Getting through euro-fear
2012: another year of living euro-dangerously
Fear of euro zone breakup became the world’s leading terror in 2011. That calamity can be avoided in 2012, even if the zone may well shrink later. This year’s global question is whether the world can keep growing while Europe ails. Probably it can, but uneasily.
Evolution of the European crisis will again drive markets in 2012. Italy may provide the year’s first big test. The euro zone’s third-largest economy has over 200 billion euros in debt to refinance and currently faces 7 percent yields despite some European Central Bank bond buying. The risk of a blowout in spreads is high.
The markets fancy the easy option to avoid that: large-scale bond buying by the European Central Bank. Germany, and the ECB, are reluctant. Such purchases are against the ECB’s rules, might encourage debtors to soft-pedal on fiscal and structural reform and could bring future losses to the ECB and its member central banks. The Dutch central bank has put provisions aside for that very purpose.
Germany and the ECB think euro zone governments should support their peers, using funds raised through the EFSF or ESM or obtained from the IMF. But this route has a blatant cost, burdening core economies that are at risk themselves of ratings downgrades – as France currently laments.
The best option is the simplest – Italy, a rich country which has long had excessive debt but also has high private savings, should help itself more. The proposed spending cuts of the new Italian government of Mario Monti amount to only about 2 percent of GDP over three years, less than Ireland is contemplating in one year. It might take a financing emergency in 2012 and a passive ECB to push Italy towards tough but fruitful change.
Even Italian progress would leave Europe with continuing serious problems. In the euro periphery of Portugal, Ireland, Greece and Spain, the problems have different roots: deficits and debts have worsened since formation of the euro. Despite one bailout, Ireland has among the worst public finances in Europe. It will need more help. The other three have large fiscal and trade deficits, look uncompetitive and may need external support for years. Supporting the periphery will test Europe. Years of austerity will test the periphery. Eventually one or more of these economies may leave the zone – and creditors – behind. But the euro itself should survive.
In 2012 European slowdown will be a global drag. Central and eastern Europe will feel it most strongly. Hungary will need an IMF deal.
Outside Europe the world looks better – but not great. The United States is finally adding jobs and the housing market is improving but the fiscal deficit is enormous and must begin to be brought down. Signs of moderate growth mean the U.S. Federal Reserve seems less likely to embark on a third round of quantitative easing, or money printing. That the Fed shuns QE3 may be important for global growth.
For in 2011, money printing in the U. S. helped drive up oil and commodity prices, making for higher inflation — and growth-slowing policy tightening – in China, India, Brazil and other emerging economies. In 2012, the biggest challenge for them should shift away from inflation towards sustaining growth, with Europe importing less and investors less willing to send capital in their direction. Less frothy commodity markets would permit monetary easing in emerging economies, leading to more rapid growth in consumer spending.
That would be healthy. The world needs the BRIC consumer to emerge further. China and other countries running big trade surpluses need to rebalance. The best way to do that is to allow currencies and imports to rise. Cheaper, more abundant imports will help change the structure of emerging economies – and provide Europe, the U.S. and Japan with more open export markets.
The outlook for 2012 is neither promising nor hopeless. Collapse of the global financial system, a return to the 1930s, a new depression, deflation – each threat to the world economy since 2008 has been real and has so far been averted. Euro collapse is the next threat. Policymakers will have to be resourceful again. That the world is still just about recovering shows that unlike in the 1930s they haven’t got everything wrong.
Predictions: Breakingviews is publishing a series of articles over the holiday that look ahead to 2012. The pieces will be collected together in the annual ’Predictions Book’, produced in print and electronic form early in the New Year.