Barroso triumphant as jobless Europe wastes five (precious) years of global recovery
By Ambrose Evans-Pritchard Economics
Last updated: January 9th, 2014
José Manuel Barroso has declared victory again. The European Commission chief tells us that the eurozone crisis is over. The scorched-earth contraction policies have succeeded.
Ireland has conducted a "clean exit" and is tapping the bond markets again. Latvia has joined the euro and is now the EU's fastest growing country.
"This shows that the programs do work when they are properly implemented," he said.
Senhor, it shows no such thing. Ireland is highly competitive (second best in EMU after Finland on the World Bank gauge).
It has an open economy with a trade gearing of 108pc of GDP, giving it three or four times more export leverage than Club Med. It trades heavily with the dollar and sterling zones, now recovering. It has a current account surplus near 4pc of GDP.
Ireland was never unable to cope with the rigours of the euro as a "trade" currency. It was instead in the wrong interest rate regime, causing a destructive credit bubble (which it failed to contain by other means). This tells us nothing about the entirely different circumstances of Italy or Portugal where the intra-EMU exchange rate is overvalued.
But even if Ireland can make it without debt restructuring (and that is not certain), the underlying erosion of the workforce through hysteresis from mass unemployment – and from mass migration to the UK, US, and Australia – has greatly damaged the long-term growth potential of the economy.
Public debt is 125pc of GDP and the budget deficit is still the highest in Europe at 7.8pc of GDP. There is no margin for any error.
Mortgage arrears are still rising to record levels. We will find out whether or not the banks need another shot in the arm from an Irish state that cannot afford any more.
At the end of the day, Ireland was forced by the EU authorities to take on the vast liabilities of Anglo-Irish to save the European banking system in the white heat of the Lehman crisis, and the EU has since walked away from its pledge to help make this good.
The Irish people have been stoic, disciplined, even heroic. They have survived this mistreatment. To cite it as a vindication of EU strategy sticks in the craw.
Ditto Latvia, another open export economy subjected to a brutal internal devaluation – in my view a morally indefensible policy since it works by breaking the back of labour resistance to pay cuts through mass unemployment.
Latvia should be a post-Soviet catch-up economy enjoying Asian Tiger growth levels. Instead its output is still far below peak a full six years after the country spiralled into crisis. It has lost 7pc of its population, storing up an even bigger demographic crisis for the near future. That is success?
Mr Barroso goes on to say that Spain is out of the woods and that Portugal is enjoying its ninth month of falling unemployment. In reality the numbers employed in Portugal have merely stabilised after crashing from 5.228m to 4.554m. The young are still migrating, flattering the jobless rate.
Portugal may well succeed in tapping the debt markets in the current mood of near euphoria, but what does that tell us? Portugal's public debt has jumped from 108pc to 128pc of GDP in the last two years (IMF), a pattern replicated in Italy and Spain.
This has happened in part because contractionary policies have themselves played havoc with debt dynamics. A rising debt burden has to be supported on a shrinking nominal GDP base. The EMU slide towards deflation is tightening the screw further through the denominator effect.
Portugal's budget deficit is coming down at a glacial pace and is still 5.5pc of GDP (with no QE offset to erode the debt effects). Portugal's net international investment position (NIIP) – what really matters – has risen from minus 105pc to minus 114pc of GDP since 2011. Spain's is not much better at minus 92pc.
Let us remember the mood of optimism in 2010 and then again in 2011, those false dawns that were preceded by spasms of the EMU economic crisis. If you were looking at bond yields or sentiment indicators you might have thought that the crisis was over. Mr Barroso himself proclaimed as much.
So what was the key failure in macroeconomic analysis? What scientific error induced the ECB to raise rates twice in 2011 and abort recovery? What caused regulators to force banks to quicken the pace of deleveraging with pro-cyclical effect? How badly did the Eurocrats miscalculate the fiscal multiplier in a world of deep and pervasive slump, with a broken financial system? Have any of these lessons really been learned?
ECB's Mario Draghi removed the risk of an Italian and Spanish debt collapse in July 2012 by securing Berlin's support (through Asmussen) for an emergency backstop. People talk of this as if it were magic. All that happened is that the ECB stepped up to its responsibilities as a lender-of-last resort, as it should have done from the beginning.
But monetary policy remains passive and contractionary, arguably incubating another nasty surprise. Broad M3 money has been flat for six months. Business lending has fallen by 3.9pc over the last year. There will less fiscal drag in 2014 as austerity eases, but the eurozone is doing almost nothing to generate its own internal growth. Europe is once again relying on the rest of the world to pull it along, and the world may not oblige.
Countless risks remain. Bond tapering by the US Federal Reserve will lead to imported monetary tightening. The eurozone faces its own "endogenous tapering" as banks deleverage, paying off €700bn of ECB loans (LTRO). ECB’s balance sheet has fallen from €3 trillion to under €2.3 trillion in a year, dropping from 31.8pc to 23.7pc of GDP.
Emerging markets have barely begun to adjust as the Fed start to cut off $1 trillion of global dollar liquidity (annualised). China is trying deflate its $24 trillion credit boom, arguably the greatest such bubble in history.
Far from building a base for recovery, the eurozone has wasted the last five years of global expansion holding together a dysfunctional currency union, lurching from crisis to crisis. The result has a been double-dip recession and a worse macro-outcome for the same European states than in the comparable years from 1930 to 1935.
Mr Barroso may have to face the awful possibility that this golden phase right now – relatively golden given that GDP contracted by 0.4pc in 2013 – is as good as it gets, that the "boom" phase of the liquidity cycle is nearing maturity and may start to roll over in 2014 or early 2015.
What happens if the eurozone goes into the next global downturn with unemployment already at or near 12.1pc – and youth jobless already at 57.7pc in Spain, 54.8pc in Greece, and 41.6pc in Italy – and with core inflation running at or near a record low of 0.7pc?
Europe is one external shock away from a full-blown deflation trap, and one recession away from an underlying public and private debt crisis. Nothing has been resolved.
Aggregate debt ratios are higher than they were before the austerity experiment. In the end there will still have to be a "Brady Plan" like the Latin American debt write-offs at the end of the 1980s, but on a far larger scale and with far more traumatic effects on the European body politic.
So celebrate today while the sun is still out, and dream on.