Tagged: EUROPE

OECD Wrong on European Crisis

The Great Recession continues to baffle economists around the world. Some have actually admitted that their academic research has been wrong – kudos to the economists at IMF for leading the pack – while others continue to stumble around in the dark. A story in The Guardian gives an example of economists in the latter category:

A failure to spot the severity of the eurozone crisis and the impact of the meltdown of the global banking system led to consistent forecasting errors in recent years, the Organisation for Economic Co-operation and Development admitted on Tuesday. The Paris-based organisation said it repeatedly overestimated growth prospects for countries around the world between 2007 and 2012. The OECD revised down forecasts at the onset of the financial crisis, but by an insufficient degree, it said. “Forecasts were revised down consistently and very rapidly when the financial crisis erupted, but growth out-turns nonetheless still proved substantially weaker than had been projected,” it said in a paper exploring its forecasting record in recent years.

Technically they under-estimated the effects of the credit losses that financial institutions suffered, but not for the reasons the OECD believes. Their forecasting mistake is instead founded in a two-pronged misunderstanding of the true nature of the crisis. First, they fail to realize that this was a welfare-state crisis, created by a slow but relentless growth in the burden of government on Europe’s economies. The weight of the government’s fiscal obesity eventually became so heavy on taxpayers, and the disincentives toward work and investment so strong, that it did not take much to nudge the economy into a deep, severe crisis.

The welfare state’s role in the crisis was enhanced by the fact that in the years leading up to the crisis Europe’s banks bought a trillion euros worth of Treasury bonds, a good chunk of which was from countries that soon turned out to be junk-status borrowers. This seriously aggravated the balance sheets of banks that were already struggling with credit losses.

If they had not been forced to deal with the junkification of Greek, Spanish, Portuguese and Irish government bonds, the banks would have been able to manage and endure the private-sector credit losses. But the unlimited irresponsibility of spendoholic legislators escalated a recession into a crisis.

The second prong of the OECD’s forecasting mistake has to do with austerity. Humbly put, nobody outside of my office grasped the truly negative impact of austerity as early as I did; the only ones who have caught up are IMF economists. On the other hand, their analysis of the role of the multiplier has, frankly, been intriguing. Nevertheless, by not understanding that austerity is always negative for macroeconomic activity, the OECD has missed the forecasting mark even more than by just misunderstanding the relation between the welfare state and the financial sector.

All in all, there is still a lot to be said on what has happened in Europe these past few years, and what implications that has for the future of Europe as well as for America. I am impatiently looking forward to the July release date of my book Industrial Poverty which provides a thorough analysis of the crisis.

Interestingly, as we return to The Guardian, the OECD denies my point about austerity:

The OECD said a failure to understand the impact of austerity policies in various countries did not appear to be a major driver of forecasting inaccuracies. It said the OECD became better at factoring in the impact of austerity amid little space for further monetary loosening as the crisis continued. Overall, “fiscal consolidation is not significantly negatively related to the forecast errors”.

This is a blatant refutation of what the leading economists at the IMF concluded over a year ago. The IMF paper is compelling and based directly on observed forecasting errors. Their main point is that the multiplier effect of one dollar’s worth of government spending cuts is stronger than the multiplier of one dollar’s worth of government spending increases. They show good evidence for this conclusion, evidence that the OECD ignores entirely.

Furthermore, as I report in my forthcoming book there is a wide range of literature on austerity and its effects, and that literature has one thing in common: politicians always under-estimate either of two things: the negative effects of austerity, or the persistent problems with pulling out of a recession by means of austerity.

But there is yet another point where the OECD is wrong. If the financial-sector problems were to blame for the depth and the length of this recession, then why is it that the credit losses happened several years ago, that the bank bailouts have been essentially wrapped up and that, thanks in part to the European Central Bank’s easy monetary policy, there are no longer any credit worries in the European banking system – and Europe is still sinking into higher unemployment and more budget problems??

The underlying presumption in the OECD’s focus on the financial system is again that this was a financial crisis, nothing else. But if that was the case, we would have entered the crisis with sky high interest rates; the banking system would have signaled systemic credit defaults by drying up credit and raising interest rates to the sky before the macroeconomic downturn began. But none of that happened. Interest rates in Spain, Greece and other troubled EU member states started rising only after the recession had escalated into a crisis!

What does this tell us? To answer that question, let us take one more step into the technicalities of macroeconomics. The reason why interest rates went up was not that the financial sector raised the price of credit. The reason was that Treasury bonds in Europe’s big-government states were sent to the financial junk yard. The reason why the Greek government has had to pay ten times higher interest rates than, e.g., the Swiss government is that the Swiss government has never defaulted on its loans while the Greek government forced its creditors to write off part of their loans.

In short: when interest rates started rising in Europe, it was because of unimaginable budget deficits, i.e., a crisis in the welfare state, not the financial system.

One last weirdo from the OECD:

“The macroeconomic models available at the time of the crisis typically ignored the banking system and failed to allow for the possibility that bank capital shortages and credit rationing might impact on macroeconomic developments,” it said.

Credit rationing? At a time when the central bank has flooded every corner of the economy with liquidity?? Europe’s banks hold trillions of dollars in government bonds, and in theory they could go to the ECB and, under the ECB’s bond buyback guarantee, demand cash right now for them. That would be free money for the banks who could then lend it out to whoever they wanted to lend to, and almost be guaranteed to make good money.

In reality, the rationing is not on the supply side of the credit market. It is on the demand side where there are not enough credit-worthy households and businesses to gobble up Europe’s rapidly growing money supply. The fact that the OECD fails to see this adds to my conclusion that they have not done their homework on the Great Recession.

Again: this is a welfare-state crisis, not a financial crisis.

Deflation and the Global Economy

A while back I warned about the deflation threat to the European economy:

When prices fall over time, tax revenues fall with them. This is especially true in economies with value-added taxes, but the deflation effect on tax revenues spills over on income taxes as well. With deflation fewer workers get raises, meaning that there is much less, if any, growth in the income-tax base. A stagnant or a shrinking tax base is not exactly what the governments of Europe’s welfare states want to have on the horizon.

I also explained that businesses are discouraged from making investments and hiring people. Investment costs are paid upfront, or if financed with loans the costs of principals and interest rate are nominally locked over time. However, deflation reduces per-unit revenue over time, making the investment increasingly unaffordable at constant sales and pushing the break-even point into the territory of growing sales. A similar outlook discourages businesses from hiring people: money wage contracts specify a certain amount to be paid out per worker per pay period, forcing the business that faces deflation to expand sales just to break even.

In the case of new employees this means that the employees have to constantly nudge up their productivity just to produce what their money wage is worth. If they want a raise they have to almost expand their productivity exponentially.

Neither the investment calculation nor the productivity mandate on employees favors businesses under deflation. Therefore, I explained back in my January article that the best Europe can hope for under deflation is that stagnation replaces depression.

The concern about deflation is now spreading. On January 29, Ambrose Evans-Pritchard, the Telegraph’s excellent columnist and experienced political journalist, elaborated on his view of the situation:

Half the world economy is one accident away from a deflation trap. The International Monetary Fund says the probability may now be as high as 20pc. It is a remarkable state of affairs that the G2 monetary superpowers – the US and China – should both be tightening into such a 20pc risk, though no doubt they have concluded that asset bubbles are becoming an even bigger danger.

His point about monetary tightening is based on the premise that monetary expansion fuels inflation and that, by logical extension, monetary contraction would lead to deflation. But it would be a leap to conclusion to say that the combined monetary contraction in the United States and China would automatically add to the deflation trend. While China has had an inflation problem for a while, and while they have been printing money like a runaway train, the technical reason for their inflation is related to their currency sterilization efforts more than anything else. Venezuela’s hyper-inflation is related to a similar type of exchange-rate defense policy. (I will write a separate article about sterilization later.)

