MACROSCOPE
Macroscope
by

Euro’s survival in grave danger from Europe’s fault lines and sputtering economy

PUBLISHED : Friday, 01 January, 2016, 12:34pm
UPDATED : Sunday, 03 January, 2016, 8:00am

The euro has been through very tough times in recent years, battered by political, economic, and financial storms, but it is not out of the woods yet. 2016 looks set to put the European single currency through the wringer yet again. A break below parity for the euro versus the US dollar looks a reasonable bet in the next 12 months.

Disturbing structural fault lines remain under the currency. A less stable political picture, the worsening economic outlook and extremely fragile financial fundamentals add up to a difficult trading backdrop for the euro in the months ahead.

Economic and political divisions are widening in the 19-nation euro zone block and threaten to spin out of control unless Europe’s leaders take bolder steps to bridge the yawing gap between the euro zone’s haves and have-nots.

The politics of inequality stand at the heart of deepening stresses between prosperous Germany and the euro zone’s hard-up economies. The contrasts could hardly be more stark. Germany boasts low unemployment, a vibrant economy and greater national wealth. Less well-off nations are struggling with high unemployment, stagnant growth and are saddled with crippling debt.

Anger is mounting and Europe’s traditionally strong social and political cohesion is at risk

Winds of political change have been sweeping across the euro zone ever since the global financial crisis first broke in 2008, precipitating recession, high unemployment and financial mayhem in its wake. It has polarised European voters away from the political centre-ground and led to emergence of anti-austerity movements, especially in the euro zone’s less well off economies.

The political deadlock in Spain after December’s inconclusive general election result is the most recent sign of Europe’s spreading political crisis. Spain’s left-wing Podemos party has risen to become the country’s third largest party and is demanding an end to austerity and the introduction of new measures to protect the poor and unemployed.

It is no surprise for a country which has 1 in 4 workers without a job. With youth unemployment running close to 50 per cent in Spain, Podemos has tapped into a power base among the young unemployed.

Economic disenfranchisement, especially among Europe’s ‘lost generation’ of young jobless is swelling the ranks of popular movements which are not just anti-austerity, but increasingly anti-EU too. European leaders need to take note.

It is not just the economically distressed nations like Greece, Spain, Italy, Portugal and Cyprus which are at risk. High unemployment levels in Europe’s economic heartland like France highlight the widening gulf with Germany’s prosperity. Anger is mounting and Europe’s traditionally strong social and political cohesion is at risk.

Europe’s policymakers need to take bolder action. The global economy is losing momentum and the inevitable consequence will be slower growth and rising unemployment in Europe. The continent needs faster growth and stronger job creation, spread equitably to nurture political unity.

The European Central Bank’s zero interest rate and open-ended quantitative easing strategy has gone so far, but more effort is needed. There are already signs that the euro zone economy is showing signs of QE exhaustion, with risks that the ECB’s projection for 1.7 per cent GDP growth in 2016 and 1.9 per cent in 2017 are far too optimistic.

Calls for greater structural reforms and wider deregulation will take years to put into effect. In the meantime, quicker progress can be made on the fiscal side. Austerity policies should be abandoned and EU governments must commit to fiscal reflation to complement the ECB’s monetary stimulus. Economic policies need to be working in harmony for better effect.

Euro zone policymakers must implement much fairer economic redistribution to close the wealth gap between Europe’s richer nations and the less well-off. The failure of European Monetary Union and the single currency is that it happened without full fiscal union.

Germany’s comparative trading advantage has surged under EMU, as there have been no fiscal safe-guards to facilitate capital, investment and economic resources back into the needy euro zone nations. By default, Germany has become wealthier at its European partners’ expense.

This cycle of widening inequality needs to be broken as soon as possible and rectified by fiscal transfers and subsidised infrastructure spending and investment through a common euro zone budget. Euro zone government debt needs to be integrated in a system of mutual common bonds.

It will be a tough medicine to swallow, especially for Germany, but it is imperative that Europe begins the process of much closer economic integration before it begins to fragment and splinter.

Once started, euro zone disintegration will be unstoppable and mark game over for the euro.