Eurozone 2015: Act or Crash

Alphen, Netherlands. 12 January. John Maynard Keynes once said, “…the oppression of the taxpayer for the enrichment of the rentier is the chief lasting result [of deflation]”. On 7 January the Eurozone tipped into deflation when it was announced by the European Central Bank that year-on-year prices had fallen by 0.2%. This is the first time the Eurozone has dipped into deflation since the height of the financial crisis in 2009.  Some economists (dismal scientists) suggest that ‘temporary’ factors such as the collapse of the oil price, the weakening Euro and stable European consumer confidence mean this latest deflationary dip will be temporary.  However, many indicators suggest otherwise.  The Eurozone economy is bereft of economic growth (Italy has not grown since 1999), few of the vital structural political, economic and regulatory reforms necessary to render the single currency credible or the Eurozone economy world competitive have been made, there is over-reliance on Germany as the engine of growth and both consumer and bond market confidence is fragile in the extreme.  Even the slightest shock could tip the Eurozone into a full blown deflationary crisis that could in turn tip much of Europe into a full-blown depression. That trigger may well come this month with the 25 January Greek elections and the prospect of the fiscally ill-disciplined Syriza party gaining power.  It is that prospect which saw German Chancellor Angela Merkel scurry to London last week for talks with David Cameron.  Even though the UK is outside the Eurozone such a crisis would need Europe’s two strongest economies to act closely together.  It would also need an awful lot more, which is why 2015 is a tipping point and why Europe needs a game-changer.

In a 1933 Econometria article economist Irvine Fisher established a proper understanding of the dangers of deflation.  Entitled, The Debt-Deflation Theory of Great Depression the article demonstrated just how dangerous structural deflation can be for both economies and societies.  During a deflationary spiral, which the Eurozone is in or very close to entering, the value of assets and incomes shrink rapidly pushing up the real burden of personal and corporate debt.  Soon debts can no longer be repaid which weakens vulnerable, debt-exposed banks some of which suddenly collapse.  Such a collapse effectively destroys confidence in the entire banking sector as investors and depositors rush to withdraw their cash and governments are forced to borrow and use the money of already hard-pressed taxpayers in an effort to prop up the banking sector.  A bond market crash then ensues as the cost of government-borrowing soars and confidence further evaporates leading in turn to emergency asset sales and the further driving down of confidence, hoarding and the effective end of normal economic activity with catastrophic social and political consequences.

The Eurozone today is full of individuals, corporations and governments with a high degree of personal debt.  It is unlikely Eurozone states would be able to stimulate or re-inflate the Eurozone economy as they are already dangerously indebted and their taxpayer’s effectively broke.  In such circumstances only external help from a rich, powerful state or other actor such as the International Monetary Fund or World Bank could help to stabilise the Eurozone economy.  Such ‘help’ would invariably come with political strings attached and calls for deep reform.  However, because so many Eurozone societies have been weakened by an economy now in its third recession in six years state institutions are possibly incapable of hard reforms for fear of social unrest.

The Euro itself is central to the problem.  Neither state nor super-state the EU lacks both the political and economic cohesion and fiscal and economic discipline to apply even the limited instruments possessed by the European Central Bank to effect.  In the end, the taxpayer’s of the eight member-states that actually pay for the twenty-eight member EU, led by Germany and to a significant extent Britain, are likely to be called upon to bail out the Eurozone by spreading the cost of Eurozone debt AND by stimulating the economy through counter-deflationary/inflationary measures such as the printing of money. 

The hope would be that the use of so-called Eurobonds and quantitative easing would help restore some semblance of economic confidence and all-important economic growth.  However, such is the fragility of the wider world economy, and the propensity for further geopolitical shock, the scale of the Eurozone debt mountain and resistance to reform in debtor states that any such stimulus by the ‘eight’ would in effect have to be permanent.  This situation would quickly lead to the complete and irrevocable bankrupting of the creditor states, the final crash of the Euro and with it the destruction of people’s hard-earned savings and pensions.  In other words deflation and depression could lead to a first order European political disaster.  

There are two immediate possible political steps that might buy European leaders some more time.  First, much deeper integration of fiscal and monetary policy could be pursued by the Eurozone in parallel with the sharing of sovereign and bank debt across all Eurozone and/or all EU taxpayers.  However, such a move would in effect entail the creation of a European super-state and almost certainly see Britain’s exit from the EU.  Second, those economies which bear too high a level of debt and refuse or are unable to reform their inefficient economies could be cut free from the Eurozone.  Greece is the obvious candidate. However, if a crash begins even Italy, Europe’s fourth largest economy, might be forced to exit the Euro.  That would either lead to a consolidated Euro focused on north and western European economies or simply mark the end of the Euro and with it Project Europe. 

There is a third game-changer option; move the strategic economic goalposts. Some economists believe a Transatlantic Trade and Investment Partnership (TTIP) with the US and Canada could boost trade and growth significantly.  Indeed, whilst TTIP could never resolve the Eurozone’s many structural contradictions it could act like a kind of economic NATO affording collective economic defence to its members against the kind of speculations and panics that might trigger a great European depression. 

TTIP would create a market of some 900 million people between the world’s most advanced economies and signal to the markets a willingness to take strategic steps to prevent deflation, TTIP could also help force Europeans become more competitive and re-inject meaningful growth into Europe, although to do so would mean Europeans abandoning the expensive social models to which they are so attached and which renders Europe so uncompetitive.  Above all, TTIP would buy European leaders time to undertake the reforms vital to prevent a depression which they have singularly failed to do since the 2010 Eurozone crisis.

There is of course at least one major caveat (and whole host of minor ones).  For TTIP to be successfully concluded American and Canadian politicians would need to be certain that they and their taxpayers are not being suckered into some kind of implicit, back-door Marshall Plan that would end up with them funding Eurozone debt.  Equally, it is not in the either the American or Canadian strategic or economic interest to see Europe fall prey to depression.

In an important article last week entitled A Comeback Strategy for Europe former Swedish Foreign Minister Carl Bildt and former EU foreign and security policy supremo and NATO Secretary-General Javier Solana Bildt and Solana called on Europeans to conclude a TTIP agreement quickly.  Critically, the high-some twosome said, “…TTIP’s goal is to unleash the power of the transatlantic economy, which remains by far the world’s largest and wealthiest market, accounting for three-quarters of global financial activity and more than half of world trade” However, Bildt and Solana contrasted the stalled TTIP talks with the progress being made in creating a Trans-Pacific Partnership or TPP and the very real danger of European economic decline in the absence of TTIP.  They also gave a stark warning: “If the TTIP stalls or collapses while the TPP moves forward and succeeds, the global balance will tip strongly in Asia’s favour – and Europe will have few options if any for regaining its economic and geopolitical influence”.

2015; the year Europe must act…or crash. There can be no more muddling through.

Julian Lindley-French