for global growth.
Third, America’s politicians are, once again, threatening to wreck the recovery with irresponsible fiscal brinkmanship.
With each passing week, the negative ramifications of fiscal austerity (the primary topic of my recent essay) are being noted more widely and frequently. But neither governments nor monetary authorities are as yet listening to the drumbeat from those without the power to do anything about it.
But I digress. Let’s get back to what the Economist has to say.
On the eurozone:
The doom-laden lectures from the Americans and others in Washington last week did achieve something: Europe’s policymakers now recognise that more must be done. They are, at last, focusing on the right priorities: building a firewall around illiquid but solvent countries like Italy; bolstering Europe’s banks; and dealing far more decisively with Greece. The idea is to have a plan in place by the Cannes summit of the G20 in early November. That, however, is a long time to wait—and the Europeans still disagree vehemently about how to do any of this (see article). Germany, for instance, thinks the main problem is fiscal profligacy and so is reluctant to boost Europe’s rescue fund; yet a far bigger fund is needed if a rescue is to be credible. The most urgent solutions, such as restructuring Greece’s debt or building a protective barrier around Italy, require the most political courage—something that Angela Merkel, Nicolas Sarkozy et al have yet to exhibit. The chances of a bold enough plan will shrink if markets stabilise. The less scared they are, the more likely Europe’s spineless policymakers are to jump yet again for a plan that does just enough to stave off catastrophe temporarily, but lets the underlying problem get worse.
[...] Even if the euro-zone crisis were to be solved tomorrow, the region’s GDP would probably shrink over the coming months.
On the U.S.:
Whatever it does, America is currently on course for the most stringent fiscal tightening of any big economy in 2012, as temporary tax cuts and unemployment insurance expire at the end of this year. That could change if Congress came to its senses, passed Barack Obama’s jobs plan and agreed on a medium-term deficit-reduction deal by November. If Democrats and Republicans fail to hash out a compromise on the deficit, draconian spending cuts will follow in 2013. For all the tirades against the Europeans, America’s economy risks being pushed into recession by its own fiscal policy—and by the fact that both parties are more interested in positioning themselves for the 2012 elections than in reaching the compromises needed to steer away from that hazardous course.
On emerging economies:
Some emerging economies, including China, have less room to repeat their 2008-09 stimulus because of the debts that splurge left behind. Monetary policy can be loosened: several central banks have cut rates. But, overall, the emerging world will be less of a buoy to global growth than it has been hitherto.
The bottom line:
. . . governments are not just failing to act: they are exacerbating the mess . . . more often than not, policymakers seem to be getting it wrong. Their mistakes vary, but two sorts stand out. One is an overwhelming emphasis on short-term fiscal austerity over growth . . . The second failure is one of honesty. Too many rich-world politicians have failed to tell voters the scale of the problem . . . At a time of enormous problems, the politicians seem Lilliputian. That’s the real reason to be afraid.
Now, at the end of this exposition, it might be useful for me to tell you what is the assessment that the European Systemic Risk Board has expressed after its last meeting only two days ago:
Since its previous meeting on 22 June 2011, risks to the stability of the EU financial system have increased considerably. Key risks stem from potential further adverse feedback effects between sovereign risks, funding vulnerabilities with the EU banking sector, and a weakening growth outlook both at the global and the EU level. Over the past few months, sovereign stress had moved from smaller economies to some of the larger EU countries. Signs of stress are evident in many European government bond markets, while the high volatility in equity markets indicates that tensions have spread across capital markets around the world. The situation has been aggravated by the progressive drying-up of bank funding markets, and availability of US dollar funding to EU banks had also decreased significantly. In that context, central banks have decided on coordinated US dollar liquidity-providing operations with longer maturities. The high interconnectedness in the EU financial system has led to a rapidly rising risk of significant contagion. This is threatening financial stability in the EU as a whole and adversely impacts the real economy in Europe and beyond.
Looking ahead, decisive and swift action is required from all authorities. In the immediate future this includes: (1) implementing, fully and rapidly, the measures agreed upon at the 21 July meeting of the Heads of State or Government of the euro area; (2) adopting sustainable fiscal policies and growth-enhancing structural measures so as to achieve or maintain credibility of sovereign signatures in global markets; and (3) enhancing the coordination and consistency of communication.
Authorities must act in unison with a total commitment to safeguard financial stability. Supervisors should coordinate efforts to strengthen bank capital, including having recourse to backstop facilities, taking benefit from the possibility of the European Financial Stability Facility to lend to governments in order to recapitalise banks, including in non-programme countries.
European officials are working on a grand plan to restore confidence in the single currency area that would involve a massive bank recapitalisation, giving the bail-out fund several trillion euros of firepower, and a possible Greek default.
TODAY’S RECESSION does not merely resemble the Great Depression; it is, to a real extent, a recurrence of it. It has the same unique causes and the same initial trajectory. Both downturns were triggered by a financial crisis coming on top of, and then deepening, a slowdown in industrial production and employment that had begun earlier and that was caused in part by rapid technological innovation. The 1920s saw the spread of electrification in industry; the 1990s saw the triumph of computerization in manufacturing and services. The recessions in 1926 and 2001 were both followed by “jobless recoveries.”
