Bleak Outlook for European Economies

Although Rajoy proclaimed 2014 is the year of recovery for Spain it does not look as bright for the rest of Europe. All of the European stock exchanges have shown this, with the exception of the Spanish Stock Exchange closing 0.25% higher than it opened.

The situation in Europe is unsurprising due to many reasons, one of which is the reconstruction of the Banco Espírito Santo (BES) which not only caused panic in Portugal but as we live in a globalized world, American markets were affected as well. BES had a huge impact on the French bank Credit Agricole which wrote off 708m Euros, almost halving their profits, which just shows how European countries and business are linked. Nevertheless, the way in which the Portuguese authorities are dealing with BES by dividing it into 2 banks, Banco Nuevo which will have all the good assets and another bank which will hold all the toxic assets. The idea being that the European taxpayer will not be hurt, but this means that the shareholders and junior bondholders will be left with high risk assets. Although this strategy saves the taxpayer it also might drive away future investors who are interested in Portugal. Moreover, if this becomes an exemplary outcome of how banks will be treated, this could be perceived as anti-investor behaviour and drive away future investments in the region.    

Recent statistics have not been too positive with regards to the European economy. The Italian economy falling back into a recession and the inflation in Germany being only 0.4% in July, thus highlighting Europe's fragile state. Most importantly, for which the markets haven't reacted too enthusiastically to is the decision by the ECB. The decision to keep the benchmark interest rate at 0.15% and not introduce any open market operations in order to combat inflation. There is a little detail which seems to have been overlooked, the one the ECB has looked into, this is the bonds market which are pricing Eurozone inflation at 0.5% for the next 5 years, then 2% for the following 5 years. Nevertheless, one needs to ask how much longer until the Eurozone economy will turn back to normality, if the crisis started in 2007 and we will keep facing inflation of 0.5% until 2019, that means that only after 12 years of reforms, will the Eurozone economy start growing again. A way to increase inflation is through monetary easing for which the ECB hasn't introduced, which came as a shock. One reason for this is that the Fed is doing its own quantitative easing (QE) and so there is plenty of money going around the global economy (the impact of the Fed's monetary easing is having an enormous effect upon the Latin American economies which in turn make a lot of investments in Spain, so this is one of the many links that connects the Fed's QE with Europe). More importantly is that the ECB doesn't want to risk stagnation, given the high levels of unemployment (in Spain unemployment is 24.47% and 27.2% in Greece) and so this creation of money might lead to inflation but it will not lead to job creation. And so the real problem is the lack of jobs rather than inflation. Regardless of the statistics, the ECB has made the correct decision, and in the long-run European economies should grow naturally, firstly through job creation which then should bring up inflation.

Furthermore, a more damaging event is that of Russia, the sanctions which Russia has imposed on EU imports. It has been estimated that €12 billion worth of agricultural exports have been traded with Russia in 2013, thus being the EU's 2nd largest trade partner for agricultural goods since 2003 (first is the USA). The imposed sanctions will damage Europe but not as much as it seems, the reason being that the EU is increasing its trade with other countries, mostly with Asia, exporting to China has increased by 19.7% (from 2012 to 2013). And so, the EU does have other options but it mostly depends on the demand by the other countries and let's not forget the countries which Russia has imposed sanctions to will most likely start trading with one another to make up for the excess in their trade balances. Nevertheless, there is a big gap to fill, from the €12 billion exported to Russia, the EU's next biggest exporter is China (with regards to 2013 figures) where exports are over €7 billion. And so will there be enough capacity by other countries to take on the €5 billion gap?

The way around this is for each country to stick to the advice that has been given to them by different institutions, regardless of the short term effect and opinions of the citizens. In the long run the imposed policies should be triumphant. A great example for this is the case of Portugal, if it hadn't kept aside some funds in case of a banking crises (which the IMF suggested) it would have ended up in a much worse situation with the burden weighing down on the taxpayer.  Therefore, although the world is in a difficult situation, with the USA and Iraq, Israel and Palestine, Ukraine and Russia, once all of these are overcome, then will the world move towards a healthier economic recovery, when countries work together. However, at this point in time, the near future does not seem to provide the right circumstances for European economies to move forward at a reasonable pace, as the main issues which need to be addressed are unemployment and trade.

