World - Depression stalks the eurozone

David Gow

Europeans, the young above all, greeted the deepest economic recession for half a century and an apparently bottomless financial crisis with riots from Athens to Kiev in late 2008. Manufacturing workers walked disconsolately out of car, tyre, steel, chemicals, plastics and cement plants that closed down behind them for two, three, even four weeks from Antwerp to Zaragoza.

Mainland Europe, which kidded itself in the autumn that it was immune from the worst excesses and subsequent heart failure of Anglo-Saxon capitalism, felt dark, depressed and downtrodden by Christmas. Only in the brightly lit street markets did shoppers, fuelled by mulled wine and strong euros in their wallets, delude themselves into short-lived festive celebrations.

If the eurozone and the rest of Europe ended 2008 on a fearful note, 2009 is shaping up to confirm the worst nightmares of the EU-27’s 500 million citizens. The spectre of a 1930s-style depression is foremost in many people’s minds. Analysts are forecasting an economic contraction of as much as 3 per cent despite the likelihood of the European Central Bank (ECB) cutting interest rates close to zero during the year.

Unemployment could leap by millions this year and in 2010 as business leaders, their confidence at 15 to 30 year lows, shut down entire companies or several plants or offices. Consumer spending, buoyed up so far by pay increases and low inflation in some countries, will freeze in all likelihood.

Four decades after the Paris events of 1968 drove General de Gaulle to seek temporary refuge in Baden-Baden, fears have seeped into the souls of political leaders that students and others will confront the ruling order on the streets in a “hot” spring of protests.

Anxieties about mounting social and economic tensions are strongest in southern Europe where the recession, already under way, threatens to be longer and deeper. Long-delayed structural reforms have been put on ice.

They surfaced at the mid-December EU summit when Italy’s Silvio Berlusconi and Spain’s Jose Luis Rodriguez Zapatero voiced them to chairman Nicolas Sarkozy, the French President, who immediately put reform of the lycees on hold for at least a year. “When you have such an economic depression, such social despair, all it takes is a match,” said Laurent Fabius, former socialist premier of France. It makes for an apocalyptic background to the celebrations — probably muted privately, if over-hyped publicly — of the 10th anniversary of the euro on Thursday, when Slovakia becomes the 16th country to embrace the single currency. The ECB will from now set monetary policy, including borrowing costs, for 328 million Europeans.

The economic bloodbath of 2009, more than likely to be prolonged into 2010, will inevitably prompt eurosceptic politicians and analysts to warn of the impending implosion of the eurozone. Divergences, exacerbated by Germany’s regained competitiveness and fiscal thrift, will become unsustainable, it will be argued. Most rational economists doubt this for political as well as economic reasons. But the EU’s claim that the euro, an infant currency moving towards adulthood, has brought economic stability, low inflation, 16 million new jobs, lower unemployment, reduced budget deficits, will be overturned by events. Germany, the eurozone’s biggest economy, witnessed at year-end what Tom Mayer, Deutsche Bank chief European economist, calls a “competitive devaluation” of forecasts. Leading institutes pointed to a contraction of between two and 2.7 per cent while the federal economics ministry admitted to a memo envisaging at worst a 3 per cent downturn.

Unemployment, at a historic low, could grow by one million people by the end of 2010 as the country experiences the worst recession since the federal republic was founded in 1949. In France, the eurozone’s second-largest economy, where youth unemployment, especially among immigrants, prompted the 2005 riots, recession has already taken hold.

So it has in Italy, Spain, Ireland and the Netherlands where Nout Wellink, ECB president, is now contemplating a 2 per cent contraction before a partial recovery in 2010. Eastern Europe, which has enjoyed stellar growth since eight former communist states joined the EU in 2004, is being sucked into the vortex.

Spain, where new car sales plunged by half in November, is being forced by the collapse of its construction boom, which brought in 3.5 million migrant workers, to slap new restrictions on incomers. Ireland, Celtic Tiger turned Deflated Baboon, is reckoning with a 4 per cent contraction and 10 per cent unemployment.

Eurozone governments, which have committed more than €1tn to bail out banks and guarantee liabilities, seem flummoxed by their unwillingness to lend to the real economy and preference for earning interest by parking the money overnight with the ECB.

The result is that fiscal and monetary easing will continue this year. January will see the start of the general election campaign in Germany and a new stimulus package of between €40bn and €50bn after the sharp criticism of the earlier €12bn programme. Sarkozy will almost certainly increase his government’s €26bn package soon. Both will continue to be focussed on public works such as roads and schools and to eschew British-style boosts to consumer spending via cuts in purchase tax — Sarkozy is a late convert to German-style fiscal probity.

Mayer, who favours “temporary, targeted and timely” cuts in taxes, believes the €25bn cuts demanded by the German economy minister, Michael Glos, are politically off-limits. But he warns: “The trouble with infrastructure projects is the time it takes to implement them.”

Howard Archer, of Global Insight, will revise his eurozone forecast in January to a 1.5 per cent contraction. He says: “Germany is the one country where consumers have the money to spend and the government has the room to do a bigger stimulus. But ministers seem so far out of synch — even in denial.”

Despite lingering doubts about the effectiveness of interest rates at near-zero as in the US, Japan and, coming soon, Britain, both forecast that the ECB will cut further. Archer sees a 0.5 per cent cut in January and says: “I’m not certain they will bring them down to zero. The consensus is for 1.5 per cent but the consensus is moving down all the time.”

Mayer has pencilled in 0.75 per cent as the ECB’s bottom line. “They’ll grind out cuts — not voluntarily but simply because they will be pushed down by the data; so far they have simply been overwhelmed by events.” He argues that the tougher the ECB sounds on inflation and stability compared with the Fed, the stronger the euro will become and, with it, the worse the economic outlook will be. “A 10 per cent appreciation is equivalent to a 1 per cent rate increase,” he says. For Germany, world champion exporters, that threatens much of its manufacturing, already in the doldrums with the euro at $1.40. And the cry from its neighbours will get louder for measures to stimulate demand at home and in the rest of the EU.

Almost two decades after unification, Germany’s political elite has been tempted to reverse the Kohl/Genscher motto of a “European Germany” for one of a “German Europe,” refusing to bail out its partners and adding to the economic and social tensions along the way. But that should change this year.

German ECB hawks such as Jurgen Stark, its chief economist, worry that eurozone stability is threatened by fiscal “laxity.” There may even be temptations to create a “hard currency” zone instead around a new Deutsche Mark. But Mayer, a native German, insists the economic and, above all, political costs will be too high to bear. — © Guardian Newspapers Limited, 2009