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Interesting Articles, Editorials, Opinions & Blogs from across the world.

Grexit = End of Euro ?

posted Feb 17, 2015, 7:05 AM by Mikin Shah   [ updated Feb 17, 2015, 7:09 AM ]

The acrimonious breakdown of talks last night between Greece and other eurozone governments on a new financial and economic settlement for the debt-burdened country isn't just another swerve in the longest game of chicken in financial history.

It crystallises for the first time how much is at stake for Berlin and other eurozone governments, in the nature of what led to this latest impasse.

Because the fact that Berlin, Madrid, Lisbon, Dublin and the rest are insistent that Greece must agree to an extension of the current bailout, and its terms (however flexibly interpreted), goes to the heart of the matter.

For Germany et al the long-term success of the euro depends on the perception that its rules, and the applications of its rules, apply to all, in all circumstances.

If they create an exception for Greece, they fear they may find themselves obliged by politics and justice to revisit the austerity and hardship forced on Ireland, Portugal, Spain and Cyprus.

The euro would look like a hastily cobbled together monetary pact driven from pillar to post by economic expediency, with no reliable underlying governance structure.

Or at least so they worry.

And that would be the road to endemic economic and financial instability.

But there may be an even worse outcome for them from this impasse - which is that Greece could leave the euro.

That arguably would be an even more severe existential threat to the euro than bending the fiscal and financing rules for Greece.

Because in theory the euro is forever. That is what all the law associated with it says.

And once it is not forever for Greece, it is not forever for any nation, even Germany.

Whether Berlin likes it or not, the moment Greece leaves, those who control the world's huge pools of liquidity or cash will start placing bets on the next country to head for the exit.

Once that happens, eurozone fragmentation is almost impossible to reverse: the vast and widening gulf in access to global capital between vulnerable and stronger eurozone economies would reinforce their diverging economic performances.

Gamble

As the rich north became ever richer relative to the over-indebted south, a more devastating eurozone breakup would become almost inevitable.

So, it is the big gamble of Greece and its finance minister Yanis Varoufakis that its exit will ultimately be seen by Berlin as the bigger existential threat.

To be clear Greek exit is also an existential threat for the Syriza government, given that most Greeks say they want to keep the euro.

But Syriza can be confident Greece would endure if Greece leaves the euro, although the country would be considerably poorer for a while.

By contrast, Berlin, Paris and the rest simply cannot be confident the euro will be for all time if Greece is either bundled out the exit door or chooses to walk through it.

Because it would demonstrate that the euro had failed in its core underlying purpose, which was to bind its members ever closer together, economically, financially and - perhaps critically - in a political sense too.


The Problem with B-School Placements

posted Feb 2, 2015, 8:24 PM by Mikin Shah

An interesting article by Indrajit Gupta (Business Standard) :

If newspaper headlines are anything to go by, the silly season is already upon us. Every year, come January, smartly togged-out business-school students prepare for the most important period in their campus life: placements. Students compete with each other to land plum jobs. Business schools trumpet their achievement, either by way of a 100 per cent placement record and/or the fact that they did so in a record time of two-three days. The media has a field day, too, going to town about how soaring dollar salaries on campuses are now the new normal.

This annual tamasha masks a dirty little secret that no one is willing to address. I recently heard about the results of a survey done by a premier management school in the country. The school's director of placements studied the alumni job data on LinkedIn for nearly two decades and followed it up with a survey of the more recent batches of students to understand their career path after graduation. And that recent survey data threw up a worrisome spectre: most students who landed a job during campus placements had a shockingly low tenure. Among these recent batches, nearly 70 per cent of students were apparently disillusioned with their jobs and exited their organisations in less than nine months to a year.

So what lies at the root of this phenomenon? These days, a large majority of students who choose to study management end up taking on large student loans to fund their education. A few of them would much rather skip placements and start new enterprises on their own. But more often than not, they realise that they need to pay back the loan. And taking on a job is the only recourse, if they are to escape a debt trap. But within months of joining, they realise that this job wasn't what they had bargained for. And then they end up looking for a new one, in the hope that it would provide them release from the drudgery of their current job.

Then there is a lack of proper career counselling. A large majority of students come into business school without any prior work experience whatsoever. Business schools are in a tearing hurry to fill seats and don't seem to care about the profile. At placement time, herd mentality takes over. The same survey found that most students depended a lot on their seniors for advice. And they would often be asked to pick a marquee company, because it was a "prestigious job" to have. They would often land the job because they were exceedingly bright. But no one bothered to look at whether that job was the best fit for them. The soul searching would begin, as the data show, invariably within a year of joining this "dream" job.

If that wasn't bad enough, business schools make it even worse by reducing choice, in a bid to shore up a 100 per cent placement record. So they design pernicious rules that punish students keen to explore options and look for the best fit, and reward those inclined to take the first job on hand. And that's a direct fallout of the infantile system of business-school rankings. Most business-school rankings conducted by various media organisations don't ask for data on the "fit", or even "tenure". If they did, the current system of ranking would perhaps turn upside down.

