The Spanish disease, or ”La Grippe”, was the name of the flu epidemic that fundamentally changed what the world looked like in the years 1918-19. More people died from La Grippe than during WWI while life expectancy dropped by ten years. Now, Europe, and to some extent the U.S., are suffering from a new kind of Spanish disease – sagging growth and still higher debt burdens.
The financial crisis was a unique opportunity for political leaders to take a stab at the structural imbalances that exist both in Europe and the U.S., but instead, the politicians chose to pile more liquidity onto something that basically is a solvency problem. They solved a debt problem with more debt and moved the debt from one account, the private sector and the banks, to the public sector as it, theoretically, had a better chance of financing the debt in a cheaper manner. This, however, is no longer true. One bail-out after the other means that some countries are incapable of raising funds in the capital markets i.e. Greece, Ireland and Portugal, while other countries - like Spain and Italy - are facing higher premiums to do so. So now, there are two fundamental problems:
Sagging growth and societies that have too many entitlements. We now have societies that have reversed J.F. Kennedy’s famous words: “Don’t ask what your country can do for you, but what you can do for your country.” Today, it sounds like this: “My family and I are just going to get the most out of the public benefits so that I don’t pay for anybody else.” This could perhaps be all right in a situation with high growth, balanced external balances, and social equality. But unfortunately, Europe is headed towards the precipice when we are talking about possibilities to preserve these rights and all the while social imbalances are only getting bigger and bigger.
Spain is facing an unemployment rate above 21 percent, and in some places youth unemployment is above 40 percent. Clearly, this cannot be sustained for long – neither economically or socially - and the price for this is sagging growth and a growing budgetary deficit. Spain’s growth on average in the past five years is 0.74 percent – less than one percent even if you include the period of high growth before the crisis. The same numbers for Italy are even more depressing, since Italy’s average growth in the past five-year period has been -0.4 percent. And thus, the economic Spanish disease is Europe’s lack of growth. Even if debt stabilises there will still not be enough growth to drive Europe forward and create more prosperity. We are caught in a debt trap with decreasing productivity and a lack of political mobility.
This leads me to my market based, political premise for all analytical thinking in the post-financial crisis period: everything is driven by politics. Politicians will always prefer to do nothing as long as the opportunity costs are zero or negative or - in other words – only when the opportunity costs of doing nothing about the fundamental problems are higher than doing something will we see political movement towards a solution.
Interestingly, we may be close to seeing this happen as Chancellor Merkel is beginning to feel that her position is getting shaky. She is going to run for re-election in 2013, the year that is seen as decisive for the EU and its survival. That makes it likely that Merkel will have to lead an election campaign while further assistance for Greece, Portugal, and most likely Spain, will be on everybody’s minds and lips. This is not her dream scenario. Hereby Merkel will be facing an opportunity cost that is too great, and exactly for that reason I think that we will see Germany trying to find a more constructive solution to Southern Europe’s debt problems. This will involve the expected “re-profiling” of debt (as debt restructuring is called in EU speak these days). I expect such a re-profiling of Greek debt no later than Q4.
It is important to keep in mind that the EU is a political experiment and just that. A solution to the problems in Europe must be based on a political solution and the only political solution is that Germany pays up.
As the graph above shows Germany has experienced a significant rise in its competitiveness and its current account surplus since the introduction of the Euro. The Euro has meant that the weaker countries have been unable to devalue their currencies vis-à-vis Germany, and at the same time, restrained German wage policy and its productivity have made the Germans stronger than ever.
Unfortunately for Germany and Europe, a huge part of this success is based on low interest rates which the South European countries got by borrowing on Germany’s credit because in the beginning, the Euro, by mistake, was considered to be the currency of one coherent economy. This was not the case because of the one decisive condition presented by the Delors Report as the basis: “Entry into force a stability and growth pact” – i.e. a co-ordinated financial policy with some very liberal rules. It is like giving your 18-year old son a Platinum Card without giving him any other rules than telling him “And now don’t spend too much”. This leads to a lose framework, lack of discipline, and over-consumption. Eventually you will have to take the card away from him.
The interesting dynamics when dealing with lack of growth, a growing debt burden and the absence of political mobility is that even if politicians succeed in postponing the problems once more, then we are still closer to the point of facing the bill for the recession 2.0. The cause is the social dimension which has become increasingly important.
In the past six weeks, I have been travelling in Asia, the Middle East and Europe. And although these regions are dealing with quite different circumstances and challenges in political and economic terms, they have one overarching problem: social imbalance is greater than ever. This is a problem in China, in the Middle East, and Europe. Low interest rates and a lack of access to credit has made the rich richer, and the middle class and the poor poorer. That, in my view, is a dimension that will only gain more importance not only in the economic debate, but in the political debate as well. Last week, we saw pictures from Madrid where young people were camping in the central square, and at first glance it was hard to tell if it was Cairo or Madrid.
Today’s young generations are extremely active in using social media and and they don’t mince their words when they say ”Enough is enough! We need political change now.” Ironically, it will be easier to accomplish if we get another mini-crisis. I am very optimistic on behalf of the individual’s ability to overcome a crisis and become adjusted to a new reality. Conversely, I am very negative with regards to the political will and ability to do something about the substantial imbalances in our society today.
We risk losing a generation, an entire decade, by pretending that there is nothing wrong. The politicians have gotten away too easily with their non-solutions, but now the social factor has turned against them. Because of that, we have moved one step closer to beginning long term reconstruction which will lead to some extraordinary change for the better. It’s time to prescribe medicine for the Spanish disease!