March 23, 2023

Economix Blog: The Euro Zone Crisis: A Primer

View From Europe

Dispatches on the economic landscape.

A euro sign sculpture in front of the European Central Bank's headquarters in Frankfurt, Germany. Hannelore Foerster/BloombergThe European Central Bank‘s headquarters in Frankfurt.

FRANKFURT — With the daily drumbeat of alarming news from the euro zone, it’s often hard to hear above the din. Here’s a quick chance to catch up before the shouting starts again.

What’s all this talk about ‘‘contagion’’? Why is the global economy threatened by a small country like Greece, or a few troubled Spanish banks?

If Greece leaves the euro, anyone who is owed money by the Greek government or private individuals there can probably forget about being paid in full. In fact, that has already happened to a lot of Greece’s creditors in the debt restructuring completed in March.

The next time, if it comes, a lot of the people getting hurt would be European taxpayers, because most of the government debt is owned by the European Central Bank or the European Union. The investment bank UBS estimates the total cost at 225 billion euros, or $286.5 billion.

Commercial banks that have extended loans to Greek clients would also suffer. And some could fail, destabilizing the European financial system, which is already vulnerable enough. Likewise, the failure of several banks in Spain or elsewhere could stick those banks’ creditors with losses, perhaps causing more failures, as the problems cascaded through the system.

But the biggest effect might be psychological. Investors would begin to worry that the whole common currency union would fall apart. Europe could become toxic to international lenders and investors. Governments and businesses in the region could be cut off from credit, with disastrous effects on the whole economy.

What about the social and geopolitical effects if Greece leaves the euro?

The social effect of the crisis is already visible in jobless numbers, which are at depression levels in Spain and Greece, and at a record high of 10.9 percent for the euro zone as a whole.

There are also political consequences. In countries like Greece, the Netherlands or even France, the economic pain is nourishing the growth of parties on the far right and far left, as voters lose faith in mainstream political leaders.

At the geopolitical level, Europe has lost prestige because of the perception that its leaders have mishandled the crisis.

All these trends would intensify if Greece left the euro zone, raising questions whether the continent could continue the historic economic and political integration that followed World War II. The whole concept of Europe as a single entity might be in doubt.

Now Spain seems to be a big worry. Is Spain just another Greece — but one with an economy and population more than four times as large?

Spain is in better shape than Greece by many measures. But, yes, it’s a much bigger country. So its problems could cause much more trouble.

Spanish government debt is equal to about 69 percent of gross domestic product. That is far more manageable than in Greece, where the ratio is 165 percent.

The gaping issue with Spain, though, is not public debt but private i.o.u.’s. A real estate boom and bust has left Spanish banks burdened with 663 billion euros in property loans. A bank bailout would cost an estimated 200 billion euros, which the government in Madrid could not finance without European help.

Like Greece, Spain has an economy that is not competitive. It is burdened by industry restrictions and labor laws that tend to retard growth. It faces a long restructuring process of its social services and its business markets that will test the fortitude of its people. The real estate collapse has led to thousands of jobless construction workers who must be retrained before the economy can recover. At nearly a quarter of the work force, unemployment in Spain is even worse than in Greece. Among young Spaniards, it tops 50 percent.

Economists estimate the cost of a Greek exit from the euro zone at as much as ¤500 billion. The cost of a Spanish collapse would be in the trillions.

What are the main ways that Europe has tried to solve the debt crisis, and why aren’t those remedies working?

European leaders have created a 780 billion euro bailout fund with a lending capacity of 500 billion euros. That would not be adequate to deal with a collapse in investor confidence in Spain or Italy.

Leaders from the United States and elsewhere have called on Europe to commit a wall of money so large that it would erase all doubts about leaders’ commitment to the euro. Such a wall would probably have to be worth 2 trillion euros or more.

German leaders like Wolfgang Schäuble, the finance minister, have resisted committing more sums, however, because they fear southern European countries would feel less pressure to fix the underlying weaknesses in their economies.

European leaders have also agreed on a so-called fiscal pact to prevent countries from running up unsustainable debts, and have tried to strengthen European institutions. For example, the European Banking Authority has been given more power to supervise banks throughout the euro zone. So far, though, those measures have not been convincing enough to restore investor confidence.

We keep hearing about ‘‘growth versus austerity.’’ Are the two mutually exclusive?

Economists practically get into fist fights on this issue. In Germany, the prevailing view is that growth is the natural outcome of budgetary prudence by the government. Austerity, the argument goes, will restore confidence of both consumers and investors and lead to growth.

On the other side, economists of a Keynesian bent say that countries should increase government spending to stimulate growth. But this may not be an option for Greece, Portugal and some other countries, because no one is willing to give them any more money.