Our business schools aren't inclined to change the system. Instead, they'd rather go along and game the system. This is compounded by the fact that recruiters, too, are inclined to look largely for academic excellence, even if that has sometimes very little to do with performance on the job or the basic issue of fitment. After all, human resources departments get measured by whether they were able to attract the cream of the batch across the premier business schools.

The media, too, must share a large part of the blame. The screaming headlines that focus on top drawer salaries accentuate the herd mentality on campuses. And by focusing on the dubious 100 per cent placement record at various B-schools, they merely perpetuate a system that's clearly broken, and with no one willing to fix it.

Last week, I got an intriguing email from a young girl graduating from one of the Indian Institutes of Management. She was looking for a possible career in the media and entertainment industry. But none of the media companies had come to her campus. She either didn't push the placement cell for greater choice or was never asked. In the thick of placement, she suddenly realised that while her high grades would get her a coveted job in a consumer-goods company, her heart lay in a more creative role in the media and entertainment industry. She came across my LinkedIn profile and reached out for help. After speaking to her on the phone, I connected her to various heads of media organisations and nearly all of them responded saying they would set up interviews with her.

I don't know if she eventually landed her dream job in the media, but here's the moot point: isn't it time we end this charade, dare to be different and allow our young people to follow their hearts? And there's a sensible way to start this clean-up: let's begin by measuring the "right" set of metrics. For one, recruiters would do well to plan competency-based interviews and on their part, placement committees need to focus on competency-matching, instead of an age-old "mine the experience and hope for the best". Or else, this systemic failure will only worsen.

What is Quantitative Easing (QE) ?

posted Jan 26, 2015, 11:33 PM by Mikin Shah

AMERICA'S Federal Reserve surprised markets in December by starting to "taper" (ie, gradually reduce) its programme of monthly purchases of government and mortgage bonds—a process known as "quantitative easing", or QE—from $85 billion a month to $75 billion. Some worry that scaling back QE could endanger America's recovery or create financial instability in emerging markets. Meanwhile, expectations are rising that the European Central Bank may soon launch its own QE programme to boost the euro-area economy, where high unemployment is contributing to deflation. But what exactly is quantitative easing, and how is it supposed to work?

Central banks are responsible for keeping inflation in check. Before the financial crisis of 2008-09 they managed that by adjusting the interest rate at which banks borrow overnight. If firms were growing nervous about the future and scaling back on investment, the central bank would reduce the overnight rate. That would reduce banks' funding costs and encourage them to make more loans, keeping the economy from falling into recession. By contrast, if credit and spending were getting out of hand and inflation was rising then the central bank would raise the interest rate. When the crisis struck, big central banks like the Fed and the Bank of England slashed their overnight interest-rates to boost the economy. But even cutting the rate as far as it could go, to almost zero, failed to spark recovery. Central banks therefore began experimenting with other tools to encourage banks to pump money into the economy. One of them was QE.

To carry out QE central banks create money by buying securities, such as government bonds, from banks, with electronic cash that did not exist before. The new money swells the size of bank reserves in the economy by the quantity of assets purchased—hence "quantitative" easing. Like lowering interest rates, QE is supposed to stimulate the economy by encouraging banks to make more loans. The idea is that banks take the new money and buy assets to replace the ones they have sold to the central bank. That raises stock prices and lowers interest rates, which in turn boosts investment. Today, interest rates on everything from government bonds to mortgages to corporate debt are probably lower than they would have been without QE. If QE convinces markets that the central bank is serious about fighting deflation or high unemployment, then it can also boost economic activity by raising confidence. Several rounds of QE in America have increased the size of the Federal Reserve's balance sheet—the value of the assets it holds—from less than $1 trillion in 2007 to more than $4 trillion now.

The jury is still out on QE, however. Studies suggest that it did raise economic activity a bit. But some worry that the flood of cash has encouraged reckless financial behaviour and directed a firehose of money to emerging economies that cannot manage the cash. Others fear that when central banks sell the assets they have accumulated, interest rates will soar, choking off the recovery. Last spring, when the Fed first mooted the idea of tapering, interest rates around the world jumped and markets wobbled. Still others doubt that central banks have the capacity to keep inflation in check if the money they have created begins circulating more rapidly. Central bankers have been more cautious in using QE than they would have been in cutting interest rates, which could partly explain some countries' slow recoveries. At least a few central banks are now experimenting with stimulus alternatives, such as promises to keep overnight interest-rates low for a very long time, the better to scale back their dependence on QE.

