In a couple of articles recently I have noted that Greece and Spain seem to be breaking the ranks of economic stagnation in Europe. While we wait for Eurostat to release third-quarter GDP data, let us take a look at what has happened on the job front in those two countries.
Let us, first of all, make one thing clear: a recovery as traditionally defined in the macroeconomics literature is not necessarily a recovery from a crisis of the kind Europe is now stuck in. This crisis is structural – permanent by default – and it will take a permanent change in the structure that perpetuates the crisis in order to end it. We may see an improvement in economic activity without such changes, but that improvement will not be strong enough to actually recover these economies.
A real recovery means a permanent elevation of economic activity above the two-percent growth threshold. Greece and Spain are far away from that threshold – even if they occasionally hit it in one quarter, it does not mean that they have recovered.
That said, there is one area where the Greek and Spanish economies are at least showing some resiliency: the job market. Analyzing Eurostat employment data we find quite a few interesting factoids.
Both Greece and Spain saw stronger job growth in Q2 2014 than the euro zone as a whole. In Greece the total number of employed persons grew by 1.58 percent over the previous quarter; in Spain the increase was 2.37 percent. For the 18-country euro area as a whole, job growth was a modest 1.21 percent.
In Q1 2014 total Greek employment increased by 0.11 percent, while Spain saw a 1.07-percent decline. Both numbers beat the euro zone where total employment fell by 1.57 percent over the previous quarter, Q4 2013.
Annually, the improvement is not quite as impressive. The Greek economy only grew total employment by 0.1 percent in Q2 2014 over Q2 2013. For Spain, the number was better at 1.1 percent, clearly beating the euro zone’s 0.3 percent. But both Greece and Spain lost jobs in the first quarter over same quarter previous year: employment was down 0.6 percent in Greece and 0.5 percent in Spain, while euro-zone employment expanded by 0.2 percent.
Nevertheless, looking back, the Greek economy has clearly been moving in the “right” direction for some time. Their annual quarter-over-quarter employment numbers have been improving for five quarters in a row now. This means four quarters of smaller and smaller decline, and again one quarter with an improvement year-to-year. The Spanish economy has seen a similar trend, though not quite as pronounced as in Greece.
The euro zone, by contrast, is not exhibiting any clear job-creation trend. Year to year, its quarterly employment numbers vary within a narrow band: from a decline of one percent to 0.4 percent growth. This verifies that the Greek and Spanish economies are bucking the trend, and this in turn calls for a deeper analysis of why that is happening. Furthermore, it means finding out whether or not it is realistic to expect the improvement trend to continue.
There is more good news for Greece and Spain: both countries have been able to turn around, or almost turn around, the employment situation for their young. In the age group 15-24, Greece has again seen five straight quarters of improving numbers: three quarters of a slowdown in job losses and two straight quarters, Q1 and Q1 2014, of actual growth in youth employment. For Spain, the trend is again not as pronounced – young Spaniards are still losing jobs – but at least situation is not worsening nearly as fast now as it did in 2012. For Q1 2014 Spanish youth employment fell by 4.7 percent; for Q2 2014 it fell by 1.2 percent. By contrast, the first two quarters of 2013 the decline was 14.7 and 12.4 percent, respectively.
In this area the euro zone is still very much in trouble. Consider these changes, quarterly year-over-year, to youth employment in the 18 euro-zone countries:
|Euro-18 youth employment change||-3.94%||-3.05%||-2.88%||-2.71%||-3.01%||-2.75%|
As soon as third-quarter GDP data is out we will take a close look at them. Then we will get a good opportunity to asks whether or not Greece and Spain are indeed recovering, or if their job improvement numbers are merely a reflection of the end of the harshest austerity measures known to free men (outside Sweden) since the 1930s.
Usually when my regular workload intensifies I find it hard to get time to put meaningful content up on this blog. However, recently that has not been the case. Instead, my predictions from the past two years – and especially from my book Industrial Poverty – are now cashing in, yielding bundles and barrels of content material. What I have been saying since 2012 is now dawning on political leader after political leader in Europe, namely that the continent simply is not going to recover.
Yesterday, British Prime Minister David Cameron joined the chorus of alarmed, baffled, concerned and desperate European political leaders who, with rising anxiety in their voices, try to determine why their continent’s economy is going nowhere. Cameron got plenty of room in The Guardian:
Six years on from the financial crash that brought the world to its knees, red warning lights are once again flashing on the dashboard of the global economy.
