Nouriel Roubini's Global EconoMonitor

Early Retirement for the Eurozone?

Whether the eurozone is viable or not remains an open question. But what if a breakup can only be postponed, not avoided? If so, delaying the inevitable would merely make the endgame worse – much worse.

Germany increasingly recognizes that if the adjustment needed to restore growth, competitiveness, and debt sustainability in the eurozone’s periphery comes through austerity and internal devaluation rather than debt restructuring and exit (leading to the reintroduction of sharply depreciated national currencies), the cost will most likely be trillions of euros. Indeed, sufficient official financing will be needed to allow cross-border and even domestic investors to exit. As investors reduce their exposure to the eurozone periphery’s sovereigns, banks, and corporations, both flow and stock imbalances will need to be financed. The adjustment process will take many years, and, until policy credibility is fully restored, capital flight will continue, requiring massive amounts of official finance.

Until recently, such official finance came from fiscal authorities (the European Financial Stability Facility, soon to be the European Stability Mechanism) and the International Monetary Fund. But, increasingly, official financing is coming from the European Central Bank – first with bond purchases, and then with liquidity support to banks and the resulting buildup of balances within the eurozone’s Target2 payment system. With political constraints in Germany and elsewhere preventing further strengthening of fiscally-based firewalls, the ECB now plans to provide another round of large-scale financing to Spain and Italy (with more bond purchases).

Thus, Germany and the eurozone core have increasingly outsourced official financing of the eurozone’s distressed members to the ECB. If Italy and Spain are illiquid but solvent, and large-scale financing provides enough time for austerity and economic reforms to restore debt sustainability, competitiveness, and growth, the current strategy will work and the eurozone will survive.

In the process, some form of fiscal and banking union may also emerge, together with some progress on political integration. But, however important the fiscal and banking union elements of this process may be, the key is whether large-scale financing and gradual adjustments can restore sustainable growth in time. This will require considerable patience from governments and publics in the core and periphery alike – in the former to maintain large-scale financing, and in the latter to avoid a social and political backlash against years of painful contraction and loss of welfare.

Is this scenario plausible? Just consider what must be overcome: economic divergence and deepening recessions; irreversible balkanization of the banking system and financial markets; unsustainable debt burdens for public and private agents; daunting growth and balance-sheet costs in countries that pursue internal devaluation and deflation to restore competitiveness; asymmetrical adjustment, with moral-hazard risks in the core and insufficient financing in the periphery fueling incompatible political dynamics; fickle and impatient markets and investors; austerity fatigue in the periphery and bailout fatigue in the core; the absence of conditions for an optimal currency area; and serious difficulties in achieving full fiscal, banking, economic, and political union.

If a gradual process of disintegration eventually makes a eurozone breakup unavoidable, the path chosen by Germany and the ECB – large-scale financing for the eurozone periphery – would destroy the core central banks’ balance sheets. Worse still, massive losses resulting from the materialization of credit risk might jeopardize core eurozone economies’ debt sustainability, placing the survival of the European Union itself in question. In that case, surely an “orderly divorce” now is preferable to a messy split down the line.

Of course, a breakup now would be very costly, requiring an international debt conference to restructure the periphery’s debts and the core’s claims. But breaking up earlier could allow the survival of the single market and of the EU. A futile attempt to avoid a breakup for a year or two – after wasting trillions of euros in additional official financing by the core – would mean a disorderly end, including the destruction of the single market, owing to the introduction of protectionist policies on a massive scale. So, if a breakup is unavoidable, delaying it implies much higher costs.

But politics in the eurozone does not permit consideration of an early breakup. Germany and the ECB are relying on large-scale liquidity to buy time to allow the adjustments necessary to restore growth and debt sustainability. And, despite the huge risk implied if a breakup eventually occurs, this remains the strategy to which most of the players in the eurozone are committed. Only time will tell whether betting the house to save the garage was the right move.

This post was originally published at Project Syndicate and is reproduced here with permission.

21 Responses to “Early Retirement for the Eurozone?”

TomAugust 23rd, 2012 at 8:57 pm

Great point. Absolutely right that "the key is whether large-scale financing and gradual adjustments can restore sustainable growth in time". Experience so far is so negative, the outlook has to be considered bleak. But they've chosen their path and there's not much sign of anyone being ready to turn from it anytime soon.

