June 8th, 2011
in Op Ed
by Elliott Morss
For more than a year, there has rarely been a day without a headline of a new Euro crisis. The basics of the situation are quite simple. I present them below, coupled with my view on where it will all lead. Follow up:
The Euro Countries
The Euro (€) is used as money in 22 countries: Andorra, Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Kosovo, Luxembourg, Malta, Monaco, Montenegro, the Netherlands, Portugal, San Marino, Slovakia, Slovenia and Spain and the Vatican. Monetary policy for all Euro countries is made by the Euro Central Bank.
The most important feature of being a Euro member is that you don’t have a central bank to print money “when you need it”. If you run out of Euros, all you can do is try to borrow them. What does “running out of Euros mean”? The country can run out of Euros if imports of goods and services continually exceed exports. The government can run out of Euros if its expenditures exceed revenues for an extended period of time.
The current account is a good proxy for a country’s import/export balance. Current account deficit data are presented in Table 1 for Euro countries with serious financial problems. These deficits are not just a problem in dealing with the rest of the world. A current account deficit means Euros are leaving the country which in turn means the domestic money supply (Euros) is declining. With less money in circulation, domestic interest rates will increase thereby reducing aggregate demand. The deficits of Portugal and Greece are cause for concern. Deficits of this size are not sustainable. They are simply buying more from the rest of the world than they can afford.
Government deficits of Euro countries facing serious financial problems are presented in
Consider now Greece, Ireland, Portugal, and Spain. All three of these countries have effectively “run out of money” in the sense that their credit ratings have plunged and borrowing has become very expensive. Consequently, the first three have entered into IMF-enforced austerity programs that require government deficit reductions. And Spain, hoping to avoid such a program, is making efforts to reduce its government deficits on its own.
Table 3 indicates IMF-enforced deficit targets of the first three countries along with Spain’s goals.
In looking ahead, one has to wonder whether these four countries can sustain their austerity programs, given the increases in unemployment that will be generated. The IMF has done the most comprehensive research on the effects of stimulus packages. It concludes that a fiscal consolidation of 1% of GDP results in an increase of .3 percentage points in the unemployment rate.1
Using this IMF estimate, I generate the unemployment effects resulting from the Table 3 deficit reduction targets. In Table 4, using 2010 unemployment rates as a starter, I estimate what happens to unemployment resulting solely from the government budget deficit reductions.
Of course, government deficit reductions are not the only factor influencing unemployment rates. But will little evidence of growth coming from elsewhere in these countries, these effects cannot be ignored. And in my view, they will not be acceptable politically.
It also appears the IMF has underestimated the negative GDP and unemployment effects of their Greek and Irish austerity programs. Table 5 compares IMF estimates of GDP growth and unemployment rates made in its October 2010 World Economic Outlook with actual results. In all cases, things have turned out to be worse than predicted.
What If Spain Needs a Bailout?
The IMF/Eurozone’s special fund is capitalized at €440bn. The Greek (€110bn), Irish (€90bn) and Portugal (€78bn) bailout programs leave €162bn, and there is talk of a large supplemental for Greece. A Spanish program would require maybe another €500bn. Enough said.
Things are bad enough in Greece, Ireland, Portugal, and Spain. But they will get worse as the unemployment rates increase and people take to the streets with increasing frequency.
The Germans and European Central Bank agree that the Greek debt has to be reduced. The Germans want to change the debt terms (partial default?) while the Central Bank is hoping the debt can be rolled over and stretched out when it comes due.
There are other things the Germans and Dutch are not happy about. However, they have to worry about their “weak sisters” because their citizens and institutions have investments in them.
In the meantime, Table 6 indicates the financing needs of the “weak sisters” over the next two years. Who is looking to buy their debt? It will be an interesting and dangerous time.
The Rough Politics of European Adjustment by Michael Pettis
Fragmentation of Global Power by Elliott Morss
Will Europe Face Defaults? by Michael Pettis
End of the Shell Game? by Dirk Ehnts
Financial Reform - What are We Getting? by Elliott Morss (at Morss Global Finance)
Why Iceland Voted "No" by Michael Hudson
A Brief Overview of Global Empires by Elliott Morss
Is the ECB Fighting the Right Evil at the Right Time? by Dirk Ehnts