A Grim Outlook for the Eurozone?

Ambrose Evans-Pritchard, who has been consistently alarmed about Europe (and often charged in comments of going overboard in general, and on this topic in particular) sounds a particularly loud alarm on Europe, based on the view that the ECB has not eased enough.

I have limited insight here. I have been told that German banks are clamping down hard even on very sound Mittelstand borrowers, and the Mittelstand companies are the German growth engine. I was also just in Europe in June, well before the peak of tourist season, in cities along the Rhine and Danube. I saw far fewer signs of visible distress than in New York, meaning no homeless (that may not be a valid indicator, between social services and policy possibly shooing them away) and no shuttered retail stores (while vacancies are pretty high throughout Manhattan). And the streets and stores all looked pretty busy, although I have no benchmark for what normal activity would be.

The one thing we may discount in our assessment of the responses of most European countries to the crisis is that they have far greater automatic stabilizers than we do, Germany, for instance, has generous unemployment programs. So with their high level of automatic stimulus, fewer discretionary measures are needed.

That does not speak to the adequacy of the overall effort, particularly on the monetary front, which Evans-Pritchard addresses.

From the Telegraph:

Without a radical change of strategy, the ECB risks pushing the weakest states into a debt-compound spiral that can only end in bond crises and/or the disintegration of Europe’s monetary union – whichever comes first.

The International Monetary Fund says the eurozone will contract by 4.8pc this year, worse than the UK (-4.2pc) or the US (-2.6pc). The deepest damage will occur next year as Europe remains mired in slump, even as the rest of the world recovers. It is the length of recession that matters most for jobs, social stability, and public finances. I am not easily shocked any longer but I did sit up when Spain’s budget chief Luis Espadas said the economic collapse could “easily” push Spanish public debt to 90pc of GDP by 2011. This is up from 36pc in 2007.

Nobody knows where the tipping point lies on public debt, though anything above 100pc of GDP in a currency union is courting fate. Some are already there. The European Commission says Italian debt will jump to 116pc in 2010. Greece is vaulting back to 109pc, Belgium to 101pc, France to 86pc.

Even German finances are falling apart…..Berlin says the deficit is heading for 6pc next year, taking debt to 82pc. This is happening all over the world, of course. But the ECB is compounding the effect, whether for reasons of politics, Bundesbank fetishism, or misjudgment. By refusing to join the US, Japan, Canada, Britain, and Switzerland in quantitative easing (QE) the ECB has allowed a contraction of private credit this summer. The M3 “broad” money supply has shrunk since February.

Ignore M3 at your peril. It flashed awarning signal in the US months before the collapse of Lehman Brothers last September; it is flashing the similar warning signals in Europe now.

Professor Tim Congdon from International Monetary Research said the eurozone money figures are “horrifying” and portend a serious crunch ahead. “My verdict is that the senior people in the ECB [and the Fed] have little organised understanding of the debt-deflationary processes initiated in late 2008,” he said.

Ireland’s M3 contracted at a 30pc annual rate last month, a death sentence for a hyper-indebted economy…

In Germany, the Mittlestand lobby (BVMW) says half its members are facing a liquidity squeeze, while the strutting finance minister, Peer Steinbrück, has assumed a ghostly pallor. “We must take seriously the threat of a credit crunch in the second half of this year,” he said.

Mr Steinbrück has called for a suspension of the Basel II accounting rules in order to rescue banks, and even suggested that the German government undertake direct lending to boost credit. The regulator BaFin has already told us that bad debts are set to “blow like a grenade” this year. A leaked BaFin memo said “problematic” assets have reached €816bn (£700bn), led by Hypo Real with €268bn.

ECB experts think eurozone banks will have to write down a further €203bn by the end of next year. Yet ECB policy-makers seem unwilling to face the implications. Yes, they have injected €442bn in a one-year tender, but the money is not reaching the economy. Simon Ward from Henderson New Star said the ECB is repeating errors made in Japan when it first trifled with QE, relying on banks to pass on credit rather going for massive bond purchases.

Inevitably, Europe’s politicians are taking matters into their own hands. They will not sit idly by as millions lose their jobs. If the ECB deflates, budgets must bear the strain, and that is exactly what Europe cannot afford with a birthrate of 1.53 per woman and the onset of demographic decline. The commission says the number of workers per pensioner over 65 will halve from four to two by 2040. Age-related costs will explode by 15pc of GDP in Greece, 9pc in Ireland, Spain and Holland. The populations of Germany and Italy will soon be shrinking.

Viewed strategically, Europe’s mix of monetary deflation and rampant deficit spending by the states is nothing short of lunatic.
Needless to say, Britain faces it own colossal mess, but of a different kind. It is the Prime Minister who is taking the country over a cliff, not the Bank of the England. Voters will soon have the joy of sacking him. How do Europe’s voters sack the ECB?

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  1. Wade

    I don't know exactly where you were in Europe, but if you didn't see boarded up stores then you obviously didn't visit London. Along a short stretch of the Kensington High Street I recently counted 13 stores closed and empty.

  2. Yves Smith


    I said I was in cities on the Rhine and Danube. And Evans-Pritchard, with his scolding of the ECB, is not including the UK in his analysis.

