Dr. Doom Sees More Doom

Nouriel Roubini, a professor from NYU most famous for predicting the housing collapse, sees more disaster ahead. Writing in the Financial Times, Roubini, nicknamed Dr. Doom for predicting disaster in the housing market when everyone else was riding high, spells out the problem facing Europe, and thus the rest of the world.

Italy is too-big-to-fail, but also too-big-to bail. Even if it restructured its debt (2.58 trillion USD), it would still suffer from “a large current account deficit, lack of external competitiveness and a worsening plunge in gross domestic product and economic activity.” To resolve those problems Italy may “need to exit the monetary union and go back to a national currency, thus triggering an effective break-up of the eurozone.”

Until recently the argument was being made that Italy and Spain, unlike the clearly insolvent Greece, were illiquid but solvent given austerity and reforms. But once a country that is illiquid loses its market credibility, it takes time – usually a year or so – to restore such credibility with appropriate policy actions. Therefore unless there is a lender of last resort that can buy the sovereign debt while credibility is not yet restored, an illiquid but solvent sovereign may turn out insolvent. In this scenario sceptical investors will push the sovereign spreads to a level where it either loses access to the markets or where the debt dynamic becomes unsustainable.

Roubini continues:

So Italy and other illiquid, but solvent, sovereigns need a “big bazooka” to prevent the self-fulfilling bad equilibrium of a run on the public debt. The trouble is, however, that there is no credible lender of last resort in the eurozone.

He explains that Eurobonds are out of the question due to German politics – they’ve bailed out enough people, they say (rightly) – and the ECB is prevented from doing so: “as unlimited support of these countries would be obviously illegal and against the treaty no-bailout clause.” Roubini also dismisses other discussed options as ineffective or unrealistic.

The austerity necessary to pay down the debt and save the credit ratings, he argues, will make the recession worse: “Raising taxes, cutting spending and getting rid of inefficient labour and capital during structural reforms have a negative effect on disposable income, jobs, aggregate demand and supply. ”

Even a restructuring of the debt – that will cause significant damage and losses to creditors in Italy and abroad – will not restore growth and competitiveness. That requires a real depreciation that cannot occur via a weaker euro given German and ECB policies.

If you cannot devalue, grow, or deflate to a real depreciation, you must abandon the Euro. The eurozone could survive Greece or Portugal doing so, but not Italy (or Spain). That would effectively break-up the eurozone. That “slow-motion train wreck is now increasingly likely.”

Only if the ECB became an unlimited lender of last resort and cut policy rates to zero, combined with a fall in the value of the euro to parity with the dollar, plus a fiscal stimulus in Germany and the eurozone core while the periphery implements austerity, could we perhaps stop the upcoming disaster.

There are even odds that this will happen. Berlusconi has resigned as prime minister, but that will only calm the markets for so long. The structural problem of their debt remains. As does the threat of the collapse of the euro. They will continue regardless of who hosts the next bunga bunga party.

Why The Euro Will Fail

Not so in the case of the euro. The euro zone is a hybrid: a single currency with 17 national fiscal and economic policies. It has no common treasury, no tax-raising powers, no joint bonds and no central bank acting as lender of last resort. In good times, this did not matter. But in the worst financial crisis in decades, the flaws are glaring. Even Mr Berlusconi cruelly described the euro as “a strange currency that has convinced nobody”.

Countries cannot quit the euro without extreme economic pain, but nor is it easy to fix. Vetoes may be needed to maintain democratic consent, even if they make for poor crisis management. A blockage in one country endangers all. The markets are testing the ambiguities to destruction. Vague promises to “do whatever it takes” to save the euro are not enough. Will the ECB deploy its full resources to stop the crisis? How much intrusion into national policies are Greece and Italy ready to accept? How far is Germany willing to extend its credit? Will the euro zone’s states hang together or hang separately?

These are big questions, affecting the nature of the state, sovereignty and democracy. Mr Papandreou may have messed up his tactics, but he was right on one point. The changes needed to save the euro are so profound in nature that, sooner or later, they must have the explicit consent of the people—or they will fail.

Source.

Monday Smorgasbord

I don’t have time to post these by themselves. They’ve been sitting in my “to do” pile for too long, but I find them all to be interesting reads. Read what interests you.

“How to Prevent a Depression” by Nouriel Roubini.

France imposes a “fat tax” on sugary soft drinks to combat obesity.

CNAS publication: “Hard Choices: Responsible Defense in an Age of Austerity,” by LtGen David Barno, Nora Bensahel, and Travis Sharp.

Megan McArdle: “By 2020, cases of throat cancer caused by the human papillomavirus may outnumber those of HPV-caused cervical cancer.”

Hitch on the killing of Anwar al-Awlaki.

Maurizio Viroli: Silvio Berlusconi and the moral malaise of Italy.

“The Value of Values: Soft Power Under Obama” Mark P. Lagon

A debate on whether too many students are in college. (My answer is yes.)

Cliff May, “Autocracies United: Why “reset” with Russia and “engagement” with Iran have failed”

A journalist on the argument for better football helmets, and an economist on the trade-off.

Lot of stuff going on here. Enjoy.

Berlusconi and Germany’s Nightmare Scenario

As I wrote two days ago, Beslusconi is an embarrassment to Italy. Fareed Zakaria writes that he is also a nightmare for Germany, and by default (pun completely intended), the rest of the Eurozone.

A few weeks ago, we got a glimpse of Germany’s nightmare scenario: Markets began focusing on Italy and its debt became expensive. The European Central Bank intervened, buying Italian bonds, which lowered rates at which Rome could borrow. As soon as the situation stabilized, Italy’s prime minister, Silvio Berlusconi, began watering down his commitments to enact economic reforms.

With such leadership, the future looks bleak for Europe.

Europe needs a crisis agenda to get out of its bind, but beyond that it needs a growth agenda, which involves radical reform. The fact is that Western economies — with high wages, generous middle-class and political subsidies, and complex regulations and taxes — have become sclerotic. Now they face pressures from three fronts: demography (an aging population), technology (which has allowed companies to do much more with fewer people) and globalization (which has allowed manufacturing and services to locate across the world). If Europe — and, for that matter, the United States — cannot adjust to this new landscape, it might escape this storm only to enter another.

I Wouldn’t Call Them Dissidents

From the FT:

Silvio Berlusconi’s centre-right coalition survived a vote of confidence in parliament on Friday but its slim margin of victory left persistent doubts over its ability to govern effectively and raised expectations of elections in early 2012, a year ahead of schedule.

The alliance of Mr Berlusconi’s People of Liberty (PDL) party and the Northern League of Umberto Bossi escaped defeat by 316 votes to 301 in Italy’s lower house of parliament, which has a total of 630 deputies.

The government’s success in securing an absolute majority – by just one vote – will be seen as a boost for the 75-year-old prime minister who has led three centre-right administrations since 1994. But opposition parties took heart that his majority is eroding after four of his long-standing allies deserted the government.

Faced with the prospect of the coalition going under, which most likely would have led to them losing their jobs, “dissident” MPs within Mr Berlusconi’s faction-ridden party buckled under and voted in favour of the government.

Berlusconi continues to embarrass and weaken an already embarrassed and weak nation, at a time when solid leadership is needed. Italy’s chances of a reasonably quick and steady recovery are slim to begin with. They are doomed to more pain and misery without proper governance. Berlusconi may have won a confidence vote, but the Italians have nothing to be confident about. The worst is yet to come.