Charlemagne

Danger ahead for the mighty euro

Euro-zone economies face external woes and internal tensions

AT THE World Economic Forum in Davos in January 2001, the mood was sombre. The dotcom bubble had burst spectacularly, the Nasdaq stockmarket had crashed, and the American economy was tipping into recession. Yet most continental Europeans were breezily optimistic. The long years of being lectured about their inadequacies by the Anglo-Saxons were over. Europe had wisely skipped the dotcom mania, and its new currency, the euro, was giving the continent a boost. Some Europeans even dreamed of taking over as the motor of the world economy. But it was not to be, as Europe promptly fell into a deeper recession even than America.

Seven years on, the parallels are uncanny. Continental Europe has sensibly avoided America's subprime follies, it is argued. Its banks are in better shape, average euro-area unemployment of 7.1% is the lowest in almost 20 years, the euro is resurgent and, as Joaquín Almunia, the engaging European economics commissioner, insists, there is no sign of a recession. The commission will trim its forecasts later this month, but euro-area growth is likely to stay close to 2% this year. It is true that the European Central Bank (ECB) in Frankfurt has, like America's Federal Reserve, flooded the financial system with liquidity in response to the credit crunch. But unlike the Fed, it has not so far felt the need to bring down interest rates.

ust as in 2001, however, the outlook for the euro area seems to be deteriorating a lot faster than the optimists had expected. After all, the main reason that the ECB has been reluctant to cut rates is not because growth is so robust but because inflation has picked up to 3.5%—the highest in the euro's nine-year existence. Troubles in the region's two biggest export markets—recession in America and slowdown in Britain—are starting to bite. Exports to Asia have been strong, especially from Germany, but in most countries nervous consumers remain reluctant to spend.

And two bigger worries have emerged. The first is the strength of the euro. A weaker dollar is driving an American export boom; a stronger euro is likely to have the opposite effect in Europe. Mr Almunia says the euro is “overvalued” and adds that, although the impact has been moderate so far, “we are at the limits, if not beyond them.” It is a delusion to suppose that euro-area exports can continue to barrel on regardless of their cost.

The second worry is the housing market. Europe may have avoided the American subprime mess, but in several countries house prices have been even bubblier than in America. They are already falling in Spain and Ireland, and, beyond the euro zone, are starting to do so in Britain. A property bust may not produce an American-style mortgage meltdown, but it will surely topple economies heavily dependent on construction (which accounts for 15% or more of Spanish and Irish GDP, for example).

Indeed, Mr Almunia's home country of Spain appears especially vulnerable. He maintains that Anglo-Saxon commentators are excessively pessimistic about Spain's prospects. But the signs of a sharp slowdown are clear even to the re-elected prime minister, José Luis Rodríguez Zapatero, who has announced a fiscal stimulus to help Spain weather the “turbulence”. Given that Spain has in recent years accounted for a big chunk of euro-zone growth and close to half of all jobs created in the euro area, its slowdown will be widely felt. And not just in economics. It will be a lot harder to sell the EU's ambitious plans to cut CO2 emissions in a faltering economy, for instance.

The political fallout will be felt in other ways too, because of the differential performance of euro-area economies. Mr Almunia admits that France and Italy are a lot weaker than Germany; soon enough, French and Italian leaders (especially if Silvio Berlusconi wins Italy's imminent election) will squeal ever more loudly about the euro's strength, the ECB's rigid monetary policy and, quite possibly, will demand that their industries be protected from “unfair” competition. Such pressure will be resisted by the Germans, who remain comfortable with the euro's strength and always hate criticism of the ECB.

The dark face of success

Even critics of the euro would concede that it has had considerable success, establishing itself in less than a decade as a genuine rival to the dollar as a world currency. But that success disguises two failings. The first is that some countries have adapted a lot better to the discipline of the euro than others. Germany and the Netherlands have cut labour costs and introduced enough reforms to make their economies more competitive. France, Spain and especially Italy have done less—and are suffering more, from both the euro's rise and the global slowdown.

