Why We Must Accept The Likelihood Of Economic Disruption – Possibly With The Collapse Of Euro

R Jagannathan

Oct 12, 2016, 04:02 PM | Updated 04:02 PM IST

Euro currency symbol (JACQUES DEMARTHON/AFP/Getty Images)
Euro currency symbol (JACQUES DEMARTHON/AFP/Getty Images)
  • A further slowdown and even major economic disruption lie ahead.
  • The disintegration of the euro is clearly on the cards, and it may not be such a bad thing as long as its disintegration is managed well.
  • Eight years after Lehman Brothers collapsed, causing the global financial crisis and the Great Recession – a recession that’s not ended for large parts of the Eurozone and Japan – the conclusion staring us in the face is simple: when extraordinary medicine hasn’t worked, maybe it’s time to accept that real improvement will happen only after a major disruption and rollback of excesses. The cure for excess booze is not more of it but abstinence for a while and letting the hangover happen and pass.

    The disruptions, starting with Brexit, could begin with a gradual (or speedy) unravelling of the euro, the Eurozone’s misbegotten child that has caused more misery than integration. But before we come to that, let us question the several mistaken assumptions we (i.e., the world, and not only India) have made that got us here in the first place.

    Growth is forever. There needs to be no pause.

    This has never been truer. Every burst of high growth has been followed by at least a slowdown in the last century. What is unique about the Great Recession that followed Lehman’s collapse is that it has been prolonged and has enveloped several continents, including the wealthiest – the United States (US), Europe and Japan. What this suggests is that sustained growth can bring sustained hangovers. In previous recessions, companies failed. This time, it is countries that are failing. And that is a big qualitative change.

    Growth can be built on unlimited debt.

    Fat chance. The current weak growth impulses in India are largely the result of excess debt incurred in the United Progressive Alliance years. This is the case with the world too. As V Anantha Nageswaran puts it in his column, the solution to prolonged debt-fuelled growth cannot be more growth fuelled by even more debt, as the US Fed and European Central Bank have been aiming to do by keeping rates near zero or even negative. He writes:

    That won’t cut it. With economic growth in advanced countries in the last three decades spurred by debt accumulation, the only alternative is to accept and experience a period of low growth with elites sacrificing something in favour of the most disadvantaged. Countries have to adjust, cope and restructure. Elites are not ready. They are resisting and resisting fiercely.

    Globalisation is always good. No proof required. There are ultimately no losers in globalisation.

    Wrong again. Globalisation is good for many, but also bad for others. The Brexit vote showed that half of British voters don’t think being part of the European Union was good. The rise of Donald Trump, even if he does not win the US presidential election, shows that protectionist and anti-trade sentiments are strong in many places. This means that globalisation has many discontented folks, and they are not discontented despite globalisation showering many benefits on them. They are the losers from globalisation, and as long as there is no mechanism to compensate losers, globalisation cannot be business as usual.

    When globalisation brings endless immigration, no country is going to accept it. Immigration will have to be regulated, and inflows need both cultural and economic adjustments. What we will see is a slight retreat from globalisation while we understand how to cope with its downside, and this in itself will cause a further slowdown and disruption.

    Economic integration is good always, never mind how this integration is achieved.

    The biggest exhibit to disprove this thesis is the euro, the European Union’s single currency. No integration project has done more damage to more people than the unscientific rush to create a common currency in the Eurozone.

    Jamie Dimon, chief executive officer of JP Morgan, believes that the euro is five times more likely to implode now due to Brexit. Joseph Stiglitz, Nobel prize winner and former chairman of the US President’s Council of Economic Advisors, says as much in his book on The Euro - and its threat to the future of Europe. He writes:

    The Eurozone was flawed at birth…for a single currency to work over a region with enormous economic and political diversity is not easy…A single currency entails a fixed exchange rate among the countries and a single interest rate…Even if these are set to reflect the circumstances in the majority of member countries, given the economic diversity, there needs to be an array of institutions that can help those nations for which the policies are not well suited. Europe failed to create those institutions.

    Put simply, the euro is doomed as long it is run for the benefit of the stronger economies (basically Germany, and the northern European and Scandinavian countries), and there is no mechanism to share the costs of adjustment being incurred by the PIIGS – Portugal, Ireland, Italy, Greece and Spain – in the form of super high unemployment rates. The US has half the unemployment rate of Europe, and in the continent, unemployment rates among the young are as high as 50 per cent in some cases. A single currency needs a wealth transfer mechanism from rich to poor, and this could include writing off some of the debts of the southern Europeans and/or allowing some of the weaker economies to exit the euro, again with the rich providing the cushion for this exit. Brexit was involuntary; Grexit needs to be negotiated to be smooth.

    Either way, there will be global disruption to growth, and we need to take it on the chin to revive growth in the medium term.

    Inequality does not matter to growth.

    Capitalists don’t like to acknowledge the Marxist idea that capitalism, in seeking higher and higher returns, will end up with a situation where inequality itself keeps shrinking markets. When too many people earn too little and a few people earn too much, and it is the latter group that influences policies, capitalism will keep lurching from crisis to crisis. You don’t have to accept the Marxist solution to prevent capitalism’s crises, but capitalists need to accept the reality that the creation of expanded markets needs a better distribution of resources. The poorer the distribution of incomes, the weaker the possibility of developing a wider market for any product. India’s real estate market is focused on the top 0.1 per cent of the population; it has to implode for this very reason.

    Consider also how the post-2008 policy response has ended up making inequality worse. After Lehman, central banks and governments, in order to save financial institutions that were “too big to fail”, kept interest rates near zero and also recapitalised them with public money. These institutions, and Wall Street, fed off this cheap money that went to inflate stocks, which were the main beneficiaries of zero rates. The rich got richer, even though it was Wall Street that brought on the Lehman crisis. Wall Street was rescued with Main Street money, but Wall Street has not yet returned this favour.

    With growth yet to revive, there is now talk of using “helicopter money” to help the poor rework their own balance sheets. But consider what could have happened if “helicopter money” had been used as the weapon of the first resort instead of the last? Few bank loans would have gone bad, and even some sub-prime mortgages may have turned good, preventing thousands of foreclosures. Instead, central banks helped the fat cats, and not those more deserving of this help.

    Automation will not erode jobs.

    Maybe so. But there is now a huge industry speculating on the future of jobs, automation and robots. That automation will eliminate human jobs is not in doubt; what is in doubt is when this change will help create new jobs, where, and for whom. Like globalisation, which is beneficial to many in theory, automation also benefits many, but it is damaging in the interim, when it kills more jobs than it creates. The backlash against automation can be predicted, unless world governments figure out how to provide safety nets and protect the vulnerable and take responsibility for retraining them in new skills.

    The simple takeout is this: the world needs a new understanding on the gains and losses from globalisation, increased trade and automation. No one will accept the benefits as self-evident. In the meanwhile, it is best to allow economies to adjust to the reality of excessive debt-driven growth and make amends.

    A further slowdown and even major economic disruption lie ahead. The disintegration of the euro is clearly on the cards. It may not be such a bad thing either as long as its disintegration is managed well.

    Jagannathan is Editorial Director, Swarajya. He tweets at @TheJaggi.

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