Euro Zone Still in Danger of Break Up

EU faces two tough months of bargaining to boost euro confidence | Reuters.

A temporary lull in a crisis is not the same as the abatement of danger. Since July and Draghi’s famed statement, yields on periphery debt have improved, and the euro has strengthened. These favorable factors do not lead to the optimistic conclusion that the crisis is ending.

To wit, here is a chart displaying the DJIA from 1929 to 1933:

Temporary lulls marked by short-term rallies are part of a crisis. The long-term trend is what is significant.

In Europe the long-term trend for economic and fiscal conditions is troubling. Greece and Spain are in the midst of depressions. The rest of the periphery is in a recession. France and Belgium are stagnant, and the northern tier is growing slowly.

The total budget deficit in the eurozone has been rising since the onset of the crisis and will continue to do so to a record 88% of GDP this year.

Part of the problem is the uncompetitive economies of the periphery. The rest is the use of an ill-fitting currency for a diverse economic area. Neither of these situations has improved appreciably in the past three years.

In order to end the eurocrisis, the euro zone has to be repaired, and all the economies of Europe need to enact reforms to make themselves competitive with the rest of the world.

These are the steps needed to fix Europe. Anything less than adopting these steps and allotting the money to pay for them is merely engaging in a can-kicking exercise:

  1. Adopt a banking union like I write about here: http://dareconomics.wordpress.com/2012/10/20/merkel-and-hollande-issue-face-saving-announcement-but-no-summit-agreement/
  2. Enact a fiscal union with both control over national budgets and fiscals transfers from the rich to the poor just like the dollar uses.
  3. The EU must deal with the current debt problems in the periphery so that these countries may begin growing again.
  4. The EU must adopt union-wide changes to make all of their economies more competitive with the rest of the world. These reforms would include the loosening labor and internal and external markets for goods and services.

The adoption of the euro has created huge imbalances within the eurozone. In order to repair these, the steps listed are necessary. Anything less will leave a broken system, which will continue to limp along until it doesn’t.

There are political roadblocks to enacting these reforms. Change is hard for people and for countries. An entire political status quo is based on these welfare states with generous worker and politician protections.

Power is a zero-sum game. Any secession to Brussels is less power for the mainstream political establishment and their constituents and therefore will be fiercely resisted by both these groups. An example of this resistance is the current situation in Spain where the Prime Minister will balk at a bailout until the last possible moment in order to wring concessions out of the EU and ECB.

Another political problem is the frosty relationship among France, Germany and the U.K. France wishes to obtain money with concessions to be announced later, Germany promises money in the future for a closer political union today, and the U.K. wants to wash their hands of the whole mess.

The political tensions within the EU have led to a dangerous game of brinkmanship in European politics. It seems the only way to get anything done nowadays is in reaction to a burgeoning crisis.

One day, but not today, the Europeans will stall too long, and a major crisis will erupt that will be beyond their capacity to fix with a summit and a few announcements.

 

 

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