Satyajit Das: Europe’s debt disease is in remission – it’s not cured

Economic Outlook: Growth will not be strong enough to reduce unemployment  or improve solvency

European leaders are interpreting stabilisation of economic activity and stable borrowing costs as evidence that the debt crisis is over. Austerity programmes, debt write-downs, the European Central Bank’s commitment to “do whatever it takes” to preserve the euro, the proposed banking union and the finalisation of the primary bailout fund (European Stability Mechanism) have all helped restore relative financial stability. There were falls in the interest rates of peripheral countries and a rally in stock markets, although no meaningful recovery in the real economy.

The cost of Spanish 10-year debt fell from more than 7.5 per cent to around 4 per cent; Italy from 6.7 per cent to under 4 per cent; Greece from 30 per cent to about 10 per cent; Portugal from 12 per cent to around 6 per cent. The Spanish and Italian stock markets recorded a one year gain of 31 per cent and 24 per cent respectively. The French and German stock markets rose by over 24 per cent. In contrast, eurozone gross domestic product fell 0.1 per cent during the third quarter of 2012, 0.6 per cent during the fourth and 0.3 per cent during the first quarter of this year, with sharper falls in the weaker economies. Modest growth was registered in the second quarter.

But austerity has failed to bring public finances and debt under control. Increases in taxes and cuts in government spending have led to contractions in economic activity, reducing government revenues as unemployment rates increase. Budget deficits, while smaller, persist and debt levels continue to rise.

Eurozone GDP is now 3 per cent below the 2007/2008 level. It is also some 13 per cent below trend levels. Individual economies have fared even worse: the Greek economy has decreased by 23 per cent; Italy by 9 per cent; and Ireland, Spain and Portugal by 8 per cent. Eurozone unemployment is 12 per cent. Some weaker nations have higher figures: Greece 28 per cent;  Spain 26 per cent; Portugal 17 per cent; and Italy and Ireland 14 per cent. Youth unemployment is significantly higher in some countries, at 25 to 50 per cent.

The eurozone used large current account surpluses, which have increased to a surplus of 2.3 per cent of GDP, to reduce the need for internal adjustment. Falling Greek wages and improvement in Italian and Spanish exports are cited as evidence that imbalances are correcting and peripheral countries are regaining competitiveness.

Unfortunately, this improvement may be dependent on the value of the euro. If the euro continues to rise, due to the US continuing its quantitative easing programme for longer than expected, then improvements in economic activity may slow. Fundamentally, all countries cannot achieve an increase in net exports. 

The IMF recently concluded that eurozone internal adjustments were cyclical, due to slower growth and weaker currency rather than sustainable structural policy changes. Internal cost adjustments within the euro-  zone have been slow, driven in part by the reluctance of stronger countries, led by Germany, to reflate and switch from their export-driven models. The prospects of such changes occurring in the short term are poor.

Reduced dependence on foreign capital has also stabilised borrowing costs. Leading into the crisis, Greece, Ireland, Portugal, Spain and Italy were running current account deficits which were financed by imported capital. Most countries are now funding their needs domestically. Around 70 per cent and 60 per cent of all Spanish and Italian government bonds respectively are now held domestically. Almost 100 per cent of net issuance of Spanish and Italian government is now purchased by domestic investors, reducing vulnerability.

The ECB provided low-cost funding to domestic banks to buy government bonds which are lodged as collateral for the loan. Withdrawing from foreign markets and reducing exposure to riskier investments, the banks have been “encouraged” to purchase government bonds, which generate attractive profits.

The policy does not address the problems of debt levels. It concentrates exposure to government bonds and creates problems if the debt has to be restructured and it increases the vulnerability of the banking system.

Stabilisation has meant that governments are reluctant to continue austerity programmes in the face of weak economic activity and high levels of unemployment. Pleading exceptional circumstances, many nations have sought and received exemptions. Deficit and debt reduction targets have been deferred, although even these are unlikely to be met.

Overall, economic improvement will, at best, be slow. Growth will not be strong enough to reduce unemployment or improve solvency of banks, corporations or households.

In reality, the European financial crisis has been in remission since mid-2012, with the symptoms of the underlying disease temporarily suppressed. There is a high probability of a relapse.

