Don't panic, there's good news in this meltdown

It may be the oldest cliché in the foreign correspondent’s phrasebook, but at present it happens to be true: when America sneezes, Europe catches pneumonia. The worst of the economic epidemic spread by accounting scandals on Wall Street will not hit America’s Main Streets, but the factories of Germany, Italy and France.

Not many people yet seem to understand this, especially not in the European Commission or the European Central Bank. Conventional wisdom asserts that the meltdown in global stock markets is a strictly American pathology, symptomatic of the Americans’ reckless and speculative approach to economic life. The prudently managed and thrifty European economies, protected from currency turbulence by the newly minted euro, are immune from financial crises originating in far-flung corners of the world. Europe could even gain in relative economic stature, as the profligate Americans face a day of reckoning after years of living off other people’s hard-earned savings. This confidence is confirmed by financial markets. The euro has risen sharply against the dollar.

Doesn’t this prove that the crisis on Wall Street is a purely American problem, which will leave Europe unscathed? Well, up to a point. If economic activity were fuelled by moral self-righteousness instead of profit, Europe would certainly be the richest and most prosperous region of the globe. But sadly for Europe’s jobless, that is not how the world works. History and economics both suggest that the stagnant economies of continental Europe will suffer more acutely than any other region. Meanwhile, in America and Britain, where rising public deficits and booming property markets were starting to raise fears of inflation, Wall Street’s troubles could even prove a blessing in disguise, rather like the 1987 stock market crash and the Russian default of 1998.

Let me start with history. In every financial crisis since the 1980s, Frankfurt and Brussels have boasted that “Europe will be a safe haven” from global turbulence. They said this after the 1987 crash on Wall Street, after the 1995 Mexican crisis, after the 1997 Asian crisis, after the 1998 hedge fund collapse, after the dot-com crash of 2000 and after the horror of September 11. Each time, investors were suckered into selling American assets and buying euros (or marks). In each case, they turned out to be wrong. After a few months the euro turned tail and fell below the level at which it started as investors realised that the economic fallout from all these crises (even the ones originating in the western hemisphere) would prove more lethal to Europe than the US.

To understand why this happened — and why it will probably happen again — we must turn to three principles of economics. First, an economy which is growing rapidly and operating near full employment is better able to withstand shocks than an economy teetering on the edge of recession. Secondly, a modern economy can usually overcome deflationary dangers provided interest rates, taxes and public spending are actively managed to maintain the growth of consumer demand. Thirdly, a country whose growth depends primarily on domestic consumption will find it easier to deal with shocks than one which relies on exports.

America and Europe both suffered major shocks in 2000 and 2001 — the crash of technology shares, the doubling of oil prices, the collapse of computer and telecom investment and the attack of September 11. Each of these blows hit America more directly than Europe. So conventional wisdom maintained that America would sink into recession, while Europe sailed ahead. Yet the two economies grew at almost identical rates of 1.2 and 1.3 per cent respectively in 2001. This year the US is likely to grow by 2.7 per cent, according to the latest survey by Consensus Economics — more than double the 1.3 per cent growth in the eurozone.

This paradox is explained by my three economic precepts. First, the American economy had enormous momentum as it moved from the prosperous 1990s into the present troublesome period. Euroland grew feebly throughout the 1990s and was still suffering 9 per cent unemployment in 1999. Like a bicycle moving very slowly, it was easier to knock off course. This is even truer today, with euroland stagnating and unemployment at 11 per cent.

Secondly, American policymakers acted boldly to maintain the growth of demand as soon as they saw the danger of a major slowdown. The Federal Reserve Board slashed interest rates from 6.5 per cent to 1.75 per cent in just 11 months. The White House then cut taxes and boosted public spending, contributing more than 1 per cent to GDP.

The ECB, by contrast, continued to raise interest rates up to the winter of 2000. It reduced them only grudgingly after September 11 and its total monetary easing has amounted to just 1.5 percentage points, compared with the Fed’s 4.75 points. It beggars belief, but European interest rates are actually higher today than they were in the summer of 1999, at the peak of the millennium boom. Meanwhile, the misnamed Stability Pact forces governments to tighten fiscal policies when they should be cutting taxes to stimulate demand.

This perversity — one could almost say economic vandalism — is easily explained. Neither the ECB nor the Commission believes that monetary and fiscal policy have any role to play in managing demand and stimulating growth. The Fed (and the Bank of England) correctly perceived that the jump in oil prices during 2000 would slow growth and even raise a risk of recession; but the ECB had (and still has) a policy of studied indifference to growth, recession and unemployment. Cleaving to the true religion of Bundesbank monetarism, all it saw was inflation. When oil prices rose the ECB tightened monetary policy, while the Fed, the Bank of England and the Bank of Japan cut their rates.

The ECB’s monetarist dogmas are likely to be as damaging today as they were two years ago. The collapse in equity prices has led to speculation about further reductions in US interest rates and has prompted the Bank of Japan into a huge expansion of its money supply. Yet ECB officials continue to mutter darkly about inflation and hint than an increase in European interest rates is still just a question of time.

This ECB bias was stupid even before the stock market crises, given that euro interest rates are double the American level, while growth is only half the rate in the US. Now the need for easier monetary policy is acute. Not only has the stock market collapse hurt consumer and business confidence, but the 10 per cent rise of the euro now threatens to devastate exports — the sector of the economy that has been responsible for almost all of the past two years’ growth.

This point brings me to my third precept: an export-dependent economy is far more vulnerable to financial shocks than one relying on home-grown demand. And in a stagnant economy addicted to export growth, a strong currency is the kiss of death. Europe’s addiction to exports is now greater than that of Japan, Korea or Taiwan. Euroland’s feeble economic recovery in the first quarter of this year was entirely due to exports. Domestic spending has continued falling — and at an accelerating pace — in Europe, even as the American, British and Japanese economies have bounced back. Now the strength of the euro will be Europe’s sole source of growth.

So Wall Street may sneeze, but American businesses benefit from a weaker dollar, an easy monetary policy and a huge relaxation of fiscal policy. Meanwhile, European companies will catch pneumonia from the turmoil on Wall Street, just as they did after the 1987 crash and after the various crises of the 1990s.

Europe is more than ever a hostage to foreign crises outside its control. This is not just bad luck. It is a conscious decision. The creation of the euro has made Europe more dependent than ever on America by paralysing national fiscal policy and putting interest rates in the hands of an unaccountable monetarist clique. How long can this madness continue? When will Europe accept responsibility for its own economic future? When will Europe cease to be an economic vassal of the United States? I can only answer with three further questions. When will European governments tear up the misconceived “Stability Pact” that has sabotaged fiscal policy? When will the sado-monetarists at the ECB swallow their pride and slash interest rates? When will pigs fly?

The prudently managed and thrifty European economies

huh?
I guess this can maybe rationalized as a good thing if a person liked Stalinist central planning.

Still, it seems like a foolish statement given the unemployment levels in places
like France and Germany.
And given the number of their citizens the USA absorbs (usually to it's gain) each year
that help keep the unemployment in Europe at even the current levels.

His point was this is how Europeans see themselves. And he answers their vision with - "If economic activity were fuelled by moral self-righteousness instead of profit, Europe would certainly be the richest and most prosperous region of the globe."

Among other things... He points out that 11% unemployment is hardly thrifty...

Gee, why don't we ever hear any of this on the news? Why do you suppose our media wants us to think that America is crashing and the rest of the world is just sailing along?

They're not going to be able to keep it hidden much longer.

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