The American money-printing spree is evidence that straight monetary expansion does not create inflation. That said, Evans-Pritchard’s link between monetary policy and deflation is not without merit. By contracting money supply, a central bank tightens the supply of liquidity in the economy. That in turn spills over on the banking system as the economy’s interest rates start creeping up. Private credit gets tighter.

If in this higher-interest rate environment there is already a trend of deflation, the rising cost of debt-funded investments is going to further widen the gap between investment costs and expected sales revenues. As a result, even more investment projects become unaffordable. Stagnation prevails and there are no forces at work in the economy to turn around the deflation trend.

Then Evans-Pritchard outlines a global scenario that could follow the aforementioned liquidity tightening:

The World Bank warns in its latest report – Capital Flows and Risks in Developing Countries – that the withdrawal of stimulus by the US Federal Reserve could throw a “curve ball” at the international system. “If market reactions to tapering are precipitous, developing countries could see flows decline by as much as 80pc for several months,” it said. A quarter of these economies risk a sudden stop. … The report said they may need capital controls to navigate the storm – or technically to overcome the “Impossible Trinity” of monetary autonomy, a stable exchange rate and free flows of funds.

In other words, what has kept money flowing to higher-risk economies is the combination of inflation driving asset values in those countries and the low interest rates in more reliable economies. If the latter goes away, there is suddenly more money to be made in, e.g., comparatively low-risk U.S. Treasury bonds.

A reversal of the flow of emerging-market investment funds means that the risk for recession in those economies increases significantly. Emerging economies are usually less able to produce enough liquidity to maintain a fully reliable financial-market system than advanced economies in Europe, North America and East Asia. If international capital flows reverse and start going toward the advanced economies, they have little if any margin before their financial systems stop functioning as intended.

Evans-Pritchard then makes a good point about the role of economics and economists in this:

William Browder from Hermitage says that is exactly where the crisis is leading, and it will be sobering for investors to learn that their money is locked up – already the case in Cyprus, and starting in Egypt. The chain-reaction becomes self-fulfilling. “People will start asking themselves which country is next,” he said. Emerging markets are now half the global economy, so we are in uncharted waters. Roughly $4 trillion of foreign funds swept into emerging markets after the Lehman crisis, much of it by then “momentum money” late to the party. The IMF says $470bn is directly linked to money printing by the Fed.

Yes, we are in uncharted waters indeed. Traditional, costly and highly sophisticated macroeconomic models, developed for forecasting purposes to be used by global investors, are essentially useless here. These models, as good as they are within their territory, are based on rigid assumptions about the institutional framework of the economy, namely that those will remain unchanged. This includes the balance between emerging markets and advanced markets; in order to forecast the repercussions of an unprecedented capital exodus from the emerging markets, economists would have to make their models inherently unstable.

I am yet to see a model that can do this, and there is a simple reason why such models are practically impossible. The branch of economics known as macroeconomics is based on a model structure where the economy is “self-healing”: after a disturbance, such as a decline in consumer spending, it reverts back to full employment if left alone. The theory behind this mechanism is that you can study disturbances one by one – in my doctoral thesis I referred to them as “singularities” – and estimate how important each one would be in explaining a recession.

The task before macroeconomists at this point is far more complex. Systemic changes to the economic system, such as the slow decline of Europe or a major, rapid change in global financial investment patterns, requires an upside-down approach to the problem: you have to assume that instability, not stability, is the prevailing norm for the economy. This calls for macroeconomic models that are entirely “open”, where there is really no predictable end result. This in turn basically defeats the purpose of developing a traditional model, which in my experience is the reason why economists do not even try to forecast systemic changes.

For better or worse, this means that the economists who otherwise would be able to give reliable advice to politicians, global investors and government bureaucrats on how to handle this situation, are lost for words. There simply won’t be anyone there to give reliable advice (making you wonder why some banking economists make the six figures they do…) which exposes investors to a situation of genuine uncertainty.

How to handle that? Well, that is an entirely different story. Important as it is, we will have to stop at concluding that what the world is looking at now is a combination of deflation in Europe and possibly elsewhere, higher interest rates in low-risk countries, unusually strong and coordinated monetary tightening, and probable capital flight from emerging to advanced economies that could have major political repercussions.

All this in addition to the fact that none of this will contribute to an improvement of the highly troubled European economy. As for the United States, the situation is a bit more uncertain. A global recession will depress exports which have to some degree driven the recovery in manufacturing; at the same time higher interest rates may weaken the recovery in construction. But there is also the growing likelihood that major federal government incursions into the economy will be reversed, the most significant of them being Obamacare. Even the president is now pondering a delay of the nail-in-the-coffin parts of the “reform”.

Add to that the possibility for tax cuts when the shrinking deficit has reached a critical low-point and a regulatory cease-fire if the Republicans win the Senate in November.

In other words, the U.S. economy is better suited than the rest of the world to continue to slowly grow and move forward. There are significant risks, but unlike Europe, we are not standing on the doorstep of industrial poverty. Deflation will hurl Europe into that territory.

Or, in the concluding words of Evans-Pritchard:

Those who think deflation is harmless should listen to the Bank of Japan’s Haruhiko Kuroda, who has lived through 15 years of falling prices. Corporate profits dried up. Investment in technology atrophied. Innovation fizzled out. “It created a very negative mindset in Japan,” he said. Japan had the highest real interest rates in the rich world, leading to a compound interest spiral as the debt burden rose on a base of shrinking nominal GDP. Any such outcome in Europe would send Club Med debt trajectories through the roof. It would doom all hope of halting Europe’s economic decline or reducing mass unemployment before the democracies of the afflicted countries go into seizure.

Well said.

Europe’s Industrial Rollback

One of Europe’s ailments is the persistent belief that government can engineer prosperity. You would think that the past five years of crisis had brought them to abandon that belief, or at least that the poor GDP growth of the past two decades would make them question the role of government. But no. Instead of rethinking their government-based approach to every problem, the Eurocracy is doubling down on statism. This story from EUBusiness.com is a good example:

The European Trade Union Confederation (ETUC) and IndustriAll European Trade Union welcome the adoption by the European Parliament of the report Reindustrialising Europe to Promote Competitiveness and Sustainability. “This report underlines the importance of a strong industry to support lasting and quality jobs in Europe,” said Jozef Niemiec, ETUC Deputy General Secretary.

Listen to this – it is the sound of mashed potatoes:

“Encouraging the reindustrialisation of Europe through the mobilisation of adequate financial means and through support for innovation is essential for Europe to get out of the crisis”.

Now, if there was no role for government in Mr. Niemiec’s vision, he would not be talking about it. What he is after is, of course, to have government – ostensibly the European Commission – “mobilize” the “adequate financial means” to help “reindustrialize” Europe. Again, it is fairly easy to see what that means for regular Europeans: higher taxes. The same goes for his call for “support for innovation”.

It is interesting, though, to note that there is now growing concern in Europe about the continent’s de-industrialization. Technically the term refers to a systemic loss of manufacturing jobs, either in absolute terms or in relative terms. Relatively speaking, manufacturing has been losing ground in Europe and North America over the past four decades, which is in good part due to the long-term growth of the service sector. However, during the Great Recession, the European Union (counted as the 27-country block) has lost more than 440,000 manufacturing jobs from 2008 to 2012, a 4.4-percent decline from the 10.1 million jobs in ’08.

