The month of January 2015 gave
us several, interlocked reasons for moderate optimism about the prospects for
economic recovery in the Eurozone and in Italy.
First, the further fall in oil
prices, strengthening the trend already present from last summer. From mid-June
2014 to the end of January 2015 the price of crude oil fell by as much as 60
percent, reducing the energy costs of Eurozone producers in spite of the parallel
but much lower depreciation of the euro against the dollar (on which more
below). Quantitative estimates of the effect of this cost reduction on the rate
of GDP growth are uncertain and vary around 0.5% -0.8%, but undoubtedly the
positive effect is present and is not negligible.
The second reason for moderate
optimism is the ECB decision on 22 January to implement Quantitative Easing, albeit with the disapproval of the
Bundesbank president Jens Weidmann and a minority of other representatives of
the Nordic member states of the
Eurorozone: € 60 billion per month for 19 months, from March 2015 to September
2016, and if necessary even further, until the Eurozone inflation target "below
but close to 2 percent" is reached. This amount however includes other interventions
already decided previously, so that the additional amount really is not €1,140bn
but only about €900bn, and the surprise effect (important for example in the Swiss
frank large appreciation of 15 January) had been diluted by months, indeed
years, of announcements, discussions and debates. However the size of the
intervention was still greater than earlier expectations, of the order of €500bn,
and therefore there still was some element of surprise. The provision that
National Central Banks should take on 80% of the risk of default on 80% of their
country’s bonds purchased by the ECB is an important limitation of the Monetary
Union but an acceptable price for this massive intervention.
Third, the depreciation of the
euro down to a rate of $ 1.11, then stabilized at $1.13 (below the rate of $ 1.17
at which the euro was first introduced and a far cry from its peak of $1.47),
for several reasons: ECB Quantitative Easing; the expectation of the Fed
raising interest rates, repeatedly announced and now postponed probably to next
June; expectations - rightly or wrongly - of the worsening of the Greek crisis
and even a possible exit of Greece from the Eurozone (Grexit). Such devaluation should have a
significant impact on the competitiveness of all member countries and therefore
their exports and growth, improving the relative position of those who like
Italy have seen labour productivity stagnate or even decline over the last
decade. Predicting the quantitative impact of euro devaluation on the rate of
GDP growth is difficult and risky, but this effect could have an order of
magnitude of 0.8-1%.
Fourth, the resounding victory
of Alexis Tsipras and his party Syriza in the Greek elections of 25 January,
which has called into question the austerity policy adopted by European
institutions under the hegemonic influence of Germany as the only strategy response
to the Great Recession of 2007, along with so-called "structural
reforms". These last are a
euphemism for the dismantling of the welfare state, privatization of under-valued
public assets and the cancellation of decades of achievements of the labour
movement.
The first moves of the new Greek
government were reassuring: Greece has no intention to leave the euro (a choice
supported by 60% of the Greek population), nor to press for further cancellation
of public debt, nor to request additional aid.
At the end of February Greece expected to receive €2 bn aid from the
European Union and €5 bn from the IMF, conditionally on reform implementation. Now the Greek government requests only €1.9bn
from the ECB as reimbursement of the additional interest earned by the Bank on the
Greek bonds in its portfolio. As Finance Minister Yannis Varoufakis rightly
said, "A Monetary Union responding to a serious financial crisis by
granting more loans to deficit countries on condition that they shrink their national
income is not sustainable”. Varoufakis
proposes a " menu of swaps " of Greek bonds with new bonds of two
types: one indexed to nominal economic growth, whose service therefore would be
conditional on the resumption of growth, and the other a "perpetual
bond" that would replace the Greek government bonds in the hands of the
European Central Bank. The Greek budget would remain in primary surplus, but
only on a more modest scale of 1-1.5%, thanks to the decision to pursue big tax
evaders. In this way Greece could effectively
honour existing commitments, while creating a fiscal space sufficient to
finance the reconstruction of the welfare state, to increase the minimum wage
and pensions, as well as to grant the benefits in kind or subsidies (for
example in electricity and transport) promised and partly already introduced by
the new government. Otherwise,
Varoufakis says, "Greece will become deformed rather than reformed."
Varoufakis' plan was received favorably at its presentation to the City of
London, and provides an excellent and credible basis for discussions and
negotiations with the European institutions.
Why, then, the
"moderate" nature of optimism rooted in so many positive
developments?