  3. gronkk

    One thing to keep in mind is that most british journalists have a very anti-euro and anti-ECB stance. Frankfurt or Brussel can't do anything right by definition.

  4. MC7447a

    More specifically, Evans-Pritchard has a very anti-Euro, anti-ECB , anti-EU stance. I don't think he's ever written anything positive about any of them.

  5. Tiago

    Dear Yves,

    Ambrose Evans-Pritchard (A E-P) predicted the catastrophic fail of the Euro from the onset. The Euro is still here.

    A E-P has an axe to grind. A very big one. He is staunchly anti-EU and essencially everything that smells like the EU is labelled as a disaster.

    He is an UK independence party (UKIP) supporter.

    His employer, the Telegraph (sometimes known as the Torygraph – in reference to the Conservative Party) is very right of center and currently is said to be more near the UKIP than the conservatives.

    While I have nothing against people having strong opinions (and I am still a avid A E-P reader), it is quite obvious that A E-P will always paint the EU as a disaster. In fact reading A E-P is becoming more boring and less informative every day: you know what he will say just by reading the titles of his articles. Staunch nationalist, anti-EU.

    A E-P will not allow facts to get in the way of his opinions if it involves the EU.

    I still read the guy though, and think that, if it does not involves the EU, he is a good read. But I more or less ignore him on EU issues where is is simply a propaganda writer.

    Disclaimer: I am far from being an EU/ECB lover.

  6. Brick

    You could argue that Europe is adjusting to less credit being available generally and the ECB is taking a stance that it will lend money at very low rates but never bailout. I am actually not convinced that the ECB has not been doing some QE through buying up Spanish distressed debt. Still Ambrose may have a point in that one of the traditional engines of Europe is misfiring (Germany) and the other seems extremely subdued as well (France). I guess Norway is one of the few last members to still be moving ahead. I fully expect Europe to engineer some sort of rescue for eastern Europe, not least to save Austrian and Swedish banks and the likes of Ireland, Spain and Italy to rely heavily on the safety of the Euro but the big question mark for me is what happens to Greece. A lot of Greece's economy is entangled in shipping whether directly through the shipping lines or through the money lent to shipping.

  7. Gunther

    To put things into perspective it would be good to compare bank losses with GDP. Then the numbers look different. A while ago there was a Bloomberg article http://www.bloomberg.com/apps/news?pid=20601109&sid=aI.TvvSBYXBM dealing with the bank rescues giving the following numbers:

    Country – rescue – GDP
    U. Kingdom – 781.2 – 1910 not in euro zone
    Denmark – 593.9 – 245 not in euro zone
    Germany – 554.2 – 2620
    Ireland – 384.5 – 195
    France – 350.1 – 2046
    Belgium – 264.5 – 361
    Netherlands – 246.1 – 621
    Austria – 165 – 296
    Sweden – 142 – 346 not in euro zone
    Spain – 130 – 1150

    All figures are in billions of euros and include capital injections, guarantees granted, effective asset relief and liquidity interventions.

    I added the GDP numbers from wikipedia:
    (Numbers in Euro, US$ divided by 1.4)

    Did the easing in the UK and Sweden help?
    The numbers for public debt in Belgium and Italy are that that high since who knows when and the countries still exist. I do not want to do A E-P’s job and look them up over time but as memory serves for both countries they were higher when the euro was introduced.
    That is a grim outlook for the Euro zone and probably a worse outlook for – to quote Willem Buiter- Reykjavik on Thames.

  8. Peripheral Visionary

    The interesting thing about this recession is that it has not, until recently, been a very visible one. In Washington, DC, I saw virtually no signs of crisis until the closing of some chain stores, probably a year ago; only now are construction projects slowing down and "for sale" signs continuing to sprout up. The financial crisis moved well in advance of the broader economic impact. The same is certainly true in Europe, and so even though the banks and stock markets have been in serious trouble, it is only now starting to be felt by the broader economy.

    On the specific issue of the homeless, it was in my most recent trip to Europe that I finally figured out why they have far fewer than the U.S. It's subtle, but I noticed that while they have some homeless people, what they don't seem to have many of are mentally ill homeless people. I think you are right, in that it is "social services" at work, whether the otherwise homeless like it or not: in general, European countries have more freedom to commit mentally ill persons. In much of the U.S., the standard is that the person has to be an immediate threat to themselves or others, which in practice means that they can't be committed until they have committed a crime; for the most part, the laws in Europe are not nearly as strict. With doctors, rather than legal courts, making decisions for commitment to institutions, the end result is fewer homeless people on the streets.

  9. ambrose evans-pritchard

    Just to address a couple of points on this thread.

    I was not in any way apologising for the dire state of affairs in Britain. The UK is not my brief but personally I think British public accounts have been grotesquely mismanaged. We ran a fiscal deficit of 3pc of GDP at the top of the cycle when Spain and Finland ran surpluses of 2pc or 3pc.

