Column : Europes economic war of attrition

Written by Mohamed A El-Erian | Updated: Dec 5 2012, 07:18am hrs
I was nine years old when Egypt entered what became known as its war of attrition with Israel. During this period of no war and no peace, underlying tensions festered, and a fragile tranquillity was periodically interrupted by armed skirmishes.

The war of attrition followed the June 1967 war, in which Egyptto the immense surprise of most of its citizens and the outside worldwas soundly defeated. Its air force was crippled and its army was virtually overrun, with Israel capturing the entire Sinai Peninsula.

Positioned on the eastern bank of the Suez Canal, Israels army was just over 100 kilometres from Cairo. And, with Israeli jet fighters still controlling the airspace, Egypts capital and its major population centres were greatly exposed.

The official narrative reflected little of this. Whether on state television or in government-controlled newspapersat the time, there was no free press, Internet, or cable newscitizens were reassured that Egypt had regained control of its destiny. But they knew better.

To this day, I remember vividly the sense of general anxiety that prevailed among citizens, accentuated by deep concern about what the future might hold. People were afraid to invest, and many wondered whether they should emigrate in search of a better future.

With the underlying issues left unaddressed, the war of attrition was followed by another full-scale war in 1973one that again surprised most people inside and outside Egypt. This time, the Egyptian armed forces won a number of early battles and secured a cease-fire that regained part of the Sinai, setting the stage for the 1979 peace agreement with Israel.

I recount this history not to draw a parallel with todays Israeli-Palestinian conflict, which, just a couple of weeks ago, resulted in many civilian deaths, overwhelmingly in Gaza. Rather, it is because I see too many parallels with what is happening in the European debt crisis.

European citizensparticularly in peripheral economies such as Greece, Portugal and Spainare anxious. Unemployment is unacceptably high, and is still rising. Their economies continue to implode, leading to cumulative contractions that are setting tragic new records. Poverty is on the rise. Not surprisingly, increased emigration to the stronger eurozone countries (such as Germany) has been accompanied by higher outflows of financial capital.

Admittedly, and fortunately, the parallels are far from perfect. Europe does not have armed conflicts. Feelings of intense insecurity are not related to bombs and sirens. The threat is economic rather than military. Yet there is a real sense of no peace and no war.

Europes economic peace remains elusive for a simple reason: governments have still not found a way to generate the trifecta of growth, employment and financial stability. The longer this prevails, the more oxygen is sucked out of sectors that remain relatively healthyand for three distinct reasons.

First, the eurozone economy is extremely interconnected. As such, it is only a matter of time until weakness in one part migrates to other parts. Witness what is happening in Germany, a well-managed country once thought itself immune from the troubles around it. After a period of record low unemployment, economic growth has slowed markedly, reaching just 0.2% in quarterly terms in July-September. On current trends, the fourth quarters growth rate will turn negative.

Second, the eurozones bailout bill continues to rise. Cyprus is expected to join the other three programme countries (Greece, Ireland and Portugal) in requiring considerable official financing; and, of the other three, only Ireland is getting close to regaining normal access to capital markets. With Spain also requiring billions more to recapitalise its banks, the contingent claims on taxpayers in the core countries continue to mount. Indeed, this is one of the factors that contributed to Moodys decisionfollowing Standard & Poorsto strip France of its AAA credit rating.

Finally, adverse contagion is extending beyond the 17 countries in the eurozone. The regions debt crisis is undermining cooperation within the larger 27-member European Union, resulting in the spectacular failure of the recent summit on the EU budget. It has also contributed to the economic slowdown in China, raising concerns (which I believe are exaggerated) that the countrys new leadership may have problems engineering a soft landing for an economy accustomed to double-digit (or high single-digit) growth.

This lack of peace would have resulted in outright economic and financial war if not for the criticaland growingrole played by the European Central Bank. Under the bold leadership of Mario Draghi, the ECB has committed to provide as much time as possible for most governments to get their acts together. And it has done so by relying on innovative measures that substitute its elastic balance sheet for those of over-extended governments, gun-shy private investors and fleeing bank depositors.

Yet it would be a grave mistake to assume that the ECB can deliver lasting economic peace. It cannot. If governments continue to dither and bicker, the most that it can do is delay the war for a while.

Like Egypts war of attrition, the eurozones underlying economic, financial and social ferment continues. If governments continue to stumble from one patchwork remedy to anothera probability that remains uncomfortably highthe delay in implementing a comprehensive solution will eventually overwhelm the defences that the ECB has so courageously put in place.

Some say that, just as Egypts war of attrition eventually gave way to a full-scale war and then a peace treaty, Europe needs a major crisis to move forward. But this is a dangerous notion, one that entails not just massive risks, but also unacceptably high interim human costs.

European governments are well advised to use the financial cease-fire that the ECB is willing to buy for them. Allowing it to expire without progress toward permanent stability would expose Europe to disruptions that would diminish significantly its prospects for long-term economic stability, growth and job creation.

Mohamed A El-Erian is CEO and co-CIO of PIMCO, and the author of When Markets Collide

Copyright: Project Syndicate, 2012

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