We have been saying for some time now that the European debt crisis will soon turn into a European demographic crisis, and at its heart is a European socio-economic-cultural crisis, with no exits.
This may sound gloomy but it is pointless to understate the gravity of the Eurozone's financial and demographic problems. While the likes of Britain, Scandinavia and even Russia are tied up with the fate of the Eurozone, (excluding Finland) they would get wet by a European sinking ship, but would not go down with the cargo.
It is in continental Europe where the problems are deepening. It would take politicians of such cerebral brilliance to figure out, like some kind of rubik's cube, where to begin with Europe's seemingly intractable problems.
The BBC's Stephanie Flanders laid it out well when she said that European €governments may well be damned if they do, and damned if they don't.€ This is because the crisis is a competitiveness issue as much as a fiscal one. For countries like Spain their costs of borrowing go up both when the market doubts they will fix their debt and when the market fears that the necessary austerity will sink their economies. Both of which are true.
Europe's competitiveness issue is compounded by the fact that each country is in an economic union without its own currency. As Flanders explained, according to Goldman Sachs, €Portugal needs a real devaluation of around 35%. In other words, the nominal cost of Portuguese labour and other inputs has to fall by 35%, relative to their trading partners. The equivalent figure for Greece is around 30%, while Spain needs a real depreciation of just over 20%, and Italy about 10-15%.€
The problem is however that, €achieving that kind of improvement without changing the exchange rate requires a long period in which domestic prices and wages in these economies are falling relative to other countries' €" notably Germany.€
In the near future then, €improving competitiveness is likely to make things worse, and not just because shrinking pay packets will tend to shrink the economy€, since €cutting (or slowing the growth of) domestic prices and wages has to slow the growth of domestic inflation €" and therefore the cash value of national output,€ said Flanders. €Other things equal, the slower the growth of nominal GDP, the more cuts and tax rises will be needed to bring those ratios down.€
According to Goldman Sachs, the effects of restoring competitiveness could raise Portugal's debt to GDP ratio by about 35% over a decade, Greece's ratio by around 30%, and Spain and France could see a 10-15% rise in their public debt ratio over the decade.
Not only could the austerity (which is absolutely necessary) undermine growth but also increase the debt, since making the likes of Spain €more competitive on world markets will almost certainly squeeze the cash value of the economy, which (you guessed it) is likely to make their debt problems even worse,€ according to Flanders.
According to Goldman, €Our results suggest that, for some euro area countries €" notably Greece and Portugal, but arguably Spain as well €" the task of regaining fiscal and external balance through cyclical adjustment alone appears large, to the point of being insurmountable.€
As Nouriel Roubini said, while European €banks there don't have a liquidity problem now, but they do have a massive capital shortage. Faced with the difficulty of meeting their 9 per cent capital-ratio requirement, they will achieve the target by selling assets and contracting credit €" not exactly an ideal scenario for economic recovery.€
This is now compounded by a decreasing population and increasing outflow of Europeans. As Kathleen Brooks wrote in Reuters, for €Germany and Italy the demographic damage is done€, since €the bigger beast that threatens Europe's solvency is the demographic and entitlements crisis.€
It is predicted that by 2040 there will be less than two people of working age for every retired person in Germany and Italy, which compares with just over three today. While the recent EU bailout is just over 700bn euros and counting, as Brooks said, €the cost to bailout the union from an entitlements crisis would be on a far larger scale and could bankrupt the entire currency bloc.€
While the mighty export giant Germany remains in a healthy financial position now, it must eventually €draw down on its fiscal surpluses in future to pay for its aging population.€ By 2060 the number of 14-year olds and under in the EU will have fallen by nearly 10%, while the number of people over 80 will have tripled.
As Brooks asks, €who is going to want to lend to a country that has to spend its revenue on health care and pensions rather than infrastructure and investment? This will make it more expensive for countries already nursing huge deficits to finance themselves going forward.€
€It won't be long before investors start to worry about long-term liabilities and how western nations with high debt-to-GDP ratios will fare when the cohort of retirees in their populations start to rapidly increase,€ Brooks said. Couple that with Flanders' €catch-22€, uncompetitive markets and the exodus of the brightest and best Europeans, what will the Eurozone possibly look like in the next 5, 10, 15 and 20 years?