During the same time period, the United States lost eleven percent of its 13.4 million manufacturing jobs. However, while preliminary quarterly data indicates that the European decline continues, the U.S. manufacturing sector is on a slow but visible rebound: since October 2010 U.S. manufacturers have had more employees every month than the same month a year earlier.

The difference? Less government involvement and a more flexible labor market here in the United States.

But as we return to the EUBusiness.com story, we are once again reminded that the role of government is practically never questioned in Europe:

The report is based on a comprehensive vision of industrial policy and also addresses related issues of relevancy such as training and skills of the workforce. It also strongly acknowledges the importance of industrial democracy. “There is no credible industrial policy if workers are not taken into account, that’s why it is so important to promote training and worker’s participation through social dialogue” said Ulrich Eckelmann, IndustriAll General Secretary.

And it gets better:

The report also stresses the importance of common social and environmental norms to frame the development of international trade. It also deplores the absence of action by the European Commission to tackle restructuring, or social and wage dumping in Europe.

In other words, the European Commission should throw out the remaining pieces of the free market in Europe and bet everything it has on government. So called “wage dumping” is nothing more than a decline in wages due to an excessive supply of labor. That excessive supply, in turn, is caused by high and still rising unemployment: in the third quarter of 2013 the EU-27 had a total unemployment rate of 10.9 percent, 0.4 percentage points higher than the same quarter in 2012 and 1.2 percentage points higher than the third quarter of 2011.

This rise in unemployment is happening while government has never been more involved in running economic policy in Europe. From out-of-control money supply to the tax choke hold on private businesses to top-down imposed, harmful austerity measures, the European economy is under siege by government. So long as that siege remains, the continent’s de-industrialization will continue. Other sectors will not have the thrust to pull Europe up from its decline into industrial poverty.

The only things that will continue to grow in Europe are government and the economic wasteland it is trying to live off.

Eurocrats Worry about Rising Poverty

Government expansionists are quick to tell us that big government is a perfect tool against poverty. If that was the case, then Europe would be the first poverty-free continent on Earth. That is not the case, of course: as I explained in September last year, poverty is in fact expanding in Europe again. The fact of the matter is that government perpetuates poverty:

The goal with the European welfare state was the same as that of the “war on poverty”, namely to elevate everyone to a standard of living beyond what is at any point in time considered “poverty”. Yet, when the welfare state was allowed to grow uninhibited by economic common sense it brought about economic decline of a scale that is now at the very least sentencing an entire generation of Europeans to life-long poverty.

The European Commission – the unelected de facto government of the EU – is now recognizing that poverty is back. In a new report called “Employment and Social Developments: Annual Review highlights need to address risks of in-work poverty” the Commission expresses worry that as many as 25 percent of working Europeans are at risk of poverty. However, as one could expect they blame this poverty not on the existence of a welfare state, but on the “economic crisis” and “wage polarization”:

A significant increase in poverty among the working age population is one of the most tangible social consequences of the economic crisis. A gradual reduction of unemployment levels may not be enough to reverse this situation if wage polarisation continues, notably due to a rise in part-time work. … The review shows how taking up a job can help people to get out of poverty, but only in half of the cases: much depends on the type of job found, but also on the household composition and labour market situation of the partner.

It is worth noting the comment about growing part-time employment. There are two reasons why this is happening, and they are related to one another. Europe has some of the world’s most rigid labor laws, with France and Spain among the leaders. Sweden also belongs in the top, though their labor laws give unions exceptional powers to interpret the laws as they see fit. This rigidity usually only applies to full-time workers, with part-time employees being subject to much more market-friendly conditions.

On top of these laws, European businesses in general have not been doing very well lately. Five years of recession – a depression in some countries – have wiped out profit margins, made investments largely unprofitable and shortened planning horizons for entrepreneurs big and small. When profits are slim, future prospects dicey and labor laws rigid, the only way to go about creating jobs for most businesses is to do it on a part time basis.

This means, then, that government is helping create poverty by making it prohibitively costly for businesses to hire people on a full-time basis.

None of this is within the realm of comprehension when the EU Commission talks about its report:

“We need to pay attention not only to job creation, but also to the quality of jobs, in order to achieve a sustainable recovery that will not only reduce unemployment but also poverty”, Commissioner for Employment, Social Affairs and Inclusion, László Andor, stressed.

In other words, Commissioner Andor envisions more government involvement in the job market. Since European governments already heavily regulate how, why and when people can be hired and fired, the Commissioner’s statement hints at regulations of actual employment conditions. This would be a terrible mistake that would for all intents and purposes socialize the European labor market.

The Commmission review again:

[Contrary] to commonly held beliefs, people receiving unemployment benefits are more like to get a job than people not receiving benefits (other things being equal). This especially applies to well-designed benefit systems (like those reducing benefit levels over time), accompanied by appropriate conditions, such as requirements to look for a job.

These are features that Europe’s governments have added after experiencing at least a quarter century of slowly rising entitlement dependency among expanding layers of their constituents. Even working Europeans often have a problem making ends meet without receiving a government hand-out; in some countries the dependency rate exceeds 50 percent of the population.

Such dependency rates have put an enormous burden on taxpayers. Tapering-off unemployment benefits is one measure to somewhat alleviate this burden. While a good idea in itself, it is a feeble attempt at keeping employment levels up so long as the regulatory hurdles on the labor market remains intact.

It is good that the EU Commission at least tries to care about what is happening “on the ground” in the European economy, but at the end of the day their report rests on the presumption that government can in fact better people’s lives. At the very best, all government can do is whisk around already created economic resources, on average making nobody wealthier and nobody poorer. A much more common experience, though, is that government reduces economic activity – more the bigger it gets – and that nobody’s life is improved but many people’s lives are affected negatively.

Again: Europe is transforming into an economic wasteland of long-term stagnation, and the major cause of this not a financial crisis, but a welfare-state crisis. It’s that simple.

Deflation: Insult to Europe’s Injury

Those who say that Europe is heading for a recovery should pay close attention today. If there was a recovery under way, the European economy would be seeing some slight increase in inflation. But according to a story from EUBusiness.com, the exact opposite is true:

Ultra-low inflation in the eurozone has sparked a divide among officials and analysts over whether the risk of deflation is a real “ogre” or just a phantom menace. The head of the IMF, Christine Lagarde, warned this past week of the “rising risks” of deflation, which she called “the ogre that must be fought decisively”. “With inflation running below many central banks’ targets, we see rising risks of deflation, which could prove disastrous for the recovery,” Lagarde said.

When Lagarde talks about the detriments of deflation, she has two things in mind. First, there is the general problem that when prices are falling businesses have a disincentive to invest. Their investment costs are paid “today” while revenues recovering the cost are earned over a series of tomorrows. Under inflation the prices earned tomorrow slowly rise, increasing the margin between the fixed investment cost and cost-recovering revenue. On the other hand, under deflation future prices fall, gradually eliminating the cost-recovery margin.

This perspective on deflation is a perfectly valid concern. What is not valid is the second reason why Lagarde is worried. When prices fall over time, tax revenues fall with them. This is especially true in economies with value-added taxes, but the deflation effect on tax revenues spills over on income taxes as well. With deflation fewer workers get raises, meaning that there is much less, if any, growth in the income-tax base.

A stagnant or a shrinking tax base is not exactly what the governments of Europe’s welfare states want to have on the horizon. However, there is a very simple solution to this deflation problem: dismantle the welfare state. Reform away entitlement programs, privatize education and health care and individualize income security programs.

Back to EUBusiness.com:

Data released this past week showed that the annual inflation rate in the 18-nation eurozone dipped to 0.8 percent in December, considerably below the European Central Bank’s target of just below 2.0 percent. That masks large differences between countries, however. While average inflation came in at 2.6 percent in the Netherlands in 2013, it was just 1.0 percent in France, the eurozone’s second largest economy. In crisis-hit Greece, prices actually fell by 0.9 percent on average over 2013, according to data from EU data agency Eurostat.

