Bill Jamieson Searching for life after death

COMMENT

BILLJAMIESON | Executive Editor of The Scotsman

Searching for life after death

Seldom has a year opened with more dire foreboding as to what could lie ahead for the economies of Europe.

No-one could say we weren’t warned. First came the credit rating downgrades by Standard & Poors – nine out of 17 eurozone countries saw their ratings cut – with France and Austria stripped of their coveted triple A rankings. Among reasons cited were tightening credit conditions, simultaneous de-leveraging by governments and households, weakening economic growth prospects and disagreement over policy approaches to bring about recovery.

Then came forecasts from the International Monetary Fund of recession. It warned eurozone GDP would fall 0.5 per cent in 2012. Greece was a no-hope case, having contracted six per cent in 2011, and with no improvement in sight. Growth in France and Germany was likely to be minimal. Spain and Italy were likely to see GDP falls of 1.7 per cent and 2.2 per cent respectively.

The World Bank agreed, declaring that, largely because of the eurozone debt crisis, “the world economy has entered a dangerous phase.” Economists wrote off the southern eurozone economies as ‘austerity traps’. The outspoken Joseph Stiglitz called them “suicide pacts, akin to medieval blood-letting.”

Britain, though mercifully out of the eurozone, has looked on helpless and aghast. More than 47 per cent of UK exports went to the eurozone in 2010. A recession across Europe would not just spell trouble for thousands of UK companies but would dash hopes that the UK could enjoy an export-led recovery.

Arguably the greater threat was the chaos that a sovereign default or bank failure would trigger across Europe and the Western economies. UK banks would be immediate casualties and would require further bail-out, dwarfing previous efforts.

Thus we entered 2012 deeply apprehensive over what might unfold. Predictions of a Greek default and exit from the single currency have been commonplace and finance ministries have drawn up contingency plans for just such an event. All this has had a corrosive effect on business confidence in the UK. Forecasters warned that a recovery may not really set in for another two years, making this the longest recession/recovery cycle for a hundred years.

A recession across Europe would not just spell trouble for thousands of UK companies but would dash hopes that the UK could enjoy an export-led recovery.

Back from the brink

Yet the opening weeks of the year have brought a step back from the immediate precipice. A key reason for the change is that since late December the European Central Bank has resorted to liquidity support for Europe’s stricken commercial banks on a scale without precedent. Its Longer Term Refinancing Operation (LTRO), a back door form of quantitative easing, takes the form of very cheap three-year loans designed to help the banks meet a colossal mountain of £1.4 trillion of debt refinancing over the next two years. The bulk of this falls due in the first six months of this year. Not only have the banks eagerly grasped the immediate €500 billion (£420 billion) lifeline – many have been frozen out of commercial funding markets for months – but a further massive extension of this support is scheduled to launch in February. In addition to relieving pressure on the banks, this has also helped relieve the funding crisis for stricken eurozone governments. Banks, now flush with cheap funds, have been encouraged to buy government debt, thus earning useful profits while enabling France and Spain to hold successful bond auctions. Government bond yields still remain high, but they have pulled back from the crisis levels seen at the end of last year. And at the same time bank shares have risen strongly, igniting a broader recovery across equity markets.

Crisis over? Unfortunately, this support does not in any way address the underlying problem of the banks’ bad debt pile or even provide more transparency as to the scale of write-off required – an exercise that would almost certainly see many banks declared insolvent. It is this epic unresolved leverage that lies at the heart of the crisis in Western economies and explains the inability of banks to provide the lending that would turn the wheel of recovery.

What LTRO does is to buy time. It gives the governments of the eurozone a limited breathing space in which they can embark on desperately needed structural reform of their economies. Austerity alone won’t fix it. Business taxes need to be brought down, public services provided more efficiently and resources shifted to the productive sectors. Above all, productivity and competitiveness need to be substantially improved as the option of devaluation is effectively blocked off.

For the moment political Europe can see little further than a Financial Transactions Tax, convergence of corporate tax policies (threatening Ireland’s competitiveness), more energy taxes and European Commission administered regional funds. The heart sinks.

But there are small flickers of hope. The German IFO business index, helped by the ECB liquidity injection, rose in January, beating consensus forecasts and staging the biggest jump since data collection began two decades ago. And the Brussels-based Conference Board Leading Economic Indicator for the euro area saw a modest rise in December – the first such increase in ten months. Amid all the uncertainties still dogging the eurozone, here are signs that there may be indeed be life after death. n