Doom, Gloom, Dread Threaten Eurozone
In a concession to the continent’s increasingly unmanageable state of crisis, Spain over the weekend announced that it would seek €100 billion ($125 billion) in financing through the European Financial Stabilization Mechanism and an anticipated permanent rescue fund. Faced with the prospect of dissolution should Spain’s banking woes overtake its remaining islands of stability, the European Union signaled a robust 11th-hour response. In a Saturday press release, the Eurogroup offered that “the loan will be scaled to provide an effective backstop covering for all possible capital requirements …”
The present state of affairs was not inevitable but for the vacillation of Europe’s leadership. For more than two years, opportunities to stanch the blood loss of investor confidence have been met with ambivalence and only momentary flashes of consensus about the existential threat. The pledge to Spanish containment adds to the half-trillion-dollar price tag of rescue in Greece, Ireland and Portugal.
The terms of Greek support may yet unravel when its citizens go to the polls for the second time in as many months on June 17. If parties opposed to austerity measures form a government and follow through on commitments to renegotiate terms of the bailout, Greece will almost certainly have to decamp the eurozone for the drachma. Effectively cut off from sovereign bond markets, a dramatic shift in standards of living will threaten a parliamentary republic that was only established in 1975 following the Regime of the Colonels.
Membership in the eurozone is hardly a prerequisite when its difficulties are being apportioned. In an opinion piece in this weekend’s Sunday Telegraph, Britain’s Chancellor of the Exchequer George Osborne described the United Kingdom’s coquetry with recession squarely in its European context. “Our recovery—already facing powerful headwinds from high oil prices and the debt burden left behind by the boom years—is being killed off by the crisis on our doorstep.”
From the vantage point of one Britain’s Great Offices of State, Osborne criticized his eurozone peers for their equivocation, writing, “the lesson of the last two years is that treating the latest symptom does not cure the underlying condition.” His comments are prescient; the Eurogroup’s response to Spain over the weekend extends a pattern of focusing on the immediate emergency rather than the systemic issues. Barring the disassembly of the eurozone itself, the broader solutions to the crisis require a stronger banking union focused on consistent regulation, common deposit insurance and well-understood criteria and mechanisms for recapitalization of failing banks. Whatever misgivings it may elicit, preserving the monetary union will require a degree of fiscal union, as well, through debt mutualization and a eurobond.
Osborne’s bluntness reflects the pressures on Britain from its incomplete integration with the Continent. On one hand, its own austerity programs are introducing headwinds that are dampening growth and toughening the job of meeting deficit targets. At the same time, the absence of efforts in the eurozone to address systemic challenges is heightening external pressures. Westminster hopes to set an example for Europe. But as the British expansion falters, even the business community is wavering on the Tories’ credibility-seeking steadfastness. Earlier this month, the British Chamber of Commerce called upon the government to abandon its deficit targets and inject £6 billion ($9.3 billion) in new stimulus efforts.
In the upside scenario, Britain will narrowly avoid recession in 2012. The euro area will fare worse. Amongst its anchor economies, Germany is projected to stand alone in recording barely passable growth. The eurozone’s unemployment rate, already above 20 percent in Spain and Greece, will climb, adding to political and social pressures that could result in selective defaults. In the extreme, our current stress tests of commercial mortgage performance are characterized by globalization of the ensuing fiscal crisis. A new historic low in Treasury yields will be more than offset by a dramatic tightening of credit.
Americans might adopt a measured tone when admonishing our European peers. After all, we have demonstrated an equal capacity for complacency and political dysfunction when dealing with our own fiscal challenges. It is largely by virtue of scale, perception and the dollar’s tenure as reserve currency that we are allowed to remain profligate when bond markets rebuke others.
Extraordinary capital flows into the Treasury market are being misinterpreted as votes of confidence in the U.S. handling of its public finances. That construal approaches a new level of absurdity; it rivals the positioning of Europe’s crisis as a net positive for the U.S. commercial real estate industry, evinced by stronger foreign demand for gateway market properties. While low financing costs are bolstering investment outcomes for apartments and for institutional borrowers in other sectors, value must ultimately find its ground in the fundamentals that are undercut by instability.
Sam Chandan, PhD, is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.