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Europe -- a new crisis epicentre?
Saturday, 02 May 2009 06:36

The world economy is in a synchronised recession following the US subprime crisis -- we are all down and out together.  According to the IMF, there will be a synchronised recovery going into 2010.  But, the crisis in Europe seems more complex.  The old continent may have deeper troubles ahead.

For 2009, the IMF projects a fall in US GDP of 2.8% followed by flat GDP in 2010.  For the euro area, the projections are a bit weaker, minus 4.2% and minus 0.4% respectively (similar figures for the UK).  The job situation is also bleak with unemployment jumping to high levels -- it will not fall back again until the recovery is well under way.    

To achieve these results, a positive trend has to develop through 2010.  With all the stimulus injected in our economies, a bounce-back can be expected.  Also, economies have a natural tendency to bounce back when they hit bottom.  More fundamentally, however, a recovery requires that our financial system starts functioning normally again.  Banks and other financial institutions have to get rid of bad debts and be able to lend to creditworthy customers.  
This scenario for the world's advanced economies would be the worst since the Great Depression -- even though the IMF confesses that all risks are on the downside.  With a synchronised recession, it is impossible for any group of countries to export their way to recovery as the Asian countries did after their crisis in 1997-98 and Mexico after the peso crisis a few years earlier.  Also, IMF analysis shows that economies recovery more slowly after financial crises than for other recessions.
As the crisis and recession unfold, a very bleak scenario for Europe now seems unavoidable -- when the crisis really struck in September 2008, much of the continent was already contracting because of oil prices.
Why such a bleak scenario?  First, investments in US subprime toxic assets have damaged some western European banks in countries like France, Germany, Switzerland and the UK.  Second, many European countries had their own housing bubbles, in some cases worse than the US, and countries like Ireland, Spain and the UK are experiencing major corrections.  Third, Germany, Europe's strong performer in recent years, is being hit by a globalization backlash as its strong exports are now making a U-turn.  Its recession looks like being one of the world's worst.  Fourth, European deep integration -- two-thirds of Europe's trade is with itself -- means that all European countries tend to be dragged in the same direction, up or down. 
Many of Europe's emerging economies -- previously a source of dynamism for the old continent -- are being quite simply knocked out by the crisis.  Housing bubbles, and massive foreign currency borrowing (sometimes to finance domestic mortgages) are taking their toll.  The Baltics are set for falls in GDP of over 10% this year, and much of central, south and south-eastern Europe are suffering too.  Austrian and Scandinavian banks are taking big hits because of this. 
And to top it all, Europe has been sluggish and uncoordinated in reacting to the crisis, in sharp contrast to the US where reactivity has actually been impressive.  Initially, there was a perception that this was a US crisis -- remember French President Sarkozy bullying the US into holding the Washington G20 summit.  The realisation that Europe has its own crisis was then slow to take hold.  This was followed by intra-European squabbling over the size of fiscal stimulus, and squabbling with the US.  And the European Central Bank, which was still pre-occupied by inflation, has been sluggish in responding to the crisis.  Is the ECB fighting more for the survival of the euro than the economy?
In short, as market analysts are starting to see more and more 'green shoots' of recovery in the US economy, it is difficult not see autumn leaves in Europe.  A crisis that began with US subprimes perhaps hid the fact that Europe was brewing its own crisis.  A synchronised recession makes us all feel in the same boat together. But, we should not assume that the recovery will also be synchronised.
Already, Europe's sclerotic structures mean that it has much less bounce-back capacity than the US.  And on top of that, Europe has many home-grown elements of crisis itself.  
The epicentre of the global financial crisis may indeed be crossing over the Atlantic from the US to the old continent.
Looking beyond the crisis, some were arguing that Europe and the euro would emerge as rivals for the US and its mighty dollar.  The European disunity during the crisis points to if anything weaker prospects, leaving the US on top.  The existing world order will likely remain.  
IMF website -- www.imf.org.    

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