Another Greek Debt Default?

Three years have passed since Greece simply nullified part of its debt. In the last quarter of 2011 the Greek government owed its creditors 356 billion euros; in the first quarter of 2012 that debt had been reduced to 281 billion euros, a reduction of 75 billion euros, or 21 percent. The banks that owned Greek treasury bonds were strong-armed by the EU and the ECB into accepting the debt write-down; ironically, that only added insult to injury as banks in, e.g., Cyprus started having serious problems as a result of precisely that same write-down.

As some of you may recall, a bit over a year after the Greek government unilaterally decided to keep some of the property lenders had allowed them to use – in other words wrote down their own debt – banks in Cyprus began having problems. Having invested heavily in Greek treasury bonds they had to take a disproportionately impactful loss on their lending to Athens. As a direct result the EU-ECB-IMF troika began twisting another arm: that of the Cypriot government. They wanted the government in Nicosia to order the banks in Cyprus to replenish their balance sheets with – yes – money confiscated from their customers.

That little episode of assault on private property is also known as the Cyprus Bank Heist.

Both these events, which exemplify reckless disrespect for private property and business contracts, make Bernie Madoff look like a Sunday school prankster. Unlike Madoff, government is established to protect life, liberty and property. But in both Greece and Cyprus government has voided property rights simply because it is the most convenient way at the time for government to fund its operations.

In other words, to protect the welfare state at any cost.

There were many of us who thought that Europe’s governments had learned a lesson from the massive protests against both the Greek debt write-down and the Cyprus Bank Heist. Sadly, that is not the case. Benjamin Fox, one of the best writers at EU Observer, has the story:

With fewer than three weeks to go until elections which seem ever more likely to see the left-wing Syriza party form the next Greek government, the debt debate has returned to the centre of European politics. Syriza’s promises to call an end to the Brussels-mandated budgetary austerity policies … are not new … But what is potentially groundbreaking is Syriza’s proposal to convene a European Debt Conference, modelled on the London Agreement on German External Debts in 1953 which wrote off around 60 percent of West Germany’s debts following the Second World War

Apparently, Syriza does not think twice about the actual consequences of their proposal. If it was carried out, it would have the same kind of effects on Europe’s banks as the last debt write-down. While there are no immediately reliable sources on how much of the Greek government debt is owned by financial corporations, we can get an indirect image from other euro-zone countries in a similar situation. In Spain, e.g., banks owned 54.3 percent of all government debt in 2013; in Italy the share was 55.6 percent while 41.2 percent of the French government were in the hands of financial corporations.

Adding up actual debt for these three countries, both total and the share owned by banks, gives us a financial-corporation share of almost exactly 50 percent. Using this number as a proxy for Greece, we can assume that banks own 160 billion of 320 billion euros worth of Greek government debt.

A Greek debt write-down according to the Syriza proposal would, if it cut evenly across the total debt, force banks to lose 86 billion euros. And this is under the assumption that, unlike the last write-down, banks are treated on the same footing as everyone else. Back then banks had to assume a bigger shock than other creditors.

The 2012 write-down was worth a total of 75 billion euros.

Has Syriza even taken into account that families, saving up for retirement, own treasury bonds? In Italy they own as much as ten percent of all government debt, a share that would equal 32 billion euros in Greece. But even if that number is five percent – 16bn euros – and you ask them to give up 60 percent of it, the impact on remaining private wealth in Greece would be devastating.

To make matters worse, Syriza does not confine their confiscatory dreams to their own tentative jurisdiction. Benjamin Fox explains that Syriza hopes that a write-down in Greece…

would lead to a huge write-down of government debt for … other southern European countries. The idea was initially mooted by Syriza leader Alexis Tsipras in 2012 when the left-wing coalition finished second in the last Greek elections. Roundly dismissed as fantasy for almost all the two years since then, the proposal is at the heart of the party’s campaign manifesto and Syriza insists it won’t back down if it wins the election.

In the three countries mentioned earlier, Italy, Spain and Greece, banks own a total of 2.47 trillion euros worth of debt. A 60-percent write-down of that equals 1.58 trillion euros. Compare that, again, to the total Greek write-down of three years ago of 75 billion euros.

In Italy alone households own 215 billion euros in government debt. Is the socialist cadre leading Syriza ready to rob them of 89 billion euros just to improve their government’s balance sheets? That would be 1,500 euros for every man, woman and child in Italy. Obviously, all of them do not own government debt, but the more concentrated the ownership is the bigger the impact will be on their economic decisions.

