Friday, May 8, 2009

The European Predicament

The European economy is a problem for the world recovery according to Desmond Lachman (The American, The Journal of the American Enterprise Institute, May 7th, The European Commission sees little prospect for a pickup in growth before early 2010, and a recent International Monetary Fund report warns that the shortage of capital in European banks is larger than in American ones. On top of that, the German Government now concedes that, with present policies, the German economy will contract at a staggering 6 percent in 2009 before recovering only marginally in 2010.

Meanwhile, Greece, Ireland, Portugal, and Spain are all neck deep in recessions of epic proportions, and in Ireland and Spain the bubbles bursting in the housing market make the United States’ own predicament look benign. These countries also feel the shock of global trade and tourism collapse.

In such circumstances governments usually cut interest rates and allow for a sharp depreciation of their currencies, but the euro precludes such a solution since the ECB is overly cautious in its monetary management, and because the relatively high price of the euro on world currency markets (not unrelated to the interest rate policy) renders these economies grossly uncompetitive. The European Union’s advice to tighten their budgets in the midst of this deep recession is obviously not going to help.

Let us add that the housing bubbles have also been a consequence of the euro in those countries where inflation was higher than the Union’s average, while the ECB’s nominal interest rate was the same for all of course, thus determining lower or negative real rates in Spain and Ireland for instance, and providing added stimulus for higher housing prices.

As mentioned in yesterday’s post on this blog, the current triumphalism of European colbertist elites about the alleged superiority of the “continental model” over the more competitive Anglo-American one, could soon be proved counter factual.

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