A K Bhattacharya: Chasing the growth dream

posted Jan 21, 2015, 11:30 PM by Mikin Shah   [ updated Jan 21, 2015, 11:44 PM ]

What should be the average annual economic growth rate of an economy if its size in terms of its gross domestic product or GDP has to rise from $2 trillion to $20 trillion? And how long will it take to raise its GDP size 10 times? These are not irrelevant questions. Addressing a recent business summit organised by The Economic Times, Prime Minister Narendra Modi shared with the audience his dream of growing India's GDP size from $2 trillion to $20 trillion. Similar aspirations were echoed later at the same forum by the railways minister, Suresh Prabhu.Leaders must dream. That is necessary and also their legitimate entitlement. But dreams alone are not enough. Dreams must be accompanied with a reality check on what they actually imply. For the $20 trillion dream to be realised, it is important, therefore, to understand the pace of growth that would be needed and for how long that pace has to be sustained. A simple arithmetical calculation shows that India's GDP could grow to $20 trillion if the average annual economic growth for the next 25 years is maintained at 9.65 per cent. The Indian economy has grown at a rate higher than nine per cent only in about a few years in the past. And it is wellnigh impossible for any country to manage a sustained nine per cent plus growth rate consistently for 25 long years. While it may, therefore, be logical to assume that India could theoretically grow its GDP to over $20 trillion, but it must also be acknowledged that achieving that goal would take much longer than 25 years. The bigger the economy gets, the feasible growth rate targets will have to necessarily come down. That is what happened to all economies when they exceeded a certain size. Look at what happened to the US and 
Japan and what is happening to China now. India will be no exception. Recognition of such growth limitations is as important as dreaming big or planning for achieving an annual 10 per cent growth rate target. Indeed, it is important for leaders of the government to understand
that growth does not happen in isolation. The global economy, a country's inherent potential, the domestic policy environment and its relative strengths and weaknesses are important elements in growth calculations. Equally important is the need to get a sense of what a feasible rate of growth for a country should be in the context of the reality that prevails. In the Indian context, a relevant question would be: Is a five per cent growth rate now similar to a nine per cent growth rate achieved before the global financial turmoil of 2008? In the hey days of high growth for India between 2005 and 2007, when the economy was clocking an annual growth rate of over nine per cent, most analysts would use the global economic environment to place the India growth story in perspective. The argument then was that in a high tide all boats in the sea are lifted. India's growth momentum was thus attributed to some extent to the global economic boom and the liquidity surge. According to some estimates, at least one or two percentage points in India's overall growth were certainly due to the buoyant global economic factors. For instance, while the global economy grew by five or a little more than five per cent in the years between 2005 and 2007, the Indian economy too clocked over nine per cent growth in each of those three years. India was then seen to be benefiting from the global economic upturn.

The question policy makers should now pose is whether the same argument should hold now as the world economy is once again in turmoil. Barring the United States, most emerging economies, Europe, Japan and other developed countries are experiencing a significant slowing of economic growth. According to some estimates, global growth will be capped at two per cent, although the International Monetary Fund is still a little bullish about the world GDP output projecting it to grow by around 3.8 per cent in 2015. But an overall slowdown seems inevitable.
In such a situation, a growth rate of five or six per cent for the Indian economy could well appear no less impressive than its performance in the 2005-07 period. After all, clocking a growth rate of 5-6 per cent without a global tide of good performance should be equivalent to a performance of nine per cent GDP growth when the global economy was firing on all cylinders. Shouldn't India's growth performance in a situation of low global tide get some credit just as the high global tide in the 2005-07 period had taken the gloss off the Indian economy's nine per cent plus growth performance. In any case, India's dreamers of double digit growth should now pause and recognise that the current performance of 5-6 per cent growth is not to be dismissed lightly because the global economic scenario is not too bright. Additionally, even this performance will be creditable because it is being achieved against all kinds of odds a more stringent land acquisition law even after the latest round of amendments and a more rigorous enforcement of environment protection rules. Instead of moaning over what they mistakenly consider tepid and disappointing, they should appreciate and even celebrate India's current
growth performance in spite of the adverse global headwinds. Dreaming double digit growth or a $20trillion economy must be rooted in a realistic assessment of the state of the economy both in the country and abroad.

Foreign institutional investors will not bail out Indian markets in 2015

posted Jan 9, 2015, 12:08 AM by Mikin Shah

An article from Business Standard about the outlook of Indian Equity Markets for 2015.

The emerging markets (EMs) equity asset class has had another difficult year in 2014. Having declined by 1.82 per cent (gross returns in dollars), EM equities have once again underperformed the MSCI ACWI (All Country World Index), which rose by 4.71 per cent in 2014. This is the third year of the last four (the only exception was 2012) in which EM equities have underperformed the world equity index. Over the last three years, the EM index has risen by 4.41 per cent annualised compared with 14.72 per cent for the world index (all in dollars), and even over five years the performance for EM equities is only 2.11 per cent annualised compared with 9.74 per cent for global stocks. Looking at data stretching back to mid-1994, EM equities have delivered returns of 5.85 per cent annualised compared with 7.26 per cent for global. The underperformance seems to be persistent.

