1. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 1

2. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 2 The Credit Crisis and the Euro Ben Broadbent Managing Director & Senior European Economist September 2010

3. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 3 Summary  Europe recovering but sharp divergence within the Euro- zone.  Partly industrial composition: investment-driven cycle so sharpest “V”s in capital-goods-producing countries.  Credit crunch has also blown away a decade of interest- rate convergence between “core” and “periphery”.  Eurozone needs (i) more fiscal discipline ahead in good times &/or (ii) more support in bad times. Will politics allow this?

4. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 4 Estimated banks’ losses, March 2009  Eurozone banks:EUR 920bn (10.1% of GDP)  UK banks:GBP 210bn (14.6%)  Total:USD 1.4tn (15.1%)

5. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 5 Domestic Demand and Growth Contributions, Last Decade Source: GS Global ECS Research

6. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 6 Chinese Growth: Not Just Exports

7. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 7 US not as central as it once was Source: GS Global ECS Research

8. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 8 Very aggressive policy response

9. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 9 No comparison with Japan

10. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 10 Not the Great Depression II for output...

11. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 11...or for asset prices

12. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 12 Bounce in asset prices has helped banks’ balance sheets

13. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 13 More like other post-war financial crises

14. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 14 Divergence

15. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 15 Partly reflects industrial composition

16. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 16 But markets price of sovereign debt has also diverged significantly

17. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 17 Spill-over impact on banks’ funding costs

18. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 18 Divergence follows years of convergence

19. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 19 No evidence EMU deepened trade integration

20. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 20 But it did help compress bond yields

21. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 21 And as income converged, current accounts diverged

22. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 22 Low rates encourage domestic demand

23. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 23 Strong demand raises domestic costs

24. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 24 …causing declines in the periphery’s export market shares

25. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 25 And sharp deteriorations in external positions

26. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 26 Not a problem for the Eurozone as a whole

27. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 27 Hefty adjustments needed to achieve stabilization of debt levels

28. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 28 Decline in interest rates not restricted to the Eurozone

29. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 29 Reform: The options  Nothing: let countries restructure (if they have to)  Piecemeal: More support/control ex post (EFSF plus EC intervention); tighter standards ex ante (Van Rompouy)  Wholesale:Full fiscal federalism (note US example: political union precedes monetary union).  Euro break-up

30. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 30 Macro rebalancing Keynes (Bretton Woods, 1946): “the process of adjustment is compulsory for the debtor and voluntary for the creditor. If the creditor does not choose to make, or allow, his share of the adjustment, he suffers no inconvenience. For whilst a country’s reserve cannot fall below zero, there is no ceiling which sets an upper limit”.

31. Goldman Sachs Global Economics, Commodities and Strategy Research 2010 31 Disclaimer I, Ben Broadbent, hereby certify that all of the views expressed in this report accurately reflect personal views, which have not been influenced by considerations of the firm’s business or client relationships.