The problems facing the Eurozone

The generalisation of the steps taken by the European Central Bank (ECB) to get Europe out of a crisis has shown the major weaknesses in the single market system as the same actions affecting 17 different members. It will be a lot more difficult to enter the recovery stage of the Euro area as countries are facing economic as well as political crises. The Euro members who have been affected more negatively from the  crisis have been bullied by the IMF as well as the ECB to go through with excessive austerity measures which in turn have hindered more than helped their economies. This can be seen with the PIGS countries (Portugal, Italy, Greece and Spain) which as stated above are facing political and economic challenges, Greece for example who has implemented intense austerity measures have managed to hurt their own economic growth as excessive austerity has spread towards excessive protests ( so much for the free movement of labour). Nevertheless, one must not forget that each country has different traditions, cultures and history, for example if the Greek people would pay their full share of taxes then Greece might be in a better position, also if the Greek officials were more careful and less corrupt with EU funding then they would definitely be at a more stable state, but as I said each country has its different cultures and traditions which is one of the reasons as to why the Eurozone can be seen as inefficient.

The political crises are not aiding the economic outlook for individual countries and Europe as a whole. We can see this with the current situation in Portugal,  where two weeks ago Portugal's  Finance Minister Vitor Gaspar as well as Foreign Minister Paulo Portas who lead the Popular Party, both resigned due to disagreements regarding the austerity Portugal will impose. As a result, the signs of political unsustainability have affected the country economically where its 10-year-bonds rose over 8% making it a riskier investment reflecting not only the economic outlook of the country but also the direction it is heading. Furthermore, the comments coming from the ECB don't have much of an effect as they are bland and extremely general, for example the comment given by Mario Draghi regarding the new Finance minister of Portugal; 'We are reassured by the new minister, by everything we know about her, so from this point of view, Portugal is in safe hands'. This comment either undermines everyone's intelligence that the new minister is qualified for the job or she isn't qualified and Draghi is trying to comfort people so that they don't panic concerning Portugal's future.  What's more, Europe is interconnected, hence, as well as Portuguese bond yields rising so did Italian and Spanish yields, in addition, the main stock markets throughout Europe closed more than 1% lower. This shows the huge responsibility one central bank has to take on and so far unfortunately it hasn't been doing a great job. If we look back in history at the Asian crisis of 1996 some of the actions they were advised to take were to raise interest rates and keep spending under control which is the opposite of what the ECB has done now that Europe is in a crisis. In addition, there have been talks to further decrease the base rate which will hinder the members with stronger economies such as Germany in order to compensate for the state the weaker countries are such as the PIGS, this is yet another example that a main central bank cannot have full control over  17 countries with the same currency.

England on the other hand which has its own central bank is on a much better track towards recovery principally on the data which has come out so far. First of all, the government hasn't exaggerated their need for austerity measures which is a huge bonus as it keeps the economy beating. Moreover, monetary policy has been injecting £375 billion through quantitative easing which helps to stimulate the economy although the credit channel (mostly banks) have been strict on lending even though the Bank of England has tried its best to try and encourage lending by banks. In my opinion England should now consider to increase its base rate (and not decrease it as some members of the Monetary Policy Committee were assessing). The reason for this is simple, although the crisis has not passed, there are positive signs in the economy, such as the seasonally-adjusted basis construction output rising to 4.6% in April in relation to March as well as the sector growing for a second month in a row in June, plus, business confidence is said to be at its highest level since 2007, added to, export sales having grown at the fastest rate since the British Chambers of Commerce (BCC) began publishing in 1989, last but not least, the housing market is also increasing especially in London, where nationally values have risen 2.5% from a year ago. Thus, the economy indicates it's on its way to recovery, and so luckily Mark Carney became the chairman of the Bank of England (BoE) at the right time to support the economy recover, hopefully he will do as he said and sacrifice the inflation target in order to achieve economic growth. The BoE should increase the base rate, not only to stop the economy from spiralling out of control when lending and credit become more accessible again but as a sign also. A signal to the rest of the world England is doing well and is on its way to recovery whilst other countries are still in crises, even if it is not, just the mentality of England is recovering will help, also don't forget the influx of hot money entering England after the base rate has increased.

Therefore, better moderation and regulation needs to be implemented when the EU funds projects so that the Spanish don't build unnecessary airports and the Greeks don't build  pointless infrastructure. Free trade and the free access to labour is good but the single currency which doesn't regulate, properly examine where its loans end up as well as who joins the club (Greece with false statistics) it is nearly impossible to maintain full control of the member states. The ECB cannot fully monitor as well as have full control over such a vast area where member states differ in many different ways as their economies are supported by different sectors, for example Germany has a strong services sector whereas Italy has a much stronger manufacturing sector. Thus, the decisions and actions the ECB takes will affect different member states in different ways.  The Greeks are different than the French who are different from the Germans who differ from the Spaniards and so on, thus with such adverse traditions and cultures using the same policy on all countries is an intolerable idea which cannot push through in times of hardships as these different member states need a different combination of monetary and fiscal policy, and currently they are only getting one of the two, fiscal, which is not the whole solution towards recovery. And so, the EU could learn a lesson or two from England's independent stance on having full control over its monetary and fiscal policies.