Sunday, September 25, 2011

European Crisis

The debate has focused entirely on what cannot be done rather than what can...

European policy has been constantly lagging behind. This will continue.

Do we really believe the Greek government can implement one austerity plan after another with a majority of five seats?

So even if Europe’s leaders were to come together tomorrow and agree on all the necessary steps to end the crisis, they would not have solved it until they could demonstrate that they enjoyed full political support. That is unlikely to be the case for a while yet.

The European Union has wasted two precious years with dishonest stress tests that have shaken the credibility of the European Banking Authority, the European Commission, national central banks and national bank regulators. If you factor in the economic slowdown, Europe’s banks could be undercapitalised to the tune of €500bn.

Based on previous performance, it is hard to imagine that the European Council will rise to the occasion. If it does, it is even harder to believe that they can get the support back home.

I have never seen Europe’s policymakers as scared as I saw them in Washington last week.

That is what a reputed financial journalist has to say who has been following this saga very closely.

For a lay person issues can be relatively simple:

- European banks have given lot of debts to sovereign countries of EU which are not in the position to repay. Greece is far most  but Italy, Portugal and Ireland are not far behind; though Spain could be in bit better shape. So defaults are inevitable. First question in defaults is how to compensate for losses of these European banks. You can never have a modern working economy without healthy banks. Weak banks with losses, triggers bank runs and that is the end of the story. Geithner rescue model for American Banks is the working template here, question is whether Europeans want to emulate that or not. Many countries in the world - China, Brazil, India, Australia, etc. will be interested in picking up equity of European banks and that is the way to increase the leverage of initial recapitalization by European governments.

- Once the immediate danger of bank run and consequent collapse of European banks with a shock to the global economy is avoided, next question is how would you bring recovery to these battered economies. This means demand needs to increase. With the straight jacket of single European currency and absence of more jobs which produce tradable goods and services in an economy like Greece; it is hard for these economies to have any sustainable recovery. For economy like Italy which does produce tradable goods and services, as currency devaluation option is not available; it's competitiveness is always threatened.  Not all nations can pull off Germany all the time - high cost but ultra efficient in producing high value adding tradable goods and services. Not to ignore the political tensions within Germany, but as a society and a political system; there is a degree of cohesiveness about policies which would retain this global competitiveness. Even a country like USA with it's free floating currency and high base of tradable goods and services producing economy; it  struggles to achieve basic national and political cohesiveness about policy prescriptions which can retain its global competitiveness. Hence deck is stacked against Greece and Italian economies unless their political act comes together along with all the necessary support and understanding from rest of European countries.

My impression is eventually Europeans would address the first issue; but the second is quite hard. That means chances of avoiding global shock are not too bad, but economies like Greece and Italy will be left behind for long, long time to come; dragging down most of  the Europe for a substantial period.

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