Against EFSF? Really?

Estonia's parliament will vote on expanding the powers of EFSF tomorrow together with Germany. As always media and politics have managed to develop a circus out of the discussion preceeding the vote. Polls show that Estonian people are mostly against expanding EFSF (also those supporting our current right-liberal government). Some of the people shout out arguments like "Greece should go bankrupt" or "Why do we have to feed banks". This was followed by a statement from our centre (populist) opposition party that they also don't support joining the EFSF probably hoping to get some votes. Since people are getting very emotional on this subject I will lay out some most important facts about EFSF. (Check these out yourself HERE)

1) First and foremost - EFSF was created with an intention to preserve financial stability in the eurozone by providing temporary financial assistance to governments or banks in difficulty. In other words it is supposed to AVOID crises like we are in now.
2) EFSF finances itself by issuing bonds that are guaranteed by all 17 eurozone countries up to 440 billion euros. Countries participating in EFSF do not pay any additional funds to EFSF, it is backed by guarantees.
3) EFSF is only a temporary measure to handle the current crisis and its permanent follower will be ESM or European Stabilisation Mechanism.

Q: What happens if a country doesn't participate in the EFSF?
A: There's a risk that other countries don't want to particpate as well, who will finance the EFSF then?

Q: Why do we need EFSF at all?
A: To avoid uncontrolled bankruptcies of banks and countries

Q: Why do we need to avoid their bankruptcies if they have overspent?
A: Since if we don't borrowing costs for countries like Italy, Spain, France, Belgium etc will rise significantly leading to other bankruptcies. Banking system as we know it might fall because of the losses that these banks will have (the banks are holding the bonds that are worthless after a bankruptcy of a country). There will be no more euro.

Q: What happens if euro goes?
A: Countries like Germany, Estonia, Finland, Netherlands etc that are financially sound will get currencies that will rise significantly in value causing our exports to fall greatly (it is then more expensive for other countries to buy our products). This will bring massive unemployment and loss in economic welfare. It has been estimated that the effects of such an event would lead to 20-40% fall in GDP in first year. For countries like Spain, Italy and Greece this might even leed to civil war since their currency would devalue so greatly that the people of these countries are unable to pay off their loans. There would be massive unemployment since there is no funding for investments (who would borrow to a bankrupt country in civil war?). GDP of these countries could even fall 50% or more. (Analysis is done by UBS).

The total loss of these events will surpass trillions of euros (if you look at European GDP of about 12 trillion EUR). The countries going through tough austerity measures including budget cuts and reforms will hopefully turn to growth in a couple of years. It is not like regular people of these countries aren't suffering enough already. Hasn't Europe learned anything from its history just 70 years ago? It's not like we are not on the edge of a cliff..

Europe needs a vision, not just doing something

Imagine a football match without goals and goalkeepers, everybody are just trotting around anxiously. Imagine a ship on the sea without a compass or any other navigation system. Imagine a doctor treating you for symptoms even though you haven't agreed that you want to get better. This is what Europe is doing right now with the eurozone crisis.

In strategic management a vision is defined as the way an organization should look like in the future, what is the state of things. In the same manner we could (and most definitely should!) have a vision for Europe. What is the future of Europe? Do we want an economic union, a political union or even more integrated Europe? If we knew that it would be awfully easy to find a solution for the crisis.

If we wanted tight economic cooperation amongst countries we should let Greece suffer for their own overspending and throw them out of the euro. If we wanted United States of Europe we should introduce bazookas like eurobonds or unlimited supply of liquidity, bond buying and loans from ECB.

A clear vision of Europe is making it so difficult to find a solution to the crisis since everybody has their own vision for Europe. Again - imagine a football match where everybody would have their own rules for the game.. It is not too late yet. Even though the project of Europe should have began with a common understanding of the ultimate goal, it is not too late to agree upon one right now. The markets don't need a bazooka per se, they need a clear understanding of how Europe is going to tackle the crisis.

Another recession coming up in Europe?

There has been a lot of talk about another possible recession that the world could face. Focus on debt and spending isn't helping since government spending also contributes to economic growth. Following chart presents real economic growth (adjusted with inflation) on a quarterly basis (compared with previous quarter) in the biggest economies in Europe (also for comparison purposes EU27 and eurozone countries in average)

As can be seen from the chart the sudden slowdown occured in the second quarter of current year in all countries at the same time which is remarkable. It can also be seen that sudden slowdown occured again in the final quarter of 2010. The effects of the previous slowdown was thought to be related with extreme weather conditions in northern Europe. This shows that small things (or extraordinary) can have a big effect on economic growth - considering that it is already fragile due to the recent (and still ongoing) financial crisis.

The following chart presents real economic growth on an annual basis (GDP value of current quarter vs GDP value of the same quarter last year - this methodology is not used by major statistics departments which calculate annual growth by multiplying current quarter growth by 4).

From this chart it can be seen that growth indeed has slowed considerably but there is no reason for panic. Previous recession was followed by a quick recovery and the growth has slowed. Whether we will go into negative territory we will find out in October-November.

Couple of more things have to be taken into account. Second quarter numbers obviously include the effects of Japanese nuclear disaster in March and since the whole supply line of major industries was disrupted some of the growth might have just gone there. Also European Central Bank has risen interest rates already twice this year which definitely has a negative effect as well. Cutting of budget deficits isn't helping.

We might see a bounce in economic numbers if some of the weak growth was caused indeed by the Japanese disaster. We might also see ECB lowering rates if weak growth continues and in addition to that some additional measures by the Bank of England (monetary stimulus). All in all I am pretty confident that we will not see a bad recession coming just now.