What’s next in the Eurozone financial crisis

For a year now, the once-mighty euro has lurched from crisis to crisis as debt-ridden Greece and then Ireland were forced to ask their neighbors to bail them out of financial trouble.

The fear now is that fellow Eurozone members Portugal, Spain and Italy, which also have large budget deficits, will follow suit. Borrowing costs for these countries have skyrocketed even as they scramble to pass harsh austerity plans to convince investors of their commitment to cutting public spending.

But is too much austerity also a recipe for disaster, strangling demand and stifling growth? Can Germany, Europe’s export powerhouse, continue to run up big trade surpluses with other Eurozone nations while refusing to stimulate consumption at home to help out its struggling neighbors?

Simon Tilford, chief economist for the Center for European Reform in London, spoke to The Times about the euro’s ongoing difficulties.


Are we headed for a re-eruption of the crisis early in the new year?

It’s difficult to see how we can avoid a major crisis in the new year because the countries in question — Spain, Portugal, Greece and Italy — all have to refinance a lot of debt in January and February. …

The underlying problem here is a disagreement over what the cause of the crisis is. The Eurozone, under German leadership, continues to maintain that the crisis was caused by fiscal ill-discipline. It’s quite clear that the Greeks did mismanage their public funds, but if we look at Spain or Ireland, both those countries were running budget surpluses in 2007, ahead of the financial crisis.

What has happened is that economic growth has collapsed. The reason is that the structure of economic growth across the Eurozone was very unbalanced. We saw one group of economies relying very heavily on high levels of investment in property … [and others] depended largely on exports. You had the likes of Germany, Austria and the Netherlands running steadily increasing trade surpluses, and countries in the south running very big trade deficits.

Are Greece, Ireland and Portugal doomed to years of low economic growth or stagnation as they struggle to pay off their debts?

At best, on current trends.

They’re trying to deflate their way back to trade competitiveness within the Eurozone. That basically means cutting wages. But deflation and very weak growth means that it’s going to be very hard to prevent an ongoing buildup of debt. The debt stays the same and incomes fall, so the actual burden of servicing that debt increases.

The Eurozone needs to get very serious about removing obstacles to economic growth and to accept that there is only so much economies can do to strengthen their public finances in the absence of economic growth. … By forcing excessive fiscal austerity, it’s actually unsettling investors, not reassuring investors.


Are the markets being rational and fair in their treatment of Eurozone countries?

This is perfectly rational; one just has to do the math.

Certainly in terms of Greece, Portugal and Ireland, there’s too much debt and too little income, and their strategy for bringing down public deficits and boosting competitiveness is going to undermine economic growth. …

They need to start thinking about the underlying reasons why the markets are so skeptical about their ability to pull off these huge adjustments, rather than inferring that the markets have created this crisis so that they can profit. I find that rather asinine. … They were given a free ride by the markets for a very long period of time.


Is the euro too big to fail?

It’s mistaken to believe that it could never happen. The idea it could never happen is part of the reason for the failure of the Eurozone to put forward a coherent strategy for dealing with this. …

There’ll be a number of bailouts. We’ll see steps taken to try to alleviate some of the pressure on some of the hardest-hit member states. But it won’t be enough. Borrowing costs will remain very high, growth will remain very depressed, and we’ll see ongoing stagnation and rising political tensions.

If we take the Eurozone as a whole, there is no problem. So if they agreed, for example, to introduce some kind of fiscal union, to transfer funds between the participating economies on an ongoing basis … then they could address the crisis. [But] it’s far from clear that the necessary solidarity for that kind of integration actually exists.


Would it be possible to kick out laggard countries from the Eurozone?

There could be negotiated withdrawals. Obviously that would have to happen after or together with a debt restructuring. …

The problem with that is, where would it stop? If it were just the small countries — Greece, Portugal and Ireland — maybe that could work. But if Spain, for example, were to be part of this group, I don’t see how that could work, because the pressure then on Italy would be enormous, and in turn the pressure on France would be huge.

Are defaults better than bailouts?


In the case of the three small economies, yes. … Unless they address the growth issue, then piling more debt on top of the already-excessive levels of debt is just postponing restructuring. It’s just kicking the can down the road, and it just means that the ultimate restructuring or default will be that much bigger and that much more difficult to address.

Is Germany more a part of the solution or part of the problem?

The problem in Germany is that they don’t see the contradiction between condemning other economies for their profligacy and then saying that “we must be allowed to run trade surpluses indefinitely.” … They’re going to have to do more to stimulate their domestic demand.

What the Germans really want is a Eurozone solution with limited liability. They want the Eurozone to survive, but they don’t actually want it to cost them that much. But whatever happens, it’s going to cost Germany a lot of money. If we have ongoing stagnation and bailouts, that’s going to cost the German taxpayer, because they can lend money to these governments, but these governments are not going to be able to pay it all back. And it’ll start eroding Germany’s own sovereign credibility. …


They’re going to spend a lot of money trying to shore up the Eurozone, but it’s going to be largely self-defeating. That’s the tragic thing about this crisis. It’s like watching a train crash in slow motion, or a train crash in slow motion that’s now speeding up.