The economic problems in Europe make themselves known in many different ways. Among them, a weakening of the euro. TorFX reports, via EUBusiness.com:
While the Euro recovered losses sustained in the wake of Portugal’s mini-banking crisis earlier in the month, the common currency put on a fairly lacklustre performance last week. The Euro dropped to a fresh 22-month low against the Pound and struggled against the US Dollar as investors speculated on the prospect of the European Central Bank bringing in additional stimulus measures.
It is important to keep in mind that exchange rates swing very frequently and sometimes violently, only to return to long-term stability. However, there is more than a short-term message in a 22-month low for the euro. Four variables are aligning to make the euro’s future difficult:
1. The negative interest rate. The ECB is penalizing banks for depositing excess liquidity with the bank’s overnight accounts. Even the moderately skilled speculator knows that a negative interest rate means he will have less money on Friday than he had on Monday, which of course drives investors to other currencies. The British pound comes to mind, as does the U.S. dollar. The problem for Europe is that once it has dug itself into a hole with the negative interest rate, it is mighty hard for the ECB to get out of there without any macroeconomic gains to show for it. The argument for the negative interest rate is that it will “encourage” more lending to non-financial corporations – business investments, for short. But businesses do not want to invest unless they have credible reasons to believe they will be able to pay back the loans. That really does not change because interest rates drop from almost zero to zero.
Bottom line: the ECB has entered the liquidity trap and will be stuck there for a long time to come, negative interest rate and all. This weakens the currency, especially over the short term.
2. Deflation. Part of the reason for the ECB’s move into negative interest territory is the spreading fear of deflation. The past few years have shown that a rapid expansion of the money supply has no effect on inflation, either in Europe or in the United States. Therefore, the ECB cannot reasonably be hoping to cause monetary inflation with a desperate move like negative interest rates. Its hope is instead hitched to a rise in business investments which would cause inflation through traditional, Phillips-curve style excess-demand effects.
Bottom line: not gonna happen. As mentioned earlier, businesses are not borrowing at almost-zero interest rates – why would they borrow at zero rates? There is no profit-promising activity in other parts of the economy, and there won’t be, as our next point explains.
3. Austerity and government debt. Ever since the Great Recession began, Europe has used austerity not to reduce the size of government, but to preserve the welfare state. This has led to perennially slow or non-existent GDP growth and high, perennial unemployment. This has two consequences that spell trouble for the euro over the longer term. The first is that persistent lack of economic activity discourages business investments per se. Austerity, European style, includes tax hikes which constitute further government incursions into the private sector. The perpetuation of European austerity therefore means the perpetuation of low levels of business activity. The second consequence is that even if economic activity picks up, because, e.g., a long-term rise in exports (unlikely to happen) there is so much excess capacity in the economy that there will be no excess-demand driven inflation for a year, maybe even two. The excess supply, of course, consists of massive amounts of un-demanded liquidity slushing around in the European economy, and perennially high unemployment, including 20+ percent youth unemployment in a majority of EU member states.
Bottom line: political preferences to preserve the welfare state will keep macroeconomic activity low. Long-term outlook is continued stagnation. No support for a return to interest rates above liquidity-trap levels.
4. Continued recovery in the United States. Despite dismal growth numbers for the first quarter, the long-term outlook for the U.S. economy is moderately positive. We have not applied the destructive European version of austerity, even though its tax-hiking component makes it a wet dream for many statists. Furthermore, Obama has been surprisingly restrained on the spending side of the federal budget, being far more fiscally conservative than, e.g., Ronald Reagan. This has created reasonably good space for U.S. businesses to grow. There are caveats, though, such as the implementation of Obamacare, which in all likelihood contributed to the negative GDP number in the first quarter of this year. There has also been a regulatory barrage from the Obama administration that has stifled a lot of business activity, although it has subsided somewhat in the last year and a half. But even a moderately positive business climate makes the U.S. economy notably stronger than its European competitor.
Bottom line: a slowly strengthening dollar will attract investments that otherwise would have gone to the euro zone, putting further downward pressure on the euro.
There is actually a fifth variable, which is entirely political. If Marine Le Pen gets elected president in France in 2017 she will pull her country out of the euro. That means goodnight and farewell for the common currency. Long-term minded investors would be wise to keep this in mind.
All in all, the case for the euro is not good. Stagnation at best, weakening more likely, with the probability of its demise slowly gaining strength.
The European Parliament elections in May conveyed a somewhat schizophrenic voter message. At the end of the day, though, the inevitable outcome is a strong gain for the left. Socialists were emboldened, as were their fellow statist nationalists. Both flanks are pushing for a number of policy reforms that, taken together, could very well mark the beginning of the end of the European Union as we know it. On the left, more and more voices demand a restoration of Europe’s austerity-tarnished welfare state. Some of those demands come in the form of attacks on the Stability and Growth Pact, which dictates budget deficit caps for all EU member states, attacks that are motivated by the desire to rebuild the welfare state.
Europe’s left turn seems to continue at the state level, and with it the criticism of the prevailing austerity doctrine. The most recent example is from Slovenia. Euractiv reports:
Center-left political novice Miro Cerar led his party to victory in Slovenia’s election … (13 July), indicating he would rewrite a reform package agreed upon with the European Union to fix the euro zone member’s depleted finances. The result will test investor nerves, given Cerar’s hostility to some of the big-ticket privatization programmes that the EU says are key to a long-term fix for Slovenia, which narrowly avoided having to seek an international bailout for its banks last year.
