Overview : A Recovery We Can Finally Believe In ?

This is not the first time the European economy has rebounded. From 2010 until spring 2011, the eurozone seemed to be back up and running. Buoyed by the United States and China, and supported by Germany, the recovery gained strength. In economic surveys, business leaders were showing greater optimism. The heart failure that followed Lehman Brothers’ collapse was nearly stowed away as a distant memory or a bad dream. The situation got to the point that the European Central Bank (ECB) raised its key rates on two occasions, in April and July 2011, despite Greece and Fukushima...

The rest of the story is well known. The first snags in the recovery date from summer 2011, when European leaders opted to restructure Greek debt1. Thereafter, Italy and Spain began having trouble accessing market financing; spreads surged and confidence plunged. At the same time, the US Congress stupidly blocked the Federal debt and the country was pushed to the brink of default, which cost it its triple A rating, and possibly, a few tenths of a point of growth. As to the ECB, in November it cut the same key rates it had raised just four months earlier.

Not that it was very effective. The eurozone slid into recession, where it remained throughout 2012 and into early 2013. The southern countries were in a quasi depression with the simultaneous drop off in lending and demand. Manufacturing output slumped to levels unseen for the past two or three decades. It was only after the peripheral countries threatened to drag down the European Economic and Monetary Union (EMU) in their wake that a real response to the crisis was finally orchestrated, after piling up a series of emergency plans. Since year-end 2011, several steps forward have been made that helped consolidate EMU: the ECB’s launch of long-term loans; the signing of an enhanced fiscal pact; the launch of banking union; the announcement of securities purchases to support sovereign financing; and ratification of the European Stability Mechanism. As a result, the eurozone seems to be in a better position to withstand shocks. Cyprus’ bankruptcy and the Italian political crisis, which at other times would have derailed the recovery, failed to hamper the slow turnaround in 2013.

Better health is not due solely to the advancements in European governance. The eurozone’s peripheral countries have undertaken considerable efforts to restore competitiveness and balance their accounts, which are beginning to pay off. Ireland’s economy has been recovering since spring 2013, and it should report rather robust growth rates through 2014 (2.2% according to the European Commission). The country is also expected to regain full access to the markets. In Spain and Portugal, export trends are just as dynamic as those in Germany. In both of these countries, corporate profitability has picked up strongly (see chart); they are reporting trade surpluses for goods and services; and the balance of payments are showing net inflows nourished rather abundantly by foreign direct investment2. This represents as much portfolio financing needs that disappear. A sign that debtor and creditor positions are no longer split within EMU, the sums recorded in the Eurosystem’s Target 2 accounts continue to regress. For the past year, the amount of debt securities the Bundesbank has held in other eurozone central banks has shrank by more than €155bn.

profitability has picked up strongly (see chart); they are reporting trade surpluses for goods and services; and the balance of payments are showing net inflows nourished rather abundantly by foreign direct investment2. This represents as much portfolio financing needs that disappear. A sign that debtor and creditor positions are no longer split within EMU, the sums recorded in the Eurosystem’s Target 2 accounts continue to regress. For the past year, the amount of debt securities the Bundesbank has held in other eurozone central banks has shrank by more than €155bn.

Better organised than it was two years ago, and with a less fragile periphery, the eurozone has increased its chances of seeing the economic recovery continue. This would mark the beginning of an unusual global recovery with Germany, China and even Japan consuming more; the United States saving and especially investing more; and southern Europe exporting more. The risks associated with this scenario have not changed. The first is that the eurozone heads of state and government would neglect the need for consolidation now that they are no longer encumbered with a sense of urgency. Although the crisis is abating in the southern countries of EMU, it is hard to imagine how the eurozone can pull through without a greater dose of federalism. Banking union, European debt relief funds and Eurobonds are some of the projects that have been postponed or brushed aside, but they will surely top the agenda again once German elections are over.

BY Jean-Luc PROUTAT