Europe’s economic woes are threatening the finances of the entire globe

The troubles of the eurozone economy have emerged not as individual spies, but in battalions.

First, it was the COVID pandemic that hit major eurozone economies like Italy and Spain particularly hard. Then it was a rise in euro-zone inflation to record highs that will soon force the European Central Bank to step on the monetary brakes, raising the risk of a European economic recession. It is now Russia’s Ukrainian invasionwhich has pushed up energy prices and hit overly dependent countries like Germany and Italy badly Russian natural gas imports.

All of this could have serious consequences for the global economy.

Not just because a slowdown in the eurozone economy could mean less favorable export markets for the rest of the world. The need to slam on the brakes and raise interest rates at a time when some eurozone countries have very weak public finances could trigger another round of sovereign debt crises. This in turn could raise the question of whether the euro is viable in its current form.

As we learned during the 2010 debt crisis, the eurozone is not well positioned to deal with economic shocks that hit some member countries harder than others. Because in 1999 all members of the eurozone gave up their own currency for the euro. As a result, they no longer have their own independent monetary or exchange rate policies to use as a cushion to boost exports and thus cushion the blow of their economic shocks.

A screenshot of inflation in Europe.
A report by the Statistical Office of the European Union on April 1st showed that inflation in March was 7.5% higher than a year earlier.
European Union

The lack of a dedicated currency to deal with such shocks is particularly problematic for countries in the eurozone’s periphery, such as Italy, which has a large budget deficit and the highest public debt-to-GDP ratio in that country’s 150-year history. In order to avoid another debt crisis, Italy must put its public finances on a more solid footing.

However, Italy could learn once again that tightening your belt in a euro straight jacket is counterproductive. Italy, no longer able to devalue its currency to boost exports to offset the economic impact of reduced fiscal spending, could find itself in another deep economic recession that would limit its ability to collect tax revenue.

In the past two years, the ECB’s bond-buying programs have kept countries on the eurozone’s periphery, most notably Italy, afloat. Notably, the ECB has bought most of those countries’ government bonds as part of its €1.85 trillion ($2 trillion) pandemic emergency purchase program. This has saved them from having to face the test of the markets.

Harbor cranes load container ships in the import and export port of Hamburg on Tuesday, March 19th, 2022.
Germany and Italy, which are heavily dependent on Russian oil and gas, are suffering from sanctions against the invading country.
AP/Martin Meissner

With Eurozone inflation up to 7.5% – an all-time high – it should only be a matter of time before the ECB is forced to step on the monetary brakes. The beleaguered eurozone periphery should know that such a tightening would involve a halt to the ECB’s bond-buying programs. The bank has already ended its pandemic emergency purchase program and is hinting that it will end its other purchase programs this fall.

The end of the ECB’s asset purchases seems to set the stage for another round of the eurozone debt crisis, particularly should the eurozone fall victim to another economic recession. This must be of deep concern to the rest of the global economy.

In 2010, the Greek sovereign debt crisis rattled global equity markets and sparked fears of a financial contagion that could have derailed America’s faltering economic recovery. How much more of a shock would another round of the eurozone crisis cause today if it were centered on Italy, whose economy is about ten times the size of Greece’s?

The last thing the global economy needs is another round of the eurozone debt crisis. This is especially true at a time when the Federal Reserve’s efforts to curb inflation could accelerate a US economic recession and China’s zero tolerance COVID policy could lead to a significant slowdown in the world’s second largest economy. Still, we may have to brace for such a crisis as the ECB is forced to scale back its asset purchases to deal with its own inflation problem.

Desmond Lachman is a Senior Fellow at the American Enterprise Institute. He was Associate Director in the International Monetary Fund’s Department of Policy Development and Review and Senior Economic Strategist for emerging markets at Salomon Smith Barney.

https://nypost.com/2022/04/21/europes-economic-troubles-threaten-entire-globes-finances/ Europe’s economic woes are threatening the finances of the entire globe



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