For the zillionth time - it was not a financial crisis. There. I had to make that point again. Back to Prime Minister Cameron:
As I met world leaders at the G20 in Brisbane, the problems were plain to see. The eurozone is teetering on the brink of a possible third recession, with high unemployment, falling growth and the real risk of falling prices too. Emerging markets, which were the driver of growth in the early stages of the recovery, are now slowing down. … The British economy, by contrast, is growing. After the difficult decisions of recent years we are the fastest growing in the G7, with record numbers of new businesses, the largest ever annual fall in unemployment, and employment up 1.75 million in four years: more than in the rest of the EU put together.
Back in August I noted that the U.S. and U.K. economies were outgrowing the rest of Europe. We will soon have the definitive numbers for the third quarter, but until then we can basically take Cameron’s word for it that Britain is way ahead of the rest of Europe.
Cameron then turns to the dark clouds on the global economic horizon, pointing out that the economic stagnation in the euro zone is showing up in Britain’s foreign trade statistics. And then he makes an interesting observation:
As the global economy faces greater uncertainty, it is more important than ever that we send a clear message to the world that Britain is not going to waver on dealing with its debts. This stability is vital in attracting the business and international investment that delivers growth and jobs, and which keeps long-term interest rates low. So we will stick to our plan on the deficit and continue to use monetary policy to support growth without adding to borrowing or debt.
This sounds like a generic political statement, formulated to put out specific words in a specific order to appeal to the subconscious mind of the voter. But it is more than that: this is a poke in the side of Germany and other euro-zone countries who cannot get their economies going. Cameron’s point is, plainly, that Britain has been successful in separating its fiscal and monetary policies from the European mainstream – and that Britain will continue to pursue its own, independent economic policies.
No doubt, this is an attempt at appealing to UKIP supporters, but it is also an acknowledgment of a reality where the EU is stuck in the ditch of economic stagnation and Britain will not – and cannot – let itself be held back by that same organization.
In fact, as Cameron continues, he carves out an even sharper independent profile for himself and his country:
Our long-term plan is backing business by scrapping red tape, cutting taxes, building world-class skills and supporting exports to emerging markets. Underpinning all of this is our radical programme of investment in infrastructure. … We are making the biggest investment in roads since the 1970s and the biggest in rail since Victorian times, connecting 40,000 premises to superfast broadband every week, and starting an energy revolution with the first new nuclear plant in a generation, the world’s first green investment bank and the largest production of offshore wind on the planet.
We’ll see how that energy policy works in the end. American energy prices are falling, thanks in part to an expansion of oil and natural gas production on private land. But again – Cameron’s point is that Britain stands out among European countries, that the leading euro-zone economies are in permanent stagnation and that Britain is not going to fold into the ranks of European mediocrity.
David Cameron is not the best option for Britain. He is, fundamentally, a traditional British Europhile. But the fact that he talks so forcefully about the uniqueness of British economic policies and economic performance is a clear indication of which way Britain is heading, and why. His article simply confirms how strong the euroskeptics are in Britain and thereby the high probability that Nigel Farage of the UKIP will be their next Prime Minister.
Let us hope that Cameron continues with his moderately successful fiscal policies. If he can make an example out of Britain to the rest of Europe, he can embolden Euroskeptics elsewhere in the EU. Eventually, their strength – given that they are of the UKIP kind and not aggressive nationalists – will bring an end to the stifling statism that has become endemic in austerity-ridden eurozone welfare states.
European third-quarter GDP growth data is beginning to make its way out in the public. What we have seen so far is just more of the same new normal – the same new stagnated way of life in industrial poverty.
Starting from the aggregate level, Eurostat’s third-quarter growth report says that the EU-28 grew at 1.3 percent per year in Q3 of 2014 over the same quarter 2013. The euro zone’s growth rate was half-a-percentage point lower at 0.8. This difference is the same as over the past few years: the last quarter where the euro zone grew faster than the entire EU was in Q1 of 2011. It shows that austerity is still taking a tougher toll on Europe’s core countries than its non-euro members on the outer rim.
Or, to make the same argument from the other side: if you are a European welfare state, it pays to keep your own currency.
The growth numbers for the EU and the euro zone are poor in and by themselves. By not even coming close to two percent per year, Europe is not even able to reproduce its own standard of living. But even worse is the fact that the U.S. economy grew by more than two percent annually for the second quarter in a row: 2.3 percent in Q3 of 2014, compared to 2.6 percent in Q2 of 2014. This growth disparity is slowly becoming a self-reinforcing phenomenon: when global investors see that the U.S. economy is growing while the Europeans are standing still, they choose to reallocate their investments to the United States. That way investments and new jobs go to where investments and new jobs are already going.