This is, for all it is worth, an idea of galaxy-class irresponsibility. If it ever became the law of the land in Europe it would set off a financial earthquake far beyond what the continent experienced in 2009. And I keep repeating this: all of this is under the assumption that banks will not be discriminated against – an assumption that is not likely to survive all the way to a deal of this kind. Europe’s socialists have a tendency to despise banks and consider them unfair, even illegitimate institutions. It is possible that Syriza, at least as far as Greece is concerned, would force banks to eat the entire write-down loss.

But is this really worth all the drama? After all, the Greek election is three weeks out. Benjamin Fox notes that “Syriza is so close to taking power that the proposal deserves to be taken seriously.”

This debt write-down is part of a broader plan that Syriza has put in place for the entire European Union. To work at the EU level the plan would have to be more complex and involve a series of transactions involving the European Central Bank that, frankly, amount to little more than macro-financial accounting trickery. At the end of the day, those who have lent money to Europe’s governments would make losses worth trillions of euros.

As things look today it is not very possible that Syriza would have it their way across the EU. But it is almost certain that they will go ahead and do it in Greece. What the ramifications would be for the Greek economy is difficult to predict at this point – suffice it to say that the storm waves on the financial ocean that is the euro zone will rise again, and rise high, if Syriza wins on January 25.

Monetary Madness in Europe

On Monday, in an analysis of the ECB’s declared intentions to monetize government deficits and the apparent desire to get the wheels going again in the European economy, I wrote that:

Unless the ECB is planning to buy bonds directly from European consumers, there is no direct connection between Draghi’s bond purchases and consumer spending. If he is hoping to depress interest rates even further and thereby stimulate consumption, then he has very little to play with. In most euro-zone countries interest rates are plunging toward zero – credit is practically available for free.

My comment about consumers was a bit tongue-in-cheek; it should be apparent to everyone, I thought, that handing out cash to consumers is not the way to go if you want more growth, more jobs and more prosperity.

Apparently, I had missed out on just how desperate – or economically ignorant – well-educated people can get. Alas, from Der Spiegel:

It sounds at first like a crazy thought experiment: One morning, every resident of the euro zone comes home to find a check in their mailbox worth over €500 euros ($597) and possibly as much as €3,000. A gift, just like that, sent by the European Central Bank (ECB) in Frankfurt. The scenario is less absurd than it may sound. Indeed, many serious academics and financial experts are demanding exactly that. They want ECB chief Mario Draghi to fire up the printing presses and hand out money directly to the people.

This is being done on a daily basis. Tens of millions of working-age Europeans receive cash directly from government through all sorts of cash entitlements. In 2012 the governments of the 28 EU states handed out 2.37 trillion euros in cash benefits to its citizens. That was an increase of 288 billion euros, or 12.1 percent, over 2008.

In Spain the increase was 15.8 percent, while the economy was in complete tailspin. Greek cash entitlement handouts grew by 11.7 percent; during the same time period the Greek economy shrank by one fifth in real terms.

What some thinkers in Europe are now proposing is, for all intents and purposes, the same kind of cash entitlement program, only with a short-cut administration process: instead of governments borrowing the money from the ECB and then handing it out as entitlements, the ECB should simply send the checks directly to people.

It has not worked when done the traditional way; but shame on those who give up on a hopeless idea – maybe if we print just a little bit more money, and send it to just a little bit more people, then all of a sudden the free cash won’t have the same work-discouraging effect it currently has. If we just churn out a bit more newly printed money, we will find that sweet spot when people start spending like mad dogs.

Yep.

Back to Der Spiegel:

Currently, the inflation rate is barely above zero and fears of a horror deflation scenario of the kind seen during the Great Depression in the United States are haunting the euro zone. … In this desperate situation, an increasing number of economists and finance professionals are promoting the concept of “helicopter money,” tantamount to dispersing cash across the country by way of helicopter. The idea, which even Nobel Prize-winning economist Milton Friedman once found attractive, has triggered ferocious debates between central bank officials in Europe and academics.

