After writing yesterday’s post on the reversal of globalization, I spent some more time thinking about the rest of the world. Like most Americans, that’s pretty much how I think of it: the U.S. plus the rest of world. I fully recognize just how inadequate this is, but it remains my default mode of thinking, as it does for most of the U.S. population.
While I was pondering this, and working through some of the consequences, I realized that I hadn’t discussed Europe for quite some time. The reasons are good: the recovery continues, and there’s been no significant bad news, other than Ukraine, for some time. As a major economic and political entity, though, Europe is due for another look. So here we go.
As you might guess, the basic news is good: a slow recovery continues, consumer confidence is rising, business is back in positive territory, and the politicians and European Central Bank continue to cooperate. No news is good news.
The reason I’m taking another look now is that, while the recovery has started, it has not taken off. Unlike in the U.S., where growth accelerated through 2013 and looks to be healthy this year, Europe’s growth is stuck in first gear.
With low growth, deflation remains a concern. And given the continuing overhang of debt, deflation could be one thing that would reverse the recovery and start another systemic crisis. It can’t be allowed to happen.
One of the actors that could help stave off deflation—the banks—remains crippled. Unlike in the U.S., where banks actively delevered and raised capital, European banks are still undercapitalized and therefore less willing to lend aggressively. While U.S. banks have started to lend more, European banks simply won’t, and this has contributed to the deflation risk.
The recent Russian invasion and annexation of Crimea will make the situation worse. Uncertainty will prompt business to pull back, any energy problems will do the same thing, and the prospect for a possible widening of the Russian incursion has everyone nervous. Hiring, investment, and lending are all likely to tick down.
The ECB, to its credit, has noticed and is prepared to start taking extraordinary measures. According to the Wall Street Journal, Fed-style quantitative easing through buying assets is now on the table, as is the imposition of negative interest rates on bank reserves. (Nothing like taking away their money if they don’t use it to encourage lending.) Even the Germans are now on board, to some extent—and that, if anything, shows the extent of the problem.
The real question here is whether it’s too little, too late. The economic risks are substantial, but the political risks may be even greater. Euroskeptic parties continue to gain ground in almost all countries, driven by the slow recovery and raising the political risk for the euro. Policies like QE that have worked in the U.S. take time to have an effect (and then for people to realize the effect), and Europe’s voters may not see any positive results for years. Survival of the euro has become a race between the voters’ patience and policymakers’ willingness and ability to bring back healthy growth.
Whether or not Americans have been paying attention, the European story isn’t over, and the Russian faceoff over Ukraine may be the precipitating incident that starts the slow slide down.