But does not that mean that the U.S. economy will run into inflation problems that, in turn, will even out the differences between the United States and Europe? No, not necessarily. In fact, that is a very unlikely scenario. We are now rising to become the global leader in producing energy, with costs far below those of European countries. Right-to-work states offer a union-free manufacturing environment, something that, e.g., Volkswagen successfully took advantage of when they opened their new plant in Tennessee. The large US-only Passat they build there is a runaway sales success, $7,000 cheaper and selling ten times more (100K units per year) than its German-built predecessor.
Long-term, it looks like manufacturing is making its way back to the United States. This does not bode well for Europe, whose exporting manufacturing industry has, basically, been the only part of the economy that has not sunken into the three shades of gray that is industrial poverty. That European manufacturing is in trouble is well proven by the Eurostat report, according to which Germany has seen a decline in growth for two quarters in a row: now down to 1.2 percent on an annual basis.
Another supposedly big manufacturing economy, France, barely finished the third quarter with growth at all: 0.4 percent over Q3 of 2013. Austria’s growth is also dwindling, with 0.3 percent this quarter compared to 0.5 in Q2 and 0.9 in Q1.
The only real positive news is that the Greek economy showed annual growth for the second quarter in a row - at 1.4 percent this quarter - with growth numbers improving steadily for a year now. Spain also shows positive growth, 1.6 percent, with a similar upward long-term trend.
Neither the Greek nor the Spanish number is anything to write home about, but it looks like the two countries are slowly recovering from the bad austerity beating they took in 2012 and 2013. It is an extremely hard journey back for both of them, though, especially for Greece which lost one quarter of its economy to destructive austerity policies. The welfare states of both Spain and Greece have now been recalibrated, so that government budgets paying for the welfare states will balance at a much lower employment level than before. This means, effectively, that government will begin to net-tax the economy and thereby cool off a growth trend long before full employment is restored.
This structural problem is entirely unknown to Europe’s lawmakers – and, frankly, to almost every economist on the planet. I defined the problem in my book Industrial Poverty; if unsolved, this problem will guarantee permanent economic stagnation in Europe for, well, ever.
That said, I don’t want to spoil the fun for Greek and Spanish families who are now seeing the first glimpse of daylight after a long, horrible nightmare. Let them celebrate today; tomorrow they will still be living in industrial poverty.
The one good thing about the rising levels of frustration in Europe over the crisis, is that the public debate is being enriched with voices whose message might actually make a difference for the better. Today, a group of leading German economists has decided to speak up against the lax monetary policies of the ECB. This is a welcome contribution, but their contribution would be stronger and more to the point if they also learned a thing or two about what has actually brought Europe into the macroeconomic ditch.
Reports Benjamin Fox for the EU Observer:
The European Central Bank’s (ECB) plans to pump more cheap credit into banks risk undermining the long-term health of the eurozone, according to Germany’s leading economic expert group. The ECB’s “extensive quantitative easing measures” posed “risks for long-term economic growth in the euro area, not least by dampening the member states’ willingness to implement reforms and consolidate their public finances”, the German Council of Economic Experts (GCEE) said in its annual report, published on Wednesday (12 November).
That monetary expansion is indeed a problem. In September 2014 the M1 money supply in the euro zone had grown by 6.5 percent over September 2013. Over the past 12 months the annual growth rate has averaged 5.86 percent, showing that monetary expansion in the euro zone is actually increasing. In fact, adjusted for the large expansions in M1 euro supply that resulted from an expansion of the monetary union, the current expansion rate appears to be the highest in the history of the euro (though that is just a preliminary observation – I am not completely done with the simulation).
If current-price GDP was growing at the same rate, then all the new money supply would be absorbed by transactions demand for money. But the euro-zone GDP is practically standing still, which means that all the new money supply is directed into the financial sector (theoretically known as “speculative demand for money”). That is where the real danger is in this situation.
Unfortunately, the German economists are not primarily worried that the ECB is destabilizing the European financial system. Their concern is instead that lax monetary policy discourages fiscal discipline among euro-zone governments. They appear to be stuck in the state of misinformation where budget deficits are keeping the euro-zone economy from recovering.
Benjamin Fox again:
The Bundesbank is also uncomfortable about the ECB’s increasingly activist role in the bond and securities markets. … But the German call for the Frankfurt-based bank to limit its intervention remains a minority position. Most governments in and outside the eurozone, together with the International Monetary Fund, want the ECB to provide increased monetary stimulus. Last week the Organisation for Economic Co-operation and Development (OECD) also urged the bank to “employ all monetary, fiscal and structural reform policies at their disposal” to stimulate growth in the currency bloc, including a “commitment to sizeable asset purchases (“quantitative easing”) until inflation is back on track”.
