Triple shocks threaten Europe's sickly and deformed recovery
Europe has not recovered. It has begun to stabilise, but only just, amid mass unemployment, with debt trajectories still spiralling out of control in Italy, Portugal, Spain and once again in Greece.
By Ambrose Evans-Pritchard
7:27PM BST 04 Sep 2013
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The debt spiral cannot be checked until Euroland embarks on full-blown reflation Photo: Reuters
The complacency of those dictating Euroland's policies - though not its victims - is breathtaking.
"Europe, it seems, has become anaesthetised to bad news," says Simon Tilford from the Centre for European Reform. Tentative signs of life after six quarters of contraction are deemed a vindication of shock therapy, even as the underlying crisis gets worse in almost every key respect.
"The reality is that the Spanish and Italian economies will shrink by a further 2pc in 2013. Greece is on course to contract by an additional 5pc to 7pc and Portugal by 3pc to 4pc. Far from being on the mend, the economic crisis across the South is deepening. Real interest rates are increasing from already high levels," he said.
An end to the slump - hardly assured - is not enough to reverse a compound interest trap across Club Med as debt loads rise faster than nominal GDP, or enough to render Italy and Spain viable within EMU. Such is the "denominator effect".
Mr Tilford says the elephant in the room is the rise in the debts of Portugal and Spain by 15 percentage points (pp) of GDP over the past year, by 18pp in Ireland and by 24pp in Greece. Italy's ratio rose 7pp to 130pc of GDP, already at or near the point of no return.
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This is the fruit of "naked" austerity, conducted without offsetting monetary stimulus. Debt ratios are rising even faster. The hairshirt strategy has been self-defeating, even on its own terms.
The debt spiral cannot be checked until Euroland embarks on full-blown reflation, yet EMU creditors shun such a course. The Club Med states in turn have yet to throw up a leader of stature, willing to forge a debtors' cartel, and bargain from strength. They let themselves be picked off one by one.
Much was made of a slight fall in Spain's registered unemployed in August. The more relevant detail is that a net 99,000 people left the workforce in a single month. Some are coming to Britain. We now know that 45,530 Spaniards signed up for UK National Insurance last year.
The EMU refugees are still arriving daily at Victoria Station, where the Telegraph is based. They make a bee-line for a currency shop nearby known for low fees. Three Andalucians in their 20s were in the queue ahead of me the other day, chatting about their prospects. Each changed a thick wad of euros into pounds, starting new lives in London.
Bienvenidos. They are Britain's gain; and Spain's loss. They no longer pay Spanish taxes or contribute to Spain's Social Security system, sliding towards bankruptcy as the reserve fund is depleted at an exponential pace. The ratio of workers to those receiving benefits has already fallen to 1:7 in Aragon.
Not that the exodus from Southern Europe has made a dent in youth unemployment rates: 62.9pc in Greece, 56.1pc in Spain, 39.5pc in Italy, 37.9pc in Cyprus and 37.4pc in Portugal. It is surely the greatest policy failure of modern times.
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Unemployment over the past five years
Whether you think Europe's recovery is reaching "escape velocity" depends on what you look at. Optimists cite PMI manufacturing indices, punching back above the boom-bust line of 50, though these are the same PMI surveys that gave no forwarning of EMU disasters of 2012.
Money data are a different story. Growth of "broad" M3 money has stalled, slowing to a 1.5pc rate (annualised) over the past three months, a harbinger of economic stagnation over the winter. Credit to business fell at an accelerating rate of 1.9pc in July as banks continue to retrench too fast, compelled by overzealous pro-cyclical regulators. If that is the launch-pad for a new cycle of growth, I will eat my monetarist hat.
Euroland has been hit by three shocks, none life-threatening but serious when combined, which are likely to bite with a delay. The euro has risen 30pc against the Japanese yen over the past year, 25pc against the Indian rupee and 20pc against the Brazilian real. It is has even risen against the resurgent US dollar, an odd state of affairs for the world's slowest growing economic bloc.
To make matters worse, borrowing costs have jumped by 70 basis points across Europe since the US Federal Reserve began to talk tough in May, the difference between life and death for small firms in Spain, Italy and Portugal clinging on by their fingertips.
The ECB has not done much about this, beyond waffle on about "forward guidance". It has allowed imported tightening to run its course, while plans for direct lending to small businesses in the South have withered on the vine. The ECB's Mario Draghi pledged last year to do "whatever it takes" to save monetary union. He is not in fact doing so.
His masterplan to backstop Italy and Spain has averted an immediate chain of sovereign defaults, and kudos to him for that, but has not averted the slow slide towards insolvency. If the ECB targeted 5pc growth of M3, or even better 5pc growth of nominal GDP, this would lift Club Med off the reefs. It could do this easily. It chooses not to do so.
Europe will now have a third shock to contend with, and perhaps a fourth if the emerging market rout continues. Brent crude has jumped by $15 a barrel since June, nearing the economic inflexion point around $120 even before Tomahawk missiles rain on Damascus. This will tighten the deflationary vice yet further by draining spending power from the economy, like a tax.
It was a Princeton professor called Ben Bernanke who wrote the last word on this in "Systematic Monetary Policy and the Effects of oil Price Shocks". Central banks themselves cause most damage from oil shocks because they panic, over-reacting to short-term inflationary noise.
Yet the mystics at Bundesbank still seem to think that oil spikes are inflationary. They have largely succeeded in imposing their 1970s views on the ECB's Governing Council. They raised rates to counter the pre-Lehman oil shock in July 2008, even though half of Europe was already in recession, the worst monetary policy blunder since the Second World War. They repeated the mistake in 2011, causing Europe's double-dip. Third time lucky, perhaps?
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Euro trade-weighted exchange rate
Even if eurozone growth does indeed gather speed, this will bring forward the day when Germany demands rate rises to head off overheating in its own misaligned economy. This will change the contours of the crisis, not solve it. The 20pc gap in labour competitiveness between North and South - the fundamental cancer of the EMU Project - will remain.
And no, the North-South current account chasm has not closed in any meaningful sense. It has been masked by crushing internal demand and investment in the Latin bloc.
Germany's surplus actually grew to 7pc of GDP last year. The misalignment is so extreme that even a full depression in the South cannot bring intra-EMU trade into balance. Should they be even trying to hold the currency together given sheer scale of the task, you might ask.
How this gap in incompetitiveness was allowed to evolve over the first 15 years of the EMU experiment is by now ancient history. It no longer matters whether it was caused by Germany's beggar-thy-neighbour wage squeeze, or by Italy's "scala mobile" wage escalator, or by a flood of cheap foreign capital into Spain. The damage from this joint venture is now done. All EMU states are in it together.
Forcing all the burden of adjustment on the debtors repeats the cardinal sin of the Gold Standard. It cannot succeed since deflation poisons debt dynamics, and mass joblessness poisons democracy. There comes a point when leaders have a moral obligation to default.
Yet to stoke EMU-wide inflation deliberately to lift the South off the reefs would destroy political consent for monetary union in Germany. It would require statesmanship of the first order in Berlin to marshall civic support for such an imperative. No such statemanship is on offer. We have an impasse.
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