Satyajit Das is a former banker and  author of “Extreme Money” and  “Traders Guns & Money”

PROMOTED VIDEO
News
ebooksAn unforgettable anthology of contemporary reportage
Life and Style
tech

Company reveals $542m investment in start-up building 'a rocket ship for the mind"

News
Bourgogne wine maker Laboure-Roi vice president Thibault Garin (L) offers the company's 2013 Beaujolais Nouveau wine to the guest in the wine spa at the Hakone Yunessun spa resort facilities in Hakone town, Kanagawa prefecture, some 100-kilometre west of Tokyo
i100
Arts and Entertainment
James Blunt's debut album Back to Bedlam shot him to fame in 2004
music

Singer says the track was 'force-fed down people's throats'

Sport
CSKA Moscow celebrate after equalising with a late penalty
football

News
i100
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Helpdesk Analyst

£23000 per annum + pension and 22 days holiday: Ashdown Group: An established ...

Senior Helpdesk Analyst / Service Desk Co-ordinator

£27000 per annum + pension, 22 days holiday: Ashdown Group: An established ind...

Senior Pensions Administrator

£23000 - £26000 Per Annum: Clearwater People Solutions Ltd: Our client is curr...

Corporate Actions Administrator / Operations Administrator

£25 - 30k: Guru Careers: A Corporate Actions Administrator / Operations Admini...

Day In a Page

Two super-sized ships have cruised into British waters, but how big can these behemoths get?

Super-sized ships: How big can they get?

Two of the largest vessels in the world cruised into UK waters last week
British doctors on brink of 'cure' for paralysis with spinal cord treatment

British doctors on brink of cure for paralysis

Sufferers can now be offered the possibility of cure thanks to a revolutionary implant of regenerative cells
Let's talk about loss

We need to talk about loss

Secrecy and silence surround stillbirth
Will there be an all-female mission to Mars?

Will there be an all-female mission to Mars?

Women may be better suited to space travel than men are
Oscar Pistorius sentencing: The athlete's wealth and notoriety have provoked a long overdue debate on South African prisons

'They poured water on, then electrified me...'

If Oscar Pistorius is sent to jail, his experience will not be that of other inmates
James Wharton: The former Guard now fighting discrimination against gay soldiers

The former Guard now fighting discrimination against gay soldiers

Life after the Army has brought new battles for the LGBT activist James Wharton
Ebola in the US: Panic over the virus threatens to infect President Obama's midterms

Panic over Ebola threatens to infect the midterms

Just one person has died, yet November's elections may be affected by what Republicans call 'Obama's Katrina', says Rupert Cornwell
Premier League coaches join the RSC to swap the tricks of their trades

Darling, you were fabulous! But offside...

Premier League coaches are joining the RSC to learn acting skills, and in turn they will teach its actors to play football. Nick Clark finds out why
How to dress with authority: Kirsty Wark and Camila Batmanghelidjh discuss the changing role of fashion in women's workwear

How to dress with authority

Kirsty Wark and Camila Batmanghelidjh discuss the changing role of fashion in women's workwear
New book on Joy Division's Ian Curtis sheds new light on the life of the late singer

New book on Ian Curtis sheds fresh light on the life of the late singer

'Joy Division were making art... Ian was for real' says author Jon Savage
Sean Harris: A rare interview with British acting's secret weapon

Sean Harris: A rare interview with British acting's secret weapon

The Bafta-winner talks Hollywood, being branded a psycho, and how Barbra Streisand is his true inspiration
Tim Minchin, interview: The musician, comedian and world's favourite ginger is on scorching form

Tim Minchin interview

For a no-holds-barred comedian who is scathing about woolly thinking and oppressive religiosity, he is surprisingly gentle in person
Boris Johnson's boozing won't win the puritan vote

Boris's boozing won't win the puritan vote

Many of us Brits still disapprove of conspicuous consumption – it's the way we were raised, says DJ Taylor
Ash frontman Tim Wheeler reveals how he came to terms with his father's dementia

Tim Wheeler: Alzheimer's, memories and my dad

Wheeler's dad suffered from Alzheimer's for three years. When he died, there was only one way the Ash frontman knew how to respond: with a heartfelt solo album