Selling off government-owned businesses is a way to temporarily reduce the budget deficit:
Cerar’s government will now oversee a raft of crisis measures agreed upon with the EU, in order to reduce Slovenia’s budget deficit and remake an economy heavily controlled by the state. Cerar, however, opposes the sale of telecoms provider Telekom Slovenia and the international airport, Aerodrom Ljubljana, fuelling investor fears of backsliding. … He said his cabinet would immediately consider which companies would remain in state hands and what to do with the rest. … The outgoing government suspended the privatization process this month pending the formation of a new government, which is not expected before mid-September. Cerar will have to find other ways to raise cash if he is to meet to targets agreed to with the EU, in order to slash Slovenia’s budget deficit to 3% of output by 2015, from a forecast 4.2% this year.
The Slovenians better make up their minds on this issue. According to the EU Observer, the EU and the ECB are not budging on the Stability and Growth Pact:
ECB boss Mario Draghi urged EU leaders not to meddle with the bloc’s rules on debt and deficits on Monday, warning that it could turn the tide on much needed economic reforms.
It remains to be seen to what extent the emboldened left in the European Parliament can influence the way the EU Commission interprets the Stability and Growth Pact. So far, though, the Draghi view is also that of the Commission.
And just to add to the schizophrenia of current European politics, Draghi added a curious remark:
Addressing MEPs on the Parliament’s economic affairs committee in Strasbourg (14 July), Draghi said structural reforms combined with government spending cuts and lower taxes were the only route to restoring economic stability. “There should be a profound structural reform process,” he said, adding that “there is no other way”. “We should take great care not to roll back this important achievement, or to water down its implementation to an extent that it would no longer be seen as a credible framework,” he said.
The combination of less government spending and lower taxes is almost the antithesis of what the EU and the ECB have been preaching to euro-zone member states in the past few years. The austerity packages they have forced on member states have been of the government-first kind, aimed at balancing budgets to make welfare states more fiscally sustainable.
This type of austerity relies at least partly on tax increases. A combination of less taxes and less spending is in fact not austerity at all – it is a policy for government roll-back. If Draghi really means this, he is the first major EU figure to step forward and promote such a structural change to the Euoropean economy.
It is unlikely, though, that Draghi will get much support for any kind of permanent reduction of government. There is far too much power to be had in making the Stability and Growth Pact more flexible. Not only does it allow statist politicians to save their welfare states, but it also opens for a classic form of “Italian governance”. The EU Observer again:
Italian prime minister Matteo Renzi, whose government holds the EU’s six month presidency, has led calls for the pact’s rules to be applied with more flexibility to allow governments to increase public investment programmes. The demand was rejected by Draghi who stated that “the present rules already contain enough flexibility”. “If a rule is a rule then it has to be complied with,” he said, commenting that “I’m not sure I get – perhaps because I lack political skills – the chemistry of flexibility being essential to make a rule credible”.
It’s simple. The flexibility that Renzi wants is simply a way to apply a general law selectively. That, in turn, gives elected officials more power, as they can oversee the “flexible” application and choose who will get and exception and who will not. Inevitably, the choice will be made based at least in part on the size of the brown envelopes that exchange hands under the negotiation tables in Brussels.
Between corruption and the welfare state, big government has enough supporters to stay right where it is in Europe. Furthermore, regardless of what kind of interpretation of the Stability and Growth Pact that will set the tone in the next few years, it is going to be there as a power tool for the EU over the member states. The left’s desire for more flexibility is just a desire to put more direct power in the hands of bureaucrats and legislatures.
I got some really positive feedback on my first austerity video. Thank you! The topic is timely, especially with reference to the crisis in Europe. After the elections in May when statist parties on the left gained seats in the European Parliament, the debate over how to handle the perennial economic slump has intensified. Austerity critics have become more vocal, and the funniest part of that is that they do not even realize that the kind of austerity they criticize is really the kind I define as “Government-First” austerity in my video.
This is telling of what the debate over austerity in Europe is really about, and who the participants are. Proponents of the European version of austerity are not out to reduce the size of government, but to make sure government – the welfare state to be precise – survives the recession as unharmed as possible. As I point out on the video, if they had a “Limited Government” purpose behind their austerity they would use private-sector growth, or lack thereof, as their metrics for whether or not austerity was successful. But since private-sector activity has been plunging in the countries hit worst by the European version of austerity, it is clear that the purpose behind austerity as applied in the EU is of the “Government First” kind.
This puts an absurd light on far-leftist criticism of austerity. Since there are no limited-government proponents on the scene in the European debate, statists are bashing statists over not using the right tools to save the welfare state. With the noise from their fight rising, it is becoming increasingly likely that my predictions for Europe’s future will come true: the continent is bound for a new form of stagnation. So long as Europe does not dispose of the welfare state, they will end up right there, in the economic wasteland of industrial poverty.
The harder the far left works to end government-first austerity, the farther to the left they will pull economic policy in Europe. Instead of trying to balance government budgets as a means toward saving the welfare state, the far left does not even want to have to worry about the budget. Their attacks on the EU’s constitutional stability and growth pact are symptomatic of this.
Austerity criticism is not limited to the EU level. Wherever socialists have made headway in national parliamentary elections they raise their anti-austerity voices. Italy is a case in point, as illustrated by an article in the EU Observer:
The EU is at a “crossroads” between accepting a long period of austerity and high unemployment or taking steps to boost an economic recovery, Italian prime minister Matteo Renzi has warned. Speaking in national parliament on Tuesday (24 June), Renzi told deputies that “high priests and prophets of austerity” were stifling the European economy. Renzi’s government takes control of the EU’s six month rotating presidency next week and has indicated that migration and the bloc’s stability and growth pact will be its main policy priorities. The Italian prime minister has led calls for the pact’s rules on budget deficits to be interpreted in a way that encourages more public investment.
