Asia should learn lessons from woes ravaging eurozone

By Paul Donovan , The Jakarta Post/Asia News Network

LONDON — The euro should not exist. In a perfect world (run by economists) the euro would never have been created. Sadly, however, the world is not perfect and it is run by politicians. The result is an entirely dysfunctional monetary union. The Spanish economy has youth unemployment approaching 50 percent. The Greek economy is in its fourth consecutive year of negative GDP growth and is likely to embark on a fifth year of negative growth later in 2012. Euro area countries have to share a common interest rate and a common exchange rate with Germany where unemployment is at a 20-year low and growth is positive if unspectacular at around 2.5 percent. This is an unworkable situation. What Greece needs is very different from what Germany needs.

Will the Euro Break Up? We must hope not. The consequences would be devastating (a weak country could see its economy halve in size on exit). The social unrest we have today is minor compared to what could take place if the euro were to fragment. As the euro was essentially a political creation, it must be political will that keeps it together and it would be wrong to underestimate that political will. So what will happen? Because so much rests on political decision-making, the path for the euro area is hard to determine. But it seems highly likely that there will be a recession this year. How bad that recession is depends on what happens to the banking sector. Euro area banks are increasingly reluctant to lend money and with all the risks that they have been through over the last six months, this is hardly a surprise. Slower bank lending growth will hit some economies particularly hard. Fiscal austerity is being urged by Germany. In the wake of France’s downgrade (and with the UK outside the euro and unlikely to ever join) it is Germany’s voice that is loudest in setting the euro policy agenda. When the slowing credit creation is combined with further fiscal austerity, the consequence is likely to be negative GDP growth. Not all countries will be negative, of course, but Italy, France and Spain all seem likely to see a drop in economic activity. So why do the convulsions of the euro area matter to Asia? There are three reasons why Asian companies and investors need to follow the euro drama.