The euro crisis staggers on into yet another summer break. Where will we be when the politicians get back to work in September?
Well, there has been some progress. There is about €600 billion available in the eurozone bailout mechanisms, the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM), to tide things over for a year or so.
Also, the euro leaders decided in their June summit to set up an integrated European banking supervisor by the end of this year. And funds are being found to recapitalize Spanish banks under stringent fiscal conditions.
However, the summit achieved nothing for political and fiscal integration of the eurozone – neither a blueprint nor a timetable. These are the deepest flaws in the euro structure. Germany rightly sees the way forward as political, fiscal and financial integration at a federal level, but France is unwilling to abandon national sovereignty.
That leaves the euro structurally weaker than before. This is because the French economic model will ultimately fail for the same reasons as Italy’s and Spain’s: excessive levels of unproductive debt; low productivity and poor competitiveness – both the latter due to the excessive economic role of the state.
And if France turns sour, the Germans can’t pay for France. That is why the Germans wanted limits to French fiscal sovereignty to be set before accepting the principle of joint liabilities in the eurozone.
Now that Berlin has failed to achieve any of these goals, the day the euro really gets into trouble will also be the day when France does. Problems in the other southern eurozone states are probably containable at the moment. France’s are not, but all that is not for now.
The euro crisis is one threat to the global economy that is now less of a danger because the risk of sovereign debt collapse has been removed for the moment and a banking collapse in Spain has been avoided. However, it doesn’t get rid of the bad stories – either in Europe or elsewhere.
The issues of growth and debt sustainability are unaddressed globally, including Japan and the US. If anything, it’s getting worse. EU growth will be terrible, which feeds into the debt-sustainability equation big time.
| General government gross funding needs |
| Percentage of GDP, 2013 |
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| Source: IMF |
And then there is the level of US public debt. While investors have focused on the sovereign debt crisis in southern Europe, they have taken their eye off the US. US general government gross debt is now at 100% of GDP, way above any level regarded as sustainable, according to historical research – and only better than the Economic and Monetary Union-crisis states and Japan.
Moreover, the maturity of that debt is the shortest of the main bond markets, leading to a much higher gross financing requirement for the US than any other OECD government, with the exception of Japan.
So, the pressure is on for the US to get its private and public sector debt down. If there is no action, US gross public debt will reach more than 120% of GDP by 2016, surpassing that of Italy and even that of Greece by 2018.
The irony is that the only immediate way this is going to be achieved is by inaction. Under US law, a ceiling on public debt is fixed each year. That ceiling will be hit by the autumn unless it is actively raised, stopping all government spending.
Also, the US budget deficit has reached such heights because of several government tax cuts and subsidies. They automatically expire at the end of October. If these are not renewed by Congress, around half a trillion dollars will be taken out of net government spending. This is known as the fiscal cliff, which could reduce domestic demand in calendar 2013 by as much as 5% of GDP.
Such a drastic and immediate reduction in demand in an economy that is growing at a below-par rate would push the US back into recession. So, it won’t be allowed to happen. Some deal will be reached between the Democrats and the Republicans to avoid it.
However, dealing with the fiscal cliff is not likely to take place until after the presidential election in November. Then wrangling over tax rises or government spending cuts will begin first with the rump Congress and then with the new one.
The impact of the fiscal cliff is double-edged – if it is cut back too sharply, it could push the US into recession. If there is a light touch, it will leave budget deficits too high and not achieve debt sustainability.
The world could well get worse this autumn before it gets better.