Unfortunately, despite the poor recent performance of EM stocks, there seems little respite in sight even in 2015. Given the view that we are in an environment with a strong dollar and weak commodities, it seems difficult for EM equities to do well even in 2015. EM stocks have underperformed two-thirds of the time when the dollar trade-weighted index has appreciated. A strong dollar is one of the clearest calls for 2015, and will be a huge headwind for EM stock performance. Balance sheet leverage in dollars among EM companies has surged, and may be the Achilles heel of the asset class as currency mismatches destroy balance sheets. Many smart macro funds think that we are only about half-way through the dollar-strengthening trade, ensuring continued pressure on EM stocks for the foreseeable future.

EM equities have also traded very much in sync with global commodities. If one were to plot GEM (global emerging markets) relative performance to MSCI World versus Commodity Research Bureau industrial commodity prices, they move almost in lockstep. The GEM relative performance has also very closely tracked the relative performance of the mining sector. Given that commodity prices are in deep stress - akin to a bubble bursting - with the commodity super-cycle almost surely over, this also does not bode well for EM equity performance.

The GEMs also now seem to have become more rate-sensitive than cycle-sensitive. EM equities used to move in line with the performance of cyclicals versus defensives - doing well whenever cyclicals had the upper hand. In the last two years, this has changed and EM equities seem more sensitive to rates than gross domestic product. If 2015 does turn out to be the year when the United States Federal Reserve finally hikes and begins to normalise rates, that once again could pose a challenge for EM equities.

Even on a valuation basis, once one adjusts for sectoral composition, EM equities are not as cheap as the high-level numbers seem to show. EM stocks are trading at only a three-per-cent premium to their long-term average vis-à-vis developed world equities on sector-adjusted price-earning multiples (according to Credit Suisse). This is because almost all that is cheap in the EMs is China, Russia and Korea along with the banks and resources companies. It is tough to make the argument that the EM asset class is so cheap that there is no more relative downside left. Nor are funds significantly underweight on EMs.

Given that India is a consensus and large overweight for most GEM and regional managers, unless the EM asset class does well and gets large inflows, it is difficult to see where new EM money for India will come from. We received large inflows in the last three years despite weak EM performance as India moved from a consensus underweight to a large overweight for most EM and regional money managers. This shift in relative weights is done, and we received a disproportionate share of EM inflows while it was ongoing. There is really no scope for a further rise in the India overweight among these managers.

If EM equities continue to do poorly, and we see outflows from the asset class, given relative overweight and strong performance, India is bound to be a source of funds in any redemption-linked fund raise. Flows into India from here onwards are almost entirely linked to flows into the EM asset class, the short-term prospects for which do not look good. India has now started attracting global money independent of the EM pool, and while these flows de-risk our EM dependence, they will take time to pick up speed.

I make these comments because there seems to be an implicit assumption among market participants that India is on the verge of getting huge equity inflows from foreign institutional investors (FIIs). I have heard figures of $25 billion-$30 billion being casually discussed. Time for a reality check. Even in 2014, with the positive shock of the elections and the oil price collapse, we received about $16 billion compared with more than $20 billion in 2013. The equity flows in 2015 will most likely be lower still.

Market players have to stop being obsessed about FIIs and start tracking domestic equity flows, for that is where the incremental capital will come from. 2015 may mark an important transition wherein domestic flows become larger and more relevant than global flows. After three years of selling $10 billion of equity every year, local investors can and need to buy $12 billion-$15 billion a year.

This transition to domestic flows is critical as the need for equity capital in India is very large. There are three large buckets of equity issuers: the government divestment programme (at least $10 billion a year), public sector banks (another $5 billion-$10 billion a year) and the need for balance sheet repair among corporate India (about $5 billion-$10 billion again). This is without even considering the needs for the infrastructure public-private-partnership programme and growth capital.

Without a surge in domestic savings into financial assets, especially equities, these fund-raisings will not happen. Absent this equity supply getting absorbed, how will we fund the Budget, improve corporate creditworthiness and get back to seven-eight per cent growth?

Policymakers need to focus on raising financial savings, especially into equities. Until sentiment towards the EM asset class changes significantly, we cannot expect FIIs to absorb all the paper we need to issue. We need to find domestic buyers and immediately. We need to create our own long-term pools of domestic equity capital.

The Reserve Bank of India has already moved to a regime of positive real rates, boosting financial savings - but we need the finance ministry and the securities regulator to enable changes in tax incentives and the distribution architecture of financial products to convert financial savings into equity flows. This Budget will be key to see what steps are taken in this direction.

9 Ways the Eurozone is More Fragile than the US - An Article by Nouriel Roubini

posted Jan 8, 2015, 11:05 PM by Mikin Shah   [ updated Jan 8, 2015, 11:15 PM ]

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 risks threatening the Eurozone in 2006.

My remarks proved as prophetic as I'd feared. The crisis I predicted then is still casting shockwaves through the world economy, and may do so for generations to come.