I would say the ESCB has been the dominant official financier throughout this crisis, mainly through refinancing since way back in 2007. Fiscal union is simply far more politically difficult especially when the ESCB is already de facto doing the job. The next big step after this coming ECB/EFSF/ESM bailout of Spain will be finding a way to extend it to Italy without exhausting the ESM's funds. The short-term-only mandate is partly aimed at that: after a year or so into the bailouts, the EFSF/ESM holdings will start rolling off and so won't accumulate as quickly.

Perhaps the ESM will be allowed to replenish its funds by re-selling to the "market" (ie ECB)? Sounds absurd but I wouldn't rule it out.

Matt DubuqueAugust 24th, 2012 at 4:03 am

One of the intermediate policy objectives MUST be to manage excess morbidity spikes caused by massive cutbacks in public health systems and social safety nets.

We need absolute limits on the quantity of innocents killed here.

A hard landing is MUCH better than a crash landing.

Fewer fatalities. Austerity kills.

Read the epidemiology.

We need to focus on that, reducing premature and unnecessary fatalities, rather than ONLY maximum subservience to free market jihadi nitwits.

Aegean1972August 24th, 2012 at 10:45 am

i agree that a break-up would cost, the current bail-out cost of the periphery (which will be a few trillions) multiplied by 4 and it would take the water over a decade to calm back to growth. But i disagree that a break-up is inevitable (at least for now). If Europe realises (soon i hope) that the hard austerity-measures that were enforced to Greece cannot be applied to the rest of the Euro-south (because they will cause euro-chaos), then and only then we can hope that europe can kick the can for a coupla years more while giving ECB full decisional power. Economic integration that didnt happen in the last 30 years, cannot be enforced in 5! Thats a guaranteed recipe for social and political unrest. Look what is happening already. Even core countries like Holland are totally euroskeptic!! Germany needs to realise that euro-integration will have to take time. It took America 200 years to be a "united states". Germany cant expect this to happen in 5 or 10. Its not do-able. What they ll achieve with these pressure tactics is a guaranteed (gradual) euro-break (with everyone returning to their currencies) or in the best case scenario a euro with Germany in and a coupla more states.

DiranMAugust 26th, 2012 at 4:20 pm

So the TROIKA has wrecked the Greek economy, Greece is five years in recession, GDP collapse exceeds Great Depression levels and Greece is now a EU colony with total import dependency and you sympathize with your jailers, wanting to remain in the economic prison of the Eurozone and its fixed rates?

It is no coincidence that serious countries have national currencies – UK, Norway. Sweden, etc. These are the winners. The losers – Greece, Spain, Portugal, etc are in the Eurozone with massive unemployment and deep recession. Beggars like Romania and Albania jumping to join the Euro like Greece did.

Aegean1972August 27th, 2012 at 6:54 am

Considering the way things are atm (internationally speaking), it would be insane for Greece to leave the euro. Greece needs the knowhow of the US and the EU to get itself organised (first), trustworthy (2nd) and then be able to attract foreign investment. Even if that means selling its assets at cost price.

If Greece left the euro it would become a banana rebublic. Its an import based society and with a 70% devalued currency, the cost of living would skyrocket for its people and that would create and even worse humanitarian/political/financial crisis.

If we didnt have (close to) a decade of international recession (delevaraging) in front of us and if Greece had serious politicians and an organised state, maybe i would be one of the first to consider a new currency. But with things as they are atm, it would be economical and political suicide to leave the euro.

DiranMAugust 26th, 2012 at 4:08 pm

Better to break up this monstrosity ASAP. The very idea of a super state ruling diverse peoples, depriving them of basic civil liberties, economic and political freedoms should make one's hair stand on end! The EU is concept is a tyranny. The Euro is impoverishing most of the EU periphery with collapsing GDP's, making them debt slaves and leaving large portions of their populations unemployed and in abject poverty, yet the commentators above ignore all this!

Was not the Soviet example bad enough! Now this farcical EU/ Euro currency idiocy…

If these Euroweenies had even a smidgen of common sense, they would heed Nouriel's advice for a partial break up to minimize losses and keep the Core intact, but no! Ideology as with their Communist utopia fore bearers trumps common sense!

Aegean1972August 27th, 2012 at 7:02 am

In the uncertain economic years to come, being in a herd gives you more chances for survival, than being alone. The reason the US leads the world (and will prolly continue to do so) is because its a "united" state of creativity. Europe is trying to do that, because obvioulsy they realise the benefits of such a state. When you are united you have power. Financial power, military power.