The fact that Greece is suffering from deflation should end all talk about the country’s economy turning a corner. In fact, deflation is not just a problem in Greece for December 2013 – take a look at this figure, which reports Eurostat’s harmonized consumer price indices over the past three years (annual changes broken down per month):

eu DEflation

According to this index, Greece has suffered from deflation for ten months in a row. For the five last months of 2013, deflation was at one percent or more!

This is not the climate for an economic recovery. The only silver lining in this is that those who live on government handouts will probably experience a slight increase in their purchasing power. Ostensibly, those who still have a job are not seeing their money wages cut to deflation parity, which could help explain why the Greek economy seems to be reaching the trough of its depression.

At the same time, it is always important to remember that deflation also means declining per-unit revenue for businesses. Unless they can compensate with vast gains in volume of sales – an unlikely scenario in Greece today – they are not prone to invest or otherwise expand their businesses. While deflation may help bring the economic decline to an end, it will not help bring about a recovery.

EUBusiness.com adds yet another aspect to deflation:

An extended period of deflation — falling prices in real terms — can encourage consumers to put off buying goods in the expectation that if they wait, they will become cheaper. That in turn weakens the economy as companies reduce output accordingly, hitting employment and demand, thereby setting off a very damaging downward spiral.

This is not a very strong effect, especially not in an economy like the Greek where consumers have lost, on average, one quarter of their standard of living during the crisis. What remains there is, in effect, an industrialized version of subsistence consumption. That said, the depressing effect on consumption as described by the EUBusiness article could very well throw a wet blanket over durable-goods consumption, which is often financed by credit. If a consumer wants a loan for a new car and the bank has good reasons to expect that new cars will actually decline in price for each new model year, then they can expect the car considered today to depreciate even faster than it otherwise would. This forces the bank to demand a very fast repayment schedule, or a prohibitively high interest rate. Either way, deflation will hold back consumption by restricting consumer credit.

In other words, Lagarde’s concerns are valid. However, as the EUBusiness.com article reports, the Eurocracy resort to the hunky-dory attitude they always take:

[For] the head of Germany’s Bundesbank, Jens Weidmann, “the risk is limited that we’ll see broad-based deflation in the euro area.” Weidmann, who also sits on the ECB board, said the eurozone was on brink of an economic recovery, which would tend to push up prices. The ECB forecasts a modest recovery in growth of 1.1 percent for the eurozone in 2014 after contracting in 2013. Weidmann’s scepticism is shared by economist Holger Schmieding at Berenberg Bank. “The widespread concerns that the eurozone could fall victim to malign deflation are overdone,” he said in a recent note to clients.

Perhaps the reason for this attitude is that deflation in the EU is at least partly caused by austerity. In the figure above, the euro-zone harmonized CPI starts its decline in late 2011, when the EU-ECB-IMF troika in a concerted effort forced austerity policies upon several euro-area economies. An admission that deflation, caused by austerity, is a problem would indirectly be an admission that austerity has not exactly helped bring about a turnaround in Europe.

Of all the economists that EUBusiness.com talked to, only one brought up this aspect:

[Countries] that have been making the biggest progress in reducing deficits have been doing that with austerity policies of cutting spending, which has also dampened prices. “What is strange is that the question is only being posed now because the European strategy is profoundly deflationist,” said Isabelle Job-Bazille, head of economic research at the French bank Credit Agricole. She warned against relying too much on medium-term inflation expectations, which have so far remained anchored near the ECB’s two percent target, as deflationary tendencies could set in by the time such expectations change.

Deflation is a likely indicator of stagnation. Its presence in the Greek economy reinforces my conclusion that the country leads Europe into the shadowy economic wasteland of industrial poverty.

Government and Poverty

Last week marked the 50th anniversary of President Lyndon Johnson’s declaration of “war on poverty”. The ambitious, bordering on pompous, goal behind this “war” was obviously, and officially, to create a society where nobody would have to live in conditions defined as poverty.

About the same time, the mid-1960s, Western European countries were entering the “full speed” phase of building their welfare states. Health care, income security, education and retirement were all in the hands of, or in the process of being transferred to, government. Across Europe, government spending was closing in on 40 percent of GDP. That level of spending marked a turning point for Europe’s welfare states: from that moment on their economies entered a long stagnation phase that set the stage for the slow decline that began about 15 years ago.

The United States never reached quite the same point of stagnation. While our economy has not exactly had a stellar growth record since the Millennium recession, it has proven more resilient in the current crisis. The reason for this is largely that our government is not quite as big and intrusive as it is in Europe, and that we have not yet created the massive general income-security systems that Europeans are so proud of. Those systems clearly discourage work, but also require destructively high taxes, typically on payroll, making the cost of hiring even low-skilled workers prohibitively high.

The combination of us not having a general income security and the fact that our health care system still remains largely market based is enough to set us apart, macroeconomically, from Europe. While those systems were never part of the original intention behind the “war on poverty”, Lyndon Johnson did provide America’s left with a platform from which to strive for a full-fledged American version of the European welfare state. So far they have not succeeded, which today is a blessing for us.

This does not mean that they are not trying. As I reported in my book Remaking America: Welcome to the Dark Side of the Welfare State, high-profile liberal think tanks are pushing hard to bring America even closer to the European welfare state.

Any further addition of tax-funded entitlements would of course be as bad for the U.S. economy as they have been for Europe. The last thing we need right now a combination of work-disincentivizing income security and growth-suppressing taxes. The lesson from Europe is frighteningly clear: once the welfare state passes a certain point – again represented in part by government spending exceeding 40 percent of GDP – the private sector can no longer endure the burden but begins a slow but inevitable process of decline.

In Europe’s case, this decline began around the Millennium recession, though signs were there earlier. It continued during the years up to the beginning of the Great Recession and has since then exploded into a full storm of industrial poverty. This has led to one of history’s big ironies. The goal with the European welfare state was the same as that of the “war on poverty”, namely to elevate everyone to a standard of living beyond what is at any point in time considered “poverty”. Yet, when the welfare state was allowed to grow uninhibited by economic common sense it brought about economic decline of a scale that is now at the very least sentencing an entire generation of Europeans to life-long poverty.

On top of this irony, there is another thoroughly illogical feature common to both the “war on poverty” and the European welfare state. The very definition of poverty actually makes it practically impossible to get rid of poverty: when we define poverty as a fraction of median or average income, we have practically guaranteed that we will have poor people in perpetuity.

It is important to keep in mind that neither the spending programs under the “war on poverty” nor the European welfare-state entitlement programs actually end or reduce poverty. All they do is alleviate poverty by taking money from Jack and giving it to Joe. Once these redistribution programs become woven into the social and economic culture of a country, they tend to perpetuate the need for themselves. When people get money or services – cash or in-kind entitlements – for free over a long period of time they adjust their daily lives as well as their long-term economic planning to what they get without effort. As a result they will not be very interested in replacing entitlement-based goodies with work-based income.

To sum up, the overwhelming experience from the past half-century of trying to use government to eradicate poverty on both sides of the Atlantic is that government is exceptionally inept at helping people to better their lives. Instead of improving the lives of the poor, all that the European welfare state has done is pull more people down into poverty or a near-poverty stagnant life; as for the American “war on poverty”, it redistributes at least $1.2 trillion per year – seven percent of GDP – while doing nothing to reduce the country’s poverty rate (which has remained around 12-14 percent for decades).

