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9 Ways the Eurozone is More Fragile thanthe US

I may be best known for predicting the global financial crisis and the housing bust of 2008 —

but I made another key economic prediction when I warned of major structural risksthreatening the Eurozone in 2006

!y remarks pro"ed as prophetic as I#d feared $he crisis I predicted then is still casting

shockwa"es through the world economy% and may do so for generations to come

&t the 'orld Economic (orum in )a"os% *witzerland that year% I said that imbalances in the

Eurozone would come to a clima+ — which might lead to a disaster in Europe within , years

Source: bourse.lefigaro.fr I made my remarks at a panel discussion on the -.ps and )owns of E!./ European

!onetary .nion1 $he panel included se"eral key European finance officials — including ean3

4laude $richet% who was then president of the European 4entral 5ank E451

In a nutshell% I e+plained that some countries within the Eurozone — especially Italy%

ortugal% and 7reece — would e+perience weaker growth than the economically strong

countries at the core of the Eurozone% such as 7ermany

$his kind of economic di"ergence would be a major threat to a currency union like the

Eurozone% where countries inflation rates and interest rates con"erge

&s I was e+plaining all this% the Italian finance minister threw a temper tantrum9 :e

interrupted my remarks and began shouting% ;7o back to $urkey<; $he minister was making

reference to my being born in $urkey — despite ha"ing spent two decades li"ing in Italy1

.nfortunately% by the *pring of 20=0% many of the concerns I e+pressed during that panel

discussion in 2006 turned out to be well founded

>et#s take a look at some of the highlights — or% perhaps more accurately said% the low lights

— of the last fi"e years in the Eurozone to set the conte+t

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;$he Euro sculpture is partially reflected in a puddle on a cobblestone pa"ement in front of 

the head?uarters of the European 4entral 5ank E451 in (rankfurt anuary 2=% 20=2;

CREDIT: REUTERS/KAI PFAFFENBACH  

Source: reuers.co!

• In !ay of 20=0% the 7reek go"ernment was thrown into chaos by a debt crisis@

ultimately% 7reece was forced to accept a bailout from the I!( and E.% to agree to

implement austerity measures in return% and e"entually in 20=2 to restructure in a coerci"e

way its public debt

 

• 5y une of 20=0 the member states of the Eurozone were forced to create $heEuropean (inancial *tability (acility E(*(1 a temporary crisis fund that had to lend o"er

A=00 billion to Ireland% ortugal% and 7reece after those countries made formal re?uests for

much needed assistance

 

• In the autumn of 20=2% the member states of the Eurozone created an additional

fund called the European *tability !echanism E*!1 $he E*! lent nearly A,0 billion to *pain

and 4yprus to backstop their banking crises by recapitalizing their banks

 

• erhaps e"en more significant% earlier in the summer of 20=2 !ario )raghi% the

president of the European 4entral 5ank% pledged to do ;whate"er it takes to preser"e the

euro; $his was a "ery strong commitment on the behalf of the E45 to use the full force of 

monetary policy to sa"e the Eurozone

 

• 5y 20=B se"eral Eurozone economies recei"ed "arious forms of bailouts from the

troika I!(% E45 and E.19 among them on top of 7reece were ortugal% Ireland% 4yprus and

*pain

&s a conse?uence of these inter"entions and 5and3&ids% the Eurozone has sur"i"ed — but

now% as we enter 20=,% the Eurozone has a host of economic problems that emergency

stopgap measures simply cannot fi+

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C In this map% please note the differences between the members of the E. that are in the

Eurozone% which is the currency union for which the euro is the official currency% and

members of the European .nion% like $he .nited Dingdom and *weden% which participate in

an economic free trade zone

Source: s"iegel.#e

The Eurozone: A Brief Timeline of the Troubles

*o what% e+actly% is happening inside the Eurozone now $he problems of the Eurozone are%

of course% comple+% but for the sake of bre"ity let#s take a look at a few of the most

disturbing facts that seem to highlight the key difficulties that now e+ist there9

• $he o"erall inflation rate in the Eurozone now stands at 0BF — which demonstrates

insufficient demand for goods and ser"ices G and now the EH is at risk of outright deflation

 