In other words, what they want to be able to do is to spend more on government-run, tax-funded education, on more roads, mass transit and so called research and development programs. They also want to pour more money into non-fossil energy, the kind of complete waste that has been Germany’s failed attempt at replacing nuclear energy with “renewable” energy sources. (Out of utter panic over rising energy prices, Germany is now building coal power plants almost as fast as the Chinese.)
None of that spending would help the economy grow. If you tax the private sector into oblivion, it does not matter if it can ship its products on four-lane highways or six-lane highways. There won’t be anyone there to buy their products in the first place. It matters even less if the energy that manufacturers would use is from sometimes-producing wind turbines or sometimes-producing solar panels. If the energy is too expensive to make manufacturing competitive, nobody is going to want to buy it in the first place.
Europe does not need more government. It does not need more government-first austerity either. It needs limited-government austerity. And soon. Otherwise, it is basically over for Europe as a first-world continent.
Here is the first in a four-part series on austerity, its theory, its application and its consequences:
Europe’s political leaders are showing more and more signs of discomfort – not to say emerging panic – over an economic crisis that just won’t go away. My diagnosis is that this is a permanent crisis, brought upon Europe by its fiscally obese and unsustainable welfare state. (Make sure to get my book Industrial Poverty when it comes out August 28!) By consequence, it is therefore not possible for Europe to get out of the crisis unless they first roll back and eventually fully dismantle their welfare state.
Not everyone agrees. As the EU Observer reports, the social affairs commissioner of the EU – compare him to the U.S. Secretary of Health and Human Services – is getting mighty frustrated with the crisis and calls for a restoration of the welfare state:
The EU’s social affairs commissioner on Friday (13 June) lashed out at the EU’s response to the economic crisis. Lazlo Andor, in a speech delivered in Berlin, said debt-curbing policies designed to resolve the sovereign debt crisis have wrecked Europe’s social welfare model. “Austerity policies in many cases actually aggravated the economic crisis,” he said.
Has he been sneak-peeking on this blog? Apparently, because he cannot have read my articles in full. If he had, he would know that there are two answers to his frustration over austerity and the crisis. On the one hand, yes, the spending cuts have slashed entitlement programs and made it tougher to get by on government handouts. On the other hand, though, the current European austerity model has raised taxes on businesses and households. This has stifled economic growth and thus made it harder for people to get out of their government dependency.
The reason for this is that austerity, as designed and carried out during the crisis in Europe, has had the purpose of balancing the government budget – even at the cost of depressed private-sector activity. Other forms of austerity, applied back in the late 20th century, had other goals, among them to inspire growth in the private sector. The difference is monumental for the outcome of an austerity strategy.
Europe has been under the statist version of austerity, the purpose of which is to balance the government budget and therefore restore fiscal sustainability in government. The reason for this, in turn, is that as Europe’s political leaders designed a response to the crisis, it never occurred to them that the very existence of a welfare state could have something to do with the crisis.
Back to the EU Observer:
He described the EU’s economic and monetary union (EMU) as flawed from the start, forcing troubled member states to make deep cuts in the private and public sectors via internal devaluation. “Internal devaluation has resulted in high unemployment, falling household incomes and rising poverty – literally misery for tens of millions of people,” he said.
This is a technical level of macroeconomics. What Commissioner Andor is saying is actually that Greece would have been better off when the crisis began if they had been able to devalue their own currency – the drachma – vs the Deutsch mark. However, that is a way to grossly simplify the problem: the argument rests on the assumption that Greece fell into a depression because of bad terms of trade vs. Germany. But the fact of the matter is that Greece was in trouble for years before the outbreak of the Great Recession, with deficit and debt problems resulting not from insufficient exports capacity (which is what Commissioner Andor alludes to) but from a vast system of entitlement programs that promised a lot more to their recipients than taxpayers could afford.
The EU Observer again:
[The] EMU is gripped by a social and economic paradox. “On the one hand, we introduce social legislation to improve labour standards and create fair competition in the EU. On the other hand, we settle with a monetary union which, in the long run, deepens asymmetries in the community and erodes the fiscal base for national welfare states,” he said.
There you go. No blame on the welfare state, all blame on admittedly dysfunctional EU institutions. But the role of the EU did not become acute until the economic crisis had escalated to depression-level conditions in some southern EU states. It was not until the Troika (EU-ECB-IMF) went to work in 2010-11 that the venom of ill-designed austerity went to work deep inside the economies of Greece, Spain, Portugal and Italy. By then, the crisis had already started, it had escalated and caused runaway unemployment and rampant deficits.
So long as Commissioner Andor persists in believing that the welfare state is the victim, not the culprit, in this crisis, the crisis will prevail.
Commissioner Andor’s complete ignorance on this item is revealed as the EU Observer story reaches its crescendo:
A possible way out, he says, is to disperse some money from national coffers through so-called “fiscal transfers” between member states using the euro. Some of the pooled money would be used, in part, to fund a European Unemployment scheme to better prop up domestic demand, says Andor.
How many entitlement programs, and how many levels of government, do you have to involve before government expansionists understand that pouring more gasoline on the fire is not going to put out the flames?
In last week’s elections, did Europe’s voters plant the seeds of a post-EU Europe? The question has surfaced in response to the strong showing of Euroskeptics and outright anti-EU parties across the continent. While most observers of European politics are still at loss trying to comprehend the fact that some of their fellow citizens actually don’t like the EU, some sharp-minded analysts see the writing on the wall for what it actually is. In addition to Yours Truly, you can always trust Daily Telegraph columnist Ambrose Evans-Pritchard. Again, he has elevated himself above the murmur. Starting with Britain, he gradually expands his perspective, laying out a credible scenario for Europe’s future:
If Europe’s policy elites could not quite believe it before, they must now know beyond much doubt that they have lost Britain. This island is no longer part of the European project in any meaningful sense. British defenders of the status quo were knouted on Sunday. UKIP won 27.5pc of the vote … Margaret Thatcher’s Tory children are scarcely more friendly to the EU enterprise.
