Austerity is a funny thing. Some believe it is the cure for what ails economies in Europe as well as the United States. To others, it is a stumbling block to economic growth. What’s surprising is some who believe too much austerity is a bad thing. Goldman Sachs CEO Lloyd Blankfein was especially candid when he noted that there needs to be reform in Europe, “but at the same time, you have to make sure that the radiation treatment doesn’t actually kill the patient,” he was quoted in the Financial Times.
France recently voted out its president in favor of the anti-austerity candidate. Greece, whose unchecked spending is part of the problem, may as well, continuing to cause unease throughout the region, and thus the global economy. Although an anti-austerity candidate seems a shoo-in to me, especially in Europe, those voters might have a point. Too much, too fast. Something like slowly stopping a cruise liner verses hitting an iceberg. Most people would prefer the first choice.
Menachem Sternberg does, as well. Sternberg, a trader and economist who runs Eagle Trading Systems, believes in the moderate approach (see Sternberg: Analyzing the “new normal” by Managing Editor Dan Collins). When asked about the risk of moving too fast with austerity programs in Europe, he noted, “The solution always is in a balanced approach. What Europe under appreciated is by going to a huge austerity plan without having political stability, they will have political instability that can derail the whole process. So yes, they moved too strong in Europe because they under appreciated the political [environment].”
Of course, something has to be done, but cooler heads need to prevail, and soon, because the contagion is spreading. A recent EuroFinance survey of hundreds of largely U.S.-based corporate finance executives found almost 70% of their companies had been impacted by the euro crisis, while another 13% said it hadn’t affected them yet but thought it would soon. And sadly, with Spain now in the spotlight, this crisis isn’t ending anytime soon.
But it has been long in coming. PwC recently did a white paper on the crisis, “Breaking up is hard to do,” which gives four outcome scenarios and how to prepare for them. The paper notes that the roots of the crisis go back to 1999 with the inception of the euro, but there are two underlying problems that remain unchecked: Diverging competitive positions and current-account balances. Not surprising, it’s countries such as Germany and the Netherlands that have a higher price/cost competitiveness and stronger current account balances while the weaker countries are of course Greece, Portugal, Spain and Ireland.
The paper states four possible scenarios that could play out in 2012:
- Successive phases of monetary and fiscal action hold the Eurozone together at the cost of inflation;
- Voluntary defaults for highly-indebted sovereigns;
- Greece exits the Eurozone and a firewall is built around other economies;
- A new currency union is formed by the stronger economies.
Of these scenarios, number one appears the most moderate, projecting slow growth and higher inflation that actually could restore the relative competitiveness.
The euro crisis really is a test case for the United States, and should be watched closely by those who want to hit an iceberg with harsh austerity programs. This is history in the making, and we must be careful not to become another Titanic.