The above quotation is from an essay in the current issue of The New Republic. Written by John B. Judis, titled “Doom!” and subtitled “Our economic nightmare is just beginning,” it synthesizes the economic and political angst currently being experienced here and in Europe, as well as the disturbing parallels between the Great Depression of the 1930s and what could easily become the Great Depression of the 2010s. It’s an essay I would be proud to have written. I encourage you to read every word, and would appreciate your comments.
Recession in the eurozone is now CitiGroup’s “baseline” scenario. Here’s its overview of the situation:
In this note, we revisit the likely timing of debt restructuring for Euro Area (EA) sovereigns. Although our focus is on sovereign insolvencies, these are the likely outcome of multiple interacting and mutually reinforcing financial disfunctionalities in the European Union. We are facing the likelihood of multiple sovereign defaults in the outer periphery of the EA — Greece, Ireland and Portugal. In addition there is the problem of sovereign illiquidity despite likely fundamental sovereign solvency in the inner periphery of the EA — Italy and Spain. If handled badly, illiquidity could threaten default, and the risks of this happening could spread beyond the periphery into the core EA, notably Belgium and France. Finally, there is the European Union (EU)-wide problem of undercapitalised banks threatened with insolvency by the impairment of their exposures to the risky EA sovereigns. All these problems are reinforced by the lack of effective political leadership in the European Union and the Euro Area. Neither the heads of state/heads of government of the member states, nor the leaders of the European institutions, including the European Commission, the European Council and the ECB, have been able to move beyond a strategy of trying to put out the most urgent immediate fire. There has been no sign of a comprehensive solution to the problem of excessive sovereign debt and deficits and of inadequate banking sector capitalisation. [My emphasis] Following each new emergency, the authorities are farther behind the curve.
The reason the single currency is in such terrible trouble is that governments across Europe have failed to persuade electorates that the EU itself is worth saving . . . The commentaries that puzzle me are those that say in one breath that the eurozone cannot survive and follow in the next by asserting that break-up is impossible because of the attendant costs . . . What stands in the way of a resolution of the crisis is not the absence of a plausible technical or economic fix, but the revival of the continent’s nationalisms.
A world expansion must be strong . . . It must be stable . . . it must be balanced . . . The alternative is another financial and economic crisis, worse perhaps than that of 2008-09 . . . Fiscal policy is being tightened . . . Companies are hoarding cash. Households are reducing liabilities and governments, particularly in the eurozone, are realising the limits of being the consumer of last resort.
Contrary to received wisdom, the US did not have the loosest fiscal plans of advanced economies. In fact, with tax cuts due to expire at the end of 2011, before the president’s speech, the administration was planning the deepest austerity drive in 2012 of any G7 country . . . In contrast, while Germany preaches austerity to the rest of Europe, it has the loosest plans for fiscal consolidation in the G7 for 2012.
Despite trillions of dollars of quantitative easing, huge liquidity operations and a range of experiments in central bank communication, the legacy of the financial crisis has not yet been overcome . . . most of the central bankers on this long walk are inclined to press doggedly onwards. They will not countenance the risks of aggressive action, nor will they lay down their burden of trying to ensure low but stable rates of inflation.
Wall Street Journal (no link)
“A French banking primer”
The latest available figures from BNP, Credit Agricole and Societe Generale put their respective banking-book exposures to Portuguese, Italian, Irish, Greek and Spanish public debt at €28.9 billion, €10.3 billion and €4.3 billion respectively. (Some €21 billion of BNP’s exposure is to the Italian government.)
But according to the Bank for International Settlements, the French banking system’s total exposure to the riskiest euro-zone countries is $671.7 billion (€489.9 billion) as of March. That figure is equal to nearly 7% of all banking assets in France, more than a quarter of France’s 2010 GDP and more than three times the combined equity of France’s three biggest banks, which together account for 65% of the country’s total banking assets.
David Cottle, “There’s really no way out on euro: Fix it or nix it”
. . . let us also remind ourselves precisely what those who insist on the integrity of the euro zone are arguing for: Nothing less than the maintenance of a clearly suboptimal and, now, dangerous currency zone right at the core of the world’s economy . . . The zone’s endless travails have long ceased to be either a little local difficulty or the object of a bit of schadenfreude on the part of the world’s Treasuries. They’ve become a source of grave systemic risk at a time when the world really doesn’t need another one.
