Wednesday, April 11, 2012

Is Europe in a Depression?!

The other day I read in the Business Times an interview with 4 quite notable investment managers. Kenneth Courtis, a former vice-chairman of Goldman Sachs and co-founder of Themes Investment Management, gave a quite striking remark on the situation in Europe:

“Large swathes of the eurozone are already in recession now, and its southern tier – Greece, Spain, Portugal, as well as Ireland – are in outright depressions
Link to the article

My instant reaction was: holy cow! I’ve been following the situation in Europe as you can see in my previous posts, but never even thought about it as drastic as a depression. I’ve always thought about depressions as a thing of the past, like a pre-WW II kind of event that would never happen in my lifetime (I don’t expect to live that long). At first, I thought he was just being airy and bold, after all, this was an interview and these guys will use the interview as a marketing tool.

But as I thought about it more and more, I realized that there was no way that Europe would NOT enter a depression.

When a country goes into a recession, it usually has two ways to dig itself out of the hole: fiscal tightening or monetary easing/devaluation of their currency. The former is in fact the more responsible way to do it, but is also both politically and socially tough. So most countries will choose the latter since it’s just easier to explain to the people that they’ll get to keep their jobs rather than cutting the budget. Even though monetary easing will end up hurting people’s pockets all the same through inflation, it’s a delayed process that’s easier on people – biggest example is what’s going on in the USA right now.

In the case of Europe, the countries can’t exercise independent monetary policy, so they have no choice but to go the route of fiscal tightening. Thus you see the high unemployment rates, budget cuts, etc in Europe (eg >20% unemployment in Spain), whereas in the USA you see unemployment rates easing downwards and a much more optimistic view of the economy.

If the Europeans choose to keep the Euro and the European Union intact which they seem quite intent on doing, many of the problematic countries will undoubtedly slip into not just recession, but depression. The EU may get saved, but the people will suffer for it. 

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