When the PIIGS crisis was at its height in May, many economists believed the eurozone was going to hell in a handcart and that the euro was doomed. There were predictions that fiscally-challenged economies such as Greece faced bankruptcy, ejection from EMU and a reversion to currencies such as the drachma.
However the announcement of Germany’s economic rebound during the second quarter, made on August 13, put the lid on such talk. Economists waxed lyrical when it emerged the German economy grew at the faster-than-expected pace of 2.2% in quarter two, hailing it as the country’s best performance since reunification in 1990. Commerzbank’s Jörg Krämer led the stampede of German bulls, raising his forecast for full-year German GDP growth in from 2.5% to 3.25%.
Berlin's good news was seen as a turning point for the eurozone as a whole. It immediately led to predictions that Teutonic heavy-lifting would now be sufficient to pull more troubled peripheral members of the eurozone from the mire. It also sparked a minor rally, with the euro rising against the dollar and the betting on a European sovereign-debt default to ease.
Carsten Brzeski, an economist at ING, said:
“Crisis? What crisis? The recovery has gained traction in almost all eurozone countries. Only Greece still experienced a sharp growth decline with a drop of 1.5% … [Germany’s figures] are a clear sign that the eurozone has coped with the sovereign debt crisis better than expected.”
Ten days later, on August 23, the mood darkened again. According to a Reuters report, a combination of revelations from ECB council member Axel Weber that the central bank would keep monetary policy loose for a while, coupled with a raft of disappointing figures about eurozone performance, caused the euro to slide 0.7% against the yen and 0.3% against the dollar.
Boris Schlossberg, head of currency research at New York-based GFT, said the euro was "hobbled" by concerns about the health of peripheral members. Paul Krugman, a fan neither of Chancellor Angela Merkel nor her austerity measures, questioned the solidity of Germany's revival. In his blog he wrote: "I’m not willing to declare an economy that has yet to recover to the pre-crisis level of GDP an economic miracle."
There are also mounting fears about some of the eurozone's peripheral countries. In Ireland there's a suspicion that the government's much-heralded austerity programme will worsen unemployment and depress tax revenues, giving rise to a debt-deflation spiral. After Standard & Poor's downgraded Irish debt on August 25, the premium demanded by investors to hold the asset class, vis-a-vis the coupon on German bonds, rose to 350 basis points, the highest level for three months. The equivalent premium for Greek bonds rose to 945bp after the details of the IMF/EU rescue package emerged.
So what are we to make of all this? Could it be bond vigilantes up to some of their usual tricks? Or is there something else at work?
Personally, I think former Economist editor, Bill Emmott hit the nail on the head with his recent article in The Times. In this he wrote that the summer has been “a season of contradictions, when one week’s data or market frenzy appears to turn the previous supposed trend on its head. To sound intellectual, let’s call it the Walt Whitman season." He suggested that economists and commentators have become
“hyper-judgmental since the economic crisis began three years ago this month. So burnt are they by the accusation that they failed to forecast the crash and were complacent in the face of market lunacies that they are rushing to predict the next twist or turn.”
He said that post the crisis - which was a massive embarrassment for many forecasters given their failure to predict it - people needed to find both humility and confidence:
"By more humble, I mean economists should acknowledge the uncertainties in economic trends and behaviour more freely, and not rush to judgment based on a month or two’s data or market movements … By more confident, I mean we should take a longer-term view and stick to it until it has been disproved not by a month but by a year.”
Further reading on the outlook for Germany and the eurozone:
- There is method in Merkel's madness by Ian Fraser [blog post]
- A strategic look at the euro problem - what if Greece stayed and Germany left? by Anthony Harrington [blog post]
- No printing of money, not on my watch, says Trichet by Anthony Harrington [blog post]
Tags: central banks , European Central Bank , European Monetary Union , exports , fixed-income investors , Greece , sovereign debt