In addition to the fact that proponents of this ludicrous idea won’t learn from existing examples, there is also the tiny little nagging thing called the Stability and Growth Pact – Europe’s constitutional debt and deficit control mechanism. The Pact consists of three parts:

1. Government debt cannot exceed 60 percent of GDP and government deficit cannot exceed three percent of GDP;

2. Member states cannot bail out each other in times of deep deficits; and

3. The ECB is banned from monetizing debt and deficits.

For a long time, member states have almost made a habit out of breaking the first rule. In recent years that has led to intervention from the EU, the ECB and the IMF, also known as the Troika, which has imposed serious austerity programs on those countries. The effect has, at best, been temporary and minor.

Germany broke the second rule when it participated in a bailout of Greece, and the ECB has been stretching the third rule time and time again by its participation in member-state bailouts. If this cash entitlement program goes into effect, it will drive a dagger through the heart of the last, remaining piece of the Stability and Growth Pact.

Der Spiegel is not too concerned with the consequences of the Pact falling apart. Instead, their article centers in on the fight against deflation, a battle that the ECB is not winning:

Draghi and his fellow central bank leaders have exhausted all traditional means for combatting deflation. The failure of these efforts can be easily explained. Thus far, central banks have primarily provided funding to financial institutions. The ECB provided banks with loans at low interest rates or purchased risky securities from them in the hope that they would in turn issue more loans to companies and consumers. The problem is that many households and firms are so far in debt already that they are eschewing any new credit, meaning the money isn’t ultimately making its way to the real economy as hoped.

And the bright minds at the ECB headquarters in Frankfurt did not realize this before they bing lending to banks? Of course they did. They just refused to see the causality between a recession, high household debt and the inability of said households to afford more debt.

Somehow they must have thought that if only you print money fast enough, credit scores won’t matter.

Anyway. Back to the helicopter cash idea and its prominent backers in the highly sophisticated world of advanced economic thinking:

In response to this development, Sylvain Broyer, the chief European economist for French investment bank Natixis, says, “It would make much more sense to take the money the ECB wants to deploy in the fight against deflation and distribute it directly to the people.” Draghi has calculated expenditures of a trillion euros for his emergency program, funds that would be sufficient to provide each euro zone citizen with a gift of around €3,000. Daniel Stelter, founder of the Berlin-based think tank Beyond the Obvious and a former corporate consultant at Boston Consulting, has even called for giving €5,000 to €10,000 to each citizen.

If this is such a good idea, why stop there? Why not crank it up to 50,000 euros? A hundred grand? What is keeping them back?

As an addition to the magnanimous disregard for basic economic theory that is fueling the monetary helicopter:

Many academics have based their calculations on experiences in the United States, where the government has in the past provided cash gifts to taxpayers in the form of rebates in order to shore up the economy.

It is one thing to let people keep more of what they have already earned. It is an entirely different thing to give them what they have not earned. When people get a tax refund they have already been productive, they have already participated in the production of total output in the economy. When people are given a handout they have not earned, they do not participate in that same production process, partially or entirely.

Cash handouts discourage workforce participation. It does not matter if it is a one-time event or a permanent entitlement program: the effect is the same, differing only in how long it lasts. When people reduce their workforce participation they increase their demand for other entitlements as well. That effect is small for temporary cash handouts, but consider what will happen in low-income families if, as a pundit quoted above suggested, the ECB gave away 5,000 or 10,000 euros per resident. A family of four would suddenly have 20-40,000 in extra cash.

How likely is it that both parents in that family will continue to work for the next year, when they just got more cash than one of them earns in a year (after tax)?

More cash in consumer hands and less workforce participation is a recipe for rising prices. Which, one should note, is just the intention behind this program. European economists and politicians are paralyzed with fear over the imminent threat of deflation. They will do whatever it takes to get inflation up to the two percent where the ECB would like it to be.

The problem is that if they succeed in causing inflation, it is going to be a rapid spike, i.e., an upward adjustment of prices very early in the spending cycle that the ECB would stimulate with its cash entitlement program. Retailers and manufacturers, squeezed by seven years of economic stagnation, will be quick to raise prices when they see a reason to do so. The price jump will eat up a large share of the consumption stimulus that helicopter proponents expect. As a result, the effect on jobs will be modest, if even visible.

Because of the inflation bump there will not be any lasting effect of this stimulus. It will be a blip on the GDP radar. The risk, however, is that the higher prices linger, thus putting pressure on money wages across Europe. It probably would not be a serious issue, but it would most likely eradicate any remaining stimulative effects of the helicopter entitlement program.

In other words, it is hard to find reliable transmission mechanisms to take the European economy from where it is today to a recovery simply by doing a one-time cash carpet bombing of the economy.