Fortunately, there are tangible signs that American big-government liberalism has reached the peak of its political influence. This bodes well for the future of this great nation. Europe, on the other hand, is not only worse off than we are, but still pursuing the same kind of welfare-statist policies that in the first place put them where they are right now. If this difference in policy future defines where the two continents are moving, the differences between America and Europe could, in a decade or so, be as significant as the differences are today between the United States and South America.

That said, there are some global trends and institutional changes taking place that could in fact make it harder for the United States to pursue a free-market based path back to unprecedented prosperity. More on that later. For now, let’s declare the “war on poverty” lost; let’s scrap the European welfare state and let’s make freedom big and government small.

Europe’s Authoritarian Future

Are you Europeans ready to give Brussels even more power over your lives? Well, that’s what is coming down the pike, according to a story in British quality newspaper The Telegraph:

A campaign for the European Union to become a “United States of Europe” will be the “best weapon against the Eurosceptics”, one of   Brussels’ most senior officials has said. Viviane Reding, vice president of the European Commission and the longest serving Brussels commissioner, has called for “a true political union” to be put on the agenda for EU elections this spring. “We need to build a United States of Europe with the Commission as government and two chambers – the European Parliament and a “Senate” of Member States,” she said last night.

That is not a “United States of Europe”. The EU Commission, which Reding carelessly refers to as the “government” of her envisioned USE, is already the executive branch, and would continue to be so. But it is not an elected body: by the U.S. Constitution, in case Commissioner Reding had missed it, the chief of the executive branch – the President of the United States – is elected every four years. (He is also banned from serving more than two terms, a restriction I doubt any EY Commissioner would ever accept…)

There are two ways to copy this into the EU: by having direct elections in each country for one Commissioner, or by replacing the Commission with one person, i.e., a president.

As for the two chambers – the legislature – the “Senate of Member States” could actually be modeled after the erstwhile U.S. Senate, where members were appointed by the states. But even if that is what she has in mind, the two-chamber legislative body would only resemble U.S. Congress if it held the exclusive legislative power for the EU government.

The only exception to the executive-legislative dichotomy in the U.S. Constitution is the power of executive orders that Congress granted the presidency a long time ago. It has been abused from time to time, and it is likely that there will be revisions to that power once the Obama era is finally over. Nevertheless, even with the executive order exception the U.S. Constitution is comparatively firm in its emphasis on separation of powers.

This is not going to happen in Europe. On the contrary, what Commissioner Reding seems to have in mind – and you can be a nice steak dinner that the rest of the Commission is behind her “vision” – is something entirely different than a constitutional republic. The Telegraph again:

Mrs Reding’s vision, which is shared by many in the European institutions, would transform the EU into superstate relegating national governments and parliaments to a minor political role equivalent to that played by local councils in Britain.

That alone is a violation of the U.S. Constitution. The federal government’s powers are enumerated, and even though Congress and the President sometimes behave as though there was no enumeration, court battles and state legislation constantly keep the enumeration principle alive. Two recent examples: states have started rolling back or exiting Obamacare, and a growing number of states say completely no to the new, idiotic federal attempt at creating a national school curriculum (known as “Common Core”).

But wait – there’s more:

Under [Commissioner Reding's] plan, the commission would have supremacy over governments and MEPs in the European Parliament would supersede the sovereignty of MPs in the   House of Commons. National leaders, meeting as the European Council, would be reduced to consultative, second chamber role similar to the House of Lords.

Fat chance this would work in the United States. Ask any governor of any U.S. state if he has just a “consultative” function vs. the federal government, and you will get a long, passionate lecture about how he is elected by the people of his state and how he is accountable to them alone. And again – the lawmakers in Congress make federal laws, but state legislators make state laws, and the distinction is vigorously maintained. And fought over, which keeps the constitution of this great country alive and well.

While Commissioner Reding’s vision comes nowhere close to resembling a United States of Europe, it does serve another, for Europe more healthy purpose:

Nigel Farage, the leader of Ukip, said that Mrs Reding had revealed the true choice for British voters to make at polling stations. “For people in power in Brussels that is the only choice on offer, no reform just a United States of Europe. On 22 May the British people must ask themselves if they want this and vote accordingly,” he said. “I am sure people will say no to this centralist fanaticism.”

The only point of disagreement between me and Mr. Farage – whose political mission I respect and strongly support – would be, again, that whe Commissioner Reding is creating is something far more centralized than it is presented as. By letting the Commission supersede national governments and the MEPs supersede national legislators, Commissioner Reding is de facto envisioning a traditional European nation state, elevated to govern half-a-billion people.

It was the traditional nation state that American pilgrims left behind, and European emigrants to America sought to get away from. Even as Europe’s nation states created national parliaments, they never got very far with democratizing their governments. Legislative and fiscal powers have remained heavily centralized, and with very few exceptions – Britain being one – the European standard is the unhealthy proportionate, entirely party-ruled election system.

What is truly frightening about Commissioner Reding’s vision is that actually would create an even more un-democratic Europe: more laws would be made, and more executive power would be concentrated, to fewer hands, farther away from voters. Especially frightening is the vision of a Commission that would supersede national governments – without even being elected!

To make this vision even more nightmarish, consider the fact that there are no rigorous boundaries between legislative and executive powers in the EU. During the current economic crisis the Commission has effectively served as a legislative body for the national budgets in austerity-hit member states such as Greece, Italy and Spain. With more powers, and an even stronger formalized role as the supreme institution of the EU, the Commission would effectively be the unelected dictatorial power over 500 million people.

Luckily, there are brave freedom fighters like Nigel Farage out there trying to stop the Monster State of Europe from happening. But we must not forget that others are also capitalizing on the reckless pursuit of that same monster state, such as Golden Dawn in Greece, fascists in Spain and half-baked nationalists like Front National in France.

Those parties send echoes from history into our time. As if to amplify those echoes, The Telegraph reports:

In the run up to the springtime pan-European vote, the EU is gearing up to mount an unprecedented campaign for the hearts and minds of voters. Speaking in Athens, José Manuel Barroso, the commission president, signalled that the EU would use the centenary of World War One to warn that Euroscepticism, far-Right and populist anti-European parties could bring war back to Europe.

And the answer to that risk – if it even exists – is, according to Barrosso and his Commissioner buddies, to put even more faith, trust and power in an un-elected body of bureaucrats:

“No other political construction to date has proven to be a better way of organising life to lessen the barbarity in this world,” he said. “It is especially important to recall this as we will commemorate this year the start of the First World War. We must never take peace, democracy or freedom for granted. It is also especially important to remind this as in   May the peoples of Europe will be called to participate in European elections.”

This is a clear case of self-gratulatory political delusion. When did Mr. Barrosso last visit the street level of the Europe he so eagerly tries to govern? When did he witness the barbarity of youth unemployment across the EU? When was the last time he bothered to notice the 20 countries with more than 20 percent youth unemployment under his jurisdiction? When was the last time he even cast a glancing eye at the barbarian austerity disaster in Greece?

If the EU Commission gets its new nation-state monstrosity, the people of Europe can wave democracy and liberty farewell for decades to come. The Commission has already proven, during the current economic crisis, that it is ready to rule Europe with dictatorial powers. While those powers have thus far only been put to work on a limited scale, the fiscal dictates from Brussels to Athens, Rome, Lisbon, Madrid and Paris have shown that the Commission has nothing but disrespect for parliamentary democracy.

The only reforms to the EU that the Commission would accept are those that gives it more power. That is why they will ask for those reforms.

Whenever a politician asks you for more power to defend “peace, democracy and freedom”, you should run the other way.

And take your freedom with you.