    That is the reason why the UK deficit has spiralled to 13pc. However, the UK story is sui generis. Britain is not part of a fixed exchange system, so the currency can take the strain — up to a point — as it has in Sweden. This will ensure that social damage in 2010 and 2011 will be a little less awful than it would otherwise have been.

    The debt levels of Italy and especially Belgium did indeed fall for several years after Maastrich set the path towards EMU. In the case of Italy, this was largely due to much lower interest costs as Rome came to enjoy Berlin's credit rating on bonds — ie, the convergence effect).

    What is shocking is the speed with which fifteen years of gains are suddenly vanaishing. If they can stabilize euroland in 2010, there should be time to repair the ship. However, it is getting ever harder as the demographic crunch approaches.

    My main point in this piece is that tight monetary/ loose fiscal policy is the worst conbination for a fast-aging region with high public debts. My article was not about the collapse of the euro as such. That would occur only if they the ECB fails to change course, (or at least that is my argument, others no doubt differ) so I presume that they will do exactly that under pressure from Paris, Madrid and ultimately Berlin, though serious damage is already occuring.

    On my own EU views. They are complicated. My wife used to work for the European Commission and I still have many friends in the EU institutions. For a long time, I thought Brussels did serve as an engine of free-market reform in Europe. I have certainly praised the Competition Directorate, and Neelie Kroes in particular, but also Mario Monti.

    However, I have long held the view that the EU has bitten off more than it can chew, ofter pursues a double agenda (ie power creep behind virtuous proposals),is inherently undemocratic. Euro-MPs do not hold the executive to account. The decision to press ahead with the EU Constitution/Lisbon after the rejections by France, Holland, and Ireland in referendums crosses a delicate political line in the sand — at least for me. I can no longer view the EU as a legitimate undertaking.

    I am not a supporter or member of any party, UKIP or otherwise. I wrote that I would vote for UKIP in the European elections in June for the specific reason that the candidate in my region was Marta Andreasen, the Spanish former chief accountant of the European Commission who was sacked for blowing the whistle on the EU books. (I covered the story as Brussels correspondent at the time, and obtained a leaked Commission memo admitting she was actually right — but was fired anyway).

    On a small point, where I wrote that the ECB had refused to join others in embracing QE, the line was heavily cut for space reasons without my knowledge. My original draft said it had done so late, and half-heartedly. It has of course now started with €60bn of covered bonds.

  10. ambrose evans-pritchard


    For cyclical reasons, German unemployment started rising much later than in Spain, where it has already reached 4m.

    So it is too early to see the visual effects on the streets of German cities. It will feel different in late 2010 if — as some of the institutes now fear — unemployment reaches 5m.

    That said, Germany will ultimately recover. The problem is that those countries such as Italy, Greece, and Spain that have lost competitiveness viz Germany will recover much more slowly. That is when the intra-EMU strains will become serious.

    How it all unfolds depends on politics in the end. My core view is that Europe remains very tribal. How far will Germany go to bail out Club Med, either via transfers or via inflation?

  11. T G MacAmhloaibh

    Despite my country of origin, Ireland, I am not all gung-ho on the European project but the analysis served up by EP borders on the criminally negligent. He conveniently conflats stats across country borders without giving context or the complete picture. For example, he throws out debt to GDP numbers for Germany in one sentence and then adds Ireland in next; despite Ireland having a had a relatively low ratio of c 25%.

    EP would do well to dwell on the UK and its eroding standard of living fostered by both govt and BOE policy. (Forget about quality of life issues, the UK cannot afford such luxuries anymore.)

    Europe has always had relative poverty but the fairly generous social net has dampened the outward appearance. Absolute poverty, such as is experienced in the US, will make a return imo. The ECB's main remit is to protect the value of the Euro and it has been pursuing conservative policies to ensure the Euro's success. Secondly, there is a wave of conservative fiscalism coming from Germany which will ensure one of Europe's main economic engines influences policy across the board. Social payments will decrease in the future realtive to GDP in many EU countries. Many influential European policy makers want sound income statements and balanced balance sheets as mandatory requirement for all Eurozone countries.

    Given the derth of new economic opportunities, the inability to crack open far Eastern markets in a truely meaningful manner and reduced consumption from lower social expediture, the European recovery from the financial turmoil should be slower. However, despite EP's prognostications, the Euro zone can handle its debt load and most EU countries citizen's are not personally debt burdened like those in the US and the UK.

    Europe's recovery may be slower but it will be more fundamentally sound, and with less of a debt hangover.

  12. ambrose evans-pritchard

    Reply TG

    Ireland's government debt will reach 107% of GDP by 2011, according to the National Treasury Management Agency said in a statement.

    Yes, it was around 25pc in 2007. This merely illustrates how fast it is deteriorating.

  13. Cos Mic

    If you see the chart of Euro M3 and M2, it is true that they have fallen very sharply since 2007. On the other hand, the YOY growth is at a level that is close to the 2003 bottom and slightly above previous bottoms, which seem to coincide with major equity market bottoms. If regulators to loosen it from here (similar to the spike in M1 recently), then we could be in for a massive rally in asset prices? I know bullish views are generally not too popular in this blog, but hey, someone needs to look at what markets could do in future rather than the gloom and doom now:-)

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