Can any economist at the ECB, the IMF or the OECD please explain how the ECB’s money pumping is going to create inflation in any other way than the traditional monetary kind? Nothing in either my academic training as an economist or my 14 years of practicing economics as a Ph.D. gives me the slightest clue how this is supposed to work.
In fact, the only inflation I can see coming out of this would be strictly monetary - and that is not what anyone in Europe wants. Monetary inflation, unlike inflation caused by rising economic activity, can run amok deep into the double digits, as it has in Argentina and Venezuela.
It is good that leading German economists are worried about the ECB’s activities. Time now for them to take the next step and study the true structure of the economic crisis.
With crawling speed, awareness is spreading across Europe that something has gone wrong – terribly wrong – with their economy. The latest to raise his eyes above the mainstream horizon is Jonathan Portes, director of the British think tank National Institute of Economic and Social Research. In a recent interview with Euractiv.com, Portes explained that Europe’s leaders have completely misunderstood the nature of the current crisis:
The problem for Portes is that he lists among the challenges for Europe that it needs to find a way to fund its welfare state. But the welfare state is precisely the problem for Europe. The welfare state is what eventually tipped a regular recession over the edge into a permanent, structural crisis. Surely, the welfare state was aided in its amplification of the crisis by misguided, ill-designed austerity policies. But the European economy was suffering from a structural imbalance, forced upon it by the welfare state, long before the financial crisis began.
We should not glean too much from Portes’s short statement, but it is probably not an exaggeration to conclude that he is looking for a sustainable funding model for the European welfare state. The problem is that no such model exists. In order for the welfare state to be fiscally sustainable, neither its funding model nor its entitlements can have any effect on the tax base from which the welfare state gets its revenue. This “exogenous” view of the welfare state has been thoroughly refuted, both by reality and by a long tradition of research.
There is only one solution to the European crisis, and that is to phase out the welfare state – to privatize education and health care and to return income security to the individual taxpayer. No more, no less, will save Europe.
Retail trade is one of the better indicators of how an economy is doing. It is an immediate “gauge” of both confidence and private finances of consumers. Therefore, given the overall stagnant nature of the European economy, the latest report on retail trade from Eurostat has some valuable information in it:
The 1.3% decrease in the volume of retail trade in the euro area in September 2014, compared with August 2014, is due to falls of 2.2% for the non-food sector and 0.1% for “Food, drinks and tobacco”, while automotive fuel rose by 0.9%. In the EU28, the 1.2% decrease in retail trade is due to a fall of 2.1% for the non-food sector, while “Food, drinks and tobacco” remained stable and automotive fuel increased by 0.4%. The highest increases in total retail trade were registered in Malta (+1.0%), Luxembourg (+0.9%), Hungary and Slovakia (both +0.7%), and the largest decreases in Germany (-3.2%), Portugal (-2.5%) and Poland (-2.4%).
Month-to-month changes are not that important. The one detail here to note, though, is the big contraction in Germany. It is a small but noteworthy sign that the German economy, as this blog has reported before, is leaving a period of exports-driven growth and returning to the new European normal, namely stagnation.
The Eurostat memo also reported annual data:
The 0.6% increase in the volume of retail trade in the euro area in September 2014, compared with September 2013, is due to rises of 0.9% for “Food, drinks and tobacco”, of 0.6% for the non-food sector and of 0.5% for automotive fuel. In the EU28, the 1.0% increase in retail trade is due to rises of 1.5% for the non-food sector and 1.2% for “Food, drinks and tobacco”, while automotive fuel fell by 0.2%. The highest increases in total retail trade were observed in Luxembourg (+12.3%), Estonia (+9.1%) and Bulgaria (+5.6%), while decreases were recorded in Finland (-3.2%), Poland (-1.8%), Denmark and Germany (both -0.8%).
Again Germany shows up on the negative side, reinforcing the impression that the largest economy in Europe is no longer its locomotive.
On the upside, there is one interesting detail worth noting. Greece has experienced three months in a row of annual, inflation-adjusted retail sales increases: four percent in June, 4.6 percent in July and 7.4 percent in August.
Is this an early sign that the Greek depression is coming to an end? Let’s hope so.
Back in college I had a friend who blamed a cut in Swedish government-provided student loans on Moammar Ghadaffi. It was a tongue-in-cheek exercise, of course, designed to prove that if you want to, you can make any argument credible so long as you can make people believe your chain of cause and effect.