• $he o"erall rate of unemployment in the Eurozone is ==,F

 

• 'hile ==,F unemployment is shockingly high by &merican standards% it doesn#t

really gi"e you a true sense of just how bad the problem is in the so3called I7* nations

ortugal% Italy% 7reece% *pain1 of Europe In 7reece *pain% for e+ample% the

unemployment rate is 2,F@ e"en more disturbing% though% the rate of youth unemployment

in both of those countries is about ,0F% which gi"es you some sense of the le"el of 

desperation and hopelessness among young people there

 

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• In Italy% the rate of youth unemployment is abo"e B0F Italy#s output is 8F below

pre3crisis le"els% but industrial production has collapsed 2,F In Italy% this is not just

economic stagnation — it#s industrial depression

In fact% it would be fair to say that the Eurozone is just one shock away from outright

deflation — a nightmarish state of affairs where a sustained lack of demand and economic

growth causes prices to fall

*ome people say Europe is going to get #apanified# — a reference to apan#s dismal

economic performance o"er the last twenty years% which is sometimes referred to as #$he

>ost $wo )ecades#

5ut% in fact% the risks in Europe are e"en worse 'hile the apanese ha"e stagnated% apan

has not suffered the sort of debt crisis thats affected the Eurozone $his is because% unlike

the Eurozone% the 5ank of apan has the fle+ibility and willingness to monetize debt and print

money It#s much easier for a national% independent central bank to act to bail out one

country than for (rankfurt to attempt to bail out the di"ergent economies of the Eurozone%

where there is no easy one3size3fits3all monetary policy solution to sa"e the day

Jather than get lost in the wonky math of the Eurozone% as macroeconomists so often do% Id

like to tell you about the challenges the Eurozone faces in a slightly more interesting way9 5y

comparing it to a familiar organization of states—the .nited *tates of &merica

The Eurozone & The UnitedStates

1) Rise of Extreme Political Parties

*KJIH& rally hoto by *KL (lickr

Source: li$%s.org.au

If the 20th 4entury has taught us anything% its that difficult economic times often lend

themsel"es to political radicalism 5oth the left and right seized this opportunity last century

and wreaked ha"oc $he 5olshe"iks rose to power after the Jussian empire collapsed

following economic decline and ''I Enthusiasm for the Lational *ocialists in 7ermany

followed a prolonged and intense period of deflation and depression

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*e"enty3fi"e years later% we would be wise to worry if it might happen again &mong the

most troubling concerns on the horizon for the Eurozone is the rise of Eurosceptic e+tremist

parties !ost of these parties tend to come from the political right% but there are e+amples

on the left as well% such as odemos in *pain or—more worrisomely—*yriza in 7reece% a

well3organized left coalition that is leading in polls and poised to win a majority in the

upcoming election late in anuary

!arine >a ens Lational (ront party in (rance is a perfect e+ample of how such e+treme

national mo"ements must be taken seriously (or decades% the Lational (ront was merely a

nuisance% a hotbed for rightwing cranks and malcontents *uddenly% in 20=M% the Lational

(ront won a significant number of mayoralties% and their national numbers continue to grow

In fact% if presidential elections in (rance% which are scheduled for 20=N% were held today%

current polls show that the Lational (ront would win the first round1 $hey#re no longer fringe

—theyre now players in a "ery dangerous game 5ut% just as we saw in the =OB0s%

stagnation and insecurity breed resentment 'hen hard times hit% the public looks for

someone to blame9 foreigners% globalization% or budget cuts from 5russels

E"en in Italy populist anti3Euro parties of the right and left could beat moderate centristparties of the right and left if the current prime minister Jenzi fails in his reform dri"e

'e should not underestimate the potential power of these mo"ements $he .nited *tates is

not free of such disgruntlement% of course% but the $ea arty in the .* is now more of a

nuisance and a political sideshow than a threat

In short% Europe has a "ery different kind of history — one it ought to take seriously

) Euro!e"s A#in# Po!ulation

Lot long ago ared )iamond popularized the phrase -geography is fate/ I would pair aphrase of my own beside this wise remark9 demographics are fate too

Source: &e%$o&$e'.co!

