Global Economy

European banks heading for new crisis

Jean-Claude Juncker symbol of European dilemma
Jean-Claude Juncker.jpg

Amidst an apparent and serious leadership deficit Europe’s economy is heading for a Japanese kind of ‘lost decade’ and the need to rescue weak banks within a year – unless urgent steps are taken towards debt reduction.

This is the message of a just published think piece by the Council of Foreign Relations (CFR).

“Concerns about European growth are a growing weight on markets. At the recent International Monetary Fund (IMF) and World Bank annual meetings, there was widespread talk of the risk of ‘Japanification’ of the European economy, meaning a prolonged period of underperforming growth and low inflation,” it is stated in the wake of an up-to-the-minute stress test of eurozone banks by the European Central Bank.

Two overriding problems are identified:

• “First, these remedies are well understood by European leaders – the problem is not imagination, but leadership. Europe remains stuck, and it seems that only a crisis can spur the needed response”; and

• “Second, the downside of the analogy to Japan and the three arrows of Abenomics is that Europe should also address a fourth arrow – the debt overhang—which exerts a continuing drag on investment and confidence. With the stress test complete, now is the time to address this problem as part of a comprehensive pro-growth package.”

In the meantime the head of Germany’s central bank, Jens Weidmann, has also warned that “… the current (economic) calm is misleading and even dangerous, because it takes pressure off of the governments to implement badly needed reforms. If they are not undertaken, investors could quickly change their risk evaluations.”

At the same time the recently inaugurated new president of the European Commission, Jean-Claude Juncker, elected on a “Europe first”-ticket, finds himself in the middle of a huge illegal tax deals controversy.

Last week several media outlets published detailed accounts of tricks used – and the eagerness brought to bear – by Luxembourg officials to help companies avoid paying taxes during the time Juncker was prime minister of Luxembourg.

This coincides with the CFR stating: “Now is the time to embark on a comprehensive effort to restart growth in Europe, including a fourth arrow aimed at debt reduction. Low interest rates, the relief provided by earlier maturity extensions, and the confidence that could be achieved from the stress test combine to create a window for action on the debt.

“A year from now, if growth has not returned, indebted governments will be called on to rescue or shore up weak banks, uncertainty will return, and confidence and investment will be much harder to achieve. Europe needs a rules-based approach to debt relief. … The sooner they are established, the sooner Europe will see a return to growth. Otherwise, a lost decade looms.”

The piece argues that the one critical element that is missing from Europe’s response to its economic crisis is strategy to deal with the debt overhang from the 2007/2008 financial crisis.

“Across Europe, sovereign debt is higher than it was immediately following the financial crisis. Last year, gross government debt was 175% of gross domestic product (GDP) in Greece and 133% in Italy; Portugal and Ireland's governments both hold debt stocks over 120% of GDP.

“Meanwhile, household and corporate debt remains high and continues to threaten bank balance sheets. Low interest rates make these debt burdens manageable for now, and have allowed countries such as Greece and Portugal to reenter markets. But with growth through 2015 projected at an anemic 1%, this is a problem deferred, not solved,” the report said.

The uncertainty associated with it can condemn Europe to years of low growth and its attendant ills. These ills, some with serious implications also for social stability in the so-called peripheral countries include extreme unemployment – in excess of 35% for youths in Spain, Greece, Portugal, and Italy.

“Continued weak economic performance will only further reduce confidence and investment, possibly widening the premium on periphery sovereign debt.

“The way out of the growth doldrums resides in forcefully tackling the debt problem. Europe's leaders need to find the political will to launch a structured debt-relief program,” it was stated.

As the Juncker experience indicates, balancing the overall ‘greater good’ of Europe with the narrow national best interest is not easy. It remains to be seen if countries like Germany and other creditor nations will be willing to settle for debt relief without highly intrusive reforms enforced on the debtor nations.

 

by Piet Coetzer

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