November 2012

ECONOMISTS' PANEL: Waiting for the euro to dissolve

EurozoneEuropean economists tell Funds Europe their views about the possibility of a eurozone break-up and how well policymakers are performing.

Let us hope that asset managers have emergency plans in the event of a break-up of the eurozone because our poll indicates that many of their economists expect the single currency to dissolve, at least partially. Funds Europe asked ten of the UK’s biggest asset management companies for an economist to give us their views on the crisis in the eurozone. Six of them predicted a partial break-up, three expected the eurozone to stay in one piece, and one was uncertain. The divergence in views is reflected also in the extent to which policymakers are thought to be doing the right things to mend the crisis. While some think policymakers’ actions are “quite close” to what the economists feel needs to be done, one says they are “nowhere near”. However, another respondent believes the eurozone crisis is essentially being dealt with. The economists generally agree that the €120 billion policymakers have resolved to spend on boosting growth is not enough. Some say it is an “irrelevant amount”. Our survey was carried out at the end of September and the beginning of October.

STEWART ROBERTSON, SENIOR ECONOMIST, AVIVA INVESTORS

Most expected outcome for the eurozone
Partial break-up. Although it is abundantly clear that politicians and, to a lesser extent, central bankers will do whatever they can to keep the eurozone together, I retain the idea that some countries would be better off outside the area. Greece would be the obvious first candidate, although because of recent events this may take longer than envisaged.

Best way to tackle the crisis
Political and fiscal union is the most important factor if the eurozone is to survive as it is. Many thought monetary union could happen without political union, and for a long time it did but it is clear now that this is no longer the case. Strong political will is holding the eurozone together for now, but the cracks are wide. In terms of how the crisis should be addressed today, the European Central Bank (ECB) must play a much larger role. In which case, the announcements made on September 6 [Mario Draghi, president of the European Central Bank, presented details of the ECB’s bond buying plan after its monthly council meeting] are a step in the right direction. However, they are just buying time in terms of reducing borrowing costs for those countries in trouble and they do not prevent those countries having to reform. It is a laborious and painful process as Greece is showing us, and there are major doubts about whether countries will endure this.

How in line is the EU with your suggestions?
Not very close. They are closer than they were a few years back in the case of the ECB, but in terms of a political and fiscal union, much progress is needed. The idea of a single fiscal authority for Europe is also some way off and the idea of unlimited, massive transfers from rich to poor is something that several countries are already objecting to. The reforms in many peripheral countries that are required are only in the early stages.

What policymakers are doing right and wrong
The ECB should be bolder but I understand why they are not as they do not have a unified voice: it is 17 central bankers, not just one. The Germans, for example, object strongly to what was agreed at the September 6 meeting. [The ECB said it would buy more debt from struggling countries in return for economic reforms].

Best way to spend the €120 billion that policymakers agreed at the European Summit at the end of June in order to boost growth
Primarily, the money would need to be used to help buy time for the troubled countries to reform.

Other comments
Spain, Greece, Portugal and a number of other countries still have a lot of pain, fiscal adjustment and structural reform to go through. This will be a multi-year process and some may not last the course. Ultimately, the only lasting solution is to evolve or adapt into a political union, too. This is the aspiration of many people, but it still looks an awfully long way off. In the US, there is a single fiscal authority that can determine transfers between rich and poor states, and this is generally accepted in a democracy. The euro area is inching towards this direction of a single nation where the richer help the poorer, but many will object along the way. The chance of more fissures opening up looks very high.

DOUGLAS ROBERTS, INVESTMENT DIRECTOR AND ECONOMIST, STANDARD LIFE INVESTMENTS

Most expected outcome for the eurozone
Over the next 18 months it should hold – thereafter, the outlook is more uncertain.

Best way to tackle the crisis
First, containment. Second, structural/ institutional reform. Although it may never approximate an optimal currency area (OCA), the authorities need to get closer – key will be fiscal union and probably political union – otherwise the crises will continue.