This is an important observation. The British vote shows two things: first, that British democracy, unlike continental Europe’s, still has not succumbed to Europhoristic centralism – on the contrary, Brits still believe in their traditions and their way of governing themselves; secondly, classical Anglo-Saxian liberalism still has a voice in Britain.
The second point carries more weight than perhaps even the Brits themselves realize. Deep down, UKIP’s ideology is a mild version of what we here in America refer to as “libertarianism”, namely a solid refutation of all government beyond a small set of strictly contained and enumerated core functions. A UKIP prime minister would never pursue the termination of the British welfare state, but he would most likely revive some of Thatcher’s legacy, a legacy that has been carefully squandered by the Conservatives.
Britain needs more Thatcherism. Europe could use a big dose of it as well. Hopefully, an invigorated UKIP can deliver that, with the right cooperation in the European Parliament.
Back to Evans-Pritchard:
Britain’s decision to stay out of monetary union at Maastricht sowed the seeds of separation, as pro-Europeans fully understood at the time, though almost nobody expected EMU officialdom to clinch the argument so emphatically by running the currency bloc into the ground with 1930s Gold Standard policies and youth unemployment levels above 50pc in Spain and Greece, and above 40pc in Italy. European leaders must henceforth calculate that the British people will vote to leave the EU altogether unless offered an entirely new dispensation: tariff-free access to the single market along the lines already enjoyed by Turkey or Tunisia; and deliverance from half the Acquis Communautaire, that 170,000-page edifice of directives and regulations that drains away sovereignty, and is never repealed.
In a nutshell, Evans-Pritchard is saying that the euro was doomed without Britain’s participation – a statement that is only partially correct. The structural imbalance of the euro project goes deeper than that. But more on that later. Evans-Pritchard refers to reckless austerity policies as having removed the fiscal and, especially, monetary policy foundations for a sound, strong common currency. He is right about austerity, as regular readers of this blog know; the Liberty Bullhorn contains more analysis of Europe’s austerity policies and their consequences than any other website in the world.
But even if we disregard the structural imbalances built into the euro project, it is important to note that the ECB has exacerbated the crisis by frivolously printing money right, left, up and down to save credit-crashing welfare states from fiscal ruin. If there is one single policy move that really drove the pole through the heart of the euro, it was the ECB’s decision to bail out its worst-rated welfare states. That open-ended commitment to print money reduced the euro from Deutsch Mark status to something of a business-class Drakhma.
Evans-Pritchard also makes a note of the ever-growing regulatory burden on EU’s member states. In this category, the EU is competing with the Obama administration, though in the latter case things have slowed down considerably in the last couple of years. Also, it is increasingly likely that the next president of the United States will have libertarian roots – probably stronger than those of UKIP leader Nigel Farage – which will vouch for a historic regulatory rollback. For that to happen in Britain, the country has to leave the EU.
Which, again, is probably going to happen in the next few years. Now for the broader perspective, and Evans-Pritchard’s analysis of where France is heading:
It is a fair bet that EU leaders would search for an amicable formula, letting Britain go its own way while remaining a semi-detached or merely titular member of the EU. Let us call it the Holy Roman Empire solution. Yet Britain is the least of their problems. The much greater shock is the “Seisme” in France, as Le Figaro calls it, where Marine Le Pen’s Front National swept 73 electoral departments, while President Francois Hollande’s socialists were reduced to two. … It is widely claimed that the Front is eurosceptic only on the surface. Perhaps, but when I asked Mrs. Le Pen what she would do no her first day in office if she ever reached the Elysee Palace, her reply was trenchant. She would instruct the French Treasury to draft plans for the immediate restoration of the franc… She vowed to confront Europe’s leaders with a stark choice at their first meeting: either to work with France for a “sortie concertee” or coordinated EMU break-up, or resist and let “financial Armageddon” run its course. … She said there can be no compromise with monetary union, deeming it impossible to remain a self-governing nation within the structures of EMU, and impossible to carry out the reflation policies necessary to defeat the economic slump.
Given that the Front National has suffered no notable setback in national voter support over the past decade, but instead gradually grown stronger, the prospect of a Madame President Le Pen is one that both Europe and the United States should get used to. Therefore, as Evans-Pritchard rightly explains, it is also time to get used to the prospect of Europe returning to national currencies.
The one point in this that I disagree with is that reflation is the way out of the recession. More on that in a moment. First, one more point from Evans-Pritchard, this one about the future of the euro with rising Euro-skepticism among voters:
The euro will inevitably lurch from crisis to crisis without some form of fiscal union and debt pooling. Yet voters have just let forth a primordial scream against any further transfers of power.
Indeed. So long as there is any form of government involved in the economy, there has to be a fiscal policy tied to that currency. Furthermore, so long as there is a welfare state there will be government deficits, either in recessions or on a structural basis as has been the case in Europe and the United States for decades now. Such deficits will be denominated in a currency, and that currency has to be the same that the government accepts for, e.g., tax payments, as well as the same currency that they use to pay out entitlements. In other words, there has to be a jurisdictional overlap between a currency and a fiscal government, or else the currency inevitably becomes unstable.
Some of these points were made by economists, among them Robert Mundell, already 15 years ago, before the euro was minted. However, they were drowned out by the Europhoria that dominated most of the ’90s in Europe, leaving the continent with a fundamentally unsustainable imbalance between monetary and fiscal policy.
So long as national government deficits were of manageable levels the imbalance did not have any notable political or macroeconomic consequences. As I describe in my forthcoming book Industrial Poverty, this was the case between the Millennium and Great Recessions. However, as soon as budgetary sink holes opened up around Europe from 2008 and on, the imbalance became a true problem.
