Essentially there are three parts to properly resolving the euro crisis, and one vital precondition. The first is symmetric internal rebalancing, the second is dealing with the area’s debt overhangs, and the third is to turn the flawed euro regime into a viable one by fixing the original flaws. Crucially, crisis resolution will be difficult, if not impossible, without robust GDP growth. For in a shrinking economy not even a balanced budget will prevent the public debt ratio from rising further, while interest rates cannot be low enough when even nominal GDP growth is turning negative.
Mindless fiscal austerity is self-defeating when inflicted on a deleveraging private sector and fiscal multipliers large when neither monetary conditions nor exports can provide much relief. Pursued simultaneously across the continent, European countries are deflating each others’ key export markets, implicitly relying on extra-regional exports to make up for their suicidal pursuits. By forcing adjustment solely upon debtor countries, where debt overhangs are naturally concentrated, their solvency problems are made only worse. Resisting upward wage realignment, Germany is pushing its partners, including France, into debt deflation.
Structural reform is no offsetting growth strategy at all. It worked for Germany, and only with a long delay, because Germany was going it alone while the world economy was strong. Germany needed an external surplus of 7 percent of GDP to finally balance its public budget. Today, the world economy can barely tolerate a repeat of that feat for Euroland as a whole.As over-indebted private sectors continue to deleverage alongside attempts at fiscal restraint, the EU is effectively relying on its export sector to make up the difference. In a weird twist, Draghi’s actions to stem the sovereign debt crisis have prompted a significant appreciation of the euro. This result all but ends the EU’s hopes of creating an external surplus sufficient to balance fiscal budgets and will increase downward pressure on economic growth. My conclusion remains similar to Bibow’s:
In short, the euro remains firmly on track for breakup. It is only a matter of time until Mr. Draghi’s liquidity bluff will be called.