TODAY
9 Jan 2014
Business
By Nouriel Roubini -
The global economy had another difficult year in 2013. The advanced economies’ below-trend growth continued, with output rising at an average annual rate of about 1 per cent, while many emerging markets experienced a slowdown to below-trend 4.8 per cent growth.
After a year of subpar 2.9 per cent global growth, what does 2014 hold in store for the world economy?
That's precisely what happened with most of the financial experts trying to guess the fate of the euro. Some remained optimistic about the future of Europe's common currency, but the majority predicted that the euro would not survive the global financial crisis, that it would break up with an almighty bang.
Not only did this not happen, but the euro was also one of the best-performing currencies last year. And, far from shrinking in size as some predicted, the number of countries using the currency increased: Latvia, a small republic on northern Europe's Baltic shores, ditched its national bank- notes in favour of the euro at the start of this year.
How could armies of erudite academics, financial specialists and media commentators get it so spectacularly wrong? Largely because they failed to realise that the euro's biggest flaw - the fact that it is a currency driven by politics rather than economic realities - is ironically also the euro's most durable asset. The euro remains under threat but it is Europe's political map, rather than complicated indexes of sovereign debt and money supply, which will decide the currency's fate.
Those who invented the currency two decades ago were careful to speak the language of economic necessity. The euro, they claimed, would spur cross-border investments, encourage competition and make it easier to travel and work across frontiers. But the reality was that the euro was a largely political enterprise designed to prevent a reunified Germany from translating its economic might into continental domination by depriving all nation states of one of their most important instruments of statehood: their currency. As a result, the purely economic criteria for managing the euro were largely ignored.
The outcome is, by now, well known. European countries whose finances were in shambles for decades borrowed cheaply in euros until their debts became unsustainable and drove some of them to the brink of bankruptcy.
Failures of project
YET less familiar although equally important are the other failures of the euro project. It did not spur cross-European investment: European corporations switched their production lines to Asia instead. It did not prompt a boom in financial services: London, the British capital resolutely outside the euro zone, increased its domination in these fields. And because individual countries continued to apply their own separate taxes and trade regulations, the euro did not reduce retail prices either. Seldom has any project failed in so many of its stated objectives and in such a comprehensive manner.
Given all these considerations, the smartest course when the financial crisis struck would have been for nearly bankrupt countries such as Greece or Portugal to leave the euro zone. And, if they refused, the equally logical response would have been for a country like Germany - which ultimately bankrolls every European project - to kick them out.
But nothing of the kind happened. About ¤1 trillion (S$1.7 trillion) was lent by Germany and other rich EU countries to bail out their poorer cousins. And the bankrupt states implemented draconian austerity measures of the kind nations contemplate only in wartime. Greece's gross domestic product, for instance, cumulatively dropped by a quarter during the past four years, equivalent to about 15 average European economic recessions all rolled into one.
One explanation why so many Europeans tolerated this massive exercise in self-flagellation is that the act of joining the euro was similar to that of jumping into the deep end of a pool without knowing how to swim: The only options available are either to somehow paddle along, or to drown. The Greeks could have exited the euro, but only at the cost of pulverising the bank savings of their population. And the Germans could have refused to pay for the Greek bailout, but the result would have been a default among German banks holding bad Greek bonds.
Coin with identical sides
HOWEVER, the chief reason that countries were prepared to bear the pain of austerity was political: the fear that, once out of the euro zone, they would be ejected out of Europe altogether.
That fear may seem odd for the British who never wanted the currency, but not for those who actually faced the danger of losing the euro. If Greece had been evicted from the euro zone, it would have been destined to play second fiddle to Turkey, its perennial rival and far bigger neighbour. An Ireland out of the euro would have meant its return to the British economic sphere of influence which the Irish spent a century trying to escape from. Running away from an unhappy past is also the logic which prompted Latvia to join the euro zone now: It's the only way to avoid the clutches of Russia.
And the countries which bankrolled the bailouts had their own equally powerful political incentives to throw good money after bad. The disintegration of the currency would have confronted France with its biggest foreign policy defeat since World War II: It would have meant that all the French attempts to tie Germany in as many political knots as possible had failed. And for the Germans, the demise of the euro would have spelt the end of the country's post-war policies of anchoring their nation in a peaceful, prosperous Europe.
In short, precisely the political elements which prompted Europe's financial crisis also provided the glue which held the currency together. The euro resembles a coin with two identical sides, a currency doomed to prevail regardless of how one tosses it: Heads I lose, tails you win.
Given all this, does it mean that the possibility of the euro's demise is now completely discounted? The short-term omens are good. Ireland has already exited its bailout programme. Spain no longer needs cash. Speculators worldwide continue to be deterred by the warning from European Central Bank presidentMario Draghi to do "whatever it takes to preserve the euro". And German Chancellor Angela Merkel, only recently re-elected, continues to believe that "if the euro collapses, Europe collapses", so she will pay for any mishap.
Long-term prospects
STILL, the euro's long-term future remains murky, for Europe is sitting on a ticking economic and social time bomb which can explode at any moment. The EU's current approach - cutting deficits to lower debt and enacting "structural reforms" to generate growth - has not done much to either cut debt or change Europe's economic structure.
According to a recently published paper from US economists Kenneth Rogoff and Carmen Reinhart, Europe's "debt overhang" can be resolved only by either "restructuring", a polite term which means that those who lent EU governments the cash will not get back all their money, inflation which reduces the overall value of the debt, or what the authors term "financial repression", namely forcing banks to provide cheap cash to the economy.
Encouraging inflation is out of the question since the Germans won't hear of it. Forcing banks to cough up cash is not realistic either until there is a debt relief for households that owe huge amounts to the same banks. So, the only viable solution is the further restructuring of debts, something which European governments have sworn they will not consider. Either way, the dangerous work of straightening Europe's finances has barely begun; much more pain is in the offing, at least until the end of the decade.
Identity crisis
BUT the far bigger problem is that what began as a financial and banking crisis has now turned into a crisis of European identity, for the euro, which was meant to bring Europe closer together, is tearing the continent apart. Northern Europe is doing well; Germany is bristling with optimism. But southern Europe is a disaster area, where half of those aged under 25 have never earned a salary in their lives and countries turn into ghoulish theme parks. In the Portuguese city of Porto, an architectural jewel and the capital of the region producing the port sweet red wine, the chief attraction now is the "austerity tours" which take visitors around the city's 70,000 derelict houses.
Those who still find Europe an object of desire are either Ukrainians demanding to be let in or African illegal migrants who risk their lives crossing the Mediterranean Sea; in Europe itself, a record 60 per cent of respondents no longer trust the EU to handle any of their aspirations.
The euro won't die because Europe's economics are wrong; it will only when its politics go awry. That has not happened yet but it may happen this year, when elections for the EU Parliament could result in a rise of anti-European parties and a continent-wide backlash against austerity.
Which is one reason why many of those pundits who predicted the currency's demise are still not ready to admit they were wrong.