How in line is the EU with your suggestions?
They are probably aware of where they need to get to, but the problem will be getting there given national interests over regional interests and how far they are away from being an OCA.

What policymakers are doing right and wrong
Efforts to establish a fire-fighting capability are moving forward. The over-emphasis on debtor nations shouldering all the adjustment (austerity) burden is not helpful. Creditor nations should help the adjustment process.

Best way to spend the €120 billion that policymakers agreed at the European Summit at the end of June in order to boost growth
Direct investment (perhaps infrastructure). The monetary transmission mechanism is still dysfunctional.

SIMON WARD, CHIEF ECONOMIST, HENDERSON GLOBAL INVESTORS

Most expected outcome for the eurozone
Partial break-up. The eventual departure of Greece, Spain and Portugal, leaving core including Italy and Ireland. I forecast that the eurozone economy will improve in 2013, temporarily relieving tensions. Break-up is more likely in the next cyclical downswing, probably in 2014-15.

Best way to tackle the crisis
The key requirement is growth. ECB policy was too tight in 2010 and 2011 but has adjusted under Draghi, resulting in a revival in monetary expansion, promising better economic conditions in 2013. Fiscal policy is too focused on deficit reduction – the goal should be significant spending cuts to create room for lower taxes as well as reduced borrowing. Supply side reforms, including privatisation, should be accelerated. Regulators should ease up the pressure on banks to lift capital rations.

How in line is the EU with your suggestions?
Quite close. Monetary policy is now quite close but fiscal and structural policies are not very close.

Best way to spend the €120 billion that policymakers agreed at the European Summit at the end of June in order to boost growth
It’s an irrelevant amount.

Other comments
Keeping the European Monetary Union in one piece requires a boom in German domestic demand that sucks in imports from the rest of the eurozone and lifts German prices/wages, thereby equalising competitiveness. Draghi’s monetary policy could achieve this but will the German government and Bundesbank allow it?

JOHN GREENWOOD, CHIEF ECONOMIST, INVESCO PERPETUAL

Most expected outcome for the eurozone
Partial break-up. I believe Greece or Portugal will exit within two to three years. This will happen because orthodox politicians lose control of the agenda. This could happen either as a result of adverse election results stemming from bailout fatigue in the north, or austerity fatigue in the south, or as a result of bank runs in the south.

Best way to tackle the crisis
The eurozone will only survive without continuous stress if there is a fuller fiscal union among the existing 17, or a smaller currency union. Without fiscal union, individual member states will continue to suffer fiscal or banking crises that will require frequent bailouts. Without a smaller union, the currency union will regularly be de-stabilised by large inflows into or outflows from the periphery.

How in line is the EU with your suggestions?
Nowehere near. The EU and eurozone elite have invested a huge amount of political capital in maintaining the status quo, and are reluctant to admit their fundamental errors.

What policymakers are doing right and wrong
See above. A currency union requires a contiguous or matching fiscal union but EU/eurozone leaders refuse to accept this loss of national sovereignty.

Best way to spend the €120 billion that policymakers agreed at the European Summit at the end of June to boost growth
Expanding fiscal spending by €120 billion is almost irrelevant compared with the stagnation of the €12 trillion of bank lending. It will worsen the national fiscal balances and do little to solve the banking problems.

DAN MORRIS, GLOBAL STRATEGIST, JP MORGAN ASSET MANAGEMENT

Most expected outcome for the eurozone
Stay in one piece. Best way to tackle the crisis It essentially already has been. The insolvent countries have been bailed out, the ones that need liquidity are being given it by the ECB, and the structural issues are being addressed (albeit slowly), by the peripheral governments as budget deficits are reduced and economic reforms are implemented. The process will take time and growth will be low in the meantime, but it will eventually return.

How in line is the EU with your suggestions?
Quite close.

