Hamish McRae: Europe's debt problems won't stop until it gets its head around growth
Sunday 30 October 2011
Yes, but where will the growth come from? Eurozone leaders managed to cobble together the long-awaited deal to cope with Greek indebtedness and, in the short-term, this is encouraging.
It means that Europe can go into the G20 summit this coming weekend in Cannes with something that is sort-of credible; only, I am afraid, "sort of" partly because of the element of fudge and partly because of the huge longer-term problems of Europe.
Of the fudge, I am not sure there is a lot to be said at this stage. The reason is simply that we won't know how serious the softer parts of the agreement are until they are tested. That will take some weeks.
Why so long? Well, think about the implications for the markets that the cut in the value of Greek bonds to half their value is deemed "voluntary" and therefore will not trigger the insurance against default. It is a bit like so much general insurance: you think you are covered for your wallet being stolen but when you try to claim you find there is some fine print that limits the insurer's liability. So now we all know that sovereign bond insurance is pretty much worthless; that will temper investors' willingness to buy the bonds of any country they think a bit dodgy.
It will be several months before the full consequences become clear but the very first auction of Italian debt on Friday saw three-year debt being sold at just under 5 per cent interest, the highest rate of interest on such debt since 2000. Not a good omen. It is all very well going cap in hand to the Chinese for a loan and they may well chip in a bit. But they will want to buy centralised European debt, carrying a guarantee from the eurozone as a whole; they won't want the risk of buying the bonds of individual countries.
Still, the plan will buy time – three months or three years. There will be more eurozone crises, with ministers meeting far into the night and emerging with further muddled plans that patch things for a bit longer. We just don't know how long it will be.
Meanwhile the fundamental issue remains: where will the growth come from? Europe's longer-term problem is not just that it has become a slow-growth zone, though that is bad enough given the debt burden it is carrying. It is also that some parts are managing quite well – in shorthand, northern Europe – while other parts are increasingly uncompetitive. Instead of pulling things together, the euro has pushed them apart.
You can catch some feeling for this divergence from the graphs. They come from a paper by Andrew Bosomworth, the head of portfolio management at Pimco in Munich, the world's largest bond fund. His first point is that divergence is a fact, as the main graph shows. This groups eurozone countries into three: those that have been in broad current account balance; those that have been, in general, in surplus; and those in deficit. As you can see, those in surplus have become more so, while those in deficit have tended to run up larger deficits.
One unsurprising effect of that, shown in the small graph, is that the surplus countries have not had to rely on the European Central Bank to balance their books while the banks in the deficit countries have come to rely more and more on the ECB.
This does not tally absolutely with the list of countries that have received bailouts, or might need them. For example, both Ireland and Italy have been in broad current account balance but the former has needed a bailout and the latter may need one. But it supports the wider point that the eurozone has led to economic divergence.
The central point of the paper is that the piecemeal approach from the eurozone authorities is encouraging capital flight from the fringe.
"What before was unthinkable," he writes, "has now become possible. To reach equilibrium, we believe markets are signalling the economic and monetary union's leaders to choose one of two corner solutions: downsize to a smaller, stronger, homogenous group of countries or adopt a federation with political and fiscal union. Both choices are fraught with enormous financial and political challenges."
Which will it be? Well, of course, no one can know, but I find the comments by Kenneth Rogoff, the former chief economist at the International Monetary Fund, now a professor at Harvard University, have an uncomfortably true ring to them. He believes that Greece will leave the euro within the next decade. Commenting on the package at a Bloomberg conference in New York, he said: "It feels, at its root, to me, like more of the same: where they've figured how to buy a couple of months. It's pretty darn clear the euro does not work, that it's not a stable equilibrium."
Only a couple of months? That's not good. So what could make all this seem too pessimistic?
It has to be growth. That growth has to be generated by structural reforms and those will have to take place against a background of fiscal restraint, not just in the troubled fringe but in the core: thus, France is tightening is fiscal policy in an effort to keep its AAA credit rating. But – and I think this is not said often enough – there is a huge skills base in Europe. The best European companies are excellent; world demand for the top-end goods and services they produce is soaring; productivity is, on some measures, even higher than that of the US. It is a frustration that a mixture of ill-designed regulation and high tax levels should hold the best companies back.
The point was put squarely by Simon Henry, Shell's chief financial officer, speaking after the bailout was announced. Shell is cutting back its investment in Europe to just 15 per cent of the total.
"Europe's macro-economic position can only recover, and the sovereign debt crisis can only be addressed, through underlying economic growth and we do not see the EU creating the conditions for that – in fact, quite the opposite. Most moves by the [European] Commission ... tend to ... reduce competitiveness of European industry. That's more of a concern to us ... than the sovereign debt crisis."
As world population hits seven billion, it’s wrong to think you don’t count
Seven billion people. A bit scary, isn’t it – certainly for those of us who have been around a while. If you haven’t already tried the cute app on the BBC website that enables you to work out the world’s population on the day you were born, I suggest you do so. I found that the population was just over 2.35 billion. Ignore the spurious precision because, of course, we don’t know exactly how many people there are in Britain, let alone the world.
But demography is hugely important to economics so it might just be helpful to pick out some key themes. One is that virtually all the growth is in the emerging world. Of the developed countries, only the US is expected to show a significant rise in numbers over the next 30 years (mostly from migration), though the UK may surpass 70 million. Another theme is that, within the emerging world, growth is tailing off in China and, while it is slowing in India, the fact remains that it will become the world’s most populous country within a generation. Still another is that, for the time being at least, the fall in birth rates in Africa has been slow. The result of that is that the population of Africa is set to grow faster than in any other continent over the next two generations.
Put this together and it seems likely that the world will hit eight billion in another 20 years. The obvious question this raises is whether we can feed those numbers, but I think the more relevant one is: what kind of lifestyle can the world offer this enlarged population without putting too great a burden on its resources?
The trouble with this question is that it leads into debate where there is too much heat and not enough light. So, as our species reaches that seven billion point, may we greet the news with a certain caution, recognising that what we think does not matter but what we do does matter a tiny bit.
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