Euro-Zone Calm Before the Storm?

Posted by: Linda Yueh on December 21, 2011

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It’s been quite a year, but leading economists warn that next year could be worse. The euro crisis is still unresolved, plus the economic outlook has darkened.

Nineteen months since the first bailout of Greece, the euro zone seems to lurch from one mini-crisis to another. Economists on a panel I hosted on Bloomberg Television all agree that not enough has been done to fix the euro, even after the EU’s so-called Euro-plus pact spelt out steps to create a fiscal union to complement the shared currency, and recapitalise the region’s banks.

For a start, the EU’S new fiscal rules are pro-cyclical, which means that they could worsen a downturn (and one is coming in 2012), according to UBS’s Chief Economist Larry Hatheway. Gerard Lyons, chief economist of Standard Chartered Bank, says confidence in the euro zone has been “shot to pieces” and what’s really needed is a growth strategy that also deals with intra-EU imbalances. Meanwhile, John Llewellyn, founder of Llewellyn Consulting and adviser to the U.K. Treasury, says the euro area needs to look to the U.S. as an example of a monetary union that holds together in part because of its political union.

So, the structure of the euro still needs work. In the terminology of economics, the euro zone must become a so-called optimal currency area. There are two criteria for being in an OCA: trade integration and convergence of incomes.

All 17 euro members trade largely with each other, so the first point is met. The second is tougher. For a country to grow sustainably in a monetary union it must be competitive, and this has to be based on lower costs and higher productivity rather than exchange-rate devaluation. If a country can’t compete with Germany then it’s not viable to share a currency. If a country isn’t suited to be in the same currency as Germany no amount of fiscal discipline will work. At the same time, which countries should remain part of the euro is unlikely to be sorted within the next year, in part because the euro zone may not be in a position to cope with the consequences of a country leaving. As European Commission President Jose Barroso said today: the EU isn’t yet fully equipped to defend the euro.

So, the euro crisis will weigh heavily on 2012. Standard Chartered’s Lyons, the most accurate economic forecaster in the world, according to a Bloomberg assessment, sees the global economy growing at 2.2 percent. But it’s a tale of two worlds: the fragile West, resilient East. In the first half of 2012, Europe faces deep recession, Standard Chartered says. And the U.S. will grow at just 2 percent next year, which is considerably below its normal trend growth rate. Even though emerging economies won’t be entirely isolated from Western woes, Lyons expects they will manage to grow as they’re better diversified than three years ago, including toward consumers and domestic demand.

UBS’s Hatheway says it’s “unavoidable” that the euro-zone economy will shrink 1 percent while the U.S. could gain a bit of momentum. But, he sees emerging economies slowing and estimates that they have less scope for stimulating their economies now compared with the last global financial crisis.

For Britain, the economy could already be contracting, according to Llewellyn. That echoes the forecast of the OECD that Britain is in a “mild recession” and is consistent with the flat output expected by the Bank of England until at least the middle of 2012.

For more of their insights and forecasts, watch the Bloomberg TV special: The Economy and Yueh, from Dec. 26th to Jan. 2nd at the following times:

12/26 — 4:00am, 9:30am GMT
12/27 — 4:00am, 9:00am GMT
12/28 — 5:00am, 9:00am GMT
12/29 — 6:00am, 9:30am GMT
12/30 — 10:00am GMT
01/03 — 1:00pm, 6:00pm, 9:00pm GMT

Photographer: Jock Fistick/Bloomberg

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