Cre#i: Socie( for Hu!a$ Resource )a$age!e$ *SHR)+

&ccording to a recent article in the Economist% in the ne+t fifty years the working3age

population of Europe will drop considerably% from last years peak of about B00 million to 26,

million $his will be a significant blow to nearly e"ery aspect of the Eurozone economy

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&t the same time% the old3age dependency ratio33a fraction or percentage e+pressing the

ratio of residents o"er the age of 6, to those under that age33will rise from 28F recorded

earlier this decade1 to a staggering ,8F by 2060

$his situation is% in a word% unsustainable

$he causes of this challenge are in Europe are manifold9 declining fertility% ad"ances in old3

age care% the residue of baby3boom demographics 5ut the impact will be serious

$he .nited *tates has managed to combat many of those challenges of an aging population

through immigration In the .*% Immigrants now make up more than =BF of the total

population In 20=B% the number of immigrants li"ing in the .nited *tates% both legally and

illegally% topped M0 million

Immigration may help to mitigate Europe#s aging challenge% as it has in the .nited *tates —

and then again it may not Immigration is a contro"ersial topic in Europe — and it is one of 

the many issues that e+tremist parties in the Eurozone ha"e seized upon to attempt to lend

themsel"es legitimacy within their own cultures (oreigners% after all% ha"e always madeeasy targets for e+tremist political parties seeking to scapegoat others for their domestic

economic woes in times of high unemployment

$) Susce!tibilit% to External Shocs

Pne of the reasons the Eurozone is more fragile than the .nited *tates is pure geography

&merica is surrounded by huge oceans% with relati"ely stable and like3minded countries to

the north and south Europe% on the other hand% is only a peninsula off the much larger and

much less stable continent of Eurasia

&nd &frica and the !iddle East are right there too% a short skip across the !editerranean$housands of refugees drown in that sea trying to reach Europe each year ope (rancis

recently made reference to this tragedy when he described the continent as a -"ast

gra"eyard/ 

$he aging population of Europe grows resentful of the influ+ &nd because of a wide "ariety

of social and historic reasons% Europe does not function as a melting pot% the way &merica% at

its best% can do 'e see this dri"e toward assimilation in resident Pbamas recent e+ecuti"e

action% remo"ing penalties for undocumented residents who aim to attain citizenship1

'hereas 7ermany% by contrast% contains plenty of $urks who ha"e li"ed in that country for

fifty years and still cannot apply for a 7erman passport $hey dont feel like citizens $hey

cant own a part of the dream

Europe still has not finished the task of absorbing the former Iron 4urtain countries of 

4entral and Eastern Europe within the E. roblems there still persist—as recent e"ents

in"ol"ing !r utin ha"e made clear

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Source: russia,easer$,re"ublic.co!

Eurasia is not an easy neighborhood in which to li"e &nd because Europe cannot make

centralized decisions to the same e+tent that a country like the .nited *tates can%

coordinating responses to these periodic crises is always a struggle

') (abor obilit% & *a!ital obilit%

$here is less labor mobility in the Eurozone than in the .nited *tates% since cultural barriers

e+ist between nations with thousands of years of independent history In the .*% workers

may flee a recession in Lorth 4arolina to seek work in the Lorthern cities If theres a bad

shock in !ichigan% people can pack up and mo"e to Lew Kork $he borders are open between

.* states and the language is the same 5enefits are often portable 'hereas in the

Eurozone% a number of obstacles pre"ent this

'hile there are mechanisms to allow for free mo"ement between Eurozone countries% such

as the establishment of the *chengen &rea% which allows people to tra"el without passports

between 26 European nations% the Eurozone still has a number of constraints that aren#t

present in the .* which make mo"ement more difficult $he Eurozone is a motley collection

of competing languages% cultures% and legal restrictions In conse?uence% Europe lacks the

crucial shock absorber of a truly open labor market

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Source: !erisaio$.co!

