Over the last year or so Europe has been moving towards a “crunch” point where a decision must be made between fiscal-political unity and separation. I have explained at length that the austerity measures introduced to periphery nations would not work as suggested by the IMF and EU because the reduction of debt would lead to a reduction in industrial production which is really the only thing that matters when trying to overcome a competitiveness deficit. That is exactly what PIIGS nations have, because they are bound by currency and monetary policy that does not provide a counterbalance to their underperformance compared to the German production machine.
I have repeated this theme for over a year, and been very clear about what I believed would happen to the periphery nations if austerity was introduced before the issues of production and competitiveness were addressed. You can see a timeline of my comments on Greece here.
In recent weeks we have seen some announcements that match those predictions:
In a statement, the [Greek] Finance Ministry said that the cumulative state budget deficit rose to €15.51 billion in first seven months of the year—compared with €12.45 billion a year earlier, while net budget revenues fell 6.4% budget expenditures jumped 7.1%.
“The budget figures are a big disappointment, they are completely off track and suggest that Greece’s tax collection system has all but collapsed,” said Yannis Stournaras, director of the Foundation for Economic and Industrial Research.
On unemployment:
Unemployment rate in May 2011 was 16.6% compared to 12.0% in May 2010 and 15.8% in April 2011. The number of employed amounted to 4,131,528 persons while the number of unemployed amounted to 822,719
And GDP:
Available non-seasonally-adjusted data indicate that, in the 2nd quarter of 2011, the Gross Domestic Product (GDP) at constant prices of year 2000 decreased by 6.9 % in comparison with the 2nd quarter of 2010. The decrease recorded in domestic demand (final consumption expenditure and gross fixed capital formation) has contributed to the decline of GDP.
So, basically the structure of the package forced on Greece was designed in a way that no one was every going to get their money back, and while this was occurring the macroeconomic issues that caused the problem in the first place were actually getting worse because under austerity Greece was actually becoming even less productive. They have now moved to a stage where they are selling national assets in order to meet their obligations.
To give some context to just how catastrophically badly the EU has predicted the path of the Greek economy, this is what they had to say in late 2008:
Economic growth rates in Greece will exceed Eurozone’s average growth rates in the 2009-2010 period, the European Commission said in its autumn forecasts on the EU economy.
The EU’s executive said it expected Greek GDP to grow by 2.5 pct in 2009 and 2.6 pct in 2010, sharply up from 0.1 pct and 0.9 pct in the Eurozone over the same period, respectively and growth rates of 0.2 pct and 1.1 pct in the EU-27. Greek economic growth was 3.1 pct in 2008, the Commission said.
But never to let a failing plan get in the way of ideology, the Troika pushed on forcing other periphery nations into the same self-defeating position. So here we are in August 2011, that single nation’s issues has ballooned to a point where the US authorities are now publicly concerned about the state of the European banking system:
The Federal Reserve Bank of New York, which oversees the U.S. operations of many large European banks, recently has been holding extensive meetings with the lenders to gauge their vulnerability to escalating financial pressures. The Fed is demanding more information from the banks about whether they have reliable access to the funds needed to operate on a day-to-day basis in the U.S. and, in some cases, pushing the banks to overhaul their U.S. structures, the people familiar with the matter say.
Officials at the New York Fed “are very concerned” about European banks facing funding difficulties in the U.S., said a senior executive at a major European bank who has participated in the talks.
We have seen contagion after contagion and now we see a banking crisis. Yet to this day absolutely nothing has been done to address the actual cause of the problem. The fact that single currency, monetary policy and de-regulated credit markets are completely incompatible with the diversity of productive capacity across Europe.
Given that I have seen absolutely no evidence to this point that anyone inside the European economic complex in a position of influence has shown even the most minimal amount of leadership around addressing this fundamental point, I can see no other path at this time apart from a break-up of the Union under the single currency. My post this morning concretised those thoughts in my mind as what we are now witnessing from European leaders is best described as school boy squabbling.
So it is time to move beyond the “what could have been” and start discussing the “what will be”. There needs to be a conversation around exactly what Europe will look like over the coming years and how it will get there. So today I am going to offer my transition plan to Europe for the most sensible way it can get out of this mess if it cannot find a solution toward fiscal unification.
That is by no means suggesting that this plan is without pain, it certainly is not, but it is a plan that will set all nations back on a sustainable path, which is the only alternative outside of some miraculous epiphany of European re-unification by the Euro-elite over the coming months.
So here I go…
In the case that default is inevitable the Eurozone should be split into two distinct economic areas with separate central banks and currency. The Euro should stay with the area that contains the existing southern periphery so that they are able to repay their Euro-denominated debts (that is, avoid a Latin American style debt crisis). This would also mean that the Euro itself would deflate considerably making these nations instantly more competitive and therefore able to slowly grow via export and trade. Given that they are a group of nations they would still be able to trade internally which would provide them with a buffer against the fact that their economies as a whole would have gone under a significant downgrade. There would also need to be capital controls in place for a short period.
This plan would mean a lower standard of living for these nations but that would becoming anyway under an unplanned default. At least under this system they have a way out of it.
The northern nations would exit into their own currency – call it Euro A- which would instantly appreciate against the old Euro. They would need to re-capitalise their banking system against the loss caused by the Euro depreciation, but given they would now be seen as a stronger economic block this should not present a problem. The same can be said for the rest of the world due to its Euro exposure, but again, everyone is going to have to do that anyway in the case of an unplanned default.
Both of these areas could then set about building new macroeconomic models that suited their economies. The Euro A sector would probably be able to stay with the existing European settings given that they are mostly German centric anyway. However, they will need to deal with the issue of a strong currency. The Euro section would need to significantly reprice debt and proactively manage capital inflows and outflows.
Again you need to remember this is the best version of the worst plan. The time to use it may never eventuate. The best outcome is obviously for Europe to fiscally unify and the worst outcome is for an unplanned default by one or many nations. The problem at the moment is that Europe seems to be heading in the direction of the worst of the worst plans.