The Long Depression: The Slump of 2008 to 2031
By Matthew Lynn
The single currency has turned into one of the greatest economic policy mistakes of all time, an episode in political folly that will be studied by historians for generations to come. Rather like the First World War, it will be hard looking back for anyone to understand how such a monumental and pointless blunder could be allowed to happen, and how, once it started, it was so hard to find a way of stopping it reaching its grisly conclusion. Because, in truth, it is going to be very hard to split up the euro without imposing terrible costs on the entire world economy.
There are two big issues. The first is the huge amount of political capital invested in the euro. Three generations of politicians have dedicated their careers to creating an ‘ever closer union’ between the countries of Europe. In the EU, a massive bureaucracy and government structure has been created. It knows that dismembering the euro will be a fatal blow to the project – and to their own jobs.
The second is that breaking up the euro will be catastrophic for Germany, at least in the short-term. An artificially low exchange rate has turned Germany into an export machine. It exports almost as much stuff as China. But a new deutschemark would soar in value, laying waste to much of German industry. Whilst the peripheral countries would recover quite fast, with devalued currencies, Germany would go into a terrifying slump.
The result? While you could take the euro apart fairly simply if you planned it in advance, and everyone co-operated, the resistance from the EU bureaucracy and national governments means a disorderly break-up is far more likely. How will it happen? No one quite knows.
But it looks as if the break-up will be sudden, chaotic, and dramatic. That will be a disaster. The break-up of the euro will make the crash of 2008 look like a mere hiccup- at least in the short-term.
What kind of figures can we put on the disaster? GDP may slump 20% to 30% in a single year, a depression not seen since the 1930s.
The rest of the world will be hit almost as hard.
When the euro splits apart, money will flee from Europe into the dollar and yen, and to a lesser extent sterling. The UK will suffer a huge shock as the pound jumps in value, and its main export market collapses. The coalition government may well fracture as the economy goes into its third recession in five years.
It is foolish to think that the currency of the world’s largest economic block can chaotically break apart with anything other than a calamitous impact on the financial markets and global trade.
There have been many telling criticisms of GDP. It doesn't measure quality very well: the mobile phone you buy today for £50 for example is a lot better than the one you paid the same money for five years ago. It doesn't capture all the unpaid work that parents and other carers do. It pays no attention to the environment, or to how satisfied we are with our lives. Those are all perfectly reasonable criticisms. But perhaps the most telling is that it pays no attention to debt.
It may seem like we are in a recession now. But in fact we have been in a recession since the start of the new century, and arguably since the 1970s. It was just that we disguised it by borrowing more and more.
The debt has now reached its limits. First of all we ramped up personal debts, and when that crashed in 2008, we ramped up government debt instead. Now there is nothing left to leverage.
The argument of this essay is that three linked but separate crises have come together to produce what is going to turn into a long period of stagnation. So, this is going to be a Long Recession, much like the years between 1873 and 1896.
Yet by 2012 it is surely clear that the crash of 2008 was no ordinary recession, nor even a replay of the 1930s, but something far more serious. It was the start of a prolonged downturn, and it is going to be many, many years before the excesses of the past can be purged from the system and before the mistakes of the previous two decades can be put right.
The dollar can no longer support the weight that the world puts upon it. Year-on-year the dollar continues its slow-motion decline.
As already argued, once the dollar drops below 50% of central bank holdings, we can officially declare that its days as the reserve currency are done. It looks like that will happen sometime between 2015 and 2020, but it could well be sooner.
The journey to a new monetary system is likely to be long and painful. There is no simple alternative, and yet what we have now clearly isn't working. Once a new system is agreed, the global economy will have a new anchor. It will be more stable, and should be able to start growing faster again. But it may take a decade or more to get there. *
It is all going to take a long time. One reason is that each task is intrinsically difficult – getting into debt, as most of us know from out own experience, is a lot easier and a lot more fun than getting out of it.
The euro will be gone by 2015. A new global reserve currency to replace the dollar will have emerged by 2020. And the debt crisis will have been resolved by 2030.
As the euro descends into chaos, don't be surprised if vicious, extremist conspiracy theories, which are such a large part of the continent’s past, come back to the fore.
The argument of this essay is that the depression will be a long one. The depression of the 1930s, severe though it was, was relatively short: a painful sprint across hot burning coals. This will be more like a mountain trek: an aching, at times unending struggle against terrible odds. It will shape the perceptions and attitudes of a whole generation. The assumption of easy growth, of rising living standards, of affluence with little effort that most people in adulthood today grew up with will quickly disappear. The culture will change with it.
The depression will end eventually…but from the vantage point of 2012, that moment is a long way away.