The European Debacle: Could It Cause A New Global Recession?

Introduction

Few understand what the real problems are in Europe, but the world is worried. As a result, stock markets are falling globally. Let’s see, stock markets falling globally. Didn’t this just happen, and didn’t markets lose $36 trillion? And did not this wealth loss causing a global recession the West is still trying to recover from?

What is the European problem and could it leave to a follow-on global recession?

 The European Economic Problem

In Table 1 and following tables, I have highlighted “today’s” problem European countries. They are growing slowly. This is important because rapid growth can allow countries to “grow out of debt’. The table also indicates that European countries are growing at different rates. Note that the World is projected to grow at 3.3% this year. As I have indicated in earlier postings, this is largely because of rapid growth in Asia and Latin America.

 Table 1. – GDP Growth Rates, Selected Countries

  GDP Growth
Country 2008 2009 2010 est.
Greece 2.0 -2.0 -2.0
Ireland -3.0 -7.1 -1.5
Spain 0.9 -3.6 -0.4
Portugal 0.0 -2.7 0.3
UK 0.5 -4.9 1.3
Germany 1.2 -5.0 1.2
Italy -1.3 -5.0 0.8
US 0.4 -2.4 3.1
World 1.8 -2.0 3.3

Source: IMF, World Economic Outlook Database, April 2010

In Table 2, unemployment rates are given. Note the large discrepancies among nations. More importantly, note the high rates in the European problem countries, particularly Spain. “Belt tightening” will cause these rates to increase. And if that happens, there will definitely be more rioting in the streets.

 Table 2. – Unemployment Rates, Selected Countries

  Unemployment Rates
Country 2008 2009 2010 est.
Spain 11.3 18.0 19.4
Ireland 6.1 11.8 13.5
Greece 7.6 9.4 12.0
Portugal 7.6 9.5 11.0
UK 5.6 7.5 8.3
Germany 7.2 7.4 8.6
Italy 6.8 7.8 8.7
US 5.8 9.3 9.4

Source: IMF, World Economic Outlook Database, April 2010

 The US and The Eurozone Compared

Both the US and the Eurozone are a federation of states. But there are two key important differences on their abilities to deal with economic problems. Unemployment occurs inside of both regions at different rates: Spain is different than Italy, Michigan is different than Massachusetts. But in the US, people migrate out of high unemployment areas in search of new jobs.

The second difference involves policy. The Eurozone countries gave up control over their own monetary and fiscal policies when they joined. And that is important when you have unemployment differences as large as the ones in the Eurozone. Fiscal policies with an unemployment rate of 20% should be quite different than when your unemployment is 8%.

The US is rightfully running a US$1.5 trillion deficit to stimulate aggregate demand. It is financing that deficit by selling it to public and private buyers. But, the Federal Reserve, the US central bank, is prepared to buy what others will not (for more on whether the public customers will continue to buy US debt, see my earlier articles). What the Fed buys is printing money in its purest form. And in the UK, the Bank of England provides the same service.

But Greece and the other problem countries of Europe do not have such a facility. They cannot print money. They can try to borrow money, but ultimately, the European Central Bank decides what debt it will buy. And you can be sure, Germany, France, and the Netherlands do not want the Central Bank lending to these countries.

Over the weekend, the European leaders recognized the seriousness of the situation and started buying the bonds of the problem countries. Along with the IMF, they have agreed to spend almost $1 trillion. They brought in the IMF. Why? The IMF will visit each problem country and make their loans conditional on “belt-tightening”. Far better to have the IMF doing this than even more fighting between Eurozone members.

 Belt-Tightening

What will the IMF be looking at? It will start by looking at the government deficits.

 Table 3. – Government Deficits

Country 2008 2009 2010
Greece -7.8 -12.9 -13.1
Ireland -7.2 -11.4 -12.2
UK -4.8 -10.9 -11.4
Spain -4.1 -11.4 -10.4
Portugal -2.8 -9.3 -8.7
Germany 0.0 -3.3 -5.7
Italy -2.7 -5.3 -5.2
US -6.6 -12.5 -11.0

Source: IMF, World Economic Outlook Database, April 2010

In meetings with the Ministers of Finance of Greece, Ireland, Spain, and Portugal, it will say “such deficits are unsustainable. We will provide you with X billions to get you through the next 4 months, but following that, further loans will be conditional on you developing a strategy to get the deficit down to 5% of GDP in two years.” The IMF negotiations will have the backing of the stronger members of the Eurozone.

How will these deficits be reduced? Not through an increase in revenues. Expenditures will have to be cut, and these cuts will make unemployment worse. Tough medicine.

 Other Economic Problems

Government deficits are not the only problems these countries are facing. Table 4 provides government data for these countries.

 Table 4. – Government Debt

Country % GDP
Greece 113
Portugal 75
UK 69
Ireland 64
Spain 50
Germany 77
Italy 115
US 53
World 56

Source: CIA World Factbook

Greece’s government deficit this year is approximately US$29 billion. It needed a bigger bailout because about US$40 billion of its US$374 government debt is coming due this year. Without the bailout, it did not have the money to pay off the debt – that would have meant a default.

Another indication of these countries strengths and weaknesses are their international current account balances. As Table 5 indicates, the Euro problem countries are running large balances.

 Table 5. – International Current Account Balances (% GDP)

Country 2008 2009 2010
Greece -14.6 -11.2 -9.7
Portugal -12.1 -10.1 -9.0
Spain -9.6 -5.1 -5.3
UK -1.5 -1.3 -1.7
Ireland -5.2 -2.9 0.4
Germany 6.7 4.8 5.5
Italy -3.4 -3.4 -2.8
US -4.9 -2.9 -3.3

Source: IMF, World Economic Outlook Database, April 2010

Before leaving Tables 1-5, it is worth reviewing the numbers for the UK and the US. A bit scary. Both have their own central banks, and both banks are facilitating their governments’ stimulus efforts by printing money. As I have written earlier, the transition from stimulus to a new balance will be tricky for both countries.

 A New Global Recession?

Table 6 provides GDP data on our countries.  In total, the GDPs of the problem countries is $2.2 trillion or only 3% of the global total. So what if the IMF forces these countries to grow at a slower rate? It should have little impact on global growth.

 Table 6. – GDP, Selected Countries, 2009

Country US$ bil.
Greece 331
Ireland 228
Portugal 228
Spain 1,464
sub-total 2,251
 
Germany 3,353
Italy 2,118
UK 2,184
US 14,256
World 57,925

Source: IMF, World Economic Outlook Database, April 2010

Sadly, there is an important caveat: the global recession was started by an asset loss that I estimated at $50 trillion. That included a stock market loss of $36 trillion and a real estate loss of $14 trillion. That “wealth effect” led to the reduction in Western consumer expenditures that spread worldwide.

By April 1, 2010, those losses had been pared to US$ 17 trillion. The results since then are presented in Table 7.

 Table 7 – Stock Market Losses Resulting From Euro Problem

April 1- Amount
Country May 7 bil. US$
US -5.7% -1,044
Europe -11.1% -1,320
Asia -8.6% -300
Latin America -12.0% -158
Total   -2,822

US$2.8 trillion down so far. But who knows what sort of highly leveraged investment vehicles are about to collapse? It will be an interesting ride!

The content above was saved on the old Morss Global Finance website, just in case anyone was looking for it (with the help of archive.org):
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