In the interests of balance, and because frankly I find it more convincing, I must mention another new report from the Peterson Institute for International Economics, by Simon Johnson and Peter Boone. Called “The Eurozone Crisis Deepens“, it rather depressingly lays out the ways in which we are likely to end up with a major financial crisis if the Eurozone governments don’t radically change direction.
They point out what governments seem to prefer to ignore, that markets are largely unwilling to invest in Eurozone government bonds except at interest rates that make those countries insolvent. We won’t go back to the low rates of last year and earlier because the genie is out of the bottle: investors now see that insolvency and default are a real possibility, even for Italy. They won’t forget that any time soon so Italy’s debt, which looked sort of sustainable a year ago, now doesn’t, so must be cut either by painful government austerity, or by defaulting.
So to avoid default, the high debt countries must cut their deficits more quickly than they planned to. But that in turn will worsen the recession and makes them even less able to pay their debts. Only a devaluation has any hope of providing long term economic growth, either by leaving the Euro or by sharp cuts in wages and prices that improve competitiveness. Yet they point out that Greece, despite all of its austerity so far, has not seen any significant improvement in competitiveness.
The optimistic case presented by their PIIE colleagues rests on a dramatic change of heart by Germany to accept far greater responsibility for long term financing of the debts of weaker Eurozone governments. Northern Europe paying for the welfare of Southern Europe, with France somewhere in between, neither strong enough to help the bills but not (yet) in need of help. Currently that looks most unlikely.