The full explanation of this requires an intricate but fascinating macroeconomic analysis. I am working on it separately, hoping to share it later this year. In the meantime, let’s acknowledge that Evans-Pritchard hits it right on the nail: the mounting voter resistance to more EU power is a game changer for both the EU and the future of the euro currency. What is missing from his column is the right economic conclusion, namely that dismantling the welfare state – not reflation – is the way forward for Europe. But that is a minor point. Do take a moment and read the rest of his entertaining yet sharply analytical column.
The EU parliamentary elections have barely begun – they take place over a four-day stretch from Thursday to Sunday – before representatives of the European political establishment are out in media trying to explain away the surge in support for totalitarian parties. One of the most egregious examples is Wolfgang Schäuble, treasury secretary of the German government. The EU Business reports:
German Finance Minister Wolfgang Schaeuble denied in an interview Friday that the rise of eurosceptics expected in weekend elections was due to austerity policies championed by Berlin. He was asked by The Wall Street Journal whether anticipated gains by populist and anti-EU parties in the European Parliament vote until Sunday would be the price to pay for years of belt-tightening. “Some will interpret it that way,” Schaeuble replied. “I think that’s wrong. You can see that our policy to stabilise the eurozone was successful.”
The reason why he can say this with a straight face is that his definition of “successful” is strictly limited to the fact that the EU, the ECB and the IMF – the Troika – forcefully backed by the German government, prevented a break-up of the euro zone. The Troika’s purpose with the 2012 wave of austerity policies that swept through primarily – but not exclusively – the southern rim of the European continent, was not to restore, or even open a path back to growth and full employment. The purpose was instead to end the surge in expectations that Greece and Italy were going to leave the euro zone. Policy makers and analysts in the inner circles of the Troika assumed that if they could put a leash on runaway government deficits the speculators waiting for the return of the Drakhma and the Lira would be convinced that nobody was about to exit the currency union.
In the short run, they were correct. In Greece, interest rates dropped almost as dramatically as they increased:
However, this decline could just as well be the result of the ECB’s highly irresponsible pledge to buy any amount of treasury bonds from any country within its jurisdiction. But more importantly, even if the austerity measures calmed down speculations about a currency secession, those measures did not solve the underlying macroeconomic crisis. Greece still suffers from 55-percent youth unemployment; the economy still is not growing but actually shrinking; improvements in the Greek government budget over the past year are entirely due to one-time measures related to austerity. Once these one-time effects have worked their way through the budget, there will be no lasting improvement left.
This also means that the long-term threat to the unity of the euro zone still remains. It has just fallen under the media radar for now.
Greece’s only long-term chance is that the Troika will declare austerity cease-fire. If that happens, the Greek economy will be granted some time to catch its breath and re-structure itself to function under the combination of eroded entitlements and higher taxes. Only then can the private sector begin to create jobs again – and only then will the long-term threat of a Greek secession from the euro go away permanently.
This is all common sense, founded in a sound, solid understanding of macroeconomics. Such understanding is, however, a scarce resource among political leaders, especially in Europe. As the EU Business article continues, Mr. Shäuble continues his ignorant rant:
[Schaeuble] also rejected that the tough fiscal medicine and economic restructuring [that] Germany promoted were the causes of high unemployment and recession in much of the single currency area, declaring “that is false”. “The long recession is the consequence of a financial crisis whose origin wasn’t in the eurozone,” he said, adding in a stab at the United States: “Remind me where Lehman Brothers was based.” The 2008 collapse of the US investment bank was the biggest bankruptcy in US history and sparked the global financial crisis from which the world economy is still recovering.
Yes, the myth that this was a financial crisis… If a financial crisis is going to cause a general economic recession, it needs to transmit the negative consequences of credit losses into the real sector of the economy. Consumers and businesses must be directly impacted by the credit losses in the financial system.
The problem is that there is really no evidence of such a transmission mechanism at work in 2008-2009. Put bluntly: if that transmission mechanism existed, one of its main effects would be a rise in interest rates on loans from banks to non-financial businesses. But no such increase took place. Quite the contrary, in fact, as I have explained at length: just as the financial crisis was supposed to cause a surge in interest rates, a wipe-out of credit available even to highly qualified borrowers, interest rates on business credit actually began declining.
Available evidence (which I plan to collect and thoroughly explain in a future publication; first, let’s get my book Industrial Poverty out on the market) clearly shows that there was a recession looming independently of the financial credit crunch. That crisis was already under way when the Lehman Brothers crash happened – and without that real-sector, independent downturn we would not be able to explain why the central bank policies to save the financial sector had no visible impact on the economic crisis.
In short: businesses and consumers stopped demanding credit because of a general sense of pessimism that emerges in all recessions. The problem with the Great Recession was that once growth slowed or turned negative, once unemployment rose, an entire cadre of policy makers, from the EU to the ECB to the German government, decided to make a bad macroeconomic situation even worse by raising taxes and cutting government spending.
In Greece, austerity made a bad situation worse. It does not matter how much Wolfgang Schäuble denies it – his opinion cannot change facts and solid macroeconomic analysis. In fact, even the IMF has come around on this issue.
Of course, Schäuble tries on last trick to save the unsalvageable:
Schaeuble added that “the unemployment that we have in all advanced countries, not just in the eurozone, has to do with the dramatic transformation of labour markets through technology”. “You no longer need the same number of employees to produce goods. You have different needs for skills and qualifications of young people.”
Of course. At no point in time since the first, primitive forms of manufacturing were invented back in the late Middle Ages, has there ever been any improvement in productivity. Only in the past five years has there been a spurt in productivity in European manufacturing…
Wolfgang Schäuble is either completely incompetent – which I doubt – or politically reckless. By defending austerity as a means to somehow improve people’s lives, he aligns his political views with those who believe that “higher goals” are more important in politics than the opportunity of private citizens to build their lives and carve out a path to prosperity for themselves and their families.
