As an economist, it’s hard to look at the financial news coming out of Europe recently and not get a sense of déjà vu. In the last few weeks we have witnessed the most severe stock market crashes since the post-Lehman meltdown, a major European bank has needed to be bailed out, the recovery appears to have petered out (on both sides of the Atlantic no less) and frantic discussions are taking place in the upper echelons of power in order to starve off what many believe is another imminent disaster. I don’t want to sound nostalgic but it sure is feeling like the summer of 2008, this time with Europe rather than Wall Street at the center of the gathering storm.
But it’s time to stop and think for a minute. How did we get from a debt crisis in a peripheral member of the Eurozone, to openly contemplate the breakdown of the world’s biggest and most solid economic union? To answer this question, it is necessary to see the current European crisis from two separate angles. The first is through the simple logic of economic fundamentals of debt and growth. As I will try to prove in this post (and its follow ups), the fundamentals are actually not as dire as most people think. However, the second angle is indeed quite frightening. It is that of a market crisis, triggered by a loss of confidence in European policymakers’ ability to effectively address a series of worst case scenarios related to the integrity and future of the Eurozone. Will any of these scenarios actually play out? Only if markets believe they will, thus becoming a textbook case of a self-fulfilling prophecy of apocalyptic proportions. Because if there’s anything to be learned from economic history, it is that when reason and panic collide, panic will always win out.
What follows is my humble attempt at trying to put reason back into the spotlight. So put down the latest newspaper or magazine cover story on the Euro breaking apart, turn off that video with the ranting analyst preaching doom and gloom. Let’s look at the cold hard facts. Continue reading