This week I’d like to coddiwomple through making mistakes and staying data-dependent to gain a...
Europe needs a Plan B to escape a deeper crisis--but there is no Plan B
04/27/2012 8:30 am EST
How scary and potentially dangerous can life be without a Plan B? During the last family vacation I ever took with my parents, I remember calling out from the backseat, “Hey, the gas is on empty and that signs says ‘Next exit last gas for 46 miles.” My Dad, who never wanted to stop once he got rolling, was driving and my Mom, who loved to plan was riding shotgun. Needless to say, we passed that exit without slowing. I watched, fascinated in the way that a mouse is fascinated by a rattlesnake, as the needle sank further and further below “E.” My Mom, I’m sure, was fuming. And my Dad? Did he have a Plan B? This was 1965 and we were on an almost empty stretch of newly completed interstate in Montana. What could we have done except coast to a stop and wait for a state trooper to come along—eventually? I can still feel my relief as we finally rolled into a gas station. I don’t think my father was joking when he said, “I’m never seen this car take so much gas.” I know my mother didn’t find it funny. (And as I said, it was the last family vacation we ever took.)
My Dad lucked out. His lack of a Plan B didn’t leave us stranded on the side of a deserted highway. The EuroZone countries don’t look like they’re going to be that lucky. If they want to avoid another—and quite possibly more damaging—round in the euro debt crisis, they need a Plan B. But maybe, just maybe, there’s a glimmer of a Plan B emerging from the unlikeliest of sources, French Socialist, anti-European fiscal discipline pact presidential candidate Francois Hollande.
And not a moment too soon: On April 26 Standard & Poor’s cut Spain’s credit rating to BBB+ from A on concern that Spain’s economy will continue to contract and Spain’s government will have to bail out the country’s banks, and then need a rescue itself.
Plan A looked in great shape just a few months ago. On January 30, 25 out of the 27 European Union countries agreed to sign onto a German-sponsored pact that was designed to ensure budget discipline among Europe’s economies. It was a moment of triumph for German Chancellor Angela Merkel, who had pushed to make a promise of budget discipline binding and for EuroZone politicians who had argued that a tighter fiscal union with stricter budget limits was the way to solve the euro debt crisis. “It is the first step toward a fiscal union. It will certainly strengthen confidence in the euro area,” European Central Bank President Mario Draghi said then. The logic was simple—countries would demonstrate budget discipline by passing austerity budgets with big cuts to spending and significant increases in taxes and that would restore financial market confidence in Ireland, Portugal, Greece, Spain, Italy or France. That would then enable these countries to borrow in the financial markets at reasonable interest rates. Growth would then resume—aided by economic reforms passed along with the austerity measures—and the debt crisis would be over.
But now, just about six weeks after European leaders actually signed the treaty embodying that “solution,” it is in tatters. Spain has already tried to unilaterally reset its budget deficit targets for 2012. A coalition government in the Netherlands has had to resign when a coalition member refused to support a budget designed to get the country’s 2013 budget deficit down to the 3% European Union target. On April 25 in Ireland the country’s union movement said it couldn’t support the treaty in the upcoming referendum. Opinion polls show 30% of Irish voters in favor with 23% against and a huge 39% undecided. An Irish No vote, like that of 2008 when Ireland initially rejected the Lisbon treaty that amended the basis treaties that are the foundation of the European Union, wouldn’t kill the budget responsibility pact, but it would create a financial market crisis since that pact says that any country that rejects the pact is ineligible for funding from the European Financial Stability Facility that currently underwrites Ireland’s rescue package.
But the biggest blow to Plan A has come from France where challenger Hollande has run on renegotiating the budget discipline pact and incumbent Nicholas Sarkozy has moved closer and closer to that position in an effort to catch up before the May 6 second round decides who will be the next president of France. To stand any chance of winning Sarkozy must move closer to the anti-euro stance of the National Front’s Marine Le Pen. Le Pen’s extreme right wing party came in a strong third with 18% of the vote (to Sarkozy’s 27% and Hollande’s 28.6%.)
Plan A has run into two big problems.
One is economic.
The pain of austerity budgets has produced a shrinking economy and more pain, and the need for more austerity. To use Greece as an example of how this has worked: On April 24 the Bank of Greece forecast that the Greek economy will shrink by about 5% in 2012 for a fifth consecutive year of contraction. That’s worse than the 4.5% drop for 2012 that the bank had previously projected. Unemployment, the bank predicted, will rise to 19% in 2012 from 17.7% in 2011. 250,000 of the 1 million companies in Greece in 2009 have closed since that year.
Some of that contraction is due to the budget cuts and tax increases introduced by the Greek government as it attempts to cut its budget deficit to meet the targets set by the International Monetary Fund, the European Commission, and the European Central Bank.
You can see that process at work if you compare the most recent figures and projections on the Greek economy and budget deficit to where the country thought it stood in November 2011 when the coalition government presented the 2012 budget plan to parliament. The government then thought the cuts and taxes in that budget would reduce the Greek budget deficit to 5.4% in 2012—but at that point the government was projecting that the Greek economy would contract by just 2.8% in 2012 with an unemployment rate of 17% in 2012. If everything goes according to plan, Finance Minister Evangelos Venizelos told a press briefing that November the government will not be forced to introduce further austerity measures.