It wont be easy for Europe to be one state. It might take decades or even an eon. But its the only way for survival and dominance of the geographical area.

Germany's model is obvioulsy one that works. Even the US is copying parts of it. Now its simply applying the rules that made Germany efficient, to the rest of Europe. Its not easy to do so. But its the only way.

DiranMAugust 27th, 2012 at 8:16 am

What if Greece is compelled in a few months to leave the Eurozone whether its wants to or not by dire circumstances? What if EU partners continue their game of piling on austerity conditions deliberately that they know well Greece cannot keep, making the pain so severe that there is general economic collapse, etc? What if they decide themselves to pull the rug by stopping any further bailout funding?

What about Roubini's advice to unwind now with the Periphery where the Euro does not work in order to preserve the Core and even the EU concept?

Why do so many Greeks generally appear so obtuse to these general issues that others like Roubini, Johnson and Krugman point out? They seem to be living in Alice and Wonderland world, clinging to wishful thinking rather than preparing themselves for the reality in front of them.

Aegean1972August 27th, 2012 at 12:08 pm

its not wishfull thinking. Its facts. Just because you see the whole subject from YOUR (very short minded) VIEW that does not mean that it is the right view.

Your views are biased all the way up to racist (i m referring to the Ottoman empire comments and the "Greeks lack DNS" etc.

But your analysis lacks consideration of SO many issues its pointless to start stating them one by one.

DiranMAugust 27th, 2012 at 8:19 am

One has to admire the Soviet satellites revolts in Prague and Warsaw as opposed to the pusilanimous stand of smaller EU members like Greece and Portugal, who are willingly foregoing national sovereignty and accepting general impoverishment under the boot of the EU elite and the Core countries like Germany.

Of course, capitulation happened in the 1930's, too; but that was only an interlude to a very bloody war. The EU under the weight of general economic misery, massive unemployment, and reduction of economic and political freedoms is not likely to have a happy end?

Why a Greek revolution for emancipation from Ottoman Empire to capitulate to an EU empire under German hegemony? If Greeks lack the DNA to fight for their self determination, some other countries may well do so eventually.

DiranMAugust 27th, 2012 at 8:12 am

Germany is not a desirable model for anyone but Germany and it depends on their ability to maintain their exports on everyone else. Further with the Ponzi debt pyramid of EU sovereign debt, Germany is already on negative watch list for a credit downgrade. Many feel that with needed bank capitalization of its sickly banking system and under the weight of carrying other EU sovereign liabilities, Germany will have a public debt ratio well in excess of 100% GDP, etc.

If its exports start to wane under general recession like Chinese hard landing, EU Periphery impoverishment, etc, then things will change dramatically.

Actually before this disastrous currency union, Germany had trade deficits…..

DiranMAugust 27th, 2012 at 2:35 pm

The Scandinavian countries – Norway, Sweden and Denmark – are a good example of something more desirable than Germany. Anyway, Germany has gone bankrupt twice in the last 100 years, which is as bad as Greece until the present crisis.

Of course, Greece has to go its own way, but it clearly belongs to the EU Periphery, not the core! So following Germany is really very self-destructive.

DiranMAugust 27th, 2012 at 2:40 pm

There is nothing short-sighted about my views. Indeed they are very similar to say Nouriel Roubini or Megan Greene. Do you consider Roubini some kind of fool??? He is predicting Grexit within 12 months. He recommending above early Euro retirement to save the EU Core and limit losses. Citibank is talking about the end of the year for Grexit. Citibank also idiots??? Pimco saying do not trust your money with the EU and stay away. Bill Gross another fool?

Why would EU political hacks like Olli Rehn, Barroso, or Van Rompuy be more reliable, much less our pirates like Venizelos? We have seen this game now for years where every six monthis Greece is in an even deeper recession and new austerity-bailout program.

Panayiotis Kondylis – have you ever read him? – also espressed doubts of the viability of Greek policy of total EU dependence, transfer money and 'cheap' loans. He foresaw from the late 1990's the tragedy of today – Kondylis another short-sighted fool or perhaps the real fools are the Greek political establishment whose policies have led Greece to the present mess, at the same time acquiring vast personal fortunes.

I am sad to see so many Greeks capitulate to EU blackmail and cling to the Euro without any sustainable national policy of development.