ECB Plans Deficit Monetization

When the euro was introduced more than 15 years ago it was marketed as the rock-solid currency that would beat the sterling, the U.S. dollar and the Swiss franc as the world’s safe haven for investors.

Part of the foundation for that ambitious, but not unattainable, goal was the convergence criteria that were supposed to align fiscal policy in all euro-zone countries. Those criteria, which went into effect in 1993, were elevated to constitutional status and still guide fiscal policy in the form of the Stability and Growth Pact. One of the three pillars of the pact was a ban on deficit monetization: the European Central Bank was not allowed to print money to buy up treasury bonds.

During the Great Recession the first two pillars of the Pact have crumbled; now the third one is about to fall apart as well. From the EU Observer:

The euro has begun 2015 at its lowest level in more than eight years, as markets expect the European Central Bank to present plans to buy government bonds in the coming weeks. The single currency was trading at $1.19 on Monday (5 January), its lowest rate since 2006, after ECB president Mario Draghi gave an interview stating that the bank was preparing a programme to buy up government securities in its latest bid to stimulate greater consumer demand and avoid deflation.

Unless the ECB is planning to buy bonds directly from European consumers, there is no direct connection between Draghi’s bond purchases and consumer spending. If he is hoping to depress interest rates even further and thereby stimulate consumption, then he has very little to play with. In most euro-zone countries interest rates are plunging toward zero – credit is practically available for free.

The problem is not lack of liquidity. The problem is lack of faith in the future. More on that in a moment. Now back to the EU Observer:

Speaking to German daily Handelsblatt on Friday (2 January), Draghi said the ECB was preparing to expand its stimulus programmes beyond offering cheap loans to banks and buying private sector bonds. “We are in technical preparations to adjust the size, speed and compositions of our measures in early 2015,” said Draghi, who will convene the next meeting of the bank’s Governing Council, where the support of a majority of its 25 members would be needed for a decision to be taken, on 22 January.

That will be four days before the Greek elections, which could bring the euro-secessionist Syriza to power. Syriza is a leftist hard-liner party with Venezuela’s defunct president Hugo Chavez as their political and economic role model. They would not think twice of reintroducing the drachma if they had enough political clout to do it.

By promising to buy up government bonds, the ECB could make a direct appeal to Greek voters – or at least to an incoming Syriza prime minister – that the ECB will buy all their government debt if only they choose to stay in the currency union. That, in turn, will basically give a new Syriza government the bargaining chip they need vs. Brussels to end austerity and return to the spending-as-usual policies that reigned before the Great Depression.

Precisely the situation the Stability and Growth Pact was supposed to prevent.

And again, as always, there is the change in tone among forecasters – the same kind of change that has become so frequent in recent years:

Draghi added that the risk of negative inflation had increased … Eurostat’s monthly inflation data to be published on Wednesday is likely to show that prices fell by 0.1 percent in December, the first decline since 2009. … Market analysts are forecasting another difficult year for the single currency bloc, predicting that the euro will continue to weaken against the dollar over the course of 2015, as a result of a combination of very low inflation and weak economic performance. … The eurozone economy is forecast to have grown by a mere 0.8 percent in 2014, and to grow by a meagre 1.2 percent in 2015, well below the US.

Unless there is a radical change in fiscal and welfare-state policies across the euro zone, its GDP won’t even grow by one percent for 2015.

A bond-buying program by the ECB won’t change that. All it will do is allow governments to return to deficit spending, which is not a desirable alternative to the austerity policies of the past few years. Europe needs structural reforms in the direction of free markets, limited government, low taxes and cheap energy. Nothing else will help.

German Bond Rates Go Negative

The stagnant European economy does not need more bad news. Unfortunately, there is more coming. Business Insider reports:

The amazing collapse in German bond yields is continuing. Today, five-year bonds (or bunds) have a negative nominal return for the first time ever. That means that investors buying a 5-year bond on the market today will effectively be paying the German government for the privilege of owning some of its debt. This has been happening for some time now. In 2012, people were amazed when 6-month bund yields went into negative territory. In August, the two-year yield went negative too. Less than a month ago, the same thing happened with the country’s four-year bunds.

While there is a downward trend in bond yields in most euro-zone countries, there is a clear discrepancy between first-tier and second-tier euro states. Ten-year treasury bond yields, other than Germany:

  • Austria, 0.71 percent, trending firmly downward; France, 0.83 percent, trending firmly downward; Netherlands, 0.68 percent, trending firmly downward; Italy, 1.87 percent, trending firmly downward.

