Conflict in Europe

Throughout the whole month of October attention has been centered in Europe due to the dispute between Germany’s posture, whom from its seat as the biggest and most solid European economy is pressuring in favor of austerity in spending and budget deficit control as previous conditions for a sustained growth; and against that of the European Central Bank officers who advocate for control policies, but those that are also oriented towards promoting growth and increased employment. This is a position which is partially aligned with the governments of France and Italy who already announced that their 2015 budgets’ deficits would not be reduced by the percentages defined by the European Union, since reduction in infrastructure investments and social projects would disturb the possibility of economic growth, on one hand, and would also create additional social imbalances that would allow the irruption of extremist and ultranationalist tendencies in their respective nations’ political arena. These are the so called “no austerity budgets” designed to reduce deficits in a less rapid fashion than those proposed by the extreme austerity promoters.

The period of dominance of Germany’s austerity thesis seems to be ending in Europe. Germany itself shows signs of lowering growth. The International Monetary Fund has reduced its (already low) 1.1% growth prediction to 0.8% for this year, and warns of the Eurozone’s (the 18 Euro countries) risk of falling into a third recession in 5 years. The F.M.I. Director has said that “The Eurozone is stuck in slow growth” and invites Germany to increase its public expenditure and imports from the rest of Europe to stimulate the economy of all of Europe. One of Germany’s most respected economists, Marcel Fratszcher, in his selective circulation book, criticizes his government for infrastructure investment reduction and lack of stimulus for the private sector, since this stops salary rises and increased consumer spending, as well as the mistake of the big German companies in directing their investments towards Eastern Europe, Asia and the United States, in detriment of making investments in the Euro zone.

As the month closes German officers seem attached to having their own budget very balanced; they seem willing to increase their motorway infrastructure expenditures, but not to support similar expenditures in countries like France and Italy, who, under German criteria, lack real resources to do so. The Germans say that if they have been able to tighten their belts (in social expenditures) and grow, the others should also do it. The Dutch, the Scandinavians (Sweden, Finland and Norway) and the three Baltic countries are on Germany’s side.

These clashes between Europe’s fiscal and monetary policies have direct repercussions not only in European stock markets, but also in the world’s. With slow economic growth, the European companies have little or no earnings. If this situation worsens, a deflation could occur, in which the lowering prices of articles and salaries would fall into a feedback loop that would be hard to counter. In such a scenario, governments would see their tax income diminish, since a declining economic activity makes for lower tax collection and they would not be able to honor interest and principal payments of sovereign bonds, and corporate shares would lose a big part of their value.

Economics Nobel Laureate Paul Krugman, has said that it is hard to understand why Europe, having as a mirror the Japanese recession which has lasted more than a decade, in which Japan fell because its fiscal and monetary authorities reacted too slow to stop deflation and then too fast in increasing interest at the first sign of recuperation, can be destroying its economic recuperation possibilities after the Great Recession of 2008 with its fiscal austerity policies on the one hand and monetary, of excessive worrying about an inflation flare up, on the other. Meanwhile, interest rates for credits go up in Europe, as well as the interests demanded by investors in Sovereign Bonds.

In the middle of this scenario, the European stock exchanges had strong falls during the middle of the month, from which they recuperated a few days later, thanks to the good news about the United States economic performance. As the month closes, the Madrid and Milan indexes are falling with a 3% average. London has no important variation. The United States continues showing a positive trend: its main indexes display monthly increases over 3%, as do the Asian indexes. In Brazil, the end of the political campaign brought tranquility to the market and the main index closed with a 3.3% improvement in October. On the other hand, the European banks “Stress Test” has sent signals that are still being analyzed by the investors. The determination which is sought is if after the Euro Crisis of 2012, the banks, or better, which banks are viable and which will need fresh capital investments to be in a situation to withstand another crisis, without failing.

Ultimately, only the European situation generates uncertainty. The entry of a new managing team to the European Commission (the executive arm of the European Union) at the end of the month must bring some definition into the system. Will the European Central Bank begin injecting money into the system through sovereign and private bond acquisition? Will the European commission accept that France, Italy and other peripheral countries delay their budgetary adjustment programs? Will there be an open struggle between German austerity and its Scandinavian and Baltic allies versus the flexibility and stimulus policies towards the stagnant countries in the Eurozone? Before the end of the year this riddle can be cleared up. It’s no exaggeration to say that the future of Europe depends on how this conflict is resolved.

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