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Wheels coming off southern Europe


Ambrose Evans-Pritchard

Italy's slow crisis is flaring up again.

Italy's slow crisis is flaring up again.

None of Euroland’s key actors seems willing to admit that the current strategy is untenable. They hope to paper over the cracks until the German elections in September, as if that is going to make any difference.

A leaked report from the European Commission confirms that Greece will miss its austerity targets yet again by a wide margin. It alleges that Greece lacks the “willingness and capacity” to collect taxes. In fact, Athens is missing targets because the economy is still in freefall and that is because of austerity overkill. The Greek think-tank IOBE expects GDP to fall 5 per cent this year. It has told journalists privately that the final figure may be -7 per cent. The Greek stabilisation is a mirage.

Italy’s slow crisis is again flaring up. Its debt trajectory has punched through the danger line over the past two years. The country’s €2.1 trillion debt – 129 per cent of GDP – may already be beyond the point of no return for a country without its own currency.
Standard & Poor’s did not say this outright when it downgraded the country to near-junk BBB on Tuesday. But if you read between the lines, it is close to saying the game is up for Italy.

Its point is that if “nominal GDP” remains near zero, Rome will have to run a primary surplus of 5 per cent of GDP each year to stabilise the debt ratio. “Risks to achieving such an outturn appear to be increasing,” it said.

Indeed. The International Monetary Fund has just slashed its growth forecast for Italy this year to -1.8 per cent. The accumulated fall in Italian output since 2007 will reach 10 per cent. This is a depression. Yet how is the country supposed to get out of this trap with its currency overvalued by 20 per cent to 30 per cent within EMU?

Spain’s crisis has a new twist. The ruling Partido Popular is caught in a slush-fund scandal of such gravity that it cannot plausibly brazen out the allegations any longer, let alone rally the nation behind another year of scorched-earth cuts. El Mundo says a “pre-revolutionary” mood is taking hold.

A magistrate has obtained the original “smoking gun” alleging that Premier Mariano Rajoy accepted illegal payments as a minister. The Left is calling for his head but so are members of the Consejo General del Poder Judicial, the justice watchdog.

“Citizens cannot tolerate a situation where the prime minister has received undeclared payments,” said José Manuel Gómez, a Consejo member. Much of the ruling party appears tainted by a network of covert funding. If proved, said Mr Gomez, it poses a “very grave” threat to Spanish democracy.

Portugal is slipping away. Professor João Ferreira do Amaral’s book - Why We Should Leave The Euro – has been a bestseller for months. He accuses Brussels of serving as an enforcer for Germany and the creditor powers.

Like Greece before it, Portugal is chasing its tail in a downward spiral. Economic contraction of 3 per cent a year is eroding the tax base, causing Lisbon to miss deficit targets. A new working paper by the Bank of Portugal explains why it has gone wrong. The fiscal multiplier is “twice as large as normal”, or 2.0, in small open economies during crisis times.

What is new is that Vitor Gaspar, the high priest of Portugal’s shock therapy, has thrown in the towel. He blames the fainthearted for refusing to slash with greater vigour. Needless to say, he still refuses to accept that a strategy of wage cuts and deflation in a country with total debt of 370 per cent of GDP was always likely to fail.

If Portugal does pull off an “internal devaluation” within EMU it will shrink the economic base. Yet the debt burden remains. This is the dreaded denominator effect. Public debt has jumped from 93 per cent to 123 per cent since 2010 alone.

The Gaspar exit has closed a chapter. The junior coalition partners are demanding a change of course. I write before knowing whether President Anibal Cavaco Silva will call a snap election, opening the way for a Left-leaning anti-austerity government.

The Portuguese press is already reporting that the European Commission is working secretly on a second bail-out, an admission that the wheels are coming off the original €78 billion EU-IMF troika rescue.

This is a political minefield. Any fresh rescue would require a vote in the German Bundestag, certain to demand ferocious conditions if this occurs before the elections.

Europe’s leaders have given a solemn pledge that they will never repeat the error made in Greece of forcing an EMU state into default, with haircuts for banks and pension funds. If Portugal needs debt relief, these leaders will face an ugly choice.

Do they violate this pledge, and shatter market confidence? Or do they admit for the first time that taxpayers will have to foot the bill for holding EMU together? All rescue packages have been loans so far. German, Dutch, Finnish and other creditor parliaments have never yet had to crystallise a single euro in losses.

All this is happening just as tapering talk by the Fed sends shockwaves through credit markets, pushing up borrowing costs by 70 basis points across Europe. Spanish 10-year yields are back to 4.8 per cent. These are higher than they look, since Spain is already in deflation once tax distortions are stripped out. Real interest rates are soaring.

