European downturn could be worse than US

April 2008: Investors and traders who are still buying euros near record heights, beware.

The European economy is in the danger zone, despite the sanguine noises from the Continent’s finance ministers and central bankers. Growth of the 15-nation region that uses the single European currency was 2.7 per cent in 2007, but the signs this year point to slumpflation in some nations. The International Monetary Fund is predicting that growth of the Eurozone will slow to around 1.4 percent in 2008 and to 1.2 percent in 2009, but the IMF admits that there are downside risks.

General Trichet’s staff despatch cavalry against machine guns

The European Central Bank (ECB) and its governor Jean-Claude Trichet are well behind the curve. In metaphor speak, Mr Trichet and his colleagues are like the First World War generals who despatched cavalry against German machine guns. Despite recession in Italy, a steep slide in German business and consumer confidence, a dip in French consumer sentiment and a property tumble in Spain, Ireland and the Netherlands, Mr Trichet refuses to cut interest rates. The fear of the ECB bureaucrats, particularly members of the German Bundesbank, is inflation. Unfortunately their economic reasoning and policy are way off beam. The inflation is not caused by a surge in money supply, excess credit and large wage demands. It is precipitated by soaring energy, food and raw material prices. The commodity inflation is the result of complex factors including fears of mostly nonexistent shortages, panic hoarding and an extraordinary increase in so called investment flows and rampant speculation. The commodity bubble could implode at any time, leading to a swift end to European price rises (see: commodity speculation).

By failing to cut interest rates and ease upward pressure on the euro, the European Central Bank has placed Europe at risk of recession. The euro has almost doubled against the greenback in the past six years and has soared against Asian currencies and the yen. Exporters are finding it hard to compete against Americans and Asians.

Euro overshooting against US dollar



Focus attention on European credit crunch

So far global economists have focused on the American sub prime and credit crunch, but European banks that are already deeply involved in that crisis have already incurred sizeable losses. An Organisation For Economic Cooperation and Development paper, “Assessing Risks to Global Financial Stability” estimates that European bank losses, including the UK amounted to $123 billion, almost as high as US bank losses of $144 billion. Expected further losses are a further $44 billion. Moreover, European banks have their own homemade European sub prime crisis.

German and French governments & central bankers in denial

German and French governments are in denial but they should follow events across the channel to see what could occur at home. Northern Rock, the north England bank had to be bailed out by the government. In cities such as Manchester and Leeds several new buildings sold to speculative landlords are standing half empty. Apartments of the buildings have either not been sold or have failed to find tenants. Homebuyers, who paid expensive prices in the property bubble of Spain, Holland, Ireland and France are also suffering. Credit card debt and other loans have also increased and as business conditions have weakened, banks are encountering problems of rising bad debts. Jaime Caruana, the IMF’s director of monetary and capital markets department warns of: “a significant credit squeeze in the euro zone”.

Here are some examples in individual countries:

The ZEW Center for European Economic Research in Mannheim said that its index of German investor and analyst expectations declined to minus 40.7 from minus 32 in March. Investors are worried about falling company profit margins, while consumer spending is falling because of worries about jobs and high energy and food bills.’ Germany’s benchmark DAX share index has dropped 19 percent this year.

Spain’s economy is slowing sharply after the implosion of the country’s property bubble. There is widespread gloom and there is rebellious talk that the country should exit the single European currency. Builders in Spain are offering incentives such as free cars and mortgage holidays to sell houses and apartments.
Sales of consumer durables such as washing machines and kitchen equipment dropped 32 per cent in March and sales of new cars plunged 28 per cent in March from a year earlier. The Spanish Government has announced plans to spend €10 billion (US$16 bn) a year in an economic stimulus package intended to soften the blow of a looming housing crisis.

French aircraft-maker giant Airbus, the main competitor to Boeing, for example, blames the euro’s strength for denting its exports. Airbus’s problem is that it makes most of its money in a market dominated by the weakening U.S. dollar, but incurs 70 per cent of its costs in euro.

Maybe it is time for General Trichet to retire gracefully.


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