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GLOBAL INVESTOR 1.14 — 04 Reform agenda Toward a less imperfect monetary union The Eurozone lacked robust institutions to deal with the fallout from the Greek debt default and the financial contagion that followed. In response to the crisis, the establishment of such institutions has begun in earnest. However, the reform and economic recovery process of some of the member states is far from complete. TEXT OLIVER ADLER Head of Economic Research Long before concrete plans for <strong>Europe</strong>an Economic and Monetary Union (EMU) were developed in the mid-1990s, the concept of a single currency had been perceived by many as a means to boost not just economic, but above all political convergence in <strong>Europe</strong>. Indeed, it proved easier to reach agreement on the high-level principle of a common currency than on the “nittygritty” measures and reforms that would ultimately be needed to make it work – such as the integration and coordination of banking regulation and common fiscal policy. Consequently, the euro was launched in 2002 without most of this crucial institutional structure. Some saw this as a potentially fatal omission, while others viewed it as a gap that could not have been filled beforehand, but which participants would be able to tackle later to keep the euro together. In the first years of its existence, the serious “design flaws” of the monetary union were well disguised: Germany had entered the union with an overvalued exchange rate, and the “periphery” generally with undervalued exchange rates. While Germany struggled to regain competitiveness, the periphery economies were boosted. The economic upswing in the south, combined with their seemingly cheap assets, attracted enormous capital inflows not just from Germany, but from other surplus countries and regions as well. Credit expansion further boosted economic growth in the periphery, but also drove up wages and prices, and generated asset bubbles of varying dimensions – the Spanish and Irish housing boom being the most dramatic. By the time the global financial crisis hit, the periphery had become uncompetitive as well as over-levered, and thus highly vulnerable to economic or financial shocks. The event that triggered the EMU crisis was the insolvency of the Greek government in early 2010. It not only proved to investors that the rules for enforcing fiscal discipline (the infamous “Maastricht criteria”) had failed, but also revealed the severe lack of stabilizing institutions in EMU. The history of the EMU crisis depicted on pages 6 to 7 is thus one of a prolonged struggle between member states over how to construct the missing institutions, what powers to give them and how to fund them. This process was uneven, but the outcome, in our view, is a more complete – though still imperfect – monetary union and thus 2014 EU Countries with euro effectively a major step toward a political union. Contrary to the predictions of many skeptics, the institutions of EMU have been strengthened rather than weakened by the crisis. As we show on the following pages, however, progress in individual member states is far more “patchy.” Some countries, such as Spain, have made considerable strides in reforming their labor markets and their fiscal institutions. Others, notably Italy, and also France, have a much longer way to go. Meanwhile, a still partly dysfunctional and far from integrated Eurozone banking system and capital market remains a hindrance to a vigorous and synchronous economic recovery. That said, the ascendance of the common central bank and financial regulator should continue to drive this integration process, while also EEA
GLOBAL INVESTOR 1.14 — 05 THE CRISIS 4 SPAIN GERMANY EUROZONE FRANCE ITALY GREECE 2007 2011 2014 2 0 Debt less than 60% of GDP and budget below % of GDP The crisis in the Eurozone is often regarded as primarily resulting from imbalances in the member is only part of the story. In fact, most governments, with the exception of Greece, were running government, in particular, generated a surplus in 2007 of EMU countries was no worse than that of other advanced economies, such as the UK, not to men- in the wake of the crisis itself. The true story of the EMU –2 –4 –6 –8 –10 –12 Source: EU Commission, Datastream, Credit Suisse 0 40 80 120 160 200 … but rather a balance of payments crisis Current account balances of selected Eurozone members 300 200 100 0 –100 –200 –300 Germany France Spain Greece Eurozone Source: Datastream, Credit Suisse 1997 1999 2001 2003 2005 2007 2009 2011 2013 With devaluation and currency risk apparently removed due to the creation of the single accelerated sharply from the mid-2000s on Accelerating import growth needed to be funded internationally. Given higher yields on government bonds and other investments, attracting the funds was quite easy. Low global interest rates, promulgated by the Federal Reserve’s easy monetary stance, added to the attractiveness of this trade, while savings surpluses in Germany and emerging markets were seeking an outlet and better returns. its peak in 2008. As the global recession hit and the general deleveraging process set in, contraction only started about a year after the Greek blowup. Private funds dried up as fears via the central banks’ Target2 system made up for some of the remaining shortfall. In addition, demand for external capital dropped sharply in response to the crisis and recession itself. In the meantime, the periphery has started to generate surpluses, i.e. it has begun to export capital. This is, in part, due to the improved competitiveness and trade surpluses, but also results from ongoing private sector deleveraging in the periphery. Unless domestic demand picks up much more decisively, the Eurozone as a whole will continue to generate surpluses and export capital to the rest of the world, and contribute to what former Fed Chairman Ben Bernanke has called the global “savings glut.” Real estate bubbles, busts and stabilization Economic boom, falling interest rates, easy lending estate bubbles within the Eurozone. Not all countries were affected similarly. Neither the German nor the French Spain, Ireland or the Netherlands. Tougher regulators gage rates decline. The latest data also show a slight 100 90 80 70 60 50 40 30 Source: Bloomberg, Datastream, Credit Suisse –10 –8 –6 –4 –2 0 2 4 6 8
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Risk disclosure Investors should co
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Imprint Credit Suisse AG, Investmen
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Europe

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