WASHINGTON - For most Americans, Europe is out of sight and out of mind. We figure that the worst of its debt crisis has passed.
Italy has a new government. To mute social unrest, some countries are slightly relaxing austerity policies. The European Central Bank has stabilized the bond market for weak debtor countries.
Despite problems, Europe is muddling through.
Be skeptical - very skeptical.
That's the main take-away from a talk the other day by economist Hans-Werner Sinn at the Peterson Institute, one of Washington's leading think tanks.
Sinn, head of the German think tank Ifo Institute for Economic Research, is a controversial figure in Europe. He's been a regular critic of Europe's responses to the crisis and has gotten into public tiffs with, among others, multibillionaire George Soros.
Sinn doubts that the worst has passed.
The basic problem, Sinn argued, is that years of easy credit lowered unemployment and raised inflation in debtor countries. As a result, they lost competitiveness, especially compared to Germany.
From 1995 to 2008, he noted, prices rose 9 percent in Germany, 40 percent in Italy, 56 percent in Spain and 67 percent in Greece.
When private credit dried up (Greece, Portugal and Ireland) or threatened to (Spain, Italy), countries were left at the mercy of official lenders - Europe's other governments, the ECB and the International Monetary Fund - and their insistence on austerity.
Debtor countries must restore competitiveness, Sinn argued.
Only that would reduce Europe's massive trade imbalances - Germany's huge surpluses and debtor countries' deficits - and establish a foundation for economic recovery.
Unfortunately, there are no easy ways of doing this, he said.
In Sinn's view, Europe faces three broad choices, all bad.
- First, it can continue the present austerity, which would reduce wages and prices through steep unemployment and unused production capacity. But this sort of punishing austerity is "destroying societies" and would be maddeningly slow.
Already, he said, youth unemployment is near 60 percent in Greece and 55 percent in Spain. How much further can countries go?
Ultimately, many would default on their government debt (as Greece already has) rather than submit to endless national torture.
- Second, debtor nations can regain competitiveness if Germany undoes its price advantage by embracing higher inflation. Annual price increases of about 5.5 percent for a decade might suffice.