A couple of second-tier examples:

  • Ireland, 1.24 percent, trending weakly downward; Portugal, 2.69 percent, trending weakly downward.

Greece is the real outlier at 9.59 percent and an upward yield trend. But Greece is also a reason why Germany’s bond yields are turning negative. Although the Greek economy is no longer plunging into the dungeon of depression, it is not recovering. Basically, it is in a state of stagnation. Its very high unemployment and weak growth is coupled with an ongoing austerity program, imposed by the EU, the ECB and the IMF.

Add to that the political instability which, in late January, will probably lead to a new, radically leftist government. Syriza’s ideological point of gravity is the Chavista socialism that has been practiced in Venezuela over the past 10-15 years. They are also vocal opponents to the EU-imposed austerity programs, an opposition they would have to deliver on in case they want to stay relevant in Greek politics.

If Greece unilaterally ends its austerity program, it de facto means the beginning of their secession from the euro. That in turn would raise the possibility of other secessions, such as France, where a President Le Pen would begin her term in 2017 with a plan to reintroduce the franc. When that happens, the euro is history.

There is no history of anything similar happening in modern history, which makes it very difficult for anyone, economist or not, to predict what will happen. Europe’s political leaders will, of course, want to make the transition as smooth and predictable, but without experience to draw on there is a considerable risk that the process will be neither smooth nor politically controllable. Add to that the inability of econometricians to forecast the transition; based on the numerous examples of forecasting errors from the past couple of years, there is going to be little reliable support from the forecasting community for a rollback of the euro.

That is not to say the process cannot be a success. But the window of uncertainty is so large that it alone explains the investor flight to German treasury bonds.

This uncertainty is also throwing a wet blanket over almost the entire European economy, an economy that desperately needs growth and new jobs. Since 2010 the EU-28 economy has added 800,000 new jobs, an increase of 0.37 percent. For comparison, during the same time the American economy has added eleven million jobs, an increase of a healthy 8.5 percent.

Stagnant Europe Entering 2015

Welcome back to The Liberty Bullhorn – the starting point of economic freedom on the internet!

While this year is promising for many, especially Americans who have a steadily improving job market to search for new opportunities, the outlook on the new year is hardly better in Europe today than it was a year ago. As far as Europe is concerned, 2014 went down in history as the year of squandered hopes for a recovery. I have lost track of all the forecasts that predicted “the” recovery take-off during last year, though it would be valuable for future reference to collect all the “squandered hopes” forecasts. There is a lot to be learned from the serial failures of econometrics-based forecasting during 2014.

The reason why Europe is nowhere near a recovery is that its political leadership is doing absolutely nothing to address the fundamental structural problem of their economy. The welfare state is still in place and its austerity policies have been driven by an urge to save the welfare state – make it slimmer and more affordable – so that it can fit inside a smaller economy with high unemployment and weak tax revenues. But it is precisely these efforts that have escalated the current crisis to a level where – as I explain in my book – it has now become a permanent state of economic affairs.

So long as Europe’s leaders refuse to acknowledge the nature of the economic crisis, they will continue to inject the patient with the medicine that perpetuates the illness.

There are some lights in the tunnel, for sure. The Greek economy has, of late, shown signs of transitioning from an almost unreal ratcheting down into an economic depression to a state that is at least a little bit promising. Its vital macroeconomic signs indicate stagnation rather than decline, which is hardly something to write home about, but good news for people who on average have lost 25 percent of their income, their jobs, and their standard of living since the beginning of the Great Recession.

Sadly, just as the Greeks were being given an opportunity to catch their breath, their elected officials went ahead and caused an early parliamentary election to be held in late January. If current opinion polls are correct, the next prime minister will be Mr. Tsirpas of the Syriza party – a radical socialist group that considers deceased Venezuelan president Hugo Chavez and his authoritarian government a good role model.

Greece does not need an economic model that has caused high unemployment, eradicated property rights and brought about 63 percent inflation. Greece needs major free-market reforms, thoughtfully executed and coupled with growth-generating tax cuts.

But Greece is not the only EU member state that is struggling. France is going nowhere, and going there fast. The socialists in charge in Paris stick to their tax-to-the-max policies, which is part of the reason why the country is going into 2015 with record-high unemployment. Economic forecasters, perhaps burned by last year’s irresponsibly positive predictions, now expect a 0.4-percent increase in real GDP for 2015. That is much more realistic.

