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Friday, June 25, 2010




Just split it


The opening leader in the current edition of the Economist is only one of many recent articles radiating intense pessimism over the global economy, mostly Western economies. Commenting on the sky high levels of debts of rich nations, in some countries unseen since the ww2, the Economist is wondering about if there's life after debt. The road to purgatory, it says, is paved by an acute demographic malaise intensifying over large chunks of the West and by the lack of enthusiasm on the part of the developing nations, first of all China, to do their part in rebalancing of the global economy.

For policymakers, the priorities are clear. First, they need to focus on generating growth. America, with its relatively young, rising population, will find that comparatively easy. Continental Europe, by contrast, runs the risk of ending up like Japan, which has spent two decades struggling to grow in the face of its debt burden and ageing population. The best and the brightest young Europeans may emigrate to countries without such burdens; and if the economy stagnates, those that remain may eventually decide either to default on their debts, or to cut benefits to the elderly. Faced with those dangers, Europe needs to embrace the structural reforms necessary to make its economies as fast-growing and flexible as possible.

Second, policymakers need to begin the long task of rebalancing the world economy. It makes sense for Western countries, like workers in their 50s, to save for retirement rather than run up their credit-card bills. But if one lot of people saves, another must borrow. At the moment the developing world is unwilling to run current-account deficits; even getting China to save less is a huge task...

Source: The Economist

On my part I can add that the European road to purgatory is oiled with very European peculiarities brought upon by an overgrown currency union that has overextended itself. The eurozone's periphery, in particular the Mediterranean belt and to a lesser degree East Europe and Ireland, saddled with massive debts and running huge current account deficits, with the Damocles sword of undeflated housing bubbles still hanging over some nations such as Spain, is facing a staggering task of internal devaluation. As a matter of fact, the task is so daunting that calls are growing for Germany, possibly accompanied by other stronger members of the zone, to exit the zone and let euro crash to buy some relief for the zone's weaker members.

The only little problem with the afore mentioned theory is that it does not seem to work in practice. One big European country, not a member of the eurozone, otherwise known as the UK, has been trying the trick of external devaluation for about two years now. By the end of these two years, the new UK government has unveiled one of the most atrocious austerity programs in the country's history as expectations of an export led recovery, fueled by steady devaluation of the pound, have failed to materialize. Trade balance should be expected to deteriorate shortly after devaluation as imports become more expensive and exports can take a while to shoot up. Yet this J curve is two years old now and still refusing to start taking its textbook shape. For a heavily crippled economy like Greece two such lost years are more than enough to go bust.


Yet, the alternative of internal devaluation looks even worse. Until today it was tried only by four European nations whose size ranges from small to very tiny. All four feature unusually flexible by European standards economies and they were doing their internal devaluation in an environment saturated by stimulus programs unleashed by larger EU members and Russia. While it does look like the four have succeeded to regain competitiveness and are on the way to export led recovery, it's impossible to ignore the fact that from Ireland to Latvia these economies have shed everything from 15% to 25% of their GDP.

Latvia is a particularly astonishing case of a nation who's seen her economy wiped out by a quarter in a span of less than three years. This is a feat impossible to reproduce among leftish societies of the Mediterranean belt. Let alone after a few years have been wasted on doing nothing and with leading continental economies scaling back stimulus programs and unveiling drastic austerity measures in the face of debt ratios that are plainly heading to the sky. In between the rock of internal devaluation and the hard place of external devaluation and breaking up the eurozone, I am saying, the eurozone will have to split.

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