For some reason, that idea is widespread in politics, only there it is taken with the utmost seriousness. Political leaders can make the most remarkable connections between otherwise totally unrelated events. This is particularly true in economics and policy. The latest example is the stubborn European recession and what it is blamed on. Reports the EU Observer:
The European Commission lowered its growth forecasts for the EU and the eurozone area, blaming the wars in Ukraine and the Middle East, and urging governments to do more to spur investments. According to the Autumn forecast growth in the EU is now expected to be 1.3 percent of GDP this year, compared to 1.6 percent projected in spring, while the eurozone economy is to grow by only 0.8 percent, compared to the earlier projection of 1.2 percent.
I have lost count of how many times that European forecasters have had to adjust their forecasts downward. Not to brag (actually, yes, to brag…) I have not changed my forecast at all since I formulated Europe’s current problem more than two years ago. That problem is a structurally unaffordable welfare state combined with policies that try to preserve the welfare state inside a tax base that is structurally incapable of paying for it. This structural imbalance keeps the economy in a state of stagnation for an indefinite future.
The EU’s adjusted outlook once again confirms that I am right. The EU Observer again:
For 2015, the outlook is also pessimistic: the EU economy is expected to grow by 1.5 percent (down from 2 percent predicted in spring) and the eurozone by 1.1 percent (compared to the spring forecast of 1.7 percent). EU “growth” commissioner Jyrki Katainen admitted that forecasts are difficult to trust, especially since all other international institutions publishing economic forecasts “have been more often wrong than right” because there are so many variables on growth, employment, and investments.
Oh dear, there is so much to factor in… Seriously – it is the job of the economist to separate what matters from what does not matter, and then make his forecasts for the former while not being distracted by the latter.
This kind of excuse would not pass for a serious contribution here in the United States. But the Europeans are also trying to blame their years-long, endless recession on new events. Another article in the EU Observer:
Germany is on the brink of recession after recording its weakest export levels for five years. Data published by the Federal Statistics Office on Thursday (9 October) indicated that exports slumped by 5.8 percent between July and August, the sharpest monthly fall since 2009, at the height of the financial crisis. Imports also fell by 1.3 percent, suggesting that German consumers are also losing faith in the country’s economy. In a statement, the statistics office blamed late-falling summer vacations in some German regions and the Ukraine crisis for the fall in exports and imports.
But of course, there is no problem with the high taxes in Germany, or the rising energy costs as they close their nuclear reactors and try to rely on windmills instead… As share of GDP, taxes in Germany have increased from 42.6 percent ten years ago to 44.5 percent in 2013. This places Germany 12th among the 28 EU member states, and just a hair below the 45.3-percent EU average. But being average does not cut it when times are tough, it is a buyer’s market and the consumers who can actually afford to buy things are far away from your own country’s borders.
And, as noted, exports no longer serve as the locomotive of the German economy. Berlin simply cannot continue to suppress domestic demand for budget-balancing and ill-conceived energy reform reasons.
Back to the story about Germany:
The dismal statistics are the latest sign that Germany is facing an economic slowdown. In August, the ZEW think-tank’s index of financial market confidence, a trusted indicator of German economic sentiment, hit its lowest level since December 2012. The fall was attributed to the weak eurozone and fears about the EU’s ongoing sanctions battle with Russia. According to Eurostat, the EU’s data office, Germany’s output fell by 0.2 percent between April and June, after expanding by 0.8 percent in the first three months of 2014.
So what is the prevailing advice for how to get out of this state of endless stagnation?
On Thursday, four of the country’s top economic institutes urged chancellor Angela Merkel to increase public spending in a bid to stoke the economic engine. “On the spending side, public spending should be increased in those areas which can potentially boost growth,” the IFO institute in Munich, DIW of Berlin, RWI of Essen and IWH of Halle said in a joint report.
How fortunate that four of Germany’s most prominent think tanks all agree with each other. One might wonder why they need four think tanks of they all agree on something so profoundly important as how to revive the economy. Not one of them expresses concern that Germany might need just a tiny bit more economic freedom. On that note, if they are going to expand government spending without running budget deficits – what is the point in taking money away from the private sector and dole it out again through government? Private-sector activity is going to be further depressed by higher taxes: either you take away from what they spend or you depress their cash-flow safety margins and force them to depress spending in order to restore those safety margins.