At the World Economic Forum in Davos, Switzerland that year, I said that imbalances in the Eurozone would come to a climax — which might lead to a disaster in Europe within 5 years.


I made my remarks at a panel discussion on the “Ups and Downs of EMU” (European Monetary Union). The panel included several key European finance officials — including Jean-Claude Trichet, who was then president of the European Central Bank (ECB).

In a nutshell, I explained that some countries within the Eurozone — especially Italy, Portugal, and Greece — would experience weaker growth than the economically strong countries at the core of the Eurozone, such as Germany.

This kind of economic divergence would be a major threat to a currency union like the Eurozone, where countries’ inflation rates and interest rates converge.

As I was explaining all this, the Italian finance minister threw a temper tantrum: He interrupted my remarks and began shouting, "Go back to Turkey!" (The minister was making reference to my being born in Turkey — despite having spent two decades living in Italy.)

Unfortunately, by the Spring of 2010, many of the concerns I expressed during that panel discussion in 2006 turned out to be well founded.

Let's take a look at some of the highlights — or, perhaps more accurately said, the low lights — of the last five years in the Eurozone to set the context.

  • In May of 2010, the Greek government was thrown into chaos by a debt crisis; ultimately, Greece was forced to accept a bailout from the IMF and EU, to agree to implement austerity measures in return, and eventually in 2012 to restructure in a coercive way its public debt.
     
  • By June of 2010 the member states of the Eurozone were forced to create The European Financial Stability Facility (EFSF) a temporary crisis fund that had to lend over €100 billion to Ireland, Portugal, and Greece after those countries made formal requests for much needed assistance.
     
  • In the autumn of 2012, the member states of the Eurozone created an additional fund called the European Stability Mechanism (ESM). The ESM lent nearly €50 billion to Spain and Cyprus to backstop their banking crises by recapitalizing their banks.
     
  • Perhaps even more significant, earlier in the summer of 2012 Mario Draghi, the president of the European Central Bank, pledged to do "whatever it takes to preserve the euro." This was a very strong commitment on the behalf of the ECB to use the full force of monetary policy to save the Eurozone.
     
  • By 2013 several Eurozone economies received various forms of bailouts from the troika (IMF, ECB and EU): among them on top of Greece were Portugal, Ireland, Cyprus and Spain.

As a consequence of these interventions and Band-Aids, the Eurozone has survived — but now, as we enter 2015, the Eurozone has a host of economic problems that emergency stopgap measures simply cannot fix.

* In this map, please note the differences between the members of the EU that are in the Eurozone, which is the currency union for which the euro is the official currency, and members of the European Union, like The United Kingdom and Sweden, which participate in an economic free trade zone.
Source: spiegel.de

The Eurozone: A Brief Timeline of the Troubles

So what, exactly, is happening inside the Eurozone now? The problems of the Eurozone are, of course, complex, but for the sake of brevity let's take a look at a few of the most disturbing facts that seem to highlight the key difficulties that now exist there:

  • The overall inflation rate in the Eurozone now stands at 0.3% — which demonstrates insufficient demand for goods and services – and now the EZ is at risk of outright deflation.
     
  • The overall rate of unemployment in the Eurozone is 11.5%.
     
  • While 11.5% unemployment is shockingly high by American standards, it doesn't really give you a true sense of just how bad the problem is in the so-called PIGS nations (Portugal, Italy, Greece, Spain) of Europe. In Greece & Spain, for example, the unemployment rate is 25%; even more disturbing, though, the rate of youth unemployment in both of those countries is about 50%, which gives you some sense of the level of desperation and hopelessness among young people there.
     
  • In Italy, the rate of youth unemployment is above 30%. Italy's output is 8% below pre-crisis levels, but industrial production has collapsed 25%.  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.

Some people say Europe is going to get 'Japanified' — a reference to Japan's dismal economic performance over the last twenty years, which is sometimes referred to as 'The Lost Two Decades'.

But, in fact, the risks in Europe are even worse. While the Japanese have stagnated, Japan has not suffered the sort of debt crisis that’s affected the Eurozone. This is because, unlike the Eurozone, the Bank of Japan has the flexibility 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 Frankfurt to attempt to bail out the divergent economies of the Eurozone, where there is no easy one-size-fits-all monetary policy solution to save the day.

Rather than get lost in the wonky math of the Eurozone, as macroeconomists so often do, I’d like to tell you about the challenges the Eurozone faces in a slightly more interesting way: By comparing it to a familiar organization of states—the United States of America.

The Eurozone & The United States

1) Rise of Extreme Political Parties


If the 20th Century has taught us anything, it’s that difficult economic times often lend themselves to political radicalism. Both the left and right seized this opportunity last century and wreaked havoc. The Bolsheviks rose to power after the Russian empire collapsed following economic decline and WWI. Enthusiasm for the National Socialists in Germany followed a prolonged and intense period of deflation and depression.