There is a name for such priorities. It is arrogance. When politicians ignore the fact that millions upon millions of people suffer as a result of their policies, those politicians have forfeited their credibility as participants in a democratic government.
It is understandable that Schäuble, somewhere, somehow, is trying to fend off the challenge that he and other pro-EU politicians face from the surging totalitarian movements across Europe. But you don’t defeat aggressive government expansionists by becoming one yourself. That is exactly what Schäuble can become if he sticks to his arrogant denial of facts and continues to believe that anti-democratic austerity policies can both save democracy and people’s jobs.
Europe’s political leadership keeps trumpeting out that their austerity policies actually worked. They are closely backed by their media outlets. Alas, the following story in the EU Observer:
Cash-strapped Greece recorded its first primary budget surplus in a generation last year, according to data released by Eurostat on Wednesday (23 April). Excluding interest on its debt repayments and a number of one-off measures to prop up its banks, Athens recorded a surplus of €1.5 billion, worth the equivalent of 0.8% of its economic output in 2013. Despite this, Greece still recorded an overall deficit figure of 12.7 percent, up by 4 percent on the previous year as the crisis-hit country endured a sixth straight year of recession.
As always, it is completely wrong to use the government budget as some sort of health indicator for how an economy is performing. To illustrate how dicey that can be, let us go over some numbers on the Greek economy.
First, GDP growth, measured as growth over the same quarter in the previous year:
If economic growth was any indicator, the jury would still be out on the Greek economy. It is somewhat of a relief that the contraction of the economy (“negative growth”) is slowing down – the figure for the last quarter of 2013 was -2.3 percent – but there were also two “spikes” of improvement during the ongoing recession, one in late 2009 and one in 2011.
The slowdown of the contraction that began in 2012 is still ongoing, though, which could mean that the Greek economy may actually start growing again some time in 2014. The question is what is behind this improvement. Since austerity policies are still being enforced, fiscal policy is suppressing domestic spending. Therefore, a good bet is that the “leveling out” of the long decline in Greek GDP is driven by an improvement in exports. Not surprisingly, Eurostat data show that Greek exports increased three quarters in a row during 2013. This is the longest period of improvement in exports since 2010.
If activity is improving in the exports industry, it would naturally translate into better GDP numbers, albeit limited compared to a sustained recovery in private consumption. QED. It would also translate into an improvement of government finances, as tax revenue would rise from growing corporate income. However, this improvement is probably not going to be strong enough to lift the Greek government budget to balance, thus it won’t help them end austerity.
So what, then, do Greek government finances actually look like?
If amplitude is a measure of stability, things do not look good for the Greek government. However, what the European press and its political leaders are raving about is the improvement of the budget deficit displayed as the very last data point in the chart above. There, the consolidated government budget is in a deficit of “only” 2.86 percent of GDP. If this came on top of the weak but visible trend of smaller deficits from 2009 and on, there would be a reason to believe in a recovery. However, two variables call for a reality check: first, the exceptional dip in the second quarter, plunging the deficit into 30.4 percent of GDP; secondly, and much more importantly, the fact that the Greek GDP is still shrinking.
If the deficit improves as a ratio of a shrinking GDP, it means that tax revenues are shrinking as you improve your deficit ratio. This in turn means that you are making very drastic changes to tax rates as well as spending: tax rates have to go up and spending has to decline.
In other words, the only way to accomplish an improvement in the Greek deficit is to keep austerity in place. This in turn keeps the depression lid on domestic economic activity. So long as that lid is in place there is no chance for an improvement in overall economic activity.
In addition to GDP growth there is one variable that mercilessly tells the true story of how an economy is actually doing:
If the Greek GDP is indeed nearing a point where it will no longer shrink, and if the reason is a surge in exports, then the leveling out of the employment ratio is the best the Greeks are going to see for the foreseeable future. Their exports industry cannot pull the economy out of the recession anymore than it could pull Denmark out of its very deep recession in the late ’80s, or Sweden in the mid-’90s. So long as austerity remains in place, depression will still keep its tight grip on the Greek economy.
But just to make it worse… even if austerity was lifted, the Greeks would have little reason to expect a rapid return to better days. To see why, let us return to the EU Observer story:
The surplus [in the Greek budget], which was achieved a year ahead of the schedule set out in Greece’s rescue programme, means that it is entitled to further debt relief on its €240 billion bailout. Talks on debt relief, which is likely to involve lengthening the maturity of Greece’s loans to up to 50 years, will start among eurozone finance ministers following May’s European elections.
All the EU is doing here is kicking the can down the road. They are extending the Greek welfare state’s credit line over and over again. All the bailout programs really achieve is a recalibration of the welfare state, with higher taxes, lower spending and overall a more intrusive government that takes more from the private sector – at a lower level of private-sector activity.
And this is precisely the point here. The goal with austerity policies in Greece is to balance the Greek government’s budget. The goal is not to restore full employment; the goal is not to return to high levels of GDP growth; the goal is not to reduce the ranks of welfare and unemployment benefit recipients. No, the goal is to balance the budget. If the Greek government accomplishes that, they will be rewarded by the EU with more, longer-maturity loans.
In a “normal” welfare state the budget balances at something akin to full employment. However, that changes once a welfare state ratchets down into the depths of a protracted recession, such as the one Sweden experienced in the early ’90s and Europe has been struggling with since 2009. Austerity raises the tax ratio on GDP in order to make sure that government can pay for its spending obligations; spending cuts mitigate some of those tax increases. As taxes go up and spending shrinks, the government budget eventually clears, but at a GDP that provides much fewer jobs than before. In other words, after a long period of austerity, government can pay for its expenses without having as many taxpayers as before.
