Only structural reforms not more liquidity can rescue the Eurozone

Steen Jakobsen
THE Bermuda Triangle has long captured the imagination of millions, not least my own. But now the global economy appears to have developed its own black hole, and this time it’s not just a legend. This economic triangle is a place where rationality is replaced by hope and superstition, and by pundits pretending to understand the real drivers of the economy. And the result? We see the sorts of figures announced yesterday: the Eurozone is now in its longest recession since the euro was launched in 1999.

This economic triangle runs from record stock market valuations to high unemployment, from low growth to stagnant productivity. And just like the real triangle, there is plenty of scientific evidence to explain most, if not everything, driving the current situation.

The black hole is modern monetary theory. This involves printing and spending money, then waiting and praying for better weather. It’s happening in a variety of forms across the world. But everywhere modern monetary theory is getting harder and harder to justify – if for no other reason than because the constant reminder that we are in a crisis makes investors reluctant to commit to any investment beyond the next quarter.

In today’s economy, unemployment is reaching record highs (19m in the Eurozone are now out of work), disposable income continues to fall, growth is ever lower, tax revenues come up short, and productivity growth and innovation have taken a back seat. The problem is that the idea behind printing money and hoping it will be spent is based on a historical relationship known as the wealth effect; previously when the stock market went up, sentiment also rose and spending and investment mirrored the move.

But today, while the stock market is clearly on an upward trajectory, not everyone is benefiting from the rise. Stock ownership almost exclusively centres on the top 10 per cent of the population, and the social divide is much higher than before the crisis. Further, 85 per cent of jobs and growth come from small and medium-sized enterprises (SMEs) – meaning that while the top 15 per cent of listed stocks are benefiting from the equity market boom, growth-driving SMEs are not. Global monetary policy is boosting the largest beasts in the corporate world and the richest 10 per cent who own stock. The Fed and the Bank of Japan may talk about the wealth effect, but what they really mean is the elite effect. Their premise is flawed.

However, this experiment may be in its final phase and the gloom could be coming to a end. Policymakers are realising that the growth they expected is unlikely to materialise. We are therefore seeing increased currency manipulation (always the last stage of macro policies). But we’re also seeing the previously close political relationship in Brussels between Germany and France becoming strained. The EU’s North South divide is now bigger than it ever has been.

The problem is that only failure will create a mandate for change – or even for small reforms. So far, real reforms in Europe have been few and far between, and austerity drags on. Real change could happen once the German elections in September are over. Chancellor Angela Merkel will likely win, but probably lose the broader war. There is an increasing expectation that she will step up to the challenge of saving Europe, but these hopes will likely be dashed. She cannot afford this. Bailing out other countries would hurt Germany’s credit rating, while current European policies will damage the country’s exports and growth over the long term. Merkel will likely fail to reconcile these two problems, and Germany will not be the saviour of Europe.

Each country in Europe must realise that their recovery comes from their own political willingness to reform. Unless we get a wake-up call in the form of a more severe crisis, then Europe is destined to repeat Japan’s mistake of an aggressive monetary policy resulting in a structurally weaker currency.

The good news, however, is that things can only improve. As we enter the next phase of this global slowdown, politicians must test their wrong premises and face the fact that growth is not around the corner. This summer, the Federal Reserve, the Bank of England, the Bank of Japan, and the European Central Bank will have to go back to their drawing boards. What the world is short on is innovation, appetite and risk, not liquidity.

Steen Jakobsen is chief economist at Saxo Bank.