Daniel Gros, in a well meaning, but I feel fatally flawed, move to get us all away from talking about some of the members of our own community as if they were PIGS, has decided to tell us that they are not pigs at all, they are merely GIPSYs. Of course, depending on which way you look at it, such forms of reference could be taken as a compliment ("you sure do eat like a pig"), or not, but stopping to think for a moment about the kind of controversy which has been provoked by the arrival of large numbers of Roma in Italy, perhaps telling the countries which lie on Europe's periphery that the best way to conceptualise them is as a bunch of "gitanos" is not the best way to get reasoned debate going. Nor is it necessarily the best way to do this to tell the members of core Europe that they as things stand they are essentially F-UK-De. But there it is. That's just how things are these days.
A Fiscal Adjustment Alone Won't Work
Now, taking us back a bit nearer to that harsh and horrid reality, Daniel does in fact, in his ill-named Working Paper "Adjustment Difficulties in the GIPSY Club", actually get to the heart of some very important matters, and really I thoroughly recommend everyone to read it from start to finish. The core of Daniel's argument is, I feel, the extraordinarly obvious point that the kind of fiscal adjustment currently being proposed for some of the peripheral countries is going to have one, and only one immediate consequence: these countries are going to be sent off to the outer darkness of very, very (see his numbers) sharp GDP contractions, and these contractions run the risk of preciptating pre-Argentina 2000 type situations in one after another of the countries involved, since the contractions in nominal GDP are so large that they effectively take away with the one hand what was given (in the form of sacrfice) with the other, and will lead to a seemingly endless spiral of increases in the debt-to-GDP ratios, which will in turn lead to ever deeper short-term fiscal cuts, and ever stronger contractions, etc, etc.
As Daniel argues, the only way to restore competitiveness, and avoid the dreaded Argentine spiral is to carry out some form of internal devaluation:
"What can Greece do to escape the ‘Argentine’ vicious circle of higher risk premia and a worsening economic outlook? The only way to minimise the cost of the external and fiscal adjustments that are required to... make the situation sustainable is to make Greece more competitive and thus stimulate exports."
"This can be achieved only by an across-the-board reduction of wages (or rather labour costs) in the private sector of between 10 and 20%. Cuts in wages of this order of magnitude will encounter fierce popular resistance. They could come about either at the end of an extremely painful process when unemployment has reached peaks never seen before or they could come much earlier as the result of an overarching national agreement in which the government, opposition parties and the social partners agree on what is needed in the light of present circumstances. Greece thus needs a concerted effort at the national level not just a government that pushes austerity measures through Parliament."
So Why Are The Other F-UK-De?
The problem is, conceptualising this situation as one group of fiscally derilict countries having to be controlled by another group of upright and competitive ones does not give us a complete picture of the mess we are all in, as Gideon Rachman eloquently argues in his Dr Schäuble's Torture Chamber post:
Behind the careful bureaucratic language, Schauble makes some amazing claims and proposals. Here are just a few.
“All eurozone members must return to adherence to the stability and growth pact as rapidly as possible.” This is just hypocrisy. I was living in Brussels when the pact was gutted the first time - because Germany and France were unable to keep within the 3% deficit limit.
Schauble also seems keen to resurrect the main feature that made the stability and growth pact lack credibility in the first place: the notion that countries that are running out of money need to be shocked back onto the path of virtue and prudence by being fined - a move that would obviously worsen their financial plight.
Basically, as Rachman argues, we all need to calm down a bit here, and get things rather more in persective. In the first place the Eurozone's economies - as I keep arguing day in and day out - are all roped together via the system of current account deficits and surpluses.
This is a point France’s finance minister Christine Lagarde draws attention to in an interview in this morning's Financial Times. As M. Lagarde says:
“[Could] those with surpluses do a little something? It takes two to tango,” she said in an interview with the Financial Times. “It cannot just be about enforcing deficit principles.”
“Clearly Germany has done an awfully good job in the last 10 years or so, improving competitiveness, putting very high pressure on its labour costs. When you look at unit labour costs to Germany, they have done a tremendous job in that respect. I’m not sure it is a sustainable model for the long term and for the whole of the group. Clearly we need better convergence.”
Well, let's leave aside today the issue of whether or not convergence is a realitistic (or even a possible) objective for Europe's economies given the large demographic mis-matches between countries, but still, Lagarde is on to something. What we don't have is a situation where on the one hand we have everything for the best in the best of all possible worlds, while on the other we have a group of slouchers and forgers. This kind of thing makes for nice headlines, but it is far from corresponding to reality.
Another reason the F-UK-De group are in trouble if the GIPSYs wander off to the outer darkness, is that they will have issues to resolve in their banking systems, as the chart below reveals. German banks may have little exposure to Greek debt, but their exposure to Spain and Ireland is enormous.
In fact, the massive exposure of German and French banks to Portugal, Ireland, Greece and Spain offers part of the explanation as to why Europe’s biggest economies have been steadily moving to rescue their southern neighbors in recent days, according to a recent report from Societe General entitled “Shotgun Greek Wedding.” According to the report banks in Germany and France alone have a combined exposure of $119 billion to Greece and $909 billion to the four countries, according to data from the Bank for International Settlements. Overall, European banks have $253 billion in Greece and $2.1 trillion in the four countries collectively referred to as the "PIGS".
“The exposure is enormous,” said Klaus Baader, co-chief European economist at Societe Generale in London. “The crisis in Greece isn’t Greece’s problem alone but a concrete problem for Europe’s whole banking sector. That explains the interest of finance ministers in stabilizing the situation.”
Defining Moment?
Gideon Rachman admitted that this one felt like a significant moment to him, and I am inclined to agree. We have two proposals on the table, and neither of them will work. In the first place simply treating the problem on Europe's perifery as an essentially fiscal one will not return these countries to competitiveness, and will simply precipitate GDP contractions, and deflationary spirals, that will lead inexorably towards failure, defualt, and possibly exit from the Eurozone (which, in fact, Herr Schläuble seems to feel would be an acceptable outcome to all this).
On the other hand, A Germany (or a Japan) which is not able to maintain a substantial external surplus (which is the only way a country with their kind of demographic profile can attain headline GDP growth, since internal demand is long gone as a "driver") since without a surplus and without GDP growth the implicit liabilities of ageing populations (via health and pension commitments) will become unpayable, leading to default (or a huge slashing of public welfare commitments) in these countries too.
Wolfgang Munchau also seems to think it is decision time. As he argues in his Op-ed in today's FT, "Shrink the eurozone, or create a fiscal union". I know which side I am on. As Joaquín Almunia once argued, people would need to be crazy to leave the Eurozone. So let's get on with it, and go climb that hill which lies out there in front of us.
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