Overall, when predicting Europe’s future, one should not ask “when is the economy going to recover?” but “what reasons do the European economy have to start growing again?”.

Again, there is not much positive to look forward to for our European friends. However, it is better to talk about things the way they are, and then find a solution to the problems thus identified, than to pretend that everything is really not what it really is.

Europe has a lot of potential. It could join us here in America and restore prosperity, hope and opportunity for the entire industrialized world. If Europe chooses to do so, we have a future to look forward to that is almost unimaginably positive.

If, on the other hand, Europe’s political leaders stick to their statist guns, their continent will continue on its current path to becoming the next Latin America. It will no longer be even close to comparison with the United States, whose economy will continue its ho-hum economic recovery through 2015 and 2016. Beyond that, it depends entirely on who is elected president next year. If it is a Republican friendly to Capitalism, like Rand Paul or Mitt Romney, we will know for certain that there will be good, growth-promoting tax and spending reforms. A more mainstream-oriented Jeb Bush or Chris Christie would also be good, but not only second-tier good.

Even a fiscally conservative Democrat would be preferable to the kind of leadership they have in Europe.

Hopefully, there can be some libertarian-inspired change for the better in Britain thanks to the seemingly unstoppable UKIP. Maybe – just maybe – that could inspire a surge of support for libertarian ideas elsewhere in Europe.

South Africa Under Siege

This would be funny if it was not for its grave implications. A member of the “Economic Freedom Fighters” in the South African parliament calls the country’s sitting president Jacob Zuma “the greatest thief in the world”. When the speaker tries to convince her to retract her statement she refuses. Other members of her party intervene in her support, gradually escalating the situation to where the police has to intervene.

The more I see of the “Economic Freedom Fighters” and their cunning, reckless leader Julius Malema, the more I suspect that they are deliberately trying to disrupt South Africa’s frail parliamentary democracy. Malema’s party has a platform that is filled with radical socialist rhetoric, and their methods as expressed in parliament are outright disrespectful of a free, democratic society. It should not be ruled out that Malema and his movement are out to destabilize South Africa politically in order to seize power when the opportunity arises.

EU Still Wrong on Economic Crisis

The truth about the European economic crisis is spreading. The latest evidence of this growing awareness is in an annual report by the European Commission. Called “Report on Public Finances”, the report expresses grave concerns about the present state as well as the economic future of the European Union. It is a long and detailed report, worthy of a detailed analysis. This article takes a very first look, with focus on the main conclusions of the report.

Those conclusions reveal how frustrated the Commission has become over Europe’s persistent economic stagnation:

The challenging economic times are not yet over. The economic recovery has not lived up to the expectations that existed earlier on the year and growth projections have been revised downwards in most EU Member States. Today, the risk of persistent low growth, close to zero inflation and high unemployment has become a primary concern. Six years on from the onset of the crisis, it is urgent to revitalise growth across the EU and to generate a new momentum for the economic recovery.

Yet only two paragraphs down, the Commission reveals that they have not left the old fiscal paradigm that caused the crisis in the first place:

The aggregate fiscal picture for the EU and the euro area is now considerably more favourable, thanks to the commendably large consolidation efforts made in the past. … this has allowed Member States to slow the pace of adjustment. The aggregate fiscal stance is now expected to be broadly neutral in 2014 and 2015, both in the EU and the euro area. This will reduce one of the drags on growth and should therefore be welcomed.

If Europe is ever to recover; if they will ever avoid decades upon decades of economic stagnation and industrial poverty; the government of the EU must understand the macroeconomic mechanics behind this persistent crisis. To see where they go wrong, let us go through their argument in two steps.

a) “The aggregate fiscal picture for the EU and the euro area is now considerably more favourable, thanks to the commendably large consolidation efforts made in the past.” There are two analytical errors in this sentence. The first is the definition of “fiscal picture” which obviously is limited to government finances. But this is precisely the same error in the thought process that led to today’s bad macroeconomic situation in Europe: government finances are not isolated from the rest of the economy, and any changes to spending and taxes will affect the rest of the economy over a considerable period of time. The belief that government finances are in some separate silo in the economy led to the devastating wave of ill-designed attempts at saving Europe’s welfare states in 2012.