There is a growing acknowledgment, even in Germany, that austerity may have been overdone. When a country’s economy shrinks, so does tax revenue, and the debt becomes that much more overwhelming. Greece’s economy is one-quarter smaller today than it was in 2008, while the debt has continued to increase.

One problem is that countries like Italy and Greece already have what are generally considered to be bloated government agencies that burden business with paperwork and regulations and impede job creation. So stimulus would help only if the government spent the money wisely. Policy makers are now arguing about ways to offer Greece some relief from austerity without reinforcing bad habits.

Who’s actually in charge of the currency union? Is it Angela Merkel, the chancellor of Germany? Or is Mario Draghi, the president of the European Central Bank, the de facto leader?

The euro zone has no strong political leader; the United States of Europe does not yet exist. As leader of the largest and strongest big economy in Europe, Ms. Merkel has been in a position to push policies on countries that are dependent on aid, creating much resentment on the streets of Athens.

Mr. Draghi is arguably more powerful, because the European Central Bank controls the currency printing presses and does not need legislative or popular approval to act.

But the E.C.B. controls only monetary policy. It sets official interest rates and provides loans to banks to make sure they have money they need to operate. The E.C.B. cannot rescue banks that have too many bad loans and are insolvent. Nor, by law, can it rescue governments by buying all their bonds. (It has bought some government bonds, but not on the same scale as the Federal Reserve has done in the United States.)

Because the euro zone has no real central government, policy making has consisted of continuous brinkmanship between those that have money — Germany and the E.C.B. — and those that don’t. The haves demand policy overhauls in return for aid, while the have-nots, especially in Greece, try to get more aid by raising the threat of euro Armageddon. The spectacle has been deeply unsettling for financial markets.

We hear about a ‘‘bank run’’ in Greece, and the specter of one in Spain. If every country in the euro zone uses the same currency, why aren’t one country’s banks as safe as any other’s?

Talk of bank runs is probably overblown, at least so far. But it’s true that Europe lacks the equivalent of the Federal Deposit Insurance Corporation in the United States. Individual countries have their own versions of the F.D.I.C., but depositors in Greece or Spain are understandably nervous about whether their governments would have the funds to stand behind troubled banks. Spain has already largely depleted its deposit insurance fund.

In addition, in some countries banks have sums at risk that far exceed total economic output. This was the case in Ireland, an otherwise sound country that sank into crisis when it bailed out its banks after the Irish real estate bubble burst. There is not yet a central European banking authority with the power to unwind failed banks in an orderly way.

If German taxpayers and politicians are fed up with bailing out countries like Greece, wouldn’t Germany be better off if Greece (or Spain, or Portugal or Ireland) dropped out of the euro?

Some economists, like Hans-Werner Sinn at the Ifo Institute in Munich, make this very argument with regard to Greece. If Greece had its own currency, they say, its government could devalue money and thus effectively bring wages down to a level where the country could compete in international export markets.

If Greece keeps the euro, wages would need to fall 40 percent before the country could be on competitive export terms with Germany, according to some estimates.

But many others argue that a Greek exit would be disastrous. It would be very difficult for Greece to execute a switch to a new drachma without prompting panic on the streets, as citizens tried to withdraw euros from their bank accounts while they still could.

And with the new currency probably plunging in value, questions would arise about the solvency of any foreign banks or companies with major exposure to Greece.

Courts around the world would be clogged with lawsuits as Greek companies and lenders fought about whether contracts should be paid in euros or the new currency. As has happened with Nicaragua and other defaulters, courts in the United States might seize Greek assets to enforce claims, paralyzing the Greek financial system.

The consequences of a Greek exit might not be as bad as the doomsayers say. But the effects could also be worse than proponents claim. United States policy makers thought that the collapse of the investment firm Lehman Brothers in 2008 would be manageable. Instead there was a global financial crisis.

Ms. Merkel and other European leaders are fundamentally averse to risk. Despite threats to cut Greece loose, they will probably try to keep it in the euro zone — if they can.

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Economix Blog: Placing a Bet on Brazil

MEXICO CITY — As the United States and Europe face a bleak financial reality, Latin America hums along with continued growth and optimistic predictions for the next few years.

View From Latin America

Dispatches on the economic landscape.

The latest rosy report came Tuesday from J.P. Morgan, which released a survey of 40 institutional investors in North America and Europe, finding them upbeat about investment opportunities in Latin America over the next three years and applauding improvements in investor relations.

A majority of these investors, who together hold approximately $57.3 billion of actively managed equity in Latin American companies, view Brazil as the country with the highest investor-relations standards. Mexico, along with Peru, ranked last, partly because of the disparity in investor relations standards between blue-chip companies (which make it easy to find and obtain information for investors and shareholders) and smaller companies (which tend not to be as open with their information).

