Those who have been following my blog for a while will understand I consider Europe’s “fiscal compact” to be both dangerous and counter-productive because there has been a large and significant miscalculation in what implementing fiscal austerity means in already depressed economies.
As I stated back in December last year:
So while there is no credible counter-balance for the effects of supra-European austerity any attempt to implement the new “fiscal compact” will make Europe’s economic issues worse. The continent is already on the way to recession and unless we see some additional action from the ECB, or a huge swing against this new framework, the push to implement the outcomes of the summit will simply accelerate that outcome. My assumption is that, if Europe does ratify this framework (there are a few stragglers), after 12-24 months of trying the effect will be so disastrous that they will eventually give up. But until then my base case for Europe is a significantly worse economic outcome.
And that is pretty much what we have seen.
The ECB’s LTRO was successful in providing some short term relief to the financial markets, but only in such a way that it has more tightly coupled weaker sovereigns and their now zombified banks. None of the fundamental issues in Europe was actually addressed during this short lull in the crisis, in fact the competitiveness of many of the nations went further backwards as unemployment continued to rise and industrial production fell further. This in turn has led continuing falls in national income and GDP which has meant that arbitrary fiscal targets slowing move further out of reach which ultimately bring about calls for even larger fiscal cuts.
We were reminded of this once again on Friday by Spain:
Spain was forced to revise its 2011 budget deficit upwards on Friday, after three of the country’s regions restated their own figures, exposing the struggle the autonomous communities have had curbing spending even ahead of deeper cuts this year.
Spain said its 2011 public deficit now came in at 8.9 percent of gross domestic product, up from the 8.5 percent initially stated. The country had already widely overshot its deficit target of 6 percent for last year
Over the last week we have seen the situation flare-up again with the governments of both Spain and Greece having to deny claims that their banking system are unstable and suffering from banks run. We haven’t heard much from either Cyprus of Portugal, but my assumption is that both of these nations are coming under similar pressure given their close ties with the two countries, and obviously, similar economic issues of their own.
Given the situation Greece now faces, it is very difficult to determine exactly what will happen next. There is much talk about Greece exiting Europe, the so-called “Grexit”, but as this point in time my reading of the situation is that Greece holds many of the cards and Europe is likely to make concessions due to the weakness of much larger economies. We saw a clear message from the G8 that Greece should stay in the Eurozone.
Obviously the next Greek election, to be held on June 17, has the potential to bring about renewed uncertainty , but there is also the unanswered question as to what the effect will be of Francios Hollande’s presidency in France. We’ve already seen the statements from his finance minister that France has no interest in subscribing to the “fiscal compact” as it sits, and it was obvious that was the message Hollande took to the G8.
Other reports out of the G8, however, suggest that even though they are becoming increasingly marginalised in their position, nothing has changed in the German camp:
Obama and Merkel held one-on-one talks after a two-day G8 summit at the US president’s retreat in Camp David, Maryland, that was marked by competing views on how to bring the Europe’s sickly economy back to life.
The president, who faces US voters concerned about the economy ahead of November elections, has pushed Europeans to put growth on top of the agenda but the German leader has championed austerity to combat the eurozone debt crisis.
But after the Merkel-Obama talks, a White House official said there was an understanding that the push for growth was “not to take the place of fiscal reform,” but that the two go “in tandem.”
I hope that this is code for an adjustment of the fiscal compact to take into account economic reality, but I remain doubtful. The other problem is that no one has really defined what “focussing on growth” actually means and in the meantime the continuation of aggressive “expansionary fiscal contraction” in the absence of a fail safe leaves weaker nations exposed to speculative attack by the credit markets which ultimately leads back to yet another full-blown crisis.
Given the renewed political tension, it is becoming increasingly difficult to see how Europe is going to arrest the crisis as it slowly but surely makes its way to Italy. The steps required from here are large, politically painful and increasingly bold yet once again Europe appears to be drifting further apart, both economically and politically. I would hope that the new “growth compact” leads to something measurable, but given the conflicting messages going into, and coming out of, the G8 it is very hard to find anything that has really changed.