15 May 2011

Europe’s Fake Recovery

Economic problems that led to the burst of dot-com bubble and its aftermath in the beginning of 2000s were never solved. Instead, they were hidden by blowing up an even bigger housing bubble. The IMF’s latest report on Regional Economic Outlook for Europe (May 2011) is entitled as “Strengthening the Recovery”. The report’s main message is that despite of challenges Europe’s recovery has been stronger than anticipated, growth continues, and the measures taken to deal with the sovereign debt crisis as well as to improve Europe’s financial integration are in right direction (although should be implemented more forcefully). The spring 2011 forecast by European Commission also confirms the continuing recovery of the EU economy. At the same time my strong impression is that we are again talking about a fake recovery and attempts to continue building up the so-called master bubble that is under way for more than 30 years already.

Basically these forecasts assume that US continues to consume, Asia continues to accumulate foreign reserves and Europe can nicely manoeuvre somewhere in between (see Figure 1 below). Thus there is a buyer for Europe’s products as well as those who might want US and Europe’s debts. No major change compared to the pre-crisis period in this respect.

The assumption also is that Europe’s governments can and will continue to accumulate debts. By that interest rates for governments remain to the very low levels, i.e. despite of increasing debt burdens and higher risks it is supposed that countries’ ratings will not be downgraded and/or the price of risk will go down. Figure 2 illustrates this point based on European Commission’s data and forecasts. If this should not be the case, governments’ interest expenditures at least in some EU countries (like the much discussed PIIGS countries) would go out of control and we would need to talk about such austerity measures that nullify every kind of recovery. No real improvement – rather contrary, things are getting worse.

One more expectation of the forecasts is that after some deleveraging during the financial crisis 2007-2009 and in its aftermath, leverage of households and non-financial companies continues to increase (see growing trend in outstanding credit to GDP ratio in Figures 3 and 4). This should also be viewed as a tendency that undermines the sustainability of recovery.

In addition to the promotion of fake recovery, IMF also encourages cross-border mergers and acquisitions in European banking markets. This sounds pretty strange considering the issue of banks that are too big to fail.

So where are we going to end up this way?

1 comment:

  1. For me this was always the case. The dot com period was a time of astounding growth, so when it went bad the bankers needed something to fill the space. They decided to squeeze profit out of debt, e.g. sub-prime and derivatives. Most dot com value was speculation. This was supplanted by something even more speculative, i.e. sub-prime (very risky debt)