*ince the time of &le+ander :amilton% the .nited *tates has had an integrated% federalized

banking system which allows for the free flow of capital $his ad"antage has made the .* a

good deal more nimble and resilient than the Eurozone 'hile capital mobility e+ists in the

Eurozone% there is not enough of it In"esting abroad in other Eurozone countries means

na"igating different ta+ systems% legal systems% often in different languages and cultures &s

a .* citizen% if you li"e in 4onnecticut and want to buy stock in a 4alifornia tech company%

you don#t e"en need to think about it Kou don#t ha"e to call a different broker Kou simply

buy the stock $he absence of free mo"ement of capital% in fact% is entirely alien to the

&merican way of thinking

+) As%mmetric Ad,ustment&symmetric adjustment is a wonky phrase but its fairly straightforward to understand

5asically% what it means is that there is an asymmetry between creditors and lenders%

borrowers and debtors when it comes time to adjust to economic shocks to the economy

In the Eurozone% this means that countries that tend to spend too much for e+ample%

7reece and Italy1 and those that tend to sa"e too much for e+ample% 7ermany and $he

Letherlands1 both get hurt when the flow of money ceases

'hen a shock to the economy arri"es% the lending tends to dry up In this scenario% debtor

countries are forced to spend less — but nothing forces the lending countries to adjust and

sa"e less $his is what is meant by the phrase #asymmetric adjustment

(or both sides% though% an unstable e?uilibrium is thrown out of balance $he so3called I7*

countries bristle against austerity% while the core countries% on the other hand% are left in the

position of someone playing tug3of3war when the other side suddenly drops the rope

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Source: !arias-rier.co!

In the .*% such a scenario could ne"er arise 'e are one unified economy It#s difficult to

e"en draw the same metaphor Lew Kork may lend more money that 'est Qirginia% as we

know% but both are states are parts of the same union

-) .reat Recession Res!onse

&fter the banking crisis of 2008% the .nited *tates did three crucial things that were re?uired

to fi+ the economy right

Ban Reca!italization

(irst% $he .nited *tates took the bull by the horns and recapitalized the banking system $he

.* $reasury department committed trillions of dollars to support .* banks and other

financial institutions% such as in"estment banks% money market funds and credit unions

'hile trillions of dollars were pledged to help the banks% far less capital was actually

committed% and the go"ernment has collected billions of dollars in di"idends and fees for

their in"estment1

Pnce go"ernment capital was injected into .* banks% those banks could continue lending —

as opposed to selling assets% dele"eraging% or contracting credit In addition% the (ederal

Jeser"e in the .* forced banks to engage in stress tests to determine their sol"ency (i"e

years down the line% the E45 e"entually performed similar stress tests

5ut e"en after the stress tests% European banks don#t ha"e ade?uate capital% which means

that if the banks need to shore themsel"es up% they are going to start retrenching and

contracting credit — which risks further damage to the Eurozone economy

onetar% Polic%

*econd% the .* did aggressi"e monetary and ?uantitati"e easing% while the E45 is now still

thinking about doing ?uantitati"e easing I#"e /ritten before in Joubini#s Edge about how

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monetary policy can help soften the blow of recessions and economic slowdowns but here I#d

like to just focus on the big picture 5y ?uadrupling the size of the money supply from its

pre3recession le"els% the (ed freed up desperately needed credit and helped keep the .*

economy from crashing into a full3blown depression

$he !arriner * Eccles (ederal Jeser"e 5oard 5uilding in 'ashington% )4

Source: blogs,i!ages.forbes.co!

Bac0(oaded iscal *onsolidation

$hird% the .* back3loaded its fiscal consolidation% meaning it postponed measures aimed at

balancing its fiscal budget $his is because% in the short run% raising ta+es and cutting

spending reduce disposable income and therefore reduce consumption1 In the Eurozone%

howe"er% the decision was made to front3load fiscal consolidation% which put additional

pressure on their already beleaguered economies $his front3loading% which amounted toimposing budgetary austerity% reduced the total demand in the economy — the last thing the

countries of the Eurozone needed at the time of a serious recession

2) The Eurozone isn"t a iscal Union

*eat of the European arliament in *trasbourg% (rance

Source: e$ar.#% Pne of the key challenges to the Eurozone is a lack of fiscal union & fiscal union is

something &mericans take for granted and rarely think about In the .*% when there is a

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shock to the output of one of our fifty states% fiscal transfers from the rest of the union help

to cushion the blow &s an e+ample% let#s say there is a negati"e shock to the economy of 

