The good news is that Europe is no longer going the way of Greece. The sad news is that it is threatening to go the way of Japan.
After years of hesitation punctuated by panic, Europe has finally accepted the compelling logic that a single currency needs a lender of last resort. Pro-euro voters in the Netherlands have clearly been impressed as the President of the European Central Bank (ECB), Mario Draghi, braved the scowl of the ever-cautious Bundesbank and led his ECB directors to a pledge of unlimited – if conditional – short-dated bond-buying to avert another currency crisis.
The ECB acted in the nick of time; the fuse was set for an explosion next month with the market chaos of both a Greek and Spanish crisis. President Obama has been spared a euro zone spanner in his campaign for re-election and the chances are we won’t have a pre-November Greek euro exit or Spanish bankruptcy, plus a run on Italy and a French financial crisis just for good measure.
Indeed, now that the ECB is ready to intervene to level short-term bond rates for economies intent on reform and the German Constitutional Court has removed its objections to a bailout fund, there need be no European bust-up over who pays for it.
So far so good – but it is not far enough.
The net effect of the intervention is to halt contagion, not to end the recession; to stop disintegration, rather than start a recovery that would reverse Europe’s downturn. In the week after the market euphoria at the Bank’s decision, private investors, worried about who is first to be repaid in a crisis, are not rushing to return and the ECB still has to address the moral hazard it has created by appearing to guarantee ‘last resort’ funding to countries still likely to go off track. They will now find it difficult to refuse a country support or to push them into an IMF program.
Far more worryingly, France is likely to join half of Europe in a double-dip recession. Without European leaders following on with a swift and vigorous effort to seize the initiative to grow their economies, Europe will continue to struggle. Unemployment rates of ten per cent and over appear to be the new normal and the West will continue to drag the entire world economy, including China, down.
The temptation is to say that all will be fine, if only a second stage of the rescue – a European banking union – is agreed. Earlier this month Jose Manuel Barroso, President of the European Commission, wrote an impassioned article claiming that a banking union was indeed the game changer.
But a banking union requires more than common euro-wide supervision. It requires also a common resolution fund and common deposit insurance, and these in turn require an agreement to fiscal transfers. Indeed, a banking union of the kind Europe is now discussing is not possible without a fiscal union.
Someone will have to guarantee – and be ready to stump up for – bank recapitalizations, depositors insurance and rescue operations, and it is in the implied transfer of resources from rich to poor that the next set of difficulties lies.
Europe’s banks still have €24 trillion [app. $32 trillion] of outstanding loans against America’s $14 trillion (€11 trillion). In the four years since American and British banks recapitalized, added around four per cent more capital and wrote off bad debts (an equivalent four per cent write-off), Europe has added only half a per cent of new bank equity – and submitted to an even smaller write-off of toxic debts.
A bank recapitalization – upwards of €200 billion [$260 billion] – looks necessary, and deposit insurance must be underpinned.
This puts three steps firmly on the agenda: a fiscal union, a European finance ministry, and some form of Eurobond – the very questions Germany has tried to side-step.
Such is the depth of feeling about the extent of these constitutional changes that I see the demands growing within the euro area for referenda, a process that will inevitably take years to resolve.
What has deterred the return of confidence is not simply the uncertainty over who is the lender of last resort but, more fundamentally, the continuing absence of the cyclical actions and structural reforms essential to restore European growth.
For four years, a one-dimensional obsession with public debt (‘if austerity is not working, we need more of it’) has led Europe not only to neglect the seismic tremors in its banking system but to underplay its underlying problems of low growth, diminished competitiveness and economic weakness.
Once responsible for 40 per cent of world output, Europe’s share is now only 18 per cent. In the next ten years Europe could decline so fast that this could reduce to little more than 11 or 12 per cent.
Indeed, with the exception of Germany, only a fraction of Europe’s export trade is with the world’s fastest growing economies. Just 7.5 per cent of its exports go to the emerging markets which account for most world growth.
Once at the heart of the global economy, Europe is increasingly placing itself on its periphery. Some say that by the early 2020s Asia will consume 40 per cent of the world’s goods – with Germany consuming only four per cent and France and the UK only three per cent each.
An uncompetitive European south which has failed to engage in structural reforms will inevitably fall further behind. So Europe in 2012 is facing the same problems of financial weakness, economic frailty and worsening debt, which have trapped Japan for nearly 25 years.
But today, as a consequence of the decline in the advanced countries’ share of global output, there has emerged a unique structural imbalance that is more serious than the 1980s and cannot be rectified by a repetition of ordinary post-recession policies.
Ten years ago American consumer spending ($10 trillion annually) could propel the world to a higher plateau of growth. Ten years from now Asians, with nearly half of all consumer expenditure, will drive world growth. But we are in a very awkward transition from an old world to a new one: the world’s biggest producers are already the emerging markets, but the world’s biggest consumers are still the advanced economies.
Today neither the western consumer, who now needs to earn to spend, nor the Asian producer, who needs someone to buy their goods, can drive the world economy forward independently of each other.
So high global growth will return only when Asians are confident markets are reviving in the West, and when Americans and Europeans are confident they can pay for their consuming by exporting to the East.
With inflation generally low, a coordinated Central Bank stimulus is justifiable but China can also apply the defibrillator by expanding consumer demand faster than planned and the West can mop up some of the savings glut by advancing much needed infrastructure investment.
The strategy I propose is good for Asia, a life-saver for Europe, and also the quickest way American exports can double as planned.
If President Obama has been spared the pre-election debacle of Greece pulling out and Spain going bust, he is not being spared the glum prospect of country following country into double-dip recession.
As German growth starts to sink to the levels of France, the UK and the euro area, the sense is growing that we are stuck in stagnation for years to come; quagmire is the word that comes to mind.
So the loans offered last week by central bankers will be no more than a band-aid unless followed by a growth plan from the politicians.
Europe has acted to head off a dramatic collapse but the bigger challenge ahead is preventing the long-term decline of the West. Indeed, from now on, what is increasingly going to exercise people is ‘dealing with decline’.
*Gordon Brown is the former Prime Minister and Chancellor of the Exchequer (Finance Minister) of Great Britain
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