On 24 July, the euro closed at 1.206 against the dollar, having come down from around 1.345 on 28 February 2012. On 26 July, Mario Draghi, president of the European Central Bank, made a famous speech in London. He promised to do all that it takes to save the euro and urged all of us to believe that he could and would do so. In hindsight, many have chosen to believe him. The euro closed at 1.332 on 18 January 2013. Clearly, many in the world love the euro and want it to stay alive. They range from central banks in Europe, Switzerland and the Scandinavian countries, to oil exporters. The Swiss and the Scandinavians see a lion’s share of their exports go to the euro zone and do not want to lose them to stronger currencies. Oil and gas exporters from South America to Russia to the Persian Gulf want an alternative to the dollar. America’s love for dictators and fundamentalists can be fickle. They want to diversify their petrodollar earnings. Exporters from Asia do not want to hand over their competitive advantage on a platter to Germany. Hence, they do not want the euro to weaken against their currencies. Evidently, all of them have succeeded in their goals in the last six months. What of the euro zone itself?
The euro zone manufacturing purchasing managers’ index (PMI) for June stood at 45.1 and has since “improved” to 46.1. A value of the PMI below 50 indicates contraction in the manufacturing sector. The unemployment rate in the euro zone has gone up from 11.1% in May to 11.8% in November. Output in the Netherlands, Finland and Italy is contracting. These countries are in recession. Germany may join them soon. What has Draghi achieved? Not much for the euro zone economies, as far as we can tell.
Mohamed El-Erian, chief investment officer of the world’s largest private sector bond manager Pimco, wrote in the Financial Times on 7 January 2013, that several asset classes had highly manipulated prices due to central bank activities.
However, instead of sounding cautious and concerned about the false sanguine signals coming from low market volatility and asset price stability, many commentators are repeating the mistake they committed only all-too-recently in 2007.
That is, they are ignoring the Minsky rule that stability presages instability. With euro zone unemployment spiking and growth contracting, periods of quiet in the marketplace and faux currency strength must be causes for alarm and not congratulation. The strength of the euro proved to be the last straw for many countries in the euro zone in 2007 and it might be no different this time.
In Spain, the unemployment rate stood at 22.85% at the end of 2011 and it is expected to have spiked to 26% when fourth-quarter numbers for 2012 are released on Thursday. In fact, Spain continues to be psychologically and economically bogged down by the crisis. Real estate prices are low and one can see way too many se alquila (for rent) and se vende (for sale) signs on commercial and residential property across the country, especially in Madrid. The worst affected after the construction industry is the service sector. Middle and lower income groups are the worst affected. Employment exchanges are of little use and the youth (especially daily wagers) is resorting to alternative ways to look for employment. Some sit in busy streets with signs requesting employment; others distribute their CVs to passers-by. Fresh graduates are kept as trainees with little or no pay for longer than usual by firms that cannot afford to pay them on par with the permanent staff. Most students are thus passing through a bad time psychologically, with no jobs or underpaid jobs, thus having to move back in with their parents. According to a survey by the Centro de Investigaciones Sociológicas (CIS), 61% of all those unemployed said that they would be unlikely to secure employment even in 2013.
On the positive side, bank deposits by firms and households increased in November. However, this is to a large extent attributed to the transfer of investments from bonds to savings accounts, not to an increase in incomes. Also, even though there is a net foreign institutional investor outflow for the year, the last two months of the year show a net inflow. Thus, while there may be some economic cause for optimism, the psychological pessimism will be harder to evict from the minds of the Spanish people.
With Japan all set to adopt a formal inflation target of 2% (with potentially disastrous consequences), the euro’s strength will prove to be a serious liability for the euro zone. The world needs an alternative to the dollar. But that cannot be another fiat currency.
V. Anantha Nageswaran is the cofounder of Aavishkaar Venture Fund and Takshashila Institution. Comments are welcome at baretalk@ livemint.com.
Aparna Bhat, a graduate student at the Instituto de Empresa, Madrid, contributed to this column.
To read V. Anantha Nageswaran’s previous columns, go to www.livemint.com/baretalk