$e+as% perhaps due to a fall in oil prices Economic output in $e+as would fall 5ut for e"ery

dollar in lost output% the fall in income in $e+as isn#t a dollar but only about 6036, cents

5ecause when there are bad times in $e+as the federal go"ernment transfers economic

assistance there — on the premise that when there are bad times somewhere else% booming

oil prices in $e+as might help out another state in the union It#s a kind of risk pooling and

insurance In the scenario we#"e been discussing% $e+ans who were laid off from their jobs

would be eligible for unemployment benefits $hose same unemployed $e+ans might also be

eligible for federal welfare benefits &lso% when the earnings of $e+ans decrease due to bad

economic times they would automatically pay less federal income ta+ 4on"ersely% when

$e+ans are doing well% their federal ta+es automatically rise $his ser"es as a kind of 

automatic stabilizer for the economy (inally% the federal go"ernment can decide to cushion

an economic shock to $e+as by spending more money on $e+an infrastructure or by funding

federal projects at% say% the ohnson *pace 4enter in :ouston

In the .* those shock absorbers at the federal le"el are considerable% since the federalgo"ernment accounts for 2,F to B0F of our 7) In Europe% where the E. go"ernment only

accounts for =F of 7)% there simply isn#t capacity for it to lend substanti"e assistance when

countries are in trouble *o what winds up happening in the Eurozone is that when you ha"e

a R= shock to the 7) of one country% that country#s income goes down% effecti"ely% by R=

.nless there is a full fiscal union in the Eurozone — on spending% ta+ation% and e"en common

debt issuance —the funds that the central go"ernment will ha"e to assist countries in trouble

will remain just spare change Pf course there are many reasons why citizens of some

countries in the Eurozone don#t want a fiscal union% which is a topic I will take up in the ne+t

section

3) Banin# Union: The Eurozone"s Stumblin# Bloc

In the .nited *tates% we take for granted that e"ery state in the union has banks that are

insured by the ()I4 In Europe% howe"er% 7erman deposit insurance pays only for 7erman

banks% and Italian deposit insurance pays only for Italian banks

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*eat of the European 4entral 5ank in (rankfurt% 7ermany

Source: Bloo!berg

In the .*% on the other hand% when a bank goes bankrupt in 4alifornia% we use the same

pool of money to fi+ the problem as we would for a bank that goes bust in Lew Kork

(urthermore% in the .nited *tates% we ha"e a banking system where the (ederal Jeser"e% atthe central le"el% not at the state le"el% decides which banks are in trouble and need

assistance% or in the worst case% re?uire resolution

& banking union% in fact% is an important kind of risk sharing — a kind of subset of a fiscal

union

'hat concerns the 7ermans about a fiscal union — or% for that matter% a banking union — is

that it pledges 7erman citizens to support peripheral Eurozone economies and banks that are

at risk of outright collapse $he fear in 7ermany is that risk3sharing will become risk3shifting

— and that a fiscal union will become a transfer union

In short% 7ermany% and other core Eurozone nations like $he Letherlands% don#t want to get

stuck in a transfer union where they might be forced to subsidize ortugal and Italy and

7reece and *pain fore"er (iscal unions and banking unions only work when shocks occur

randomly Pne day I ha"e bad luck in $e+as@ the ne+t day you ha"e bad luck in Lew Kork

*ometimes I help you out@ other times% you help me1 If the economies within a fiscal union

are not balanced — it#s not a two3sided risk3sharing alliance but% rather% a risk3shifting

scheme where one side passes money to the other fore"er

$hat is why the 7ermans% among other core European nations% ha"e been saying% in essence%

unless the I7* countries do reform in the form of fiscal austerity% structural reform% boost

their growth% and make progress on a"oiding future debt crises% were not going to sign on

to a fiscal union or a banking union that may become an economic suicide pact

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4) Political Union 5 And 6emocratic (e#itimac% in theEurozone

4ourt of ustice% >u+emburg

Source: s%($rg.co!

