Global Agenda: Tidings of comfort?

What’s news in Europe? On the basis of developments in the financial markets, there seems to have been a dramatic improvement in the economic and financial situation of the periphery countries, namely Greece, Italy, Portugal, Spain and Ireland. Known collectively by the unflattering acronym “PIIGS,” these have been the epicenter of the wider European economic and sovereign-debt crisis for over three years.

However, things have changed. As usual, the change shows up most strikingly in the stock markets. To take the extreme example, the main index of the Athens Stock Exchange slumped to about 500 in July, but it has been trading between 850-900 in December. A profit of 75 percent to 80% in half a year is certainly cool, but not many people recommended taking the plunge into Greek equities in July, and probably very few had the guts to actually do so. The exchanges in Lisbon, Madrid and elsewhere have also recorded large jumps, albeit smaller than those of Greece.

More important, by far, is that the market for government bonds of these countries has improved enormously.

The spreads between the yield on Italian and Spanish bonds and those of Germany have shrunken significantly, so that, while still large, they are no longer “life-threatening.”

All this has been achieved on the basis of a firm commitment by the European Central Bank to buy the bonds of troubled countries, subject to various conditions – of which the most important is that the countries themselves apply for a rescue package and then accept the (onerous) terms that the lenders (read Germany) will demand.

Perhaps most impressive of all is that the improvement is not limited to the financial markets, which, as more and more people are realizing, are entirely manipulated by government and central-bank activities and barely function any more in their primary task of “price discovery.”

Spain has become the poster boy of the improvement under way in economic structures; the Rajoy government has passed, in the teeth of intense opposition from unions and sections of the public, landmark reforms in the labor market and elsewhere.

The goal of these reforms, in all of the PIIGS countries, is to make their economies more competitive with Germany and the other “northern” EU countries. The problem for the periphery countries has been that their labor costs were far too high, relatively, their productivity too low and their laws too rigid. Taking a leaf from Germany itself, which underwent a painful reform program in the years 2003-2008, the Spanish and others are trying to improve their competitiveness without using the traditional method of devaluing their currencies. This is because, as members of the European monetary union, they don’t have their own currencies anymore. The only choice left, therefore, is “internal devaluation,” which means reducing wages and benefits sufficiently to get back on a par with Germany.

But the extent of the “internal devaluation” necessary (i.e., the reduction in real wages and ancillary benefits) is huge. Goldman Sachs, which has no interest in exaggerating the severity of the problem, estimates that in Greece and Portugal the reduction needed is in the order of 50% – and even in Spain and Italy in excess of 30%. These are massive “adjustments,” which, if carried through, will surely help bring down the very high unemployment rates that these countries are enduring. But they also imply that most working people will suffer very hefty reductions in their standard of living. Of course, those who move from being unemployed to having a job are much happier. But those who still have a job and are required to work in it harder for considerably less real income are not happy at all.

Even Goldman Sachs is dubious that an “internal devaluation” of the size needed can be imposed on the populations of these countries without a sociopolitical explosion.

There is, in addition, the very real issue of the banking systems of the PIIGS countries, which are all bankrupt and are kept alive by transfers from the ECB and/or Germany.

Spain, in particular, is belatedly facing up to the consequences of a real-estate boom and bust that, on a relative basis, was much greater than the one in the US and has gutted its banks.

But the mega-problem of Europe going forward is that both the financial and, especially, the economic aspects of the crisis are not limited to the PIIGS countries. Rather, they encompass France, which is especially resistant to structural reforms, as this year’s elections showed, as well as the UK. Nor is Germany itself as strong and vibrant as it was, and it is certainly incapable of carrying the PIIGS on its back for several more years.

In short, it seems that the improved atmosphere in Europe is something to be enjoyed while it lasts, but not to be taken as an indication that the European crisis is over and that the euro, and the EU itself, are safe.

landaup@netvision.net.il