As Roubini said €if output continues to contract, deficit and debt ratios will continue to rise to unsustainable levels.€ Now, Roubini said, the €peripheral countries suffer from severe stock and flow imbalances. The stock imbalances include large and rising public and private debt as a share of GDP. The flow imbalances include a deepening recession, massive loss of external competitiveness, and the large external deficits that markets are now unwilling to finance.€
This may sound gloomy but it is pointless to understate the gravity of the Eurozone's financial and demographic problems. While the likes of Britain, Scandinavia and even Russia are tied up with the fate of the Eurozone, (excluding Finland) they would get wet by a European sinking ship, but would not go down with the cargo.
It is in continental Europe where the problems are deepening. It would take politicians of such cerebral brilliance to figure out, like some kind of rubik's cube, where to begin with Europe's seemingly intractable problems.
The BBC's Stephanie Flanders laid it out well when she said that European €governments may well be damned if they do, and damned if they don't.€ This is because the crisis is a competitiveness issue as much as a fiscal one. For countries like Spain their costs of borrowing go up both when the market doubts they will fix their debt and when the market fears that the necessary austerity will sink their economies. Both of which are true.
Europe's competitiveness issue is compounded by the fact that each country is in an economic union without its own currency. As Flanders explained, according to Goldman Sachs, €Portugal needs a real devaluation of around 35%. In other words, the nominal cost of Portuguese labour and other inputs has to fall by 35%, relative to their trading partners. The equivalent figure for Greece is around 30%, while Spain needs a real depreciation of just over 20%, and Italy about 10-15%.€
The problem is however that, €achieving that kind of improvement without changing the exchange rate requires a long period in which domestic prices and wages in these economies are falling relative to other countries' €" notably Germany.€
In the near future then, €improving competitiveness is likely to make things worse, and not just because shrinking pay packets will tend to shrink the economy€, since €cutting (or slowing the growth of) domestic prices and wages has to slow the growth of domestic inflation €" and therefore the cash value of national output,€ said Flanders. €Other things equal, the slower the growth of nominal GDP, the more cuts and tax rises will be needed to bring those ratios down.€
According to Goldman Sachs, the effects of restoring competitiveness could raise Portugal's debt to GDP ratio by about 35% over a decade, Greece's ratio by around 30%, and Spain and France could see a 10-15% rise in their public debt ratio over the decade.
Not only could the austerity (which is absolutely necessary) undermine growth but also increase the debt, since making the likes of Spain €more competitive on world markets will almost certainly squeeze the cash value of the economy, which (you guessed it) is likely to make their debt problems even worse,€ according to Flanders.
According to Goldman, €Our results suggest that, for some euro area countries €" notably Greece and Portugal, but arguably Spain as well €" the task of regaining fiscal and external balance through cyclical adjustment alone appears large, to the point of being insurmountable.€
As Nouriel Roubini said, while European €banks there don't have a liquidity problem now, but they do have a massive capital shortage. Faced with the difficulty of meeting their 9 per cent capital-ratio requirement, they will achieve the target by selling assets and contracting credit €" not exactly an ideal scenario for economic recovery.€
This is now compounded by a decreasing population and increasing outflow of Europeans. As Kathleen Brooks wrote in Reuters, for €Germany and Italy the demographic damage is done€, since €the bigger beast that threatens Europe's solvency is the demographic and entitlements crisis.€
It is predicted that by 2040 there will be less than two people of working age for every retired person in Germany and Italy, which compares with just over three today. While the recent EU bailout is just over 700bn euros and counting, as Brooks said, €the cost to bailout the union from an entitlements crisis would be on a far larger scale and could bankrupt the entire currency bloc.€
While the mighty export giant Germany remains in a healthy financial position now, it must eventually €draw down on its fiscal surpluses in future to pay for its aging population.€ By 2060 the number of 14-year olds and under in the EU will have fallen by nearly 10%, while the number of people over 80 will have tripled.
As Brooks asks, €who is going to want to lend to a country that has to spend its revenue on health care and pensions rather than infrastructure and investment? This will make it more expensive for countries already nursing huge deficits to finance themselves going forward.€
€It won't be long before investors start to worry about long-term liabilities and how western nations with high debt-to-GDP ratios will fare when the cohort of retirees in their populations start to rapidly increase,€ Brooks said. Couple that with Flanders' €catch-22€, uncompetitive markets and the exodus of the brightest and best Europeans, what will the Eurozone possibly look like in the next 5, 10, 15 and 20 years?
As Roubini said €if output continues to contract, deficit and debt ratios will continue to rise to unsustainable levels.€ Now, Roubini said, the €peripheral countries suffer from severe stock and flow imbalances. The stock imbalances include large and rising public and private debt as a share of GDP. The flow imbalances include a deepening recession, massive loss of external competitiveness, and the large external deficits that markets are now unwilling to finance.€
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