What policymakers are doing right and wrong
Most policy at this point is correct, though that has not been the case in the past with the initial bailout for Greece, for example, which was poorly designed. Problems now are with insufficiently bold economic reform in peripheral countries (though this is not surprising given that affected parties will naturally protest), and poor economic management by the Spanish government. The rise in Spanish bond yields in July, for example, had as much to do with the government saying it was “shut out of the markets” and not appearing to have a well thought out plan to deal with the obvious problems in the banking sector.

Best way to spend the €120 billion that policymakers agreed at the European Summit at the end of June to boost growth
Economic reform inevitably creates winners and losers, so some of it can be used to aid industries or individuals find new employment. Given the lack of credit growth, the money could be used to guarantee bank loans to promising industries so they are not unduly constrained.

Other comments
The ideal outcome of the ECB’s latest proposals would be for interest rates to fall enough so that anxiety about any eurozone break-up dissipates, but not so low that the pressure for economic reform dissipates as well. The ECB can only buy time for peripheral governments as the necessary adjustments take place, but without higher growth rates, the ECB’s efforts may ultimately prove futile.

HETAL MEHTA, EUROPEAN ECONOMIST, LEGAL & GENERAL INVESTMENT MANAGEMENT

Most expected outcome for the eurozone
Stay in one piece. At least over the next 12 to 18 months. The key risk is Greece being forced to leave the euro. But with a German election only one year away, and the potential for this to hurt the German economy in the near term, this will not be in the country’s interests.

Best way to tackle the crisis
Credible debt mutualisation policies are required – a full fiscal union.

How in line is the EU with your suggestions?
We are still a long way off from this. A proper discussion of how to move forward is unlikely to take place until after the German election.

What policymakers are doing right and wrong
Wrong, by making ambiguous statements.

Best way to spend the €120 billion that policymakers agreed at the European Summit at the end of June in order to boost growth
The money should be used to boost capacity, develop infrastructure or improve energy security.

DR LUCY O’CARROLL, CHIEF ECONOMIST, INVESTMENT SOLUTIONS, SWIP

Most expected outcome for the eurozone
I’m uncertain. It’s 50:50 whether Greece leaves the eurozone; if that were to happen, it would likely be after the remaining member states have built a more credible firewall to ensure (as far as possible) the survival of the eurozone.

Best way to tackle the crisis
Short term: build a firewall, break bank/ sovereign link for countries in difficulty, more realistic conditional austerity programmes. Longer term: Greece in or out depending on which improves prospects for eurozone sustainability, a fiscal and banking union, ECB a proper lender of last resort.

How in line is the EU with your suggestions?
Not very. It’s a formidable list and not one that would endear politicians to their electorates.

What policymakers are doing right and wrong
Doing right: seeming to recognise that liquidity provides a breathing space, not an ultimate solution, and that a successful monetary union requires greater economic and fiscal engagement. Doing wrong: mis-steps en route to achieving this.

Best way to spend the €120 billion that policymakers agreed at the European Summit at the end of June in order to boost growth
A combination of where the fiscal multipliers are most effective and the economic benefits can be quickly felt. ‘Shovel ready’ infrastructure projects would seem a reasonable starting point. However, €120 billion isn’t a huge sum in the context of the eurozone economy and this crisis, so (unfortunately) our expectations shouldn’t be unrealistically high.

AZAD ZANGANA, EUROPEAN ECONOMIST, SCHRODERS

Most expected outcome for the eurozone
Partial break-up. We expect Greece to leave the eurozone in 2013 after it fails to sufficiently implement structural and fiscal reforms. We do not expect any other member state to leave.

Best way to tackle the crisis
Greece should be asked to leave as the adjustment it needs to make and remain in the eurozone is too great. Europe must move forward to create very strong fiscal rules, but with a long time allowed for adjustment. Eurobonds must be introduced, and countries should not be allowed to issue their own bonds. A banking union is required where insurance funds are pooled together to safeguard against individual banks failing. This break the link between banks and the sovereign. The ECB must be allowed to buy government bonds with unlimited quantity, without sterilisation or conditionality.

