Euro-zone has
fallen back into recession and, contrary to comments that are daily bombarding us,
most trends are pointing towards further deterioration. So it seems that “the
worst of crisis is over”, already several times repeated in the past, be a
joke. In Germany and France, industrial
production peaked in early 2011. Other countries (Greece, Spain, Portugal)
never really recovered. Retail sales are stagnating in Germany, and shrinking dramatically in countries that
had to be bailed out. The Netherlands are again a surprise, with similar
development as in Hungary. About banking, while deposits are bleeding with
annual rates of 10% in Spain and Portugal, almost all over Eurozone rising
non-performing loans and increased capital requirements force banks to reduce
their lending, often choking small and medium-sized companies (again Spain and
Portugal are front-running). In particular this is reflected in declining loans
trend by financial institutions in the PIIGS (except Italy, for now). Why
Eurozone can't take care of its seemingly never-ending crisis? Take, as
example, Italian situation. If something can be argued looking at real GDP it
is that, over the past 12 years, Italy's growth has been lower than Japan’s one
and without grow, otherwise (borderline) sustainable debt levels become too
much of a burden on the economy. This imply that GDP is a poor economic
strength indicator if ignores debt accumulated by governments, the largest
contributors to GDP. Furthermore, among PIIGS collapsing industrial production
and retail sales are eroding the tax base while unemployment, and especially
youth unemployment, provides for potentially explosive social tensions and/or
radical political movements success, making governing more difficult. Moreover,
as the average interest paid on government debt is surprisingly uniform (3-4%)
among Euro-partners, the subsidy of being member in the Euro zone does not
enforce fiscal discipline. Indeed, even in times of rapidly declining revenue,
governments in such a mess are unwilling or unable to cut spending unless
forced to do so by EU/ECB/IMF. This is the reason why most countries try to
resist any bailouts until it is too late (usually as soon as capital markets
refuse to further finance its debt). So, as fiscal adjustments are too
large and recessionary, trends take their toll on government finances and
debt-to-GDP ratios continue to rise. Finally, considering that governments do
not have any cash reserves, insolvency is only a failed debt auction away and
can happen at any time.
On the other
side, PIIGS’s trade imbalances are on the mend (anyway without the major
beneficiaries, Germany and Netherlands, giving up any of their surpluses) but,
unfortunately, despite recent improvements, Germany has still a large advantage
in unit labor costs and house prices in Spain and Portugal continue their
declining trend, weighing on banks.
Now, one likely
scenario outcome is that developments in Spain and Italy will lead to further
deficits and increase in debt levels so that at some point, capital markets
will refuse to absorb new debt and ECB/EU/IMF will be forced to step in, as
local banking systems are loaded with government bonds. Unfortunately, any
connected government bond restructuring - unavoidable in this situation as
Greece and Spain confirm - would also impair the banking system and, possibly,
rumors regarding the solvency of banking systems could trigger bank runs, as
depositors are warned by the Cypriot example. Central banks, at this point,
might certainly be able to avoid a collapse of the Eurozone by printing money
as there were no tomorrow, but still won't be able to prevent stock markets from
reacting negatively to recurring crises. At the end many years of further austerity
seem to be the inevitable result, with potential political and social
instability sprinkled in.
