El-Erian Warns About Europe’s Fake Normal

Posted by Mohamed El-Erian - Pimco

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August is traditionally Europe’s holiday month, with many government officials taking several weeks off. In the process, important initiatives are put on hold until the “great return” at the beginning of September.

 

Yet no one should be fooled. This summer’s sense of normality is neither natural nor necessarily tenable in the long term. It is the result of temporary and – if Europe is not attentive – potentially reversible factors. If officials do not return quickly to addressing economic challenges in a more comprehensive manner, the current calm may give way to renewed turmoil.

 

First, joblessness continues to spread. The overall unemployment rate (12%) has yet to peak, led by an alarming lack of jobs among the young (24% joblessness in the eurozone as a whole, with highs of 59% and 56% in Greece and Spain, respectively).

 

Second, adjustment fatigue is widespread and becoming more acute.Long-struggling European citizens – especially the long-term unemployed – have yet to gain any sustained benefit from the austerity measures to which they have been subjected. And the result is not just general disappointment and worrisome social unrest. In the last few weeks, political stability in Greece and Portugal has been threatened as governments struggle with declining credibility and a rising popular backlash.

 

Third, bailout fatigue is apparent. Citizens in the stronger European economies are increasingly unwilling to provide financial support to their struggling neighbors; and their elected representatives will find it hard to ignore growing resentment of repeated diversion of national tax revenues, which has yielded only disappointing outcomes. Meanwhile, high levels of past exposure and weakening creditor coordination are undermining the availability of external funding, including from the International Monetary Fund.

 

Finally, little oxygen is flowing to the private sector. While Europe has succeeded in stabilizing its sovereign-bond markets, financial intermediation for small and medium-size enterprises remains highly disrupted. With most credit pipelines already partly blocked, the shortage of corporate credit will become more severe as regulators finally force banks to embark on a proper mobilization of prudential capital and shrink balance sheets to less risky levels.

 

 

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