European Recession Redux?(Global Investor)(European Union treaty)

Byline: Eric Chaney; Chaney is chief economist for Europe at Morgan Stanley.

Similarities between 1992 and 2008 are striking. Politics has the same sour taste, and there is the same transatlantic divide.

In Europe, economic-history lessons are ever more in order. In June 1992, the Danish people rejected the European Union treaty negotiated in Maastricht and which laid the ground for the euro. On July 16, 1992, the Bundesbank raised its discount rate to 8.75 percent. Two months later several European currencies, including the Italian lira, the Spanish peseta and the British pound, were devalued, and core Europe slipped into recession.

Fast-forward to the present: on June 13, 2008, the Irish rejected another EU treaty, negotiated in Lisbon and designed to streamline the functioning of the Union. On July 3, the European Central Bank raised its main policy interest rate from 4 percent to 4.25 percent. What comes next?

Similarities between 1992 and 2008 are indeed striking. The politics have the same sour taste: a tougher economic environment makes EU citizens more skeptical about the benefits of the Union. The economic fundamentals are similar, too: just as in 1992, there is a profound transatlantic divide. Then, the Fed was busy bailing out the U.S. banking system, devastated by the burst of a property-price bubble, and helping an economy barely recovering from the 1991 recession. In Europe, the Bundesbank was fighting fiercely to cool an overheating German economy. Today the Fed is doing its best to prevent a recession in the United States, while the ECB is determined to fight inflation. Then, the U.S. dollar slipped to 1.35 Deutsche marks. Today the dollar would trade even lower, at 1.25 against the mark, if the mark still existed.

The euro is now firmly established in 15 European countries, none of them having any interest to leave the monetary union. There will be tensions, but they will evaporate via price changes for assets like real estate, exposing fault lines in the Central and Eastern European economies.

Then and now, there were regional macro imbalances. Before the fall of the Berlin wall, Germany was running a current account surplus of 5 percent of GDP. Today Germany is again accumulating large external surpluses: its current account reached a record level in 2007, at 7.7 percent of GDP. Symmetrically, Spain, which had a current account deficit of 4 percent of GDP in early 1992, is now in a much more impaired position, with a double-digit deficit (10.1 percent of GDP in 2007). Portugal and Greece, too, need to ...