Seventy-five years later, we would be wise to worry if it might happen again. Among the most troubling concerns on the horizon for the Eurozone is the rise of Eurosceptic extremist parties. Most of these parties tend to come from the political right, but there are examples on the left as well, such as Podemos in Spain or—more worrisomely—Syriza in Greece, a well-organized left coalition that is leading in polls and poised to win a majority in the upcoming election late in January.

Marine La Pen’s National Front party in France is a perfect example of how such extreme national movements must be taken seriously. For decades, the National Front was merely a nuisance, a hotbed for rightwing cranks and malcontents. Suddenly, in 2014, the National Front won a significant number of mayoralties, and their national numbers continue to grow. (In fact, if presidential elections in France, which are scheduled for 2017, were held today, current polls show that the National Front would win the first round.) They're no longer fringe—they’re now players in a very dangerous game. But, just as we saw in the 1930s, stagnation and insecurity breed resentment. When hard times hit, the public looks for someone to blame: foreigners, globalization, or budget cuts from Brussels.

Even in Italy populist anti-Euro parties of the right and left could beat moderate centrist parties of the right and left if the current prime minister Renzi fails in his reform drive.

We should not underestimate the potential power of these movements. The United States is not free of such disgruntlement, of course, but the Tea Party in the U.S. is now more of a nuisance and a political sideshow than a threat.

In short, Europe has a very different kind of history — one it ought to take seriously.

2) Europe's Aging Population

Not long ago Jared Diamond popularized the phrase “geography is fate.” I would pair a phrase of my own beside this wise remark: demographics are fate too.According to a recent article in the Economist, in the next fifty years the working-age population of Europe will drop considerably, from last year’s peak of about 300 million to 265 million. This will be a significant blow to nearly every aspect of the Eurozone economy.

At the same time, the old-age dependency ratio--a fraction or percentage expressing the ratio of residents over the age of 65 to those under that age--will rise from 28% (recorded earlier this decade) to a staggering 58% by 2060.

This situation is, in a word, unsustainable.  

The causes of this challenge are in Europe are manifold: declining fertility, advances in old-age care, the residue of baby-boom demographics. But the impact will be serious.

The United States has managed to combat many of those challenges of an aging population through immigration. In the U.S., Immigrants now make up more than 13% of the total. population. In 2013, the number of immigrants living in the United States, both legally and illegally, topped 40 million.

Immigration may help to mitigate Europe's aging challenge, as it has in the United States — and then again it may not. Immigration is a controversial topic in Europe — and it is one of the many issues that extremist parties in the Eurozone have seized upon to attempt to lend themselves legitimacy within their own cultures.  Foreigners, after all, have always made easy targets for extremist political parties seeking to scapegoat others for their domestic economic woes in times of high unemployment.

3) Susceptibility to External Shocks

One of the reasons the Eurozone is more fragile than the United States is pure geography. America is surrounded by huge oceans, with relatively stable and like-minded 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.

And Africa and the Middle East are right there too, a short skip across the Mediterranean. Thousands of refugees drown in that sea trying to reach Europe each year. Pope Francis recently made reference to this tragedy when he described the continent as a “vast graveyard.”

The aging population of Europe grows resentful of the influx. And because of a wide variety of social and historic reasons, Europe does not function as a melting pot, the way America, at its best, can do. (We see this drive toward assimilation in President Obama’s recent executive action, removing penalties for undocumented residents who aim to attain citizenship.) Whereas Germany, by contrast, contains plenty of Turks who have lived in that country for fifty years and still cannot apply for a German passport. They don’t feel like citizens. They can’t own a part of the dream.

Europe still has not finished the task of absorbing the former  Iron Curtain countries of Central and Eastern Europe within the EU. Problems there still persist—as recent events involving Mr. Putin have made clear.

Eurasia is not an easy neighborhood in which to live. And because Europe cannot make centralized decisions to the same extent that a country like the United States can, coordinating responses to these periodic crises is always a struggle.

4) Labor Mobility & Capital Mobility

There is less labor mobility in the Eurozone than in the United States, since cultural barriers exist between nations with thousands of years of independent history. In the US, workers may flee a recession in North Carolina to seek work in the Northern cities. If there’s a bad shock in Michigan, people can pack up and move to New York. The borders are open between US states and the language is the same. Benefits are often portable.  Whereas in the Eurozone, a number of obstacles prevent this.  

While there are mechanisms to allow for free movement between Eurozone countries, such as the establishment of the Schengen Area, which allows people to travel without passports between 26 European nations, the Eurozone still has a number of constraints that aren't present in the US which make movement more difficult. The Eurozone is a motley collection of competing languages, cultures, and legal restrictions. In consequence, Europe lacks the crucial shock absorber of a truly open labor market.Since the time of Alexander Hamilton, the United States has had an integrated, federalized banking system which allows for the free flow of capital. This advantage has made the US a good deal more nimble and resilient than the Eurozone. While capital mobility exists in the Eurozone, there is not enough of it. Investing abroad in other Eurozone countries means navigating different tax systems, legal systems, often in different languages and cultures. As a U.S. citizen, if you live in Connecticut and want to buy stock in a California tech company, you don't even need to think about it. You don't have to call a different broker.  You simply buy the stock. The absence of free movement of capital, in fact, is entirely alien to the American way of thinking.

