Euroland alarm
Unless Germany's economic crisis is dealt with soon, Euroland is in grave danger of meltdown. One only has to look at the German numbers to see how dramatic the situation is. Unemployment at 4.7 million, 11.3 percent of the available workforce jobless, a further 83,000 people added to the dole queues between January and February, 410,000 more out of work compared to this time a year ago. These numbers are horrific.
Because of this disaster, Chancellor Schr? is to deliver a make-or-break speech to the Bundestag next Friday. His "super" minister, Wolfgang Clement, wants modern, flexible labour laws, while Ursula Engelen-Kefer, the deputy chairwoman of the German trade union federation, is warning against cuts in benefits for long- term unemployed. A clean break with the past, featuring a shake-up of tax, welfare and consultative bargaining agreements is needed, but one gets the feeling that inertia has become such a factor in the system here that change is not possible anymore.
Because of Germany's position at the top of the Euroland "at risk" list, Morgan Stanley's Eric Chaney is arguing that Europe is dicing with deflation:
"From 1973 to the late-1990s, a popular macro game between industrialised economies was to export inflationist pressures. The strong-dollar policy in the Reagan period and also during the Rubin one, and the strong Deutsche Mark policy in the boom years that accompanied the German unification were textbook examples of this not really zero-sum game. Nowadays, in a durably deflationary world, the game is different. Its name is "exporting deflation" and I am afraid that Europe could be on the wrong side, this time. The analytical case is three-folded. First, the euro is already non-competitive, on a unit labour cost basis. This is particularly flagrant for Germany. Second, three years of sub-par growth have widened and continue to widen considerably the output gap. Third, the euro might rise even higher, if the US economy does not recover convincingly and oil prices stay high.In other terms, even at 95 cents, the euro was slightly overvalued, from a pure productivity-adjusted costs standpoint. Euroland manufacturers could have lived with that. For a region where restructuring is a compelling necessity, a 10% over-valuation of the currency is not that bad, in our view. But at today's rate, 107, Euroland relative labour costs (ULCs) stand at 123. A 20% to 25% over-evaluation of the currency is clearly excessive for a sector already in recession. Put simply, it is deflationary for Europe. Note that, for Germany alone, things are much worse: on the same estimates, German ULCs are now 38% higher than US ones.
As the decline of the US dollar carries on - the US currency is only half-way on its way down, according to my colleague Stephen Jen - the situation will get even worse if the euro is the only counterpart to bear the burden of the rebalancing of the US economy. Well, it seems that this is the case, since most Asian currencies are practically linked to the USD. Using the weights used by the Fed for its own currency basket, it appears that a 10% effective depreciation of the USD would require a 50% rise of the EUR/USD rate. If only half of this is behind us, there is more pain coming for Europe. In addition, it seems that the well-established correlation between oil prices and the USD exchange rate is now inverted and that, practically, the euro has now taken the status of "petro-currency." Just imagine what would happen if crude oil prices stayed around $40 for some time. As the US and Asia export their own internal deflation risks, Europe seems to be the main recipient of this poisoned chalice. Has Europe the means to absorb deflation? The answer is clearly negative, given the still very high rigidities most regional labour markets suffer from."
Over to you, Mr Duisenberg.