There are two reasons why Germany cannot grow without exports. The first is high taxes, which up until 2012 were higher than in Greece. The second is uncertainty about the future. German consumers and at least smaller entrepreneurs have adjusted their spending downward on a permanent basis, simply because they feel overall less confident and less optimistic about the future. As Keynes explained in Chapter 16 of his General Theory, a depression of economic confidence is not a temporary matter:
An act of individual saving means — so to speak — a decision not to have dinner to-day. But it does not necessitate a decision to have dinner or to buy a pair of boots a week hence or a year hence or to consume any specified thing at any specified date. Thus it depresses the business of preparing to-day’s dinner without stimulating the business of making ready for some future act of consumption. It is not a substitution of future consumption-demand for present consumption-demand, — it is a net diminution of such demand.
That downward adjustment in demand will become the new normal until consumers and entrepreneurs has a reason to become more optimistic about the future. Evidently, that is not happening in Germany.
Not in Greece either, by the way. From Euractiv:
Greece is “highly unlikely” to end its eurozone bailout programme without some new form of assistance that will require it to meet targets, a senior EU official said on Monday (3 November). “A completely clean exit is highly unlikely,” the official told reporters, on condition of anonymity. … The eurozone and IMF bailout support of €240 billion began in May 2010. Greece is in negotiation with EU institutions and the International Monetary Fund ahead of the expiry of its bailout package with the European Union on 31 December. … The official gave no details of what new aid might look like, but policymakers have said that the most likely tool is an Enhanced Conditions Credit Line, or ECCL, from the European Stability Mechanism. That means Greece would be under detailed surveillance from the European Commission, the EU executive, for the duration of the credit line. “There needs to be money available for drawing on,” the official said.
Money available for spending items that Greek taxpayers cannot afford. So long as those spending promises remain in place, Greece cannot regain its fiscal independence unless they massively raise taxes. That, in turn, would be like begging for an even deeper depression.
At least in the Greek case nobody is blaming the Klingon High Council for their bad economic situation. But unless the Europeans step up to the plate and take responsibility for their own economic failure, the entire continent will continue to dwell in the shadow realm between the economic wasteland and industrial poverty.
Today’s blog will be a short one, just a reminder of some vital statistics relating to the liquidity trap – an important topic now that Sweden, a non-euro member state of the EU, has joined the euro-zone in the trap.
The practical meaning of the trap is a situation where GDP is stalled – in other words the economy is stuck in a recession – and there is so much liquidity available in the economy that adding another euro (or krona) will not make any difference at all. Monetary policy is useless. That is where the euro zone is now, something that ECB leader Mario Draghi is well aware of, as he recently sent out a desperate call for help from Europe’s political leaders. He knows that monetary policy has reached the end of the road and that the only remaining options are within the realm of fiscal policy.
Despite this, Draghi continues to pump out M1 money supply into the euro zone like the recovery actually depended on it. Consider Figure 1:
Fig. 1: Quarterly growth rates. Sources: ECB and Eurostat
The blue line, depicting growth in euro-zone M1 money supply, deserves an explanation. The two growth peaks, one at the end of 2005 and one in late 2009, are largely related to the expansion of the euro zone, which went from 12 to 16 member states between 2006 and 2009. (Since then Estonia and Latvia have also joined.) If we adjust for the enlargement, money supply is fairly well in tune with GDP growth – until we get to 2012. That is when the ECB started making promises to buy any and all treasury bonds from “troubled” euro-zone countries, as well as to participate in the massive austerity programs that the EU and the IMF convinced the worst-off member states to adopt.
On top of that, the ECB decided this summer to take its interest rate to zero, and to punish banks – charge a negative interest rate - for depositing cash in overnight accounts with the ECB. This has flooded the euro zone with liquidity; if the theory behind this policy were right, we would see a major upturn in business investments and notable workforce expansion. However, we don’t see that; at best, year-over-year quarterly GDP growth rates show an economy barely struggling to stay afloat.
The inevitable – and from both a Keynesian and an Austrian viewpoint rather obvious - conclusion is that the theory behind the liquidity expansion is flawed. In fact, the ECB is playing with fire: sooner or later the massive supply of liquidity will go look for profitable investment opportunities. So long as the real sector of the economy remains essentially stagnant that search for profit will rapidly climb the speculative hills in the real estate and stock markets.
Again: welcome to life in the liquidity trap.
Over the past few years, Hungary has made a name for itself as one of Europe’s most nationalist countries. The nationalism that has been channeled through the Fidesz party has inspired other nationalists in Europe, as well as raised concerns among those who fear the authoritarian flank of the nationalist movement.
I normally do not want to speculate in the relations between economic growth and ideological dynamics – I do, for example, not believe that nationalism can be dismissed as the response of poor, bitter, uneducated rednecks to adverse economic challenges. That narrative is the product of ivory-tower academics suffering from serious real-life comprehension deficiency.