But everything certainly didn’t go according to plan. And as the economy shrank, Greece had to find another $4.4 billion in budget cuts in February to keep rescue funds flowing. And it looks like whatever party wins the May 6 national elections will have to come up with another $14.5 billion (about 5% of Greece’s GDP) in budget cuts for 2013-2014, according to the International Monetary Fund.
The other problem is political.
Voters in Greece and Ireland and Spain and France aren’t in a mood to sign on to what is apparently an endless round of budget cuts and falling living standards. Voters have thrown out governments in Ireland, Portugal, Spain, Greece, and Italy. They look like they’re about to throw out governments in France and the Netherlands. In countries where they’ve already replaced a government once—such as Spain—the new governing party is seeing its support erode.
And the new governments are either coming into office with hostility toward the austerity of Plan A or are being pushed in that direction by the rise of smaller parties running on platforms of No to the euro, No to austerity, No to immigration, No to globalization, and No, as one columnist in the Financial Times said of the French election, to the 21st century.
All this first eroded and then--with the fall of the Dutch government and the likely defeat of Sarkozy in France--crippled the political alliance that pushed Plan A through. Germany has lost critical French and Dutch support and finds itself increasingly isolated with only the Finnish government reliably in its corner.
Some in Germany have reacted to this by simply repeating, in a louder voice, prior arguments for fiscal discipline. For example, on April 23, Jens Weidmann, head of Germany’s central bank, responded to calls by the European Central Bank to do more to support the EuroZone economy by saying that the central bank has already done a lot, that monetary policy is not a panacea, and that action by central banks can’t be a substitute for inaction by governments on budget cutting.
I don’t know how Weidman’s comments on “inaction” on budget cutting went down with voters in Greece and Spain, for example, but I think the head of the Bundesbank is lucky he’s not a politician.
German Chancellor Merkel is unlucky enough to be a politician, one faced on the one hand with deep opposition in her own party to any more money from Germany going to rescue other EuroZone countries and on the other hand understanding the disintegration of her alliance behind Plan A. In recent days that has pushed Merkel to endorse European Central Bank President’s Mario Draghi’s call for a growth pact to go with the already approved fiscal pact.
But if you looked at what Merkel has actually proposed and the details provided by other German officials, this growth pact is really just warmed over Plan A. The austerity package has always come with calls for structural changes to national economies that are intended with time—a decade or more--to increase the competitiveness of these economies. Plan A’s growth plan is to reduce wages in these economies enough to make their products competitive on world markets and to introduce economic reforms that would increase the global competitiveness of these economies.
If that’s what Merkel and her government mean by a growth package, it’s sure not what France’s Hollande has proposed. While not backing away from France’s pledge to reduce France’s budget deficit to 3% of GDP (because that would freak out the financial markets), Hollande has suggested that the European Central Bank’s mission be expanded to include economic growth along with inflation fighting—which would bring the bank in line with the Federal Reserve’s dual mandate—and which has been emphatically rejected by the German members of the European Central Bank’s governing board. He has also said he would favor giving the European Stability Mechanism, the EuroZone rescue fund that is to go into operation in July, bank status so it could borrow from the European Central Bank—Merkel has already rejected that idea. He has also brought up the idea of EuroZone bonds that would be backed by the EuroZone economies as a whole. That’s an idea that Germany has repeatedly rejected.
And that’s where we stand right now. Plan A no longer has the political support necessary if it is to form the backbone of the EuroZone response to the crisis. It increasingly strikes the financial markets as a failed policy. And has produced so much pain in the countries now struggling to meet austerity targets that it threatens to push governments in those countries into positions that are hostile to the euro project as a whole.
The EuroZone doesn’t have the option of doing nothing. Politics aren’t standing still and the French and Greek elections on May 6 will, it’s likely, shift the balance of power in the EuroZone further against Plan A. Economies aren’t standing still—the negative feedback loop of the austerity measures of Plan A make it almost certain that Greece and Portugal, and probably Spain and potentially France, won’t meet their budget targets on time. And the financial markets aren’t standing still—the lack of a Plan B will lead to another round of this crisis if the markets become convinced that Plan A isn’t working or is in practical terms a dead issue.
So is the EuroZone doomed? Will Greece begin an exodus from the euro that will ultimately lead to the demise of the single currency? Will Spain need a bailout that’s bigger than the current rescue funds can provide?
All those are real dangers—but doomed? No. And because I actually see a viable Plan B, one the Germans could endorse, in some of the growth proposals put forward by France’s Hollande.
Besides his calls for a shift in the mission of the European Central Bank and for EuroZone bonds—both ideas DOA in Berlin—Hollande’s economic team has also suggested such growth ideas as boosting funding for the European Investment Bank with the new money to be used to finance big infrastructure projects. (Would German voters go along with their money going to that?) Along with EuroZone bonds, Hollande has proposed “project bonds” to finance economic development and research in areas such as new energy technology. These bonds could not be used to finance sovereign debt. A package of ideas like that—focused on growth and infrastructure—could be added to the Plan A austerity pact as a kind of growth sidebar to Plan A. In effect what could emerge is PlanA/B and that might be enough to prevent the current crisis from developing a political momentum that would make it all but impossible to save the euro.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any stock mentioned in this post as of the end of December. For a full list of the stocks in the fund as of the end of December see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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