Survey participants named Brazil and Colombia as the most promising countries for investment opportunities over the next three years; Brazil’s rapidly expanding middle class promises to yield tremendous growth, while Colombia’s pro-business government is attractive to investors. Argentina and Venezuela were viewed as the least promising, because of the perception of unstable or unpredictable governments.

The economy in Latin America is getting a fair amount of attention as a relative bright spot.

A World Bank report published last week attributes the region’s growth to its increasing economic ties to China. Ten years ago, there was almost no commerce between the two; today, China is one of the biggest trading partners for some of the region’s economic powerhouses, including Brazil and Chile.

But the commercial honeymoon between China and Latin America may be coming to an end. Francisco J. Sánchez, the United States under secretary of commerce for international trade, visiting Mexico City on Tuesday to promote business, said that high transportation costs, extended delivery times and high import tariffs were reversing this trend. “We are seeing more and more businesses returning to this hemisphere,” Mr. Sánchez said. Investors are taking note.

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Airlines Race for Slice of Burgeoning Asia Market

HONG KONG — Rapid economic growth, rising affluence and increased liberalization are combining to produce a flurry of new airline projects in the Asia-Pacific region.

These days, hardly a week seems to go by without news of another venture’s being set up. On Tuesday, Qantas Airways, the Australian carrier, announced plans for not just one, but two new airline operations, underscoring the broad transformation that the Asian airline sector is undergoing.

Expanding middle classes in populous nations like China and India, changing regulations and a wealth of freshly built airports have driven plans for new carriers and hefty aircraft orders in recent months, as airlines across the region rush to secure a slice of the growing pie.

“Whatever happens in financial markets over the coming weeks and months, one thing we know — Asia will continue to play a larger part in the global economy and a bigger role in the world,” Alan Joyce, the Qantas chief executive, said Tuesday in a statement announcing the airline’s new international strategy.
“It is already the world’s largest, fastest-growing and most profitable aviation market. There is nowhere like it. It has massive untapped potential.”

Qantas’s response to the shifting economic landscape is to set up two ventures in the region over the coming years, adding to its existing low-cost brand, Jetstar.

In Japan, Qantas is teaming up with Japan Airlines and the conglomerate Mitsubishi to form Jetstar Japan, a low-cost carrier that is expected to start flying within Japan at the end of next year. Later, it would start offering short-haul international service to key cities in Asia.

Separately, Qantas is planning a new premium carrier that will be based in Asia and operate with a new name and brand. No date was specified for its introduction.

The plans form part of a major revamp of Qantas’s international operations, sharpening their focus on Asia. The makeover also includes plans for a major fleet upgrade — Qantas announced it would buy as many as 110 new Airbus A320 aircraft — as well as plans to fly to Santiago and curtail services to London.

In contrast to Qantas’s business within Australia, where the carrier retains a 65 percent share of the market, the international operations have been struggling, weighed down by relatively high costs and intensifying competition from Asian and Middle Eastern competitors.

The airline’s announcements Tuesday highlighted a wider regional trend: the rapid growth of Asian air travel, and the race by carriers in the Asia-Pacific region to cater to the rapid growth that industry executives and analysts believe still lies ahead.

Demand for air service in Asia is going through a “quantum leap,” said Victor Chu, the chairman of First Eastern Investment Group, a private equity firm based in Hong Kong that is setting up a low-cost carrier in Japan. Named Peach, the airline is due to take to the skies beginning in March and will be 39 percent owned by All Nippon Airways of Japan.

Rising affluence levels in countries like India and China, he said, are causing the ranks of the middle class to swell on a scale that the world has never seen.

Over the past decade or so, that phenomenon has catapulted several Asian carriers into the league of the world’s busiest airlines.

Delta Air Lines of the United States remains the largest carrier in the world, but the mainland Chinese carriers China Southern and China Eastern, for example, are now among the top 10 airlines in terms of passengers flown,
despite being barely known outside the region.

Cathay Pacific, which is based in Hong Kong, and Korean Air Lines are the world’s largest carriers of air cargo. Hong Kong has become the busiest cargo hub in the world, and increasing traffic at the city’s airport has prompted calls for a third runway to be constructed.

Moreover, the Asia-Pacific region is the most profitable in the air transport sector. The International Air Transport Association estimated in June that Asia-Pacific carriers would make a combined profit of $2.1 billion this year, just more than half the global total of $4 billion. North American carriers’ profits could total significantly less — $1.2 billion, according to the association’s projections — and European airlines may make as little as $500 million this year.

“There are hundreds of millions of people out there who have never been able to travel before,” Mr. Chu said. “Suddenly, many of these can afford to travel, while travel restrictions have begun to ease. You have to act fast if you don’t want to be left behind.”

Many, in fact, have already acted.

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