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News : EU Economy Last Updated: Jun 17, 2014 - 8:23 AM


Debt-challenged Eurozone facing long period of low growth
By Michael Hennigan, Finfacts founder and editor
Jun 16, 2014 - 8:15 AM

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Wolfgang Münchau, Financial Times columnist writes today that "the conventional market view of the post-crisis environment is dead wrong. The most likely trajectory is a long period of slow growth, low inflation, and a constant threat of insolvency and political insurrection. If the private sector were to reduce debt in such an environment, certainly on the scale as suggested by S&P, it would be a lot harder and possibly bloodier than any of the adjustment we have seen so far."

Münchau bases his argument on the recently published book 'House of Debt,' written by Atif Mian and Amir Sufi, respectively Princeton University and University of Chicago economists, and last week's report, 'The Long Haul: Eurozone Deleveraging Could Stunt Growth For Years' [pdf] from Moritz Kraemer of Standard & Poor’s.

The Wall Street Journal said that the authors of House of Debt "make a strong circumstantial case that household debt was the recession's main culprit. They also find it skulking in the background of previous downturns, usually loitering in the vicinity of a housing bubble. . . . House of Debt is clear, well-argued and consistently informative. . . . Mian and Sufi's proposal to shift much of the risk of falling home prices to lenders—while rewarding them for their trouble—is a good place to start. If we don't put moralizing aside and analyze dispassionately what caused the last crisis, we are unlikely to prevent the next one.”

Mian and Sufi said in a blog post last Friday that "the only way the US economy can generate significant consumer spending is through aggressive lending to borrowers with low credit scores. Here is more evidence supporting that view.

In the chart above, we plot retail spending on appliances, furniture, and home improvement, or “home-related spending” (blue line) and spending on new autos (red line) from 1998 through 2014. We have highlighted the two major subprime lending booms we’ve seen in that period — the subprime mortgage lending boom from 2003 to 2006, and the subprime auto loan boom from 2010 to 2014. In order to be able to include 2014, we focus only on the first four months of each year."

Finfacts Feb 2014: American Plutonomy: Richest 5% account for almost 40% of consumer spending

Moritz Kraemer of Standard & Poor’s concluded in his report: "In our view, the sheer scale of the ramp-up in debt ratios in many periphery nations even from 2006 levels and the relatively minor reversal since the peak strongly suggest that the deleveraging process has only just begun. While for Portugal, Spain, Greece, Italy, Ireland, and Slovenia, debt as a share of GDP increased by an average 106 percentage points of GDP between early 2006 and the peak quarter in 2013, the ratio has decreased by only 3 percentage points of GDP from that peak. The disparity between these two figures signals in our view the slow progress that has been made in the periphery in bringing down combined private and public leverage, even assuming nominal GDP growth (the denominator in this equation) will perform better in the future than it has since 2006.

Accordingly, we expect that the already fragile economic recovery in the eurozone is likely to remain subdued. Moreover, if recovery expectations disappoint, we think this could exacerbate political polarization and thus pose an increasing threat to sustaining growth-enhancing, but often unpopular, reforms. We have observed rising public discontent, most recently evidenced by many voters opting for Eurosceptic parties in the May 2014 European parliamentary elections.

Without a swifter economic recovery and growth in employment, we think popular dissatisfaction could swell. Ultimately, though, growth will remain dependent on net export performance, as domestic demand will face continuous headwinds. Our sovereign ratings therefore reflect our cautious view on the eurozone's growth prospects over the medium term."

Bloomberg interview with Moritz Kraemer of Standard & Poor’s.

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