5) Asymmetric Adjustment

Asymmetric adjustment is a wonky phrase but it’s fairly straightforward to understand. Basically, 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 example, Greece and Italy) and those that tend to save too much (for example, Germany and The Netherlands) both get hurt when the flow of money ceases.

When a shock to the economy arrives, 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 save less. This is what is meant by the phrase 'asymmetric adjustment.

For both sides, though, an unstable equilibrium is thrown out of balance. The so-called PIGS countries bristle against austerity, while the core countries, on the other hand, are left in the position of someone playing tug-of-war when the other side suddenly drops the rope.


In the U.S., such a scenario could never arise. We are one unified economy. It's difficult to even draw the same metaphor. New York may lend more money that West Virginia, as we know, but both are states are parts of the same union.

6) Great Recession Response

After the banking crisis of 2008, the United States did three crucial things that were required to fix the economy right.

Bank Recapitalization

First, The United States took the bull by the horns and recapitalized the banking system. The U.S. Treasury department committed trillions of dollars to support US banks and other financial institutions, such as investment banks, money market funds and credit unions.

(While trillions of dollars were pledged to help the banks, far less capital was actually committed, and the government has collected billions of dollars in dividends and fees for their investment.)

Once government capital was injected into U.S. banks, those banks could continue lending — as opposed to selling assets, deleveraging, or contracting credit. In addition, the Federal Reserve in the U.S. forced banks to engage in stress tests to determine their solvency. Five years down the line, the ECB eventually performed similar stress tests.

But even after the stress tests, European banks don't have adequate capital, which means that if the banks need to shore themselves up, they are going to start retrenching and contracting credit — which risks further damage to the Eurozone economy.

Monetary Policy

Second, the US did aggressive monetary and quantitative easing, while the ECB is now still thinking about doing quantitative easing. I've written before in Roubini's Edge about how monetary policy can help soften the blow of recessions and economic slowdowns but here I'd like to just focus on the big picture. By quadrupling the size of the money supply from its pre-recession levels, the Fed freed up desperately needed credit and helped keep the U.S. economy from crashing into a full-blown depression.

Back-Loaded Fiscal Consolidation

Third, the US back-loaded its fiscal consolidation, meaning it postponed measures aimed at balancing its fiscal budget. (This is because, in the short run, raising taxes and cutting spending reduce disposable income and therefore reduce consumption.) In the Eurozone,  however, the decision was made to front-load fiscal consolidation, which put additional pressure on their already beleaguered economies. This front-loading, which amounted to imposing 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.

7) The Eurozone isn't a Fiscal Union


One of the key challenges to the Eurozone is a lack of fiscal union. A fiscal union is something Americans take for granted and rarely think about. In the US, when there is a shock to the output of one of our fifty states, fiscal transfers from the rest of the union help to cushion the blow.  As an example, let's say there is a negative shock to the economy of Texas, perhaps due to a fall in oil prices. Economic output in Texas would fall. But for every dollar in lost output, the fall in income in Texas isn't a dollar but only about 60-65 cents.

Because when there are bad times in Texas the federal government transfers economic assistance there — on the premise that when there are bad times somewhere else, booming oil prices in Texas might help out another state in the union. It's a kind of risk pooling and insurance. In the scenario we've been discussing, Texans who were laid off from their jobs would be eligible for unemployment benefits. Those same unemployed Texans might also be eligible for federal welfare benefits. Also, when the earnings of Texans decrease due to bad economic times they would automatically pay less federal income tax.  Conversely, when Texans are doing well, their federal taxes automatically rise. This serves as a kind of automatic stabilizer for the economy. Finally, the federal government can decide to cushion an economic shock to Texas by spending more money on Texan infrastructure or by funding federal projects at, say, the Johnson Space Center in Houston.

In the U.S. those shock absorbers at the federal level are considerable, since the federal government accounts for 25% to 30% of our GDP. In Europe, where the EU government only accounts for 1% of GDP, there simply isn't capacity for it to lend substantive assistance when countries are in trouble . So what winds up happening in the Eurozone is that when you have a $1 shock to the GDP of one country, that country's income goes down, effectively, by $1.

Unless there is a full fiscal union in the Eurozone — on spending, taxation, and even common debt issuance —the funds that the central government will have to assist countries in trouble will remain just spare change. Of 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 next section...

8) Banking Union: The Eurozone's Stumbling Block

In the United States, we take for granted that every state in the union has banks that are insured by the FDIC. In Europe, however, German deposit insurance pays only for German banks, and Italian deposit insurance pays only for Italian banks.