Europe Downgraded

And the European debt crisis rolls on

Standard&Poor’s, one of the leading US-based ratings agencies, on Friday (20 December) downgraded EU’s rating by one notch to AA+, citing concerns over how the bloc’s budget was funded. “In our opinion, the overall creditworthiness of the now 28 European Union member states has declined,” Standard&Poor’s said in a note to investors. Last month, it downgraded the Netherlands, one of the few remaining triple-A rated EU countries. In the eurozone, only Germany, Luxembourg and Finland have kept their top rating.

Not surprising. The Netherlands experienced a very tough budget fight in 2012, with a resigning prime minister, upsetting elections and, during 2013, a close encounter with harsh austerity policies. This was not exactly what the Dutch had expected that they would be subjected to. Or, as I explained the situation in March 2013:

The Dutch government, which has been clearly in favor of tough austerity measures on southern European economies where the deficit exceeds the three-percent limit, now suddenly recognizes that austerity is bad for GDP growth. To play on another American proverb, life is not as fun when the austerity chickens are coming home to roost.

Evidently, the Dutch austerity measures did not prevent a credit plunge. Back now to the EU Observer story about the Standard & Poor downgrading:

The agency noted that “EU budgetary negotiations have become more contentious, signalling what we consider to be rising risks to the support of the EU from some member states.” EU talks for the 2014-2020 budget took over a year as richer countries – notably the UK and Germany – insisted on a cut, while southern and eastern ones wanted more money.

And herein lies the gist of why S&P is worried. The EU budget fight is about countries with better government finances wanting to pay less to countries with troubled or outright catastrophic government finances. If there is a cut in EU funds to Spain, Portugal or Greece, those recipient countries will have to take even tougher measures to try to comply with the budget balance targets set by the EU and the ECB. Given that they are already chronically incapable of doing so, it is not hard to see why S&P is very concerned with cuts in the EU budget.

This message, though, seems lost on some Eurocrats:

The news struck just as EU leaders were gathering for their last day of a summit in Brussels. European Commission chief Jose Manuel Barroso dismissed the rating downgrade. “We have no deficit, no debt and also very strong budget revenues from our own resources. We disagree with this particular ratings agency,” the top official said in a press conference at the end of the EU summit. “We think the EU is a very credible institution when it comes to its financial obligations,” Barroso added. … EU Council chief Herman Van Rompuy downplayed the S&P decision. “The downgrade will not spoil our Christmas,” he said.

Perhaps we should not expect anything else from them. After all, the Eurocracy in Brussels has proven, over and over again, that it lacks insight, interest and intelligence to successfully deal with Europe’s perennial economic crisis. This is in itself a troubling fact, as the signs of a continuing crisis are everywhere for everyone to see. A good example, also from the EU Observer:

The number of people unemployed in France rose 0.5% to over 10.5% in November, figures released Thursday show. The statistics are a political blow for President Francois Hollande who had pledged to bring the rate down by the end of 2013. The figures for December will be released end January.

The Eurocracy’s refusal to see the big, macroeconomic picture is also revealed in their delusional attitude toward the EU’s crisis policy:

The EU says Spain’s banks are back on a “sound footing,” but one in four Spanish people are still unemployed. Klaus Regling, the director of the Luxembourg-based European Stability Mechanism (ESM), made the statement on Tuesday (31 December) to mark the expiry of Spain’s EU credit line. He described the rescue effort as “an impressive success story” and predicted the Spanish economy will “achieve stability and sustainable growth” in the near future.

The only problem is that the crisis in the Spanish banks was not the cause of the economic crisis. The welfare state was the cause. Europe’s banks actually suffered badly from the crisis by having exposed themselves heavily to euro-denoted Treasury bonds: when Greece, Italy, Portugal, Spain, Ireland and even countries like Belgium and Netherlands started having serious budget problems, Treasury bonds lost their status as minimum-risk anchors in bank asset portfolios.

With trillions of euros worth of exposure to government debt, Europe’s banks rightly began panicking when in 2012 Greece forced them to write off some of the country’s debt. The debt write-off was directly linked to a runaway welfare state, whose spending promises vastly exceeded what Greek taxpayers could ever afford. The same problem occurred in Spain where the government’s ability to pay its debt costs have been in serious question for almost two years now.

To highlight the Spanish situation, consider these numbers from Eurostat:

  • In 2007 the consolidated Spanish government debt was 382.3 billion euros, of which financial institutions owned 47 percent, or 179.7 billion euros;
  • In 2012 the consolidated Spanish government debt was 883.9 billion euros, of which financial institutions owned 57.5 percent, of 507.9 billion euros.

In five short years, Spanish banks bought 382.2 billion euros worth of government bonds. During that same time, the Spanish government plummeted from the comfortable lounges of good credit to the doorstep of the financial junkyard.

It was also during this period of credit downgrading that the Spanish government began subjecting the country to exceptionally hard austerity measures, the terrifying effects of which I have explained repeatedly. However, as today’s third EU Observer story reports, those effects are of no consequence to the Eurocracy, whose praise for austerity will soon know no limits:

He also praised the EU’s austerity policy more broadly, saying: “The people’s readiness to accept temporary hardship for the sake of a sustainable recovery are exemplary … The Spanish success shows that our strategy of providing temporary loans against strong conditionality is working.” Spain will officially exit its bailout later this month, after Ireland quit its programme in December. Unlike Cyprus, Greece, Ireland and Portugal, the Spanish rescue was limited to its banking sector instead of a full-blown state bailout. It saw the ESM put up a €100 billion credit line in July 2012. In the end, the ESM paid out €41.3 billion to a new Spanish body, the Fondo de Restructuracion Ordenado Bancaria (FROM), which channelled the loans, most of which mature in 2024 or 2025, to failing lenders.

So all that has happened is that European taxpayers have been put on the hook for failed Spanish bank loans – loan defaults that Spain’s banks could have dealt with had they not chosen to lend a total of half-a-trillion dollars to their failing government.

Nobody seems to ask how this debt restructuring will help the Spanish government end its austerity policies. Such an end is a must if the Spanish economy is ever to recover. That does not mean a return to “business as usual” under the welfare state – on the contrary, the welfare state must go – but what it does mean is some breathing room for the private sector to regain its regular, albeit slow, pace of business.

Instead of connecting the dots here, the Eurocracy continues to look at the European economic crisis through split-vision glasses, and Spain is no exception. The EU Observer again:

For its part, the European Commission last month warned that the Spanish economy is still in bad shape despite the good news. It noted that “lending to the economy, and in particular to the corporate sector, is still declining substantially, even if some bottoming out of that contraction process might be in sight.” Meanwhile, the latest commission statistics say 26.7 percent of the Spanish labour force and 57.4 percent of its under-25s are out of work. The labour force figure is second only to Greece (27.3%) and much higher than the EU’s third worst jobs performer, Croatia (17.6%). … A poll in the El Mundo newspaper published also on Wednesday showed that 71 percent of Spanish people do not believe they will see any real benefit from Spain’s recovery until 2015 at the earliest.

All this ties back to the Standard & Poor downgrading of the EU. There is, plain and simple, a lot of concern that nothing is going to get better in the EU. There are good reasons to believe this: the persistent message from Brussels over the past two years has been that the next austerity package will be the last, that it will turn things around and put depression-stricken economies back on track again. As we all know, that has not happened, which raises the question if the EU is going to have to actually increase its bailout efforts toward fiscally troubled member states.

This blog’s answer is “yes, very probably”. Europe’s only way back to prosperity and growth goes through the structural elimination of the welfare state.

When Is Government Big Enough?

Welcome to Year of the Lord 2014. (Forget that “Current Era” crap – we are on God’s calendar for a reason!)