Aegean1972August 28th, 2012 at 5:46 am

Many times in my posts i have given lots of credit to Roubini for his work analysis. But in this world, there are financial interests and one can write an analysis to suit his portfolio interests or his clients interests or just his personal views. That doesnt mean i have to agree with them or they have to agree with me. Especially in such an important matter.

If Greece left the euro, it would be the beginning of a nasty multi-divorce of many other euronations. And a divorce would cost 5 times more to the EU than what it costs to support these nations for 3-4 years until they stand on their feet again. The problem with Europe isnt Greece. The problem is alot bigger (international actually) and soon enough the "virus" will be all over the world. Its a really complex problem that needs a decade of major changes in order to bring jobs back. The US should be getting ready for a double dip, but they should be the first to work their way out of this.

In the financial world there are all kinds of opinions. If you believe in all of them, you ll prolly need anxiety-medication. If you believe in your gut feeling (and your gut feeling is right) you are a "Warren Buffet". And Warren Buffets are few.

Aegean1972August 28th, 2012 at 6:43 am

In addition, keeping Greece the border of Europe (that filters all the illegal immigration coming from Turkey) is of vital importance for the EU. With things they way they are at the moment in the Middle East (Syria, Lebanon, Iran, turkey) and Africa (Egypt/Arab spring), letting Greece fall into the abyss (and catching fire like the rest of the Mid-East) is a GUARANTEED way to spread the fire into Europe's front door.

A Grexit or any other exit, is not a decision that can be made only from looking at "the numbers" and if the numbers arent promising (at the moment) we break the whole thing apart. Such a decision would be totally irrational, destructive (for the whole of the EU) and suicidal for the future of the EU. Such a decision is supported only from anti-Europe interests or from right-wing Euro parties who are fishing for votes.

FeliceAugust 31st, 2012 at 4:36 pm

Terrible. Terrible (but true) what Roubini says, terrible (but true as well) what Aegean and Diran say, even if they fight each other. Aegean is right, Greece MUST stay with Euro. It is in the interest of the "core", first of all. But Diran is right as well, Greece CANNOT stay at the cost of the core only. Yes, Greece is now "slave" of EU (and tomorrow Spain will be, and after tomorrow Italy will be), but it is useless to solicit horrible nationalisms. We are on the same boat, and the boat is sinking. If we put Greece at sea, the boat shall not float either. So, we have all to fight together, but the burden must be mainly on the shoulders of the Greeks (and tomorrow of the Spanish, and after tomorrow of the Italians). Greece and Italy (like Germany) came out of WW2 totally devastated. Our parents in those countries made much worse sacrifices than the ones required today by IMF, EU etc. Why cannot we do like our parents today?

FalstaffAugust 31st, 2012 at 5:46 pm

Europe faces the same identity problem as the U.S. – who are we in a 21st century global market. The E.U. dilema is more difficult because they are in uncharted waters: they can't be a United States because they have no common language, culture, view of history or even a strong federalist governing system and they don't want to be a USSR forced together with strong centralized and authoritarian government. So what is left is something unique to human history and I for one am confident that the genius of financial innovations that have come out of Europe in the past will once again rise to the occasion.

ragingwaveSeptember 6th, 2012 at 10:28 pm

Professor Roubini has an undeserved reputation as a doom-monger. In reality, he is hopelessly optimistic, as in his wishful, wistful opinion that "breaking up earlier could allow the survival of the single market and of the EU".
In the years leading up to the eruption of the crisis in 2007, exponentially-increasing aggregate debt in Europe & N America, combined with costcutting via massive and accelerating outsourcing of production and services to low-wage countries, succeeded in staving off dreaded recession. The famous can has been kicked along a very long road! Debt-financed consumption and cost-cutting/profit-boosting outsourcing were therapies that have now become pathologies: debt has prostrated the financial system and outsourcing has piled up vast, destabilising 'imbalances'. Transfixed by these side-effects, the economists forget the underlying disease of overproduction and stagnating profit that prompted recourse to these ultimately futile measures, and for which their are now no available remedies but trade wars and shooting wars. 'All roads lead into the crisis', as I argued in this paper:

rakesh kumarSeptember 11th, 2012 at 10:07 am

the breakup of the euro zone means the break up of EU. the consequences are as disastrous as these were perceived at the time of formation. but keeping it intact requires lot of commitment by the core nations, whose support will come with a cost to be rcovered when the recovery is 100%. but initially it would put burden on the core nations of course through monetary easing and fiscal expansion. small doses of liquidity and debt be given and the recovery be monitored