First, the fall in the oil price
is the result of lower demand in the recession, the Saudi decision not to cut
production to match lower demand, and the significant growth of the US
production obtained from bituminous shale. But the price reduction undermines its causes:
not only does it stop investment in the development of alternative energy sources,
but at the current price of around $ 50 per barrel it makes most of the
production to be sold at a loss and therefore not sustainable. On 30 January
the announcement of the closure of one hundred high-cost wells in the United
States raised the price of oil by more than $ 8 in a single day although
production had continued to rise. And if the low oil price were maintained
there would be - and are already experiencing them - negative effects on the
demand for imports by oil-producers and therefore on income and employment in
the non-oil-exporting countries.
Second, in the opinion of many
observers and businessmen, monetary easing by the ECB was "too little too
late", in comparison with the $ 4.5 trillion mobilized by the Fed already
commenced in 2008, and further, in view of the greater use by US companies of
credit and securities to finance investments, compared to the larger component
of profit reinvestment by companies in Europe and especially in Italy. But there is no doubt that monetary easing -
in addition to its impact already mentioned on euro devaluation - will
facilitate the recapitalization of banks that have an excess of government
bonds in their portfolios.
Third, the devaluation of the
euro could unleash a war between currency areas with rounds of competitive
devaluations, and the associated de-stabilization of financial markets.
Finally, European and German
economic authorities have immediately taken rigid and hostile positions adverse
to any form of restructuring of Greek debt.
Matteo Renzi has been likened
to Alexis Tsipras but unfortunately we are not so lucky, all they have in
common is their young age; Italy also has €40bn credits towards Greece, and our
excellent Pier Carlo Padoan has neither the imagination nor the tenacity of Yanis
Varoufakis. If anything Alexis Tsipras
has something more in common with our new President Sergio Mattarella:
immediately after their election both went to visit a monument to the victims
of Nazi atrocities, a gesture that cannot have been greeted with enthusiasm by Angela
Merkel. The French are watching from the
sidelines; in order to widen the breach in European austerity opened by Syriza we
will have to wait for a parallel Podemos victory in the next elections in
Spain.
The danger is that the game of
chicken played by Germans
and Greeks might lead to a lethal crash, perhaps in the form of an "accidental
Grexit" (an expression coined by Wolfgang Munchau): the expiry of
any deadline before a new
agreement is reached, the loss of Greek access not only to Quantitative Easing but
also to emergency liquidity provided by the ECB, capital flight and a panic run
on the banks by the public seeking to withdraw cash from their accounts. At that point, a severe liquidity crisis could
force Greece to issue some form of national currency, perhaps initially notes
issued by the Treasury circulating in parallel with euro cash now in short
supply: from there to a formal exit is only a small step. Cyprus came within a
breath of this predicament.
Marcello De Cecco noted that while
a Greek exit from the Eurozone could very well happen in the way I described, it would
be the result of a deliberate policy of not wanting to help Greece, instead of a
series of casual fatalities, when there is will there is always a way, and if deadlines
are not met this means that Greek exit is not so much feared but wanted.
In any case, a possible Greek exit
from the Eurozone – whether accidental or deliberate - cannot be ruled
out completely, and would be catastrophic for the entire Eurozone, with contagion
spreading first to Portugal, then to the other southern countries including
Spain and Italy, eventually turning against Germany itself and the other Nordic
countries. That is enough to temper anybody’s optimism.
POSTCRIPT
On 4 February the ECB
Governing Board decided that Greek government debt will no longer be accepted
as collateral starting next week. This
appears to be like undue ECB interference in Greek negotiations with the EU,
but 1) it is well within the Bank’s discretionary powers; 2) it is likely to be
part of the price paid by Mario Draghi for the large size of his Quantitative
Easing and 3) it is also a way of raising the stakes which might, in the end,
favour Greece by raising the cost of a Greek exit for Germany and the hawks as
well as for Greece. After all, Yanis
Varoufakis is an accomplished game theorist and should know what he is doing
(see Varoufakis Y., Rational Conflict. Oxford,
Blackwell, 1991; Varoufakis Y. and S. Hargreaves-Heap, Game Theory: A critical
text. London and New York, Routledge, 2004). At least, this is what we might still hope.
For assessments supporting this last point see the excellent post by Frances Coppola, What on Earth is the ECB up to? and the other posts listed at the end of it.
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