Neils Jensen: The European Disease

Chart 5: Private, Public & Total Debt, Main European Countries

Source: Evolution Securities, McKinsey, IMF, National Debt Management

Note: Private debt excludes non-financial corporates

Is there a way out?

Is there a way out for Europe? A fiscal/political union would address many of the problems facing the eurozone today. However, by trying to salvage something which was probably beyond rescue in the first place, our political leaders have made a real mess of it and completely lost the trust of the electorate. A crisis has turned into a farce – Greece has become Grease – and, for at least the next generation, Europe has almost certainly missed the opportunity to create a fiscal union. Knowing what we know today, who in Northern Europe is going to vote in favour of a US-style federal union?

Even more sadly, by postponing the inevitable (a Greek default), the probability of a complete collapse of the monetary union has risen dramatically. But our political leaders do not seem to comprehend this. They still believe they can control events, although experience should have taught them differently. Too many of them still consider the European sovereign crisis a liquidity crisis. It is not. It is a solvency crisis with all that it entails. And one of the implications is that the €750 billion rescue package will ultimately prove a waste of money. Taxpayers’ money. Our money! There is no easy way out for Europe. Sadly, it is nothing but bad choices.

Some economists argue that whereas the situation is grim in Europe, the debt situation is in fact far worse in both the US and Japan. While it is true that the primary budget deficit is much smaller in the Eurozone than it is in the UK, US and Japan, the argument completely fails to acknowledge that it is the combination of high deficit and lack of policy tools to address the problem which is so deadly.

Greece - and about ten other eurozone members - desperately need a cheaper currency, but a falling euro doesn’t necessarily do the trick as much of Greece’s exports go to other eurozone members. Alternatively, the Greeks may choose to go for an ‘internal devaluation’ by cutting salaries in the order of 20-25%. People died in the streets of Athens following a decision to reduce salaries by 5%. I don’t even want to think about the consequences, should they be forced to make cuts of that magnitude. Again, nothing but bad choices.

A return to the gold standard? All of which brings me back to Iceland. Last time I was in Reykjavik, the ISK/GBP exchange rate was about 125; it is now 185. That is one heck of a devaluation, and the effect on tourism has been noticeable. Likewise, the UK economy has benefitted from a weak pound. The ability to play the currency card provides countries outside the eurozone with options members of the currency union do not have. They are effectively held hostage by a system which is not a million miles away from the gold standard. So, for those of you wishing for a return to the gold standard, the eurozone crisis should stand out as an alarming example of what might happen if you give up the ability to conduct your own foreign exchange policy.

Chart 6: 2009 Fiscal Data for selected Countries

Source: Citigroup Global Markets, Global Economics View”, 26th April, 2010