Could it be that Mario Draghi is alone among the key euro authorities in recognizing that the euro crisis may not be quite over yet? Given that Mr. Draghi is also widely credited as the euro’s foremost savior, this seems more than just a little odd.
Recall that, almost magically, Mr. Draghi managed to pull the euro currency union back from that yawning abyss of acute breakup scares prevailing until the summer of 2012 – and with nothing but words: the simple promise “to do whatever it takes” to keep the euro whole.
As the markets have stayed calm ever since, the euro body politic has indulged in complacency. All the more so since the release of the first non-negative quarter-on-quarter GDP growth number for the spring of last year that saw the euro authorities engage in self-congratulatory shoulder-slapping, bravely declaring that the war on the euro crisis was won as their sound policies were finally starting to bear fruit.
European Commission president José Manuel Barroso just added another refrain to the chorus, predicting that 2014 would bring definite change for the better to the euro community. Interestingly, as delusion and denial seems to fully absorb other euro authorities, the ECB’s president alone is taking a more clear-headed view on the actual state of affairs and prospects for the euro currency union. I dare to venture that this may be because he is also all too aware of the fact that his monetary powers are actually quite limited.
It may be time for a sober stocktaking of where the eurozone stands regarding the successful resolution of its internal crisis. Is the economy truly on the mend? Has the euro policy regime been put on a sound and sustainable footing?
Euro Delusion and Denial
Starting with the economy’s health check, it is certainly good that the eurozone has stopped shrinking. The initial recovery from the severe slump in 2008-9 was cut short as domestic demand started shrinking again in mid 2011, which continued for two years. Domestic demand is still some 5 percent below its pre-crisis peak in real terms and has barely recovered lost territory in nominal figures. Growth in the rest of the world prevented worse as the eurozone’s external balance has moved from deficit to a sizeable surplus.
Meanwhile, employment, down 5.5 million since 2008, is still shrinking and unemployment is stuck at 12.1 percent. Of course aggregate numbers mask huge intra-area divergences, as Germany actually has record-high employment and fairly low unemployment while euro crisis countries such as Spain and Greece have unemployment rates beyond 25 percent. There is no prospect for any meaningful improvement of the labor market situation any time soon. As the private sector stays in deleveraging mode and governments stay their austerity course, anything better than stagnation rests on the premise that global growth will continue to provide an external lifeline through rising net exports.
All along, public indebtedness has kept on rising despite – or because of? – area-wide austerity pursuits. The situation is worst where attempts to restore competitiveness vis-à-vis Germany through deflation are most ambitious. As even German wages are barely rising in real terms, the prospect for Germany’s euro partners is for continued debt deflation. Unsurprisingly, governments look shaky in numerous member states. Ultimately, one might wonder here, what will convince countries to stay with the euro as the euro comes to symbolize impoverishment rather than prosperity?
If the economy still looks rather fragile and national governments shaky, perhaps the euro policy regime is now in better shape to help the currency union withstand fresh rounds of market panic. Unfortunately, that is not the case either. Misdiagnosing fiscal profligacy as the main culprit behind the euro crisis, the main focus of regime reform was on enhanced fiscal discipline. Governments are now set to aim at balanced budgets until the end of time. As a result, the eurozone is foregoing its future by suffocating investment, both public and private, and letting its human capital stock rot.
A successful banking union was proclaimed, but actually only features common supervision while anything that might cost real money stays national. So the infamous bank–sovereign “doom loop” is still alive, even if not currently kicking too bad. The authorities will need to put on a brave face as the ECB’s asset quality review and stress tests near. Essentially, scared by the huge legacy debts concentrated in euro crisis countries and in view of looming fiscal transfers, the issue of fiscally backstopping the so-called banking union and properly complementing monetary union by fiscal union got shelved. In short, the fragile eurozone economy still rests on a deeply flawed euro policy regime – with shaky national governments in crisis countries watching powerlessly.
It is no secret that Germany alone is calling the shots in Euroland these days. And Germany itself is stuck in a perfect state of delusion and denial about the eurozone crisis. Suffering in crisis countries is regrettable but unavoidable, the result of nothing but their own past profligate failings, as Germany sees it. Calm and confident German voters re-elected Chancellor Angela Merkel as their guardian of stability, which is presumably now spreading throughout the eurozone.
Finance minister Wolfgang Schäuble denounced critics who fail to see how well his policy prescriptions are working as living in some “parallel universe.” Just as there was absolutely nothing wrong with Germany running perpetual current account surpluses inside the currency union – even as these may have wrecked its euro partners. There is also nothing wrong with the eurozone at large now trying to replicate the German model at the global level – even as those profligate Americans may be complaining about it. Things are just fine in Mr. Schäuble’s own parallel universe, in which having perpetual fiscal austerity at home offset by perpetual trade surpluses is evidence of competitiveness and the foundation of stability and prosperity.
This leaves Mr. Draghi in a tough spot though. For the ECB to stay passive even in the face of mounting deflationary pressures means accepting the German bet on net exports. While attempting to play a more active role beyond mere words would quickly meet German resistance. There is more than the coming ruling by Germany’s constitutional court on the matter of Outright Monetary Transactions (OMT). There is also the clear prospect that any meaningful liquidity action by the ECB on behalf of particular euro members would prompt both hyperinflation and transfer union outcries in Germany in any case. In short, doing “whatever it takes” inside a flawed regime designed for some parallel universe may not be very effective.
At the end of the day, the only good thing about Germany’s new grand coalition government is that it has the necessary parliamentary majority to change the German constitution – assuming that Germany might ever leave its current state of delusion and denial and finally come to realize that euro breakup would prove extraordinarily costly for Germany itself.