How in line is the EU with your suggestions?
Not very close. They know what needs to happen, they just don’t agree with it.

What policymakers are doing right and wrong
See above

Best way to spend the €120 billion that policymakers agreed at the European Summit at the end of June in order to boost growth
It should be used to buy Spanish and Italian government bonds. However, it will not be enough.

MAXIME ALIMI, EUROZONE ECONOMIST, AXA INVESTMENT MANAGERS

Most expected outcome for the eurozone
Partial break-up. Best way to tackle the crisis The following need addressing. First, a solution for Greece. An exit from the euro is not mentioned in the Treaty. Institutional reform will be needed to make a smooth exit for Greece possible. Second, larger resources for bailout funds. A credible financial backstop is required to deal with sovereign crises in Europe. This requires increasing the size of the European Stability Mechanism (ESM) or finding an agreement on leveraging it further. The ECB is playing this role but the Outright Monetary Transactions (OMT) programme is not permanent in nature. Finally, an effective banking union. We need an agreement on a single supervisor, a resolution mechanism and common deposit guarantee scheme, as well as a financial backstop dealing with the fiscal consequences of banking crises. This could be the ESM or a distinct entity.

How in line is the EU with your suggestions?
Quite close. The sequence of decisions made over the past few months is significant. Taken together, the ‘fiscal compact’, the ‘two-pack’, the ESM and the ECB’s OMT programme go a long way towards tackling the institutional loopholes in the euro area. These steps make us confident that the crisis will be overcome in the medium term. We remain cautious because of the uncertainty on the implementation of these decisions and that key agreements need to be reached on sensitive issues.

What policymakers are doing wrong and right
2013 will be a big electoral year in Europe, with general elections in Italy and Germany. Our concern is that domestic political considerations will come to the fore of the agenda for a number of policymakers. This may drive their focus away from the crisis resolution or delay decisions.

Best way to spend the €120 billion that policymakers agreed at the European Summit at the end of June in order to boost growth
It is fairly small at 1.2% of euro-area GDP. We are not expecting much. The best way to restore growth is to alleviate the massive confidence shock weighing on households and corporates, that is, push ahead with fixing the crisis.

TED SCOTT, DIRECTOR, GLOBAL STRATERGY, F&C INVESTMENTS

Most expected outcome for the eurozone
Partial break-up. With Greece leaving, possibly followed by Portugal.

Best way to tackle the crisis
The end game is for complete political and fiscal union if the currency union is to be preserved as it is. To achieve this it requires a common bond that would mutualise all the debt of the 17 members and centralisation of national budgets and finances. If this can’t be achieved, the authorities should allow Greece to leave, while containing the fall-out so preventing contagion to other countries and the banking sector.

How in line is the EU with your suggestions?
The policymakers are quite closely in ‘synch’ and closer than they were. [President of France François] Hollande is more sympathetic to the periphery countries and favours a growth stance which is increasingly recognised as necessary. ECB President Draghi has acted in the interests of the peripheries and, to some extent, isolated Germany’s hard line stance. Angela Merkel has become more pragmatic when necessary.

What policymakers are doing right and wrong
They have consistently been reactive rather than proactive. Their measures have been enough to keep the show on the road, whereas they have failed to recognise that to achieve a sustainable solution they have to move to full fiscal union (with the centralisation that implies) or restructure the union by allowing Greece, and possibly other uncompetitive and heavily indebted countries, to leave.

Best way to spend the €120 billion that policymakers agreed at the European Summit at the end of June in order to boost growth
The amount is a drop in the ocean compared with what is needed to restore growth. However it is used it will make no meaningful difference to the outcome. It should be directed towards projects that are likely to create employment and growth.

Other comments
The crisis has been ongoing for three years and we appear no nearer to finding a solution it. Meanwhile, global growth is slowing, posing another challenge. The prevarication that has postponed the denouement of the crisis will no longer be sufficient, so it is imperative that Europe’s politicians recognise this before it’s too late.

©2012 funds europe