'hile &mericans are accustomed to political s?uabbling — such as the commentary we hear

from talking heads e"ery presidential election about Jed *tates and 5lue *tates — the

fundamental democratic legitimacy of &merican politics is rarely ?uestioned by those within

the political mainstream in the .nited *tates

*upranational unions like the Eurozone — at the "ery core — are about transferring national

so"ereignty to the center

In the case of the Eurozone% decisions that were once made at the national le"el get made at

the supranational le"el 'hat was once decided by national legislatures of countries gets

decided at the European arliament in *trasbourg% (rance% while the e+ecuti"e powers of the

E. are in 5russels within the European 4ommission )ecisions that were formerly handed

down by national supreme courts get judged at $he European 4ourt of ustice in

>u+embourg &nd monetary policy that was e+ecuted by national central banks gets made by

the E45 in (rankfurt% 7ermany

'hat impact does this ha"e on the political legitimacy of democracies

If you are transferring national so"ereignty from the nation state toward super3national

authority% then you need a political union where those decisions being made at the super3

national le"el are done in a democratic way Ptherwise% there are great challenges9 (or

e+ample the E. tells you that your country#s budget is not acceptable and needs to be cut% or

the E45 informs you that se"eral of your national banks need to be shut down

)ecisions on budgets and bank super"ision ha"e already mo"ed away from national capitals

to the central authority — but the risk sharing component of fiscal and economic union ne"er

arri"ed Kou might say that countries like 7reece ha"e lost their so"ereignty on super"ision

and regulation without truly recei"ing the benefits of solidarity% ie risk3sharing

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5ureaucrats that were ne"er elected by 7reek citizens ha"e begun making decisions that

most 7reeks would prefer to be made democratically in &thens% and many ha"e already

begun to blame their woes on the E. and the E45 and the Eurozone

$he issue% of course% brings us back to where we began our list9 $he rise of e+tremist

political parties within the Eurozone

5eyond 7reece — in *pain and Italy and (rance and $he Letherlands — populist parties on

the right and the left are rising &nd their rage is being channeled toward many of the same

targets that e+tremist politics railed against during $he 7reat )epression9 &gainst

globalization% against immigration% against reform% against austerity $hey are saying%

;Enough is enough; *o far% they ha"e not come to power 5ut after fi"e years of recession%

low growth% high unemployment% little job creation% little income creation% more and more

people ha"e begun to say% ;Enough is enough;

&s their "oices grow louder% and the political legitimacy of the Eurozone is ?uestioned in more

places% those with a keen sense of history begin to worry about the causes that made

Europeans feel powerless within the political order of the =OB0s— economic depression%stock market shocks% the wrong monetary and fiscal policies leading to deflation — that led

to Europe falling into the clutches of authoritarian regimes and culminating in the *econd

'orld 'ar

The uture of the Eurozone

Source: T-e Telegra"-

&s 20=M drew to a close% I started thinking about all the things I#"e written about the

Eurozone o"er the last decade Pne of the more pro"ocati"e ways of summing up the

challenges that the Eurozone faces would be to say that in this world% economies can grow

either because they ha"e lots of young people willing to work long hard hours% or growbecause people are creati"e and inno"ate

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5arring a few e+ceptions% these are% essentially% the two different paths economies can take

to growth &sia% broadly speaking% has taken the path of working "ery hard $hough

&mericans work ?uite hard% they dont work as many hours as their counterparts in &sia do1

5ut% in many key ways% &mericans continue to lead the world in inno"ation and technological

ad"ances

Europe% at this moment in history% is -the worst of both worlds/ in this respect >eisure and

"acation time are of paramount importance to Europeans% but there is a dearth of inno"ation

to make up for those losses in producti"ity Pnly isolated elements in core Eurozone nations

follow &merican3style work patterns1 'hat Europe does ha"e—and what continues to dri"e

the major engine of European tourism—is high culture Jich 4hinese and Indian "acationers

flock there to soak up churches and concerts and ruins

If Europe wants to a"oid becoming the (lorida of the world—a peninsula full of "acationers

and retirees—then it must urgently consider radical reforms &ll of the nine points noted

abo"e are worthy of serious action by policymakers &nd all should be in the minds of 

in"estors considering taking a risk on the Eurozone and its future

4ordially%

7ouriel Roubini

4hairman

Roubi$is E#ge