Nationalism is much more complicated than that. It is, on the one hand, a sound patriotic expression of love for your country. I admire American patriotism, which combines a strong belief in the founding values of this great country with a generosity and openness toward everyone willing to respect those values, assimilate and live in peace and harmony with their fellow Americans. British politician Nigel Farage and his UKIP are driven by a similar, British patriotism. Mr. Farage has my full respect and support.
On the other hand, I fear the authoritarian version of nationalism which I see lurking in the shadows behind Marine Le Pen, and which have come out in the open with full force in the Golden Dawn movement in Greece.
I cannot say definitively where Hungary’s Fidesz party stands on the scale between patriotism and authoritarianism, but I think we can get a bit of an idea from looking at what has happened in the Hungarian economy in recent years. But before we get there, let us listen briefly to what the speaker of the Hungarian parliament had to say the other day about his country’s relation to the EU. Euractiv has the story:
If the European Union wants to dictate to Hungary, then the country should consider slowly backing out of the union, Parliamentary Speaker and Fidesz MP László Kövér said on 24 October, as quoted by the Hungarian press. … Kövér said that if Brussels wants to tell a country how it should be governed, then it resembles Moscow before the change of regime in 1989. The speaker reportedly said that if this is the direction the EU takes, then Hungary should consider leaving the union. He added however that this was only “a nightmare” scenario, and that he doubted it would come to that.
There are two, somewhat disparate reasons why Mr. Kövér would say something like this. The first reason is that the EU is indeed a super-state organization that merrily gets involved in every aspect of national politics. Nigel Farage often says that 75 percent of all new laws that apply in Britain are made in Brussels. Regardless of where the exact number is, there is no doubt that the EU continuously expands its powers at the cost of national sovereignty; the EU’s disastrous mishandling of the Great Recession and the debt crises in southern EU states brought out in full force the arrogance, even borderline totalitarian, power grabbing desires that Brussels is home to. From this viewpoint it is entirely understandable that the Hungarians are frustrated with the EU.
The second reason for the speaker’s lashing out is not quite as easily understood. The Hungarian economy has taken a bad beating during the Great Recession and is still struggling to get moving again. Let us take a look at the most critical GDP component, namely private consumption:
Figure 1 reports two angles of private consumption in the Hungarian economy and the EU. The solid lines, which refer to the left vertical axis, represent the consumption share of GDP in the EU (green) and Hungary (purple). The share has been stable in the EU but declined in Hungary.
If GDP has grown strongly in Hungary, then the decline in the consumption share is not much of a problem. However, from 2007 through 2013 annual inflation-adjusted GDP growth in Hungary was -0.53 percent, on average. That us worse than crisis-ridden Ireland, Spain and Cyprus, and only a hair better than Portugal and Italy. With this in mind, it is hardly a surprise that private consumption in Hungary has exhibited such a deplorable growth record as reported by the purple dashed line (reference the right vertical axis). Average for 2007-2013 is -1.45 percent, worse than all the aforementioned crisis-plagued countries.
Herein lies part of the explanation to why the Hungarian parliamentary speaker is so vocal with his EU criticism. The nationalist government has not been very strong on promoting economic freedom. According to the Heritage Foundation Index of Economic Freedom, Hungary scores poorly in key categories such as government spending, monetary freedom, property rights protection and corruption. Although Fidesz may not be pursuing an open, deliberate statist strategy, the combined effects of their policies is in fact an advancement of government at the expense of the private sector.
It is very likely that statist nationalism is now taking such a toll on the Hungarian economy that voters, taxpayers and even business men are beginning to complain, loudly. In situations like this, it is a well established strategy in politics to turn people’s attention somewhere else. What better object of popular frustration than the EU?
Hungary is a country with a long, rich and fascinating history. Budapest is one of the most beautiful cities in Europe. I wish the Hungarian people all the best, but I do believe it is time for them to take another look at where their nationalist leaders are taking them, politically as well as economically.
Four months ago the European Central Bank officially kicked the euro zone into the liquidity trap with its zero interest rate. Non-euro members of the EU have been resisting – or pretending to resist – the temptation of going all the way out with their central banks. But now Sweden has succumbed to the temptation. The Telegraph reports:
The world’s oldest central bank has slashed interest rates to a record low of 0pc as it battles to ward off deflation. Sweden’s Riksbank decided to cut its benchmark “repo rate” by 25 basis points from 0.25pc at this month’s monetary policy meeting, following three previous rate cuts this year. The decision was not expected by polled analysts who forecast the benchmark rate to be lowered to 0.1pc. The move is designed to increase lending and push up prices and reflects worries about the real threat of deflation which have now gripped the economy.