In the U.S., on the other hand, when a bank goes bankrupt in California, we use the same pool of money to fix the problem as we would for a bank that goes bust in New York. Furthermore, in the United States, we have a banking system where the Federal Reserve, at the central level, not at the state level, decides which banks are in trouble and need assistance, or in the worst case, require resolution.

A banking union, in fact, is an important kind of risk sharing — a kind of subset of a fiscal union.

What concerns the Germans about a fiscal union — or, for that matter, a banking union — is that it pledges German citizens to support peripheral Eurozone economies and banks that are at risk of outright collapse. The fear in Germany is that risk-sharing will become risk-shifting — and that a fiscal union will become a transfer union.

In short, Germany, and other core Eurozone nations like The Netherlands, don't want to get stuck in a transfer union where they might be forced to subsidize Portugal and Italy and Greece and Spain forever. Fiscal unions and banking unions only work when shocks occur randomly. (One day I have bad luck in Texas; the next day you have bad luck in New York. Sometimes I help you out; other times, you help me.) If the economies within a fiscal union are not balanced — it's not a two-sided risk-sharing alliance but, rather, a risk-shifting scheme where one side passes money to the other forever.

That is why the Germans, among other core European nations, have been saying, in essence, unless the PIGS countries do reform in the form of fiscal austerity, structural reform, boost their growth, and make progress on avoiding future debt crises, we’re  not going to sign on to a fiscal union or a banking union that may become an economic suicide pact.

9) Political Union — And Democratic Legitimacy in the Eurozone


While Americans are accustomed to political squabbling — such as the commentary we hear from talking heads every presidential election about Red States and Blue States — the fundamental democratic legitimacy of American politics is rarely questioned by those within the political mainstream in the United States.

Supranational unions like the Eurozone — at there very core — are about transferring national sovereignty to the center.

In the case of the Eurozone, decisions that were once made at the national level get made at the supranational level. What was once decided by national legislatures of countries gets decided at the European Parliament in Strasbourg, France, while the executive powers of the EU are in Brussels within the European Commission. Decisions that were formerly handed down by national supreme courts get judged at The European Court of Justice in Luxembourg. And monetary policy that was executed by national central banks gets made by the ECB in Frankfurt, Germany.

What impact does this have on the political legitimacy of democracies?

If you are transferring national sovereignty from the nation state toward super-national authority, then you need a political union where those decisions being made at the super-national level are done in a democratic way. Otherwise, there are great challenges: For example the EU tells you that your country's budget is not acceptable and needs to be cut, or the ECB informs you that several of your national banks need to be shut down.

Decisions on budgets and bank supervision have already moved away from national capitals to the central authority — but the risk sharing component of fiscal and economic union never arrived. You might say that countries like Greece have lost their sovereignty on supervision and regulation without truly receiving the benefits of solidarity, i.e. risk-sharing.

Bureaucrats that were never elected by Greek citizens have begun making decisions that most Greeks would prefer to be made democratically in Athens, and many have already begun to blame their woes on the EU and the ECB and the Eurozone.

The issue, of course, brings us back to where we began our list: The rise of extremist political parties within the Eurozone.

Beyond Greece — in Spain and Italy and France and The Netherlands — populist parties on the right and the left are rising. And their rage is being channeled toward many of the same targets that extremist politics railed against during The Great Depression: Against globalization, against immigration, against reform, against austerity. They are saying, "Enough is enough." So far, they have not come to power. But after five years of recession, low growth, high unemployment, little job creation, little income creation, more and more people have begun to say, "Enough is enough."

As their voices grow louder, and the political legitimacy of the Eurozone is questioned 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 1930s— 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 Second World War.

The Future of the Eurozone


As 2014 drew to a close, I started thinking about all the things I've written about the Eurozone over the last decade. One of the more provocative ways of summing up the challenges that the Eurozone faces would be to say that in this world, economies can grow either because they have lots of young people willing to work long hard hours, or grow because people are creative and innovate.

Barring a few exceptions, these are, essentially, the two different paths economies can take to growth. Asia, broadly speaking, has taken the path of working very hard. (Though Americans work quite hard, they don’t work as many hours as their counterparts in Asia do.) But, in many key ways, Americans continue to lead the world in innovation and technological advances.

Europe, at this moment in history, is “the worst of both worlds” in this respect. Leisure and vacation time are of paramount importance to Europeans, but there is a dearth of innovation to make up for those losses in productivity. (Only isolated elements in core Eurozone nations follow American-style work patterns.) What Europe does have—and what continues to drive the major engine of European tourism—is high culture. Rich Chinese and Indian vacationers flock there to soak up churches and concerts and ruins.

If Europe wants to avoid becoming the Florida of the world—a peninsula full of vacationers and retirees—then it must urgently consider radical reforms. All of the nine points noted above are worthy of serious action by policymakers. And all should be in the minds of investors considering taking a risk on the Eurozone and its future

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