Conventional wisdom may now be only half right when it comes to solving Europe’s mess. Fixing the sovereign debt problem is still necessary, but it may no longer be sufficient . . . The rapidly burning fuse is in the European banking system, particularly in France, and Europe is getting very close to yet another tipping point . . . Private institutions around the world, and even some public ones, have sharply reduced short-term lending to French banks . . . These are all signs of an institutional run on French banks. If it persists, the banks would have no choice but to delever their balance sheets in a very drastic and disorderly fashion. Retail depositors would get edgy and be tempted to follow trading and institutional clients through the exit doors. Europe would thus be thrown into a full-blown banking crisis that aggravates the sovereign debt trap, renders certain another economic recession and significantly worsens the outlook for the global economy. So far neither the authorities nor the banks have done, or are doing, enough to stop – let alone reverse – this trend.
Response by George Magnus
The interconnectedness between the deteriorating creditworthiness of sovereign states and of banks has been the elephant in the room that European policy makers and European Central Bank officials have refused to see since the Greek debt crisis began at the end of 2009 . . . The fact that this fault line has now reached into France is very worrying. French banks hold more Greek debt than those of any other European nation . . . it is surely not alarmist to say that if the political divisions and lack of determination in policy circles remain as now, we will surely hurtle to our own Kreditanstalt moment – the 1931 collapse of Austria’s largest bank which was how that appalling decade started.
As in the fall of 2008, virtually no country will be spared if continued policy incoherence leads — as it inevitably will — to a recession in Europe, dysfunctional financial markets, and bank failures. When policymakers convened at the IMF/World Bank meetings three years ago to contend with this situation, they at least had a road map of sorts: a bold bank recapitalization plan that Britain brought to the meetings and that served as a catalyst for common analysis and joint policy actions.
This year, it seems that policymakers will have no such luck. The international community lacks an effective policy coordinator. Indeed, it does not even share a common analysis of what ails the global economy. And the sense of shared responsibility has fallen victim to bickering and finger-pointing.
For months, I’ve been arguing that the simultaneous implementation of fiscal austerity programs by eurozone governments would backfire, resulting in a worsening of the sovereign debt crisis. European economic data released today indicates that this prophecy is starting to be fulfilled. To escape this crisis, Europeans are selling euros, buying dollars, and using the dollars to buy U.S. government securities. As long as this persists, our interest rates will remain at historical lows, our interest expense as a percent of GDP will remain low, and we will not have a sovereign debt crisis. This provides us with the ability to implement a very sizable fiscal stimulus program. But the political realities are such as to preclude such a program. Instead, we are proceeding down the road of fiscal austerity. We are blowing what may be our last chance to reverse the downward momentum in our economy.
From this morning’s Wall Street Journal (no link):
The prospect of Europe falling back into recession came a step closer Thursday following the latest batch of dire economic data.Financial data company Markit said its preliminary survey of purchasing managers in the 17-nation euro zone fell into contraction this month, with a reading of 49.2—below the 50 threshold that denotes expansion. That is the first monthly decline in activity since the euro zone climbed out of recession in the third quarter of 2009.
The figures indicate Europe’s private sector is retrenching at the same time as governments in many countries are slashing their expenditures in a bid to cut debt levels and ward off a long-running sovereign debt crisis. Business activity in Germany, Europe’s biggest economy, slowed to a near-standstill. Its preliminary composite Purchasing Managers’ Index fell to 50.8 from 51.3, the lowest reading in more than two years and the eighth straight month of slowdown. Germany’s manufacturing sector slowed to a reading of 50 from 50.9. Any further slowdown next month would mean that industry, crucial to Germany’s export-based economy, was now in decline. The services index fared only slightly better, dropping to 50.3 from 51.1.
The eurozone economy is on the brink of recession, according to a closely-watched survey showing private sector activity contracted this month for the first time in more than two years.
The worse-than-expected deterioration in eurozone purchasing managers’ indices adds to evidence that the region’s recovery has gone into reverse. It increases pressure on the European Central Bank to cut interest rates.
Economic prospects have been hit by sharp falls in consumer and business confidence amid the escalating eurozone debt crisis, as well as fiscal austerity measures across the continent and gloom about US growth. Adding to the gloom, eurozone new industrial orders tumbled by 2.1 per cent in July compared with the previous month – suggesting production would also slow in coming months. June saw a 1.2 per cent fall, according to Eurostat.
The “composite” purchasing managers’ index, covering services and manufacturing, dropped from 50.7 in August to 49.2 in September, falling below the 50 level which divides expansion from contraction for the first time since July 2009. With the index regarded as a reliable indicator of growth trends, the latest readings suggested Germany and France – the eurozone’s two largest economies – had seen growth almost stagnating in September, according to Markit, which produces the survey.
The FOMC statement was released minutes ago. Compared to its August 9 statement, there are two important changes in the wording of the FOMC’s view of the economic situation.
“Significant downside risks” to the economic outlook has replaced “downside risks” to the economic outlook.
The significant downside risks include “strains in global financial markets.” In the August 9 statement, there was no reference to strains in global financial markets. Clearly, this is a reference to the developments in the eurozone.
The following are the relevant quotes from the August 9 and September 21 statements:
The Committee now expects a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting and anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, downside risks to the economic outlook have increased.
The Committee continues to expect some pickup in the pace of recovery over coming quarters but anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets.