Austerity, as designed and executed in Europe, was aimed not at shrinking government but making it affordable to an economy in crisis. The end result was a permanent downward adjustment of growth, employment and prosperity. In order to get their economy out of this perennial state of stagnation, Europe’s leaders need to understand thoroughly the relations between government and the private sector.

b) “The aggregate fiscal stance is now expected to be broadly neutral in 2014 and 2015, both in the EU and the euro area. This will reduce one of the drags on growth and should therefore be welcomed.” Here the Commission says that if a government runs a deficit, it causes a “drag” on macroeconomic activity. This is yet another major misunderstanding of how a modern, monetary economy works.

Erstwhile theory prescribed that a government borrowing money pushes interest rates up, thus crowding out private businesses from the credit market. But that prescription rested on the notion that money supply was entirely controlled by the central bank; in a modern monetary economy money supply is controlled by the financial industry, with the central bank as one of many players. Its role is to indicate interest rate levels, but neither to set the interest rate nor to exercise monopolistic control on the supply of liquidity.

A modern monetary economy thus provides enough liquidity to allow governments to borrow, while still having enough liquidity available for private investments. In fact, it is rather simple to prove that the antiquated crowding-out theory is wrong. All you need to do is look at the trend in interest rates before, during and after the opening of the Great Recession, and compare those time periods to government borrowing. In a nutshell: as soon as the crisis opened in 2008 interest rates plummeted, at the same time as government borrowing exploded.

This clearly indicates that the decline in macroeconomic activity was not caused by government deficits; it was the ill-advised attempt at closing budget gaps and restore the fiscal soundness of Europe’s welfare states that caused the drag. And still causes the drag.

In other words, there is nothing new under the European sun. That is unfortunate, not to say troubling, but on one front things have gotten better: the awareness of the depth of the problems in Europe is beginning to sink in among key decision makers. What matters now is to educate them on the right path out of the crisis.

 There is a lot more to be said about the Commission’s public finance report. Let’s return to it on Saturday.

Deficit Problems in Belgium

Belgium is one of Europe’s most troubled welfare states, though its problems have been overshadowed by the macroeconomic disasters along the Mediterranean. Its fiscal problems are older than most EU member states, and it was the first country to attract sociological interest based on the fact that there were families – regular working class families – where three generations were perennially unemployed.

Today, Belgium is attracting interest because of a new report from the International Monetary Fund. The EU Observer reports:

The Belgian government is planning “many welcome measures to address the critical macroeconomic challenges facing the Belgian economy”, but it can do more, the International Monetary Fund (IMF) said on Monday (15 December). On the same day Belgian unions organised a general national strike, the IMF presented its findings from a ten-day mission to the country. “The planned reforms of social security and budgetary measures are a step in the right direction”, the IMF wrote.

As with other welfare states in Europe, Belgium suffers from disturbingly low growth. As a result, tax revenues cannot keep up with entitlement spending and the budget deficit becomes structural. GDP growth has been as disappointing in the Belgian economy over the past few years as it has elsewhere in Europe (annual growth rates, reported quarterly):

LB Belgium

The Great Recession took a big toll on the Belgian government’s finances. Its budget went from a 156 million euro surplus in 2007 to a 19.1 billion euro deficit in 2009, equal to 5.6 percent of GDP.

From there, the deficit has declined slowly but steadily, reaching the EU’s magic three-percent of GDP mark in 2013. Due to the almost clinical absence of GDP growth, the decline has been accomplished by means of welfare-state saving austerity. As the EU Observer explains, these policies are likely to continue, with some tax reshuffling to spice it up:

The centre-right government of Charles Michel, the first coalition without socialists since 1988, started work in October. It plans spending cuts and increasing the pension age from 65 to 67 by 2030. However, the IMF says that Belgium should also reform its tax system. … when it comes to labour tax, Belgium ranks top with a rate of over 40 percent. The IMF suggests that labour tax should be lowered and compensated with a higher tax on capital.

As the figure above clearly shows, there is no recovery under way in Europe. Belgium is no exception, which makes the IMF advice a problematic ingredient in the Belgian fiscal policy mix. More than anything, Belgium needs tax cuts, not a redistribution of the tax burden. It also needs massive, structural reforms to its welfare-state entitlements system, encouraging work and discouraging indolence. None of this is on the horizon, which makes it a safe bet to predict that the Belgian economy will not return to historic growth levels in the foreseeable future.