The second failing is an ironic flipside of success. To qualify for the euro in the late 1990s, countries such as Italy and Spain had to make swingeing fiscal and structural adjustments. Yet by shielding weaker countries from a currency crisis, the euro now relieves much of the pressure on them to keep up reforms. In fact, these are more essential than ever now that countries have lost the option of devaluing their currencies to regain competitiveness and offset relatively slow productivity growth. As Mr Almunia sadly concedes, it has proved impossible “to compensate for the lack of market incentives for reform through policy co-ordination and peer pressure”.

In truth, as the euro approaches its tenth birthday celebrations, it is facing the biggest test of its short life. If Europe follows America into recession, which is quite possible, the pain will be a lot greater in the Mediterranean countries than in Germany and northern Europe. Not surprisingly, the political response from the two regions will also be quite different. Even as it prepares to expand once more to take in Slovakia and later other countries from eastern Europe, the euro is about to show the world that it is not yet an optimal currency area—and the demonstration may not be a pretty one.

Politics this week

General David Petraeus, the commander of American forces in Iraq, and Ryan Crocker, America's ambassador in Baghdad, provided Congress with an update on the progress of the war. Both men emphasised the achievements in reducing violence, but General Petraeus said that the gains were “fragile and reversible”. He recommended that troop levels be maintained at around 140,000 once the withdrawal of 30,000 troops sent to Iraq in a “surge” operation is completed in July. See article

In a renewed flare-up of violence, at least 73 people died in Sadr City, in eastern Baghdad, as American and Iraqi troops continued to fight Shia militias; 15 Americans were killed in the same period.

Hillary Clinton, John McCain and Barack Obama all got their chance to question General Petraeus in Senate committee hearings. The event was a welcome distraction for Mrs Clinton in particular, who earlier sacked her chief campaign strategist, Mark Penn, for talking privately to Colombian officials about a free-trade deal that she opposes. Mr Penn has also come in for much criticism for his handling of Mrs Clinton's presidential bid.

Seizing the moment, George Bush decided to send the Colombian free-trade pact to Congress for approval. Colombia and the United States signed the agreement in November 2006; with the Democrats opposed, its passage is far from certain. See article

Michael Bloomberg's proposal for a congestion charge in Manhattan collapsed when the Democrats decided not to support it. New York's mayor wanted drivers to pay $8 to enter a busy zone in Manhattan as part of an effort to ease congestion and reduce the city's emissions, but the plan was opposed by politicians in New York's other boroughs.

Authorities in Texas carried out a raid on the ranch of a polygamist religious sect 160 miles north-west of San Antonio after reports of child abuse and forced marriages. More than 400 children and 130 women were removed and the premises searched. See article

Liberty, equality. Fraternity?

Kosovo moved its recently declared independence forward when its parliament adopted a new constitution. The document protects the rights of Kosovo's minorities, including Serbs. Serbia called the charter an illegal act.

Vandals desecrated 148 Muslim graves at a French cemetery for soldiers who fought in the first world war. Some 78,000 men from French colonies died in the war, many from Algeria and Tunisia. Neo-Nazis daubed swastikas on Muslim graves at the site last year.

A new Olympic sport

Getty Images

London, Paris and San Francisco saw protests against the Beijing Olympic Torch Relay by pro-Tibetan demonstrators. In London 37 people were arrested, the flame had to be extinguished in Paris, and San Francisco changed the route of its ceremony. China resisted calls to curtail the global relay and to rethink plans to send the torch through Tibet itself. See article

A suicide-bomb attack at the start of a marathon race in Sri Lanka killed 14 people, including the highways minister and some of the country's star athletes. The attack, blamed on the Tamil Tigers, also injured more than 90 people.

The ruling junta in Myanmar announced that a referendum on a draft new constitution would be held on May 10th. It published the draft for the first time, confirming expectations that it will entrench military rule despite allowing limited multiparty elections in 2010. See article

Fifty-four Burmese migrants died after suffocating in a lorry smuggling them into Thailand. They had been packed into an airtight container for the journey.

