21 December 2012

Graham Bishop: The euro crisis - The life-threatening cancer is only in remission! Could the US fiscal cliff be the last straw?

The cancer threatening to kill off the euro went into remission in 4Q 2012 after the ECB announced its OMT programme. In 2H 2012, the Heads of Government repeatedly promised to set off down the – admittedly long and winding - `federal’ road to a complete cure. What could trigger a market realisation that - at the December Summit – the euro area backed away from the permanent cure? Is that backing away only until the German Elections in September 2013? Will France really come to terms with the need to pool economic sovereignty? Could tiny Cyprus really be “much worse” than Greece – as Eurogroup chairman Juncker put it?

But economic growth is the key to a brighter outlook for 2013. Probably the biggest risk comes not from within Europe itself but across the Atlantic where the struggle to avoid falling over the 'fiscal cliff' is continuing right up to the cliff edge. These two economic powers have a very different approach to their fiscal problems.

Unfortunately, all policymakers will be more wary of economic forecasts in general after the IMF publicly admitted to its doubts about the basic relationship between growth and government fiscal policy. However, even if the econometric modellers wish to avoid it, the unpleasant reality is that the 'bond market vigilantes' have to be willing to buy the bonds that  fund government deficits no matter how socially desirable the deficit may be.

The European Commission’s autumn forecast for 2014 – based on uniform statistical measures – points to a sharp divergence in riskiness between the EU and US on some measures. The EU’s "net borrowing of the general government sector" should fall to 2.5 per cent of GDP – from more than 6 per cent in both 2009 and 2010. That would be driven by barely 1 per cent real growth – just enough to stabilise the “general government sector’s consolidated gross debt” at 94 per cent of GDP. For the US, the Commission assumes that only a quarter of the fiscal cliff retrenchment will be enacted so growth would remain above noticeably above 2 per cent. The combination of retrenchment (is there an American word for `austerity’?) and growth would leave the 'net borrowing' figure down from 8 per cent this year but still above 6 per cent, with gross consolidated debt rising – to more than 113 per cent of GDP. The issuer of the world’s reserve currency would still be borrowing abroad to raise 3 per cent of its GDP from the rest of the world. The euro area would be lending over 1 per cent of its GDP to the rest of the world.

See/listen to Graham's Notes:

• Part I (European Council, Banking Union and Two-pack)
• Part II (Brexit and Cyprus)

© Graham Bishop