By doing nothing to offset this, the ECB is allowing “passive tightening” to occur. Mario Draghi’s attempt to talk down yields with his new policy of forward guidance is spitting in the wind. The ECB needs to turn on the monetary spigot full blast – like the Bank of Japan – to head off a slide into deflation trap and enveloping disaster by next year. This is not going to happen.

Der Spiegel reports that the German-led bloc fought vehemently against a rate cut at the last ECB meeting, even though Germany itself has slowed to a crawl as China and the BRICS come off the rails.

Markets have reacted insouciantly so far to these gestating crises across Club Med. They remain entranced by the “Draghi Put”, the ECB’s slowly fraying pledge to backstop Italian and Spanish debt, forgetting that the ECB can only act under strict conditions, triggered first by a vote in the Bundestag.

These conditions can no longer be fulfilled. The politics have curdled everywhere.

Sooner or later, this immense bluff must surely be called.

The Telegraph, London

19 comments so far

  • Who does't know that the wheels are falling off in southern Europe, between the countries mentioned you have approximately an average of 20-25% unemployment and 50-55% youth unemployment average, while all estimates seem to be bound to countries remaining stagnant or just below in terms of growth.
    Most depressions seem to play their course over approximately 10 years or so that leave us 5 more years since the onset of the GFC till it is over if we use the past as the sole indicator rather that government forecasts.

    Date and time
    July 11, 2013, 4:09PM
    • This depression doesn't end. It only gets worse. We have hit the bounds to growth on a finite planet. Oil for a start, we've used up the cheap oil now we are scavenging for the expensive stuff e.g. good tar sands are only profitable above $70-$80 a barrel. Western economies depend on cheap energy for growth they can grow when oil costs $30-$40 a barrel +$100 a barrel kills them.

      Date and time
      July 11, 2013, 7:32PM
    • Depressions don't end of themselves.

      The only way out of a depression is to borrow and spend.

      The Great Depression was ended by a massive program of infrastructure building followed by the second world war (requiring unheard of levels of borrowing and spend).

      Date and time
      July 12, 2013, 8:44AM
  • Gold, gold, gold!

    Date and time
    July 11, 2013, 4:14PM
    • Insightful...thanks for the read.
      The real trouble lies with finding a solution. Would the pain of leaving the EMU be less than the pain of allowing the current play to role on is hard to stay. Either way there will be serious pain and those pre-revolutionary conditions may trigger in either case.

      Date and time
      July 11, 2013, 4:28PM
      • Why worry about Europe. 90% of US banks are still insolvent.

        If they were not the FEd would be singing it from the rooftops. Someone should ask Benacke in public " how many US banks are solvent? " just watch his reaction.

        Date and time
        July 11, 2013, 4:55PM
        • Why doesn't the Australian government take the opportunity to reduce the ridiculous burden of government pensions for potentially multi-million dollar property owners. Ie why is the government paying age pension payments and hosts of other subsidies to pensioners living in 5million dollar houses in Mosman. Let them get a reverse mortgage and lift the burden on the shrinking working population. Surely the voting population can see the sense in that when Europe is in tatters?

          Date and time
          July 11, 2013, 4:59PM
          • Hi rocket, I am no expert and I don't live in Mosman but do you genuinely believe it is the Mosman pensioners that are causing the issue ? Does the age pension allowance pay the rates on a $5m property in Mosman ? Not sure. Happy for you to respond. Or rant.

            I think he is a troll
            Date and time
            July 11, 2013, 7:35PM
          • Spoken like a true blue labor supporter. Don't you dare give anything to those who, through thrift and enterprise, have gone up the ladder. Make sure bludgers who smoke, drink and gamble and are on Centrelink benefits have maximum returns to reinforce that it is good to bludge. You fail to take into account the taxes and other imposts they have paid.

            Busselton WA
            Date and time
            July 11, 2013, 9:29PM
        • Monetary union without fiscal union has never worked - this is a lesson of history that has been ignored by the eurocrats in Brussels and the Eurozone. The Teutonic North, esp Germany, in the Eurozone have a devalued trading currency, ie the Euro. The Latin South have an overvalued trading currency, ie the Euro. Hence, a difference of some 20-30% plus in the relative competitiveness of their industrial economies. What is the least worst solution? Either ditch the Euro & return to sovereign national currencies or split the Eurozone into Latin & Teutonic blocs, with the former taking the Euro (which will devalue some 20/+%) and the latter adopting a reconstituted D-mark. The Latin bloc would begin to grow again & repay their debts (in devalued Euros) while the Teutonic North would probably undergo a relatively mild recession due to the revalued D-mark. Will this happen? Most unlikely.

          Howard's End
          Date and time
          July 11, 2013, 6:12PM

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