A lot is at stake this year. For us here in America we have upcoming midterm elections in November. Republicans have the momentum and it is not impossible that they take the Senate. The Democrats are panicking over what the Obama presidency is doing to their party; they have already suffered costly losses in state legislatures and gubernatorial offices.

We will also see an emerging field of presidential candidates for 2016. There are already some interesting Republicans lurking behind the curtains. New Jersey Governor Chris Christie is often suggested as an early front runner. Senator Ted Cruz has won many informal polls recently, and let’s not forget Senator Rand Paul, a much more realistic libertarian politician than his firebrand father.

To make matters even more interesting, there could actually be some respectable candidates on the Democrat side as well, such as New York Governor Andrew Cuomo (though he might hold off until he’s done two terms).

We also have to get really serious about our budget deficit. Fortunately, Compact for America – I am on their advisory council – is making progress with a good, realistic proposal for a constitutional amendment to bring about a budget balance.

Overall, the outlook for the United States is moderately optimistic. That includes the economy, which is not exactly steaming ahead, but definitely crawling forward faster than the European economy. The fact of the matter is that Europe, or at least the European Union, is in much bigger trouble than the United States. Yes, our interest rates on such indicators as the ten-year Treasury bond may be a bit higher than, e.g., France, but unemployment, GDP growth, taxes and welfare spending are all moving in the wrong direction in the EU.

To make matters worse for Europe, the current crisis, which I have described as a state of industrial poverty, is far from over. In fact, it may very well make a big turn for the worse, a fact that very few people speak openly about. We find a notable exception in one of the world’s few remaining respectable journalists, namely Ambrose Evans-Pritchard at The Telegraph, who does not mince his words when discussing the mounting debt crisis in the industrialized world:

Much of the Western world will require defaults, a savings tax and higher inflation to clear the way for recovery as debt levels reach a 200-year high, according to a new report by the International Monetary Fund. The IMF working paper said debt burdens in developed nations have become extreme by any historical measure and will require a wave of haircuts, either negotiated 1930s-style write-offs or the standard mix of measures used by the IMF in its “toolkit” for emerging market blow-ups. “The size of the problem suggests that restructurings will be needed, for example, in the periphery of Europe, far beyond anything discussed in public to this point,” said the paper, by Harvard professors Carmen Reinhart and Kenneth Rogoff.

Some telling examples of what we are talking about:

  • The EU, with 28 member states, had a gross government debt of 86.8 percent of GDP in the second quarter of 2013, up from 84.8 percent in Q2 2012;
  • The 17-member euro zone’s debt ratios were 93.4 percent in Q2 2013 and 89.9 percent in Q2 2012;
  • Greece: 169.1 percent, up from 149.2;
  • Spain: 92.3, up from 77.6;
  • France: 93.5, up from 90.8;
  • Italy: 133.3, up from 125.6;
  • The Netherlands: 73.9, up from 68.4.

Very few EU member states show a falling debt ratio, and when they do, the decline is marginal compared to the rise in other countries.

There is an implicit premise in the IMF report about the relation between the private sector and government. Before we get to it, let’s hear more from Evans-Pritchard:

The [IMF] paper said policy elites in the West are still clinging to the illusion that rich countries are different from poorer regions and can therefore chip away at their debts with a blend of austerity cuts, growth, and tinkering (“forbearance”). The presumption is that advanced economies “do not resort to such gimmicks” such as debt restructuring and repression, which would “give up hard-earned credibility” and throw the economy into a “vicious circle”. But the paper says this mantra borders on “collective amnesia” of European and US history, and is built on “overly optimistic” assumptions that risk doing far more damage to credibility in the end.

Very important indeed. Remember the Greek partial debt default? Not to mention the Cypriot Bank Heist when the government of Cyprus confiscated private savings deposits to pay for a bank bailout. Both these measures are now part of the legislative toolkit as the governments of the EU continue to fight their hopeless fight against the debt.

In reality, this fight is about something else than the debt itself. It is about the very heart and soul of the European economy. If the EU chooses to deal with its current crisis the way the IMF hints at, then it will automatically put government above the private sector. The measures proposed will save government at the expense of the private sector. This is the implicit premise in the IMF report, one that Evans-Pritchard does not address. However, as we return to his column we get some hints of how this premise would inform actual policy:

While use of debt pooling in the eurozone can reduce the need for restructuring or defaults, it comes at the cost of higher burdens for northern taxpayers. This could drag the EMU core states into a recession and aggravate their own debt and ageing crises. The clear implication of the IMF paper is that Germany and the creditor core would do better to bite the bullet on big write-offs immediately rather than buying time with creeping debt mutualisation. The paper says the Western debt burden is now so big that rich states will need same tonic of debt haircuts, higher inflation and financial repression – defined as an “opaque tax on savers” – as used in countless IMF rescues for emerging markets.

Aside the implied acknowledgement that the private sector will have to give in order for Europe’s welfare states to take, this paragraph is an effective IMF acknowledgement that Europe is now in a state of long-term economic stagnation.

The two issues actually connect. If there was any prospect of strong economic growth in the EU, there would not be any need to push for practically authoritarian measures to “save” governments from their own debts. Yet the IMF report cleverly opens for precisely that, namely debt defaults on a much wider scale than happened in Greece, as well as inflation and widespread use of so called “financial repression”:

Most advanced states wrote off debt in the 1930s, though in different ways. … Financial repression can take many forms, including capital controls, interest rate caps or the force-feeding of government debt to captive pension funds and insurance companies. Some of these methods are already in use but not yet on the scale seen in the late 1940s and early 1950s as countries resorted to every trick to tackle their war debts. The policy is essentially a confiscation of savings, partly achieved by pushing up inflation while rigging the system to stop markets taking evasive action.

We hear more and more about inflation as a “solution” to the debt crisis. This is disturbing, especially since when the inflation genie is out of the bottle, he is mighty reluctant to get back in there again. While it is difficult for politicians to cause inflation, it is not impossible, and if they are delusional enough to believe that they can turn off the inflation faucet just as easily as they can turn it on, they are going to use it.

Again, inflation is but one of the measures that politicians would resort to in order to save the welfare state from its own debt. The measures to save the welfare state would by necessity tax the private sector in every way possible, thus forcing voluntary economic activity – the heart and soul of a free society – to take the back seat while coercive economic activity – the welfare state – lives on unperturbed by the weight of its own debt.

The comparison to World War II debt is an egregious way to elevate the welfare-state crisis above the responsibility of statist politicians who built and nurtured it. World War II was an exceptional, disastrous event. The current debt crisis was not caused by a disaster. It was caused by deliberate, long-term political action to take one man’s money and time and give to someone else, for no other reason than that the recipient was considered “entitled”.

Through the build-up of the welfare state, government spending ran amok, demanding far more money than taxpayers could afford, over a long period of time. I explain this in detail in my forthcoming book Industrial Poverty; the short story is that Europe’s welfare states allowed entitlement spending to creep up above tax revenues, little by little, until the combined effect of taxes, entitlements and work discouragement had pushed back the private sector to where it was structurally unable to pay for the welfare state.

At this point it was only a matter of time before the debt that the welfare state brought about would explode. The financial crisis came along and helped the debt balloon inflate – notably the financial crisis was aggravated by banks’ exposure to deteriorating government debt!

This means two things. First, it is high time to stop imposing more regulations on the private sector. The more governments regulate the private sector, the more hindrances they put in place for the only engine that can pull Europe out of its crisis. Secondly, there is no way out of the debt crisis unless we are willing to say farewell to the welfare state. Its entitlement systems and its taxes will continue to weigh down the private sector for as long as the welfare state exists. The same crawling debt crisis that exploded in 2008-09 will begin again as soon as governments all over Europe stop their austerity measures.

