A 2008-Scale European Financial Crisis This Year? Niall Ferguson

The European debt sovereign crisis is back. Spain’s government party gets trounced in local elections, Fitch cuts Greece’s credit rating and S&P threatens to downgrade Italy. Bloomberg contributor talks about the situation in Europe:

Bloomberg: The worst electoral defeat for the socialist party in more than three decades in Spain it seems, a very harsh public repudiation of austerity measures. What does this tell you about the future of the Euro and the European Monetary Union if the Spanish can’t get behind budget cuts?

The European debt sovereign crisis is back. Spain’s government party gets trounced in local elections, Fitch cuts Greece’s credit rating and S&P threatens to downgrade Italy. Bloomberg contributor talks about the situation in Europe:

Bloomberg: The worst electoral defeat for the socialist party in more than three decades in Spain it seems, a very harsh public repudiation of austerity measures. What does this tell you about the future of the Euro and the European Monetary Union if the Spanish can’t get behind budget cuts?

Ferguson: Well it confirms my view that the Eurozone has become a kind of government killing machine, and that most governments who have been incumbent over the financial crisis are being punished. And this of course applies, just not to those on the periphery that are in trouble; the notorious pigs, but in fact it’s been happening in the core of Germany. I think it’s going to continue and this is a very trouble situation with implications for the whole global economy.

Bloomberg: Implications certainly for the whole global economy. Niall, how do you expect it to play out if the governments across Europe are loosing support?

Ferguson: [quote]As the political situation deteriorates in nearly all these countries in the Eurozone, I think we’re going to see political opportunists in the opposition parties saying “We have to do things differently”. In the north we’re going to get more of those true-fin type parties saying “Enough with bailing out the people down south and out west”, and in the periphery we’re going to hear people saying “This is nuts, we’re inflicting masochistic austerity measures on ourselves and it’s time to get out”.[/quote]

I think the idea of leaving the Eurozone, which is the most dangerous idea actually, is going to start surfacing as a politically credible one. So the outlook for the rest of this year is, more trouble if you happen to be in power, and the temptation if you’re in opposition to propose radical solutions including conceivably exiting the Eurozone all together.

Bloomberg: What you’ve described sounds like a recipe for the collapse of the European Monetary Union. At this point does it feel to you like its beginning to be more of a forgone conclusion – or something that still could be salvaged, possibly with the installation of somebody like Christina Lagarde at the head of the IMF?

Ferguson: Well certainly it’s pretty important that we have big hitting European in that body because the IMF has played a key role in trying to stabilize the sovereign debt crisis right the way through. But I’m not sure that’s necessarily going to suffice. Remember one of the problems we have right now is that a European is in charge of the ECB, and he is making life very difficult for those people who would like to see some kind of restructuring if not default on the part of the Greeks.

The tension within Europe is making me more and more nervous. The European themselves can’t seem to get their act together to come to terms with the reality that the Greeks can’t possibly manage this vast debt that they’ve accumulated – and probably [quote]the Portuguese and Irish too will have to do something in order to reduce their debt burden in the short term. But if the ECB is against that, it doesn’t really matter what the IMF does, we’re heading towards a kind of Euro-gridlock.[/quote]

I think the stakes are much higher than many of the politicians, who are so focused on domestic political issues seem to realize. On a recent trip to Spain, I met Mr. Zapatero, he seemed quite resigned to electoral disaster this year. He’s not going to run for re-election. [quote]And when I was in Berlin a week ago, I was really struck by the atmosphere of complacency about this crisis. It does seem to me as though the German government who is the key player in all of this, isn’t really prepared to write a big cheque for Greece, or anybody else.[/quote]

So I think the crisis is in many ways, worse than many people realize, and the possibility of an orderly solution is getting lower and lower.

Bloomberg: Concerns over European sovereign debt are roiling global markets yet again. There’s only so much a new head of the IMF can do to get his, or her hands around the situation. So does that mean that European bailouts have politically failed? That there isn’t the will to abide by austerity, and in the case of those handing out the money, not enough interest to see things through.

Ferguson: I think that’s a good assessment. If you think back now over a year or two when this crisis really began, there’d been all kinds of measures; bailouts here and bailouts there, and nothing has worked. Spreads have continued to blow out, the PIGS borrowing costs have continued to rise and austerity measures have failed to deliver the planned reductions in deficits. So it’s very clear they’re not working. And yet the political will to go the extra mile to make a bigger bail out for Greece doesn’t seem to be there in Germany or in any of the core countries.

More importantly, it’s getting very difficult to work out some kind of way of re-profiling Greek debt. That’s really the key issue, and unless something can be done, significantly to reduce Greek debt burdens in the near term, then they’re going to default. This will be disorderly. So the pressure is really on, you would have thought the politicians, especially the Central Bank to get its act together. And yet I don’t see signs of it happening.

It’s the lack of any determination to act in Europe that is most troubling. [quote]These problems are not enormous. Greek economy is small and in relation to Eurozone GDP its deficit debt really aren’t that large.[/quote] But this is primarily a political failure of will we’re dealing with and it could have massive economic consequences, not just in the Eurozone but right round the world.

Ferguson concludes the interview with:

[quote]“In a financial crisis there a slow burn. People see that the figures don’t add up and there’s a problem and there’s a collective denial about just how bad it could get and then suddenly expectations shift and there’s a real exit out from the bond market. I have a sense this is coming soon in the absence of an incredible plan to stabilize situation, and in the absence of leadership from the IMF and with the ECB basically saying “ We’re not going to help you sort out this Greek mess with a re-profiling”. I don’t see how much longer we’ve got but I see a 2008 scale of disaster in 2011.[/quote]

Niall Ferguson, MA, D.Phil., is the Laurence A. Tisch Professor of History at Harvard University and William Ziegler Professor at Harvard Business School.