Ahead of elections on April 10th, Nepal was scarred by violence. In one of the most serious incidents, seven Maoist activists were shot dead by security forces. See article

Hunger pains

In Haiti, a hungry mob tried to storm the presidential palace in the capital, Port-au-Prince, in continuing protests over soaring food prices. UN troops fired rubber bullets and tear gas to disperse them.

France called off a humanitarian mission to Colombia to secure the release of Ingrid Betancourt, a French-Colombian politician, after the FARC rebels who are holding her hostage said they would not allow the delivery of emergency medical aid.

Ecuador's top four military commanders resigned after President Rafael Correa accused the army of aiding the United States in operations against the FARC. The resignations came hours after Ecuador's defence minister stepped down without explanation.

Four members of an army death squad in Peru were convicted of the murder in 1992 of nine students and a professor suspected of links with Maoist rebels. The verdict is likely to affect the trial of Alberto Fujimori, a former president, who is accused of authorising the death squad.

Presidential ambition

Twelve days after Zimbabwe's presidential election, results had yet to be officially declared, though most independent analysts presumed that President Robert Mugabe had lost to Morgan Tsvangirai and that the incumbent's hardline supporters were trying to enforce a run-off. After regional leaders failed to persuade Mr Mugabe to step down, Zambia called an emergency meeting of the Southern African Development Community, which it chairs. See article

Violence erupted in Kenya again after talks broke down between President Mwai Kibaki and the opposition leader, Raila Odinga, over the distribution of ministries in a power-sharing government. Mr Odinga had rejected the results of an election in December that most observers thought was rigged in favour of the incumbent, Mr Kibaki. See article

Tension between Israel and the Palestinian authorities in the Gaza Strip rose after two Palestinian militants attacked the Nahal Oz border crossing, where fuel is carried from Israel into the strip, killing two Israelis. Two Palestinian fighters and at least two Palestinian civilians were killed by Israeli counter-strikes.

Reuters

India hosted the first India-Africa summit, with 14 African leaders attending. The event reflected India's growing commercial interest in Africa; it was also deemed an attempt to counter the growing influence of China in the continent. See article

The coming days

The week ahead

The pope goes to America, and other news

• VOTING in Italy's general election concludes in the afternoon on Monday April 14th. The main candidates of the right and left, Silvio Berlusconi and Walter Veltroni, have been doing much to downplay the chances of a post-ballot deal. But Italy's messy electoral law means that neither may be able to govern even after securing a majority of votes cast. Monday could bring a clear victory and a new leader for Italy or chaos followed by an uncomfortable compromise.

For background see article

• THE pope arrives in America for his first official visit on Tuesday April 15th. During his five-day trip he is expected to address sensitive topics in his public speeches, such as the child-abuse scandal that has riven the Catholic church. But the Vatican has not revealed what he will actually say; American conservatives (not all of them Catholic) hope to claim the pope as one of their own, but those of a leftish persuasion hope he might note the church’s opposition to the war in Iraq during his speech to the UN, or its critical view of unfettered capitalism.

• INTEREST in the Democratic campaign to find a nominee to seek election as president will pick up again with a debate televised from Philadelphia on Wednesday April 16th. Hillary Clinton and Barack Obama will try to squeeze whatever advantage they can from the event before an important Pennsylvania primary on April 22nd. Expect lots of sparring over free-trade agreements, ex-pastors and tax returns.

For background see article

• HOLLYWOOD, striving to get over the effects of a three-month strike by writers that ended in February, faces fresh industrial action that could bring productions to a standstill once again in Tinseltown. The Screen Actors Guild, the main union representing the “talent” begins negotiations over a new three-year contract with the film and television bargaining body on Tuesday April 15th. The old contract expires at the end of June and studios are already nervous about starting to shoot films that could remain unfinished during a protracted stoppage.