New found euro stability is the quiet before the storm

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Things seem to have gone very quiet around the euro currency in recent months. It appears to have found some much needed stability after years of extreme market mayhem with its very survival on the line at times as the euro zone has lurched from one crisis to another.

This new-found stability is deceptive. The currency is not out of the woods in terms of deep rooted economic and political problems, which threaten to resurface as the euro zone stands at the threshold of another global economic slowdown. It could mark the quiet before the storm.

It is an accident waiting to happen. If the euro zone heads into another downturn, it will only heighten frictions caused by the growing wealth gap between prosperous Germany and the economically distressed nations of southern Europe, especially Greece, Spain and Portugal.

Damage caused by years of chronic austerity, rampant unemployment and crippling debt threatens to pull European Monetary Union apart at the seams. If the euro zone slips back into recession and employment conditions worsen, those tensions will boil over again very quickly.

In the last two years, euro zone economic confidence signals have been surprisingly upbeat, but not anymore. The euro zone’s bellwether economic sentiment index deteriorated sharply in January, pulled down by mounting pessimism being felt in industry, services and among consumers. It spells trouble ahead for euro zone growth.

Worries about the weakening global outlook are forcing European businesses to shelve investment plans and rein in output intentions. Consumers are shying away from spending, fretting about job prospects, the squeeze on wages and damaged wealth expectations thanks to the collapse in equity values since last year.

Even with the European Central Bank’s monetary generators running at full throttle, the boost from negative interest rates and copious amounts of quantitative easing appears to be losing impetus. The ECB already recognises it needs to step up its stimulus efforts in March.

The euro zone was created leaving too many structural anomalies and internal inconsistencies. The economy was supposed to be a level playing field, with the single market and monetary union designed to boost prosperity as equitably as possible across the 19-member area. But this has clearly not happened.

The euro zone has ended up a two-cornered stool, prone to tipping over in times of deep market instability. What it has lacked is a vital policy prop from full fiscal union acting as a market stabiliser and as a spur for fairer resource redistribution throughout the euro zone. Germany has always been bitterly opposed to European Fiscal Union, frightened of ending up having to foot the bill.

The global financial crisis in 2008 laid bare these fatal flaws and exposed striking divergences of economic performance. Through ups and downs, Germany has simply got more prosperous, while the weaker economies like Greece, Spain and Portugal have fallen further behind and into hard times.

EMU’s fixed currency regime has condemned weaker nations to lag Germany’s capital-intensive, productivity-driven economy, forcing them into self-enforced domestic deflation, with lower wages and higher unemployment as one way of staying competitive. Before EMU, weaker economies resorted to currency devaluation to keep up with Germany. Locked into the euro, this option is now ruled out.

Since the financial crisis, Greece and Spain have made some progress on improving competitiveness, but only at a terrible price to their economies. In both countries, around one in 4 workers is without a job, while youth unemployment stands around 50 per cent. It is unsustainable in the long run. Breaking point will soon be reached and countries will eventually vote with their feet.

It is already happening with many European voters turning away from mainstream politics to anti-austerity protest parties like Greece’s Syriza and Podemos in Spain. Once voters make the connection between anti-austerity and anti-EU, euro sceptic sentiment, the single currency will be in trouble.

2016 will be cathartic year for the euro zone’s future, especially as Britain squares up to a momentous referendum to stay in the EU. If Britain quits the EU, it could set a dangerous precedent for EMU countries to make a similar choice about staying in the euro.

Once one country decides to leave the euro, it will be the beginning of the end. Domino effects will take-over as more countries make the choice to live in a freer, multi-currency world.

It would mean game-over for the euro and mark a return for Greece’s drachma, Spain’s peseta and Portugal’s escudo. Others will follow.