Once the economy starts improving, tax revenues will go up earlier in the recovery than they otherwise would. Since spending has been adjusted downward, this means in effect that government will begin over-taxing the economy way before it reaches full employment. In the Greek case, if austerity actually works the consolidated government will find itself running a surplus at an employment ratio 10-12 percentage points below what it was before the recession.
Excess taxation thwarts private economic activity. Taxes themselves discourage productive investments and spending, but so long as government spends the tax money there is at least some return that mitigates the loss to the private sector. Taxation for a budget surplus, however, means that literally nothing is coming back into the economy. Every tax dollar is a full loss of economic activity, meaning that the budget surplus indiscriminately prevents the creation of new jobs.
The economy gets stuck at a low rate of employment. This is a perspective on the Greek economy that nobody outside of this blog is pointing to. Yet there is ample evidence that this is exactly what will happen – unless the Greek government replaces austerity with a long series of permanent, well-designed tax cuts.
There is historic experience to show that such policies could work very well. There is also historic experience to show that if you do not cut taxes, you perpetuate the depression you are in. For more on this, please be patient and wait for my book Industrial Poverty, out in late August.
Since January 2012 I have been practically the only analyst pointing to how deeply flawed economic analysis combined with irresponsible political preferences turned an economic recession in Europe into a depression. In late 2012 IMF economists began hinting that the economic analysis behind crisis policies was not entirely up to standard. In January 2013 the IMF followed up with a formal, very good analysis explaining how they had contributed to the errors.
The IMF paper – a rare but highly respectable academic mea culpa – should have caused a fundamental change of course in fiscal policy in Europe. Sadly, that did not happen. Some rhetoric has been spread around in recent months by EU and national political leaders seeking to distance themselves from the absolutely disastrous consequences of the past few years of austerity, but in reality they have neither changed their policy preferences nor adopted new political goals.
They still have not realized the depth of the errors in their own understanding of the crisis, or what to do about it.
My book about the crisis is due out in August. In the meantime, here is another contribution, reported by Euractiv.com:
In his new book, Philippe Legrain, a former adviser to European Commission President José Manuel Barroso, says European leaders are responsible for the record-high unemployment and rock-bottom growth afflicting the EU. At the height of the euro zone debt crisis, with Portugal’s economy nearing collapse, the European Commission told the government in Lisbon that it had to slash wages if it was ever going to boost competitiveness and grow again. Portugese shoemakers – one of the economy’s main export sectors – steadfastly ignored the advice and found a way to bounce back while actually increasing workers’ pay. It is just one of many examples Philippe Legrain, a former adviser to Commission President José Manuel Barroso, cites in a new book that argues policymakers misdiagnosed the crisis and ended up prescribing the wrong medicine to resolve it.
I’m curious to see if Mr. Legrain drills down to the core of the crisis problem, namely the welfare state. I doubt he does, based on this wage-setting example. The crisis was not really about wages, at least not in the private industry. Private businesses operate in the free realm of the economy. If they set the wrong prices, they go out of business. Evidently, the Portuguese shoe manufacturers had not priced their products wrong.
Let’s see what else Mr. Legrain has to say:
He was an adviser from 2011 until resigning in March of this year, so was involved at some of the most critical moments. “The Portuguese basically said, ‘We’re not going to do that’, and they went upmarket instead,” said Legrain, the author of “European Spring: Why our Economies and Politics are in a Mess”, which is published on April 24. “They are now selling more expensive designer shoes and their exports are soaring – wages and employment have risen,” he said. “That shows in a nutshell how policy was misguided.”
Again, what do you expect of a private business? That they operate on free-market terms (and are allowed to do so by lawmakers and tax-paid bureaucrats). If you have a low-cost production facility and you think you can produce something with higher margins with that same production facility, then obviously you go ahead and do it. It is the same philosophy that Korean car manufacturer Hyundai used when they introduced their new Azera, Genesis and Equus luxury models.
The dicey part is if you can produce with the quality needed for a higher market segment. Hyundai has been able to pull it off (just look at their Equus – it has got to be one of the best looking, best built cars in the world) and, in the other end of the manufacturing world, Portugal’s shoe makers have apparently been able to do it.
But again, this is not the real story of the European crisis. Let’s hope Mr. Legrain has more than this to add. It does not look like it:
Instead of recognising that the crisis was principally the fault of a banking sector run amok, [Europe's political] leaders focused on the excessive debts of Greece, Ireland and Portugal, effectively seeing the problem as fiscal rather than financial. That led policymakers to enforce a strict regimen of budget cuts, tax increases and lower wages in an effort to improve competitiveness and make exports comparatively cheaper.
Oh, dear… First of all, this was not a financial crisis, no matter how many people say so over and over again. Secondly, austerity as designed and executed in Europe from 2010 and on – culminating but not ending in 2012 – aimed to save the welfare state by making it fit into a smaller economy. “More affordable” as someone aptly described it.
Even when Mr. Legrain touches upon the government debt issue, he misses the target by a mile:
While Legrain acknowledges that Greece, with debts greater than its GDP and a budget deficit of 6.5% of output in 2008, was facing mainly a debt crisis rather than a banking one, he says the solution chosen by Europe was wrong. Rather than renegotiating or writing down much of that debt, the Commission, the International Monetary Fund and the European Central Bank pushed through two hard-to-swallow bailout programmes totalling more than €200 billion that left Greece’s economy shattered and just as indebted. Unemployment now stands at 26% and debt is expected to peak at 170% of GDP. Social unrest is bubbling.
His prescribed solution is even worse than his analysis:
“Greece’s debts should have been restructured in May 2010,” said Legrain. “Instead, we have had a lurch towards self-defeating austerity and now have much more centralised fiscal controls, which are inflexible and undermine democracy.”