The Swedish central bank is foolish. The ECB has already proven that you cannot fend off deflation with massive money printing. The ECB has also demonstrated that zero interest rates do not bring about the recovery that almost-zero interest rates did not bring about. In other words, the marginal policy effects of going to a zero interest rate are just that – zero.
While there are no benefits from the zero rate, there are certainly costs and risks associated with it.
To begin with, the zero rate opens the last floodgates of liquidity supply. Banks can borrow money from the central bank at practically no cost. This pushes even more money out to the supply side of the credit markets, primarily for mortgages. With an already overheated real estate market, Sweden will now see further injections of virtually cost-free lending to home buyers and speculators.
At the same time, private consumption has been driven in good part by virtually cost-free access to credit. Swedish families are among the most indebted in Europe, with a household debt-to-income ratio far higher than it was here in the United States – even if we go back to right before the recession.
Loans are collateralized against real estate, which essentially means that most of the growth in private consumption in Sweden is directly related to the easy access to mortgages. The situation is increasingly unsustainable, and it is only a matter of time before the national legislature either puts an end to the debt fest by reintroducing amortization requirements for mortgages (yes, interest-only loans are very popular in Sweden) or the market puts an end to the endless upward price trend as banks run their balance sheets to the end.
The former is a distinct possibility – the latter is increasingly plausible as shareholders begin to worry about if mortgage-happy banks will ever get their money back…
The latter could actually happen simply by means of growing loan defaults. Yes, a lot of home owners do not even pay on their loan principals, but a notable tightening of fiscal policy could send many of them out in unemployment. The new green-socialist coalition government has just presented a budget filled to the brim with tax increases. Among them is a restoration of a higher level of payroll taxes for young employees, which will very likely wipe out tens of thousands of jobs for individuals and couples just getting started with their lives. Many of them have bought their first, tiny little apartment and now risk being hurled out in joblessness – and homelessness.
A wave of loan defaults would quickly gain the critical mass needed to send a shockwave through the entire Swedish mortgage industry. That will shut the door for one investment opportunity for the mass of liquidity floating around in the banking system. Banks will have to go find another place to turn their liquidity into revenue.
And here is where the zero-interest central bank policy gets in the way: by dropping their key interest rate to zero, the price of treasury bonds has by definition reached its expectational maximum. The only way for bond prices to go now is down. Therefore, the only place to go is to the stock market.
The problem with the Swedish stock market is that it operates in an economy that is stuck in a long, irritating recession. There are profitable corporations to invest in, but those are of limited supply – especially when the supply of liquidity on the stock market increases rapidly as the real-estate market grinds to a halt. This will push investors out from the low-risk, safe stocks toward stocks that carry increasing rates of risk. As investors go after increasingly risky stocks they will demand speculative returns to match that risk. This exacerbates risk taking, putting the market at risk for self-magnifying destabilization.
It is no longer impossible that Sweden could end up in a situation where both the real estate market and the stock market destabilize at the same time. I would consider this risk theoretical at this point – the stock market is sophisticated and operated with both derivatives and other stabilizing instruments. However, so long as the Riksbank’s monetary policy had some restraints on it, there was not even a theoretical possibility of two-market instability.
Many economists dismiss this scenario by saying that Sweden has performed spectacularly from a macroeconomic viewpoint. However, the seven-year average, inflation-adjusted GDP growth rate covering the entirety of the Great Recession (2007-2013) is a not-so-impressive 1.39 percent. If you deduct the effect from exports and from debt-driven consumption, there is nothing left. In fact, private consumption including that paid for with second and third mortgage loans has averaged 1.1 percent since 2007.
It is therefore irresponsible, not to say reckless, to suggest that Sweden can handle zero interest rates because of some underlying macroeconomic strength. That strength does not exist. The slightest aberration in real estate price trends could eradicate the domestic source of GDP growth.
Sweden has made the same mistake as the rest of Europe: they combined tight fiscal policy with very lax monetary policy. This is a recipe for liquidity-trap stagnation – just as Lord Keynes explained some 80 years ago. Students of Austrian economics have also reached this conclusion, especially through the analysis of the role that lax monetary policy plays in a modern economy.
Sadly, both Keynesian and Austrian economics are left out of the curriculum when modern graduate schools train tomorrow’s generation of economists. Advanced econometrics is passed off as the fix-it-all for our profession. Yet as Paul Ormerod and others have explained so elegantly, econometricians get it right so long as nothing is happening in the economy. Once the economy starts moving like it did in 2008-2009, prediction models based on stability rapidly become useless.
But that is a topic we will have to return to later.