Economic Outlook: For Europe, what next?

By ANTHONY HALL, United Press International  |  Jan. 22, 2013 at 9:48 AM
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It seems quiet in Europe these days -- too quiet, perhaps.

Some economists say that is, indeed, the case. The fear is European leaders have become tired of all those dramatic headlines, but that it is not yet time to stop pushing for further reforms to protect the euro.

Of course, there might be some backslapping in Davos, Switzerland, at the World Economic Forum. The economy in Greece remains in desperate shape, but the fear of default and of a disruptive exit from the eurozone has subsided. A series of bank stress tests, and a plan to shift regulatory oversight of the region's largest banks to the European Central Bank have calmed fears of a major calamity among financial firms.

Moreover, bank President Mario Draghi last year said the ECB would do whatever it takes to support the euro and the plan to do that appears to have stopped the sovereign debt crisis from spreading.

Spain and Italy, were literally leaning over the abyss, watching yields on government bonds climb to unsustainable levels. Greece, Portugal and Ireland had already tested the European Union's resolve. Spain and Italy would have been back-breakers.

But the to-do list for the European Union remains daunting in the extreme. The eurozone, The New York Times pointed out Monday, still has no depositor insurance that could prevent a run on a bank.

There is also need for a process for unwinding large banks if they begin to fail. And then there is the widespread recession that is a serious drag on the global economy and record unemployment rates that are hurting Europe on a local level.

Solving a economic downturn invariably sparks debate on debt versus stimulus and Europe is running a grand experiment with just that question on the table. Investor confidence should be rising now with governments putting their financial houses in order. But the more prevalent fear is that Europe is simply headed for deflation or stagnation, and that includes concerns that deflation is a very tough dynamic to correct.

The Nikkei 225 index in Tokyo has suddenly surged forward on the promise the new government will make a serious effort to stimulate the economy. It is too early to call that a success. But if the economy in Japan heats up, you can be sure Europe will take notice.

Here's the trick: Go to the racetrack and put $2 down on the fifth horse, no matter what the odds. If the horse loses, put $4 on the fifth horse in the second race. If that horse loses, put $8 down on the fifth horse in the next race. When the fifth horse eventually wins, the escalating bets guarantee that you've covered your losses.

Generally speaking, a strategy of economic stimulus works the same way, which is to say the only way to guarantee a loss is to quit before the fifth horse wins a race. If you quit early, then you've just thrown your money away with no hope of recouping losses.

On a much larger scale, that's exactly what was done in Japan, Europe and the United States. Providing economic stimulus was the first instinct around the world for keeping a slowing economy going.

Then, one by one, governments got cold feet. The results weren't fast enough or dramatic enough. Debts rose and stimulus efforts went from all the rage to last year's fashion.

One way to prove that a strategy of economic stimulus doesn't work is to stop making bets before you find a winner.

That's why it is much harder to prove that a stimulus package is doing well than it is to prove that it has flopped.

In international markets Tuesday, the Nikkei 225 index in Japan lost 0.35 percent while the Shanghai composite index in China fell 0.56 percent. The Hang Seng index in Hong Kong gained 0.29 percent while the Sensex in India slipped 0.6 percent.

The S&P/ASX 200 in Australia was flat, rising 0.03 percent.

In midday trading in Europe, the FTSE 100 index in Britain shed 0.09 percent while the DAX 30 in Germany gave up 0.62 percent. The CAC 40 in France lost 0.5 percent while the Stoxx Europe 600 shed 0.17 percent.

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