Friday, March 19, 2010

The €uro : A recession proof currency?

Europeans are wondering about the prospect for the €uro ( ,march 9, 2010), following the seriousness of the Greek economy difficulties these days. Three unbalanced account (Public debt, fiscal deficit (12% of GDP) and current account deficit), is the usual menu for economic crisis, which might turn out to be political ones. The financial situation of other European countries , has made a usual post recession scenario, a highly complicated situation to care about.
A mix of doubt and fear goes across borders within European Union concerning the implications of such a risk. Will the €uro be capable of coping with these difficult times? .
Just a few months ago international analysts were predicting the fall of the Dollar as a global currency, because of the US economy long run prospect for solving its fiscal deficit and debt. The €uro, seemed quite in good shape to take a better stand as a global currency. All of a sudden, it seems all is gone. Speculators as usual, take advantage of this uncertainty , betting against the €uro ,just as they did some time in the past against the dollar, or other weak currencies.-
Since the beginning of the €uro experience, (1999),it should have been clear that although from the economic point of view was an interesting approach to Europe economic progress and political stability , from the political point of view was not that much friendly. A currency which works like a fixed exchange rate among its different partners which are include in the monetary Union , means very unpopular and some time politically unsustainable requirements to keep it working.
Thus, there are key elements which are hard to get implemented for a single country, more so for a community of countries. These are : Flexible markets (specially labour and goods market,), steady productivity increases, and fiscal deficit under control. The founders of the monetary union ,cared publicly only about the third requirement ,setting tough restriction for making fiscal policy €uro friendly ,fixing the limit of overspending at 3%.Of course such a target become just good intentions when the recessions wind comes along the way. In fact, most of the current problems in the €uro zone ,deal with the fact that the European monetary framework is not recession proof, which means that it exacerbates the implication of fiscal activism for the €uro stability, in those countries forced to go ahead with more spending. Any adjustment follow a different path, because there is no way to depreciate local currencies, to support tradable goods to reallocate resources from domestic spending to exporting sectors , and with low level of productivity , alternatives fall within a very narrow space: To reduce both labour cost and incomes ,which is politically unthinkable .Thus ,external financial support is the only way to get through at the cost of losing sovereignty.
What is it next?. It is unlikely that the €uro will be short lived. It is more likely that the whole institutional framework which support it, will have to be more flexible, including better design for the lender of last resort issues, and the prevention of moral hazard behaviour.

Friday, March 05, 2010

Chile :After the earthquake , the painful recovery

Just a couple of weeks ago, Chileans were next to finish their vacation season. A lot of them, were getting ready to go back home with personal bags full of nice memories, after enjoying their free time .From the political point of view, the expectation were running high with the new incoming Center right Government, which was also getting in shape to cope with key challenges mainly about the economy performance . All of that, suddenly changed the Sunday February 28th at 3.34 am in the morning , because a strong earthquake(8.8 in the Richter scale)left the country upside down.
From then on, a lot of questions and considerations about the emergency management model capabilities, have been in the public discussion and analysis. Besides, the economy recovery (GDP grow 4,3% in January),from the last year global financial recession currently under way , will be delayed for some time .
Let looks each of these issues:
a.- The emergency management model. The Katrina disaster, showed clearly that it is hard to fully anticipate the magnitude of these nature disarray. So ,it was in Chile. Years of preparations, plans and trails were useless when it finally happened the furious awake of the nature. A different matter deals with the quality of the plans, its effectiveness, the level of decentralization, and the quality of contingency decision. Thus, override it by the unexpected, the emergency model did not have sufficient instruments to keep itself on. The result were, delays to make critical decisions and, lives which might have been saved, losses which might have been avoided, and desperation of those in need , which might have been mitigated . Anyone might agree with the difficulty to predict the unpredictable. However, the problem lies on the ability to design effective plans , in a country widely known because of these natural disasters, and severe past experience (1939.,1960,1985,2007), more so in a country which is pride of itself because of its economic achievement based on good public policies at all levels . Therefore ,it is the time to make a deep reform to the State, the responsible of last resort in the whole emergency machinery. Those of us who have been calling about it, were right to stress the necessity to undertake such a reform in the new Government.
b.-The recovery process. Early estimation indicates the magnitude of losses at a range of 10% up to 20% of GDP (roughly Chilean GDP is at USS150 bn).How long it will take to get all the economic infrastructure back to normal, will be key to improve the recovery speed. Some preliminary data suggest that such process, will last at least one (1) year, and up to a maximum of four (4) years. Thus ,in the optimistic scenario, GDP recovery pace will, be negatively affected throughout this year up to the month of June. It is expected that during the second half of this year, the impact of higher public spending will be in place allowing to finish GDP grow for 2010, at around 5 to 6%.The more probable scenario though ,deals with a slower process of normalization, (The same centralized model applied to a different situation),a deeper negative impact on GDP grow and higher inflation. In short, probably a couple of years with GDP growing below its long run trend. Just for the record, half of the national fishery industry is in the area devastated,100% of the forestry industry is in the same area, the highway networks will be operating at 100% capacity not before 8 months. The new rules for construction industry (heavily questioned for the poor quality of buildings), will delays the process of building construction, and employment data improvement. The damage to the stock of physical capital can not be underestimated concerning its impact on the economy. What it will become important ,is the stock of human capital. Chileans at this hour, must take the best of them no matter whether they are. That is the beginning of the real recovery.