At the same time, austerity has only made a bad crisis worse. The design of austerity measures used thus far is clearly to save the welfare state and make it fit within a tighter economy. Yet the burden of entitlement programs has not eased – on the contrary, it has increased. For every new austerity measure that has increased taxes and cut government spending, the economic crisis has worsened, thus giving rise to the need for even more austerity.

Europe must break this vicious circle, and the only way to do this is to abandon the desperate hunt for the balanced budget. Instead, Europe’s political leadership must focus on structurally phasing out the welfare state. They must privatize health care, income security and education – and cut taxes proportionately to their structural spending cuts. They must let the private sector take over what government has failed at delivering, both in terms of producing services and in terms of funding those services. Permanent spending cuts coupled with well designed tax cuts.

Only then can Europe see growth and prosperity again. If they do not choose this path, but instead stick to the old recipe of keeping the welfare state and trying to starve it into a stagnant economy, they will perpetuate their debt crisis.

That, in turn, means static or even declining private-sector activity while more and more people will clamor to the welfare state’s entitlement programs just to be able to make ends meet every month. Government will continue to grow, both in absolute and in relative terms. That growth will continue ad infinitum, until there is nothing but a planned, Sovieticized economy left.

Europe does not need that. Europe needs massive doses of economic freedom.

Now.

Stiglitz: Europe Needs Bigger State

Joseph Stiglitz is a well-known, respected economist. He has strange views on how to solve the European crisis, but he has been correct in pointing to the destructive forces of austerity as applied in Europe. At the same time, he praised the economic policies of Hugo Chavez, Venezuela’s now-deceased authoritarian socialist president. Those same policies have allowed inflation to run away past 50 percent and caused frequent shortages of power, food products and other consumer goods.

Now Stiglitz is at it again. This time he is back on the European crisis, and he actually sounds like he has read this blog. We welcome him among the readership!

That said, he has not done his Liberty Bullhorn homework all the way. While his crisis analysis is largely on the right side, his proposals for how to address the crisis are off the chart wrong. Defying common sense and thorough scholarship, Stiglitz actually wants more government in Europe, in virtually every corner of the economy.

From British newspaper The Guardian:

It has been three years since the outbreak of the euro crisis, and only an inveterate optimist would say that the worst is definitely over. Some, noting that the eurozone’s double-dip recession has ended, conclude that the austerity medicine has worked. But try telling that to those in countries that are still in depression, with per capita GDP still below pre-2008 levels, unemployment rates above 20% and youth unemployment at more than 50%.

The European Commission has downgraded its growth forecast, though Europe is still very much in a state of wishful recovery thinking. This prevents any rethinking of fiscal policy, making the continuation of the crisis the only reasonable alternative. No wonder the European Central Bank is close to full-scale crisis panic.

Back to Stiglitz:

At the current pace of “recovery” no return to normality can be expected until well into the next decade. A recent study by Federal Reserve economists concluded that America’s protracted high unemployment will have serious adverse effects on GDP growth for years to come. If that is true in the United States, where unemployment is 40% lower than in Europe, the prospects for European growth appear bleak indeed.

Exactly. As I explain in my forthcoming book, “Industrial Poverty”, Europe is in a state of permanent stagnation.

I am glad Stiglitz has come to the right conclusion regarding the nature of the crisis (and he does not have to feel ashamed that he reads this blog…). What troubles me, again, is that he is such a hopeless socialist when it comes to designing crisis solutions:

What is needed, above all, is fundamental reform in the structure of the eurozone. By now, there is a fairly clear understanding of what is required: • A real banking union, with common supervision, common deposit insurance, and common resolution; without this, money will continue to flow from the weakest countries to the strongest. • Some form of debt mutualisation, such as Eurobonds: with Europe’s debt/GDP ratio lower than that of the US, the eurozone could borrow at negative real interest rates, as the US does. The lower interest rates would free money to stimulate the economy, breaking the crisis-hit countries’ vicious circle whereby austerity increases the debt burden, making debt less sustainable, by shrinking GDP.

Please, no. First of all, the banking union would only serve the same purpose as the currency union, namely to extend a shield of artificially high credit worthiness from strong economies within the euro zone to the weak, poorly run countries on the southern rim. That artificial jag-up of credit was what allowed Greece, Portugal, Spain and Italy to borrow boatloads of money despite the fact that their economies and their fiscal policies were basically unchanged from when they had their own currencies. The banking union would do the same for private banks.

Secondly, the “debt mutualization” idea has been floating around for a long time. Superficially it is a good, or logical, idea: now that all these countries have the same currency, why not issue one and the same series of Treasury bonds for every country in the euro zone? However, this would only reinforce the skewed credit evaluation of euro-zone countries that came about as a result of the currency union. Put bluntly: German taxpayers would be responsible for Greek debt, not just de facto as is the case today, but de jure.

The only way that this could work is if all fiscal policy is completely centralized. That, however, would require the creation of a full-blown federal government in Europe. Given the huge democratic deficit that currently exists in the EU – with first and foremost the toothless parliament and the appointed executive office – this would only strengthen the forces that grow government at the expense of taxpayers and private businesses.

Third, Europe does not need more, cheap money. As I explained at length recently, Europe’s businesses and households are not borrowing for lack of money in the banks. They refuse to borrow because they have no good outlook on the future.

Back to Stiglitz:

• Industrial policies to enable the laggard countries to catch up; this implies revising current strictures, which bar such policies as unacceptable interventions in free markets. • A central bank that focuses not only on inflation, but also on growth, employment, and financial stability • Replacing anti-growth austerity policies with pro-growth policies focusing on investments in people, technology, and infrastructure.

His “industrial policy” point suggests that government needs to grow to help the European economy grow. But every time I review data of the size of government and economic growth, the inescapable result is that the smaller government is, the better the economy performs. Perhaps Stiglitz should go back and take another look at the “performance” of the Venezuelan economy?

As for the central bank idea, the European Central Bank is effectively already doing everything that Stiglitz is asking for. This is, in other words, a moot point. So is his third point, despite its note about the negative effects of austerity: unless and until he gets more specific, his criticism does not serve as the platform for an alternative that he sets it up to be.

Then Stiglitz goes on to try to make the case that central banks cannot be left independent, but must somehow be enrolled in the big government conglomerate that is his vision of our future:

Much of the euro’s design reflects the neo-liberal economic doctrines that prevailed when the single currency was conceived. It was thought … that making central banks independent was the only way to ensure confidence in the monetary system; … independent US and European central banks performed much more poorly in the run-up to the crisis than less independent banks in some leading emerging markets, because their focus on inflation distracted attention from the far more important problem of financial fragility.

No, the reason why the economies of advanced industrial economies have taken such a beating in this crisis is that they have advanced, over-sized welfare states. I have explained this at length on this blog, and – again – more is coming in my book.

And just to get a little taste of his socialist vision:

Finally, the free flow of people, like the free flow of money, seemed to make sense; factors of production would go to where their returns were highest. But migration from crisis-hit countries, partly to avoid repaying legacy debts (some of which were forced on these countries by the European Central Bank, which insisted that private losses be socialised), has been hollowing out the weaker economies. It can also result in a misallocation of labour.

And exactly how does Stiglitz define “misallocation of labor”?? There is no better way to determine where labor is best allocated than the free market. Or would professor Stiglitz suggest that countries with a higher degree of central economic planning somehow allocated their labor better than free-market based economies?

Is professor Stiglitz seriously suggesting that it is better to keep all unemployed Greeks in Greece than to allow them to pursue a better economic future abroad? Evidently, that is his vision.

Europe does not need more government. Anyone who proposes more government for Europe must answer two questions:

a) Why was government not big enough to prevent the crisis? and

b) When is government big enough?