Friday, November 11, 2011

Volume 3 Issue 45: Two-Cent Economics

Roubini The Prophet (again?)

OK, I take it back. Roubini is not a loser. He does make a lot of extreme forecasts, but some of them actually make sense. For example, he spoke at Davos in 2006 about the dangers that the Eurozone was facing. I doubt anyone listened to him at that time. Here are some highlights:
In summary, there is serious growth divergence in the Eurozone area. This performance divergence is leading to serious tensions in fiscal and monetary policy. Given the growth slowdown and the political difficulties of fiscal adjustment when growth is mediocre, larger fiscal deficit are emerging in many laggard countries. These persistent violations of the GSP are a medium term threat to EM and to the ECB no bailout rule. Also, economic divergence and the tensions it is creating is leading to political pressures on the ECB to do more to stimulate growth, as the reaction of EU finance ministers to the ECB December 2005 decision to hike rates by 25bps shows. 
This growth divergence is becoming a serious threat to EMU. As an increasing number of European observers are suggesting, different countries are coping differently to these challenges. Daniel Gros has shown that Germany has reacted with corporate restructuring, cutting labor costs and “competitive deflation”. I would argue that Italy has done little and is experiencing “stagdeflation”, a combination of stagnation and deflation. Indeed, as shown by Daniel Gros Italian labor costs have increased by 20% relative to those of Germany since EMU while Italy’s trade market shares have fallen by 20% relative to Germany. Similar competitiveness problems are faced by Greece, Portugal and Spain.
In conclusion, my view is that EMU can work and has worked for the Eurozone countries that have reformed and are reforming. But, unless Italy and other Eurozone laggards change their policies to pursue serious economic reforms that restore competitiveness and growth, they will eventually be forced to exit EMU. This would be a disaster but a disaster that may become unavoidable unless policies change. And I am currently pessimistic about the chances that such changes may occur given the policy makers and policies currently in place in countries like Italy.”
In 2006, I guess I was still in the peewee leagues in terms of analyzing economies. Nonetheless, five years later, in 2011, the fact that things are turning out to be closer and closer to what Roubini described  is enough to prove to me that he is no loser.

But I can't say that he is alone in seeing this problem. I don't know enough about the Eurozone issues. But I think the fact that he saw this as a competitiveness issue shows some deep insight. I always feel appalled when I read about people saying that the trouble with Eurozone is that they have a monetary union without a fiscal union. That doesn't even begin to scratch the surface of the problem.

The lazy PIGS are quite simply, lazy and complacent. They have brought this upon themselves through years of resting on their laurels. It is going to be a painful period for the Eurozone, and for the rest of the world. Personally, observing the way things are going with the Eurozone right now, it feels a lot like watching a tragedy in slow motion. It is agonizingly painful. It would seem like you know a disaster is coming but you can't avoid it. Something like being on the Titanic as it is sinking.

As Tim Duy points out:
There is no solution, no magic summit at hand. At this point, it is a choice between severe recession and depression. There is no happy ending to this story.
 Good times ahead.

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