So called “debt restructuring” means writing down or writing off debt. That is dangerous and reckless. It is dangerous because it means a government walks away from a contract between itself and a private citizen – a bank or a family who has invested in Treasury bonds instead of, for example, buying stocks. It is reckless because it sets a precedent that could eventually stretch into the private sector: if debtors can just write off what they owe someone, a large chunk of the private-property/private-contract dimension of our modern economy is fatally wounded.
This last point is a bit of a stretch, but deliberately so. According to this Euractiv article about Mr. Legrain’s book, all that he has to offer as a solution to Europe’s crisis is that they should have written off debt four years ago, and that the EU should not have handed out certain types of advice to private businesses. This is a very shallow analysis of a problem that runs deep into the European economy – so deep, in fact, that it cannot be solved without a major restructuring of that economy.
In fairness to Mr. Legrain I am going to order a copy of his book. But if this article accurately represents his work, I’m happy to say my book is more relevant than ever!
What is the difference between a turtle and the European economy? The turtle is moving fast forward. There are no lights in the tunnel either, especially when we take into consideration the situation in the big French economy. The socialist government came into power on promises to get the economy going, turn the tide on employment and get the austerity dementors from Brussels off the back of the French people. They have not delivered on a single one of their promises, and even though it takes time for new economic policies to sink in, the French socialist government is closing in on two years in office and should at least be able to produce some credible signs of recovery. But that is not the case. On the contrary, whatever blip on the radar they have been able to produce is succumbing under their tax increases and even more stifling regulatory incursions into the private sector:
The rather tepid growth record of the French economy is having a real impact on its government’s relations to Brussels. With the tax base (GDP) barely growing at half a percent per year, it is arithmetically impossible for the government in Paris to close its budget gap. As a result, Euractiv.co, reports:
France is again seeking an extension from the EU on the deadline to reduce its national deficit. European Parliament President Martin Schulz supports the idea but the German government is insisting on adherence to the guidelines of the European Stability Pact. EurActiv Germany reports. In a speech earlier this week, French President François Hollande made it clear he would attempt to renegotiate Brussels’ demands to reduce the French deficit to under 3% of GDP by 2015. The new finance minister, Michel Sapin, also intends to renegotiate the timeline with the European Commission. “The government will have to convince Europe that France’s contribution to competitiveness, to growth, must be taken into account with respect to our commitments,” Holland said on 31 March. But the EU has already given the country two extra years to comply with the Stability Pact’s deficit limit of 3% of GDP.
This is raising tensions over the Stability and Growth Pact, effectively the legal deficit-cap instrument in the EU constitution:
On Thursday (3 April) in Frankfurt, ECB President Mario Draghi again stressed how important it was for eurozone countries to honour their fiscal commitments within the EU. On Friday morning, European Parliament (EP) President Martin Schulz, spoke in favour of meeting French demands. Schulz is the European Socialists’ candidate in the upcoming European elections. Speaking on BFM-TV in France, he said the country must be given more time to comply with the Maastricht criteria. The rules of the Stability and Growth Pact, with its debt limit of 3% must “be reconsidered”, said Schulz. Norbert Barthle is Bundestag spokesman on budgetary policy for Merkel’s Christian Democratic Union (CDU). In his view, another postponement of the deadline should only take place under clear conditions which state that France will really put its budget back on course. The chairman of the Bavarian Christian Social Union (CSU) political group in the EP, Markus Ferber strongly criticised Schulz’s demands to soften the terms of the Stability and Growth Pact: “While the CDU and the CSU have been acting as a fire brigade to extinguish the euro debt-crisis, Martin Schulz is adding new fuel to the growing fire.”
Schulz is the socialist candidate for president of the EU Commission, with a strong statist agenda in his hand. His desire to water down the Stability and Growth Pact has nothing to do with concern for the French economy – it is primarily motivated by a desire to give government the room to grow without any real limits.
Secondarily, Schulz is vehemently against the austerity policies that the EU-ECB-IMF troika has been forcing on some EU states. I share his resistance, but for entirely different reasons. While Schulz sees austerity as an impediment on government growth, I view it – or at least its European iteration – as a macroeconomic poison pill. It is a good idea to stop austerity policies, but the replacement should absolutely not be more government. The French government is way too big, but this is also the case in Europe in general – which is why there is no recovery in sight. On the contrary, stagnation is the new normal. In the last quarter of 2013, industry activity in the EU-28 and euro-18 areas were as follows in key sectors, measured in gross value added (one of three ways of measuring GDP):
- Manufacturing grew 1.7 percent over the same quarter in 2012; 1.3 percent in the euro area;
- Construction declined 0.4 percent, the 11th quarter in a row with declining activity in this sector; in the euro area the decline was 1.7 percent, the 22nd negative quarter in a row!
- Finance and insurance contracted 0.9 percent in EU-28, 1.1 percent in euro-18.
Measured as employment, the numbers do not look better:
- Manufacturing employment contracted 0.7 percent in the fourth quarter of 2013, the eighth straight quarter with a decline; the decline was 1.2 percent in euro-18;
- Construction saw employment shrink by 1.4 percent, the 22nd straight negative quarter; the decline was a notable 2.9 percent in euro-18, marking the 23rd quarter in a row with declining construction employment;
- The financial-insurance industry basically stood still at +0.1 percent (-0.3 percent in euro-18).
(All numbers are from Eurostat.)
Things may turn around when we get the numbers from Q1 of 2014, but I see no substantial reason to expect a sustained recovery. On the contrary, everything points to continued stagnation, in France as well as in Europe. This does not bode well for the future of the continent – perhaps the EuropeanS should get used to scenes like this one: