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Monday, June 16, 2003

Rising Angst in Euroland

Stephen Roach has been visiting Europe, and is getting extremely pessimistic:

It’s been an extraordinary time to be in Europe these past two weeks. After visiting 12 cities in 9 working days, my European straw poll speaks of nothing but angst over the pitfalls of a dysfunctional global economy. Europeans freely admit that their economic model is in serious trouble -- that their economy has all but abdicated its role as an engine of global growth. Nor do they see any real possibility of an overhaul at any point in the foreseeable future. But Europe also feels it is getting blamed for more than its fair share of the world’s problems. Everywhere I go I hear complaints that two other culprits are being let off the hook -- America, for its worrisome twin deficits, and China, for its “unfair” currency peg and. Resentments are building in Europe that may even make it even harder for the world to pull together and come up with a collective fix.

There is no getting around the sad state of the European economy. The data flow from the big continental economies -- Germany, France, and Italy -- point to the emergence of recession-like conditions this spring. Moreover, this downside tilt predates the impacts of the strengthening euro, which will undoubtedly crimp export growth. For a region lacking in internal demand, that could well be the coup de grace. Germany is clearly the weakest link in the chain, yet Europe’s policies are ill-equipped to deal with this serious asymmetrical shock. Although the ECB has now slashed its policy rate to 2.0%, Germany’s 0.8% core inflation rate implies that real short-term rates in Euroland’s biggest economy are still a positive 1.2%. By contrast, with core inflation an estimated 2.4% elsewhere in Euroland, that means real short rates are a negative 0.4% in the non-German portion of the region. That underscores the ultimate inconsistency of Euroland’s monetary policy: Policy is most restrictive in the country that is most vulnerable (Germany) and most stimulative in nations that are in the best relative shape. Such are the pitfalls of an increasingly dysfunctional United States of Europe.
Source: Morgan Stanley Global Economic Forum

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