Tagged: Government Debt
Economics and the European Crisis
Europe’s austerity disaster is not just a matter of reckless policy decisions by arrogant leaders in the EU, although that is ultimately where the buck stops. Many others have been involved in explicitly or implicitly, directly or indirectly, keeping the crisis going. Among them are assorted economists in various positions whose forecasts have reinforced the desires among political leaders: while the politicians want austerity to work, economists have predicted that it would work.
There is just one problem. Austerity does not work. While it has taken economists quite a while to begin to realize this, others have raised questions for some time now. Among them are business leaders: two years ago British corporate executives began expressing concern about the soundness of continuing EU-imposed austerity policies. The seeds of that doubt have grown, so much in fact that a few days ago Britain’s Chancellor of the Exchequer found it necessary to make a plea to business leaders to stay on board with Britain’s own austerity program. The Guardian reports:
George Osborne has asked business leaders to hold their nerve and continue backing the government’s austerity measures after the Bank of England gave the first signal since the financial crash of a sustained economic recovery. The chancellor told the CBI annual dinner on Wednesday night that the business community should ignore critics of his economic policy who advocate a stimulus package to spur growth and reduce unemployment. … His speech followed a series of forecasts from Threadneedle Street showing the UK recovery strengthening and inflation falling over the next three years. Sir Mervyn King said the outlook had improved, with growth likely to reach 0.5% in the second quarter of 2013, after the 0.3% registered in the first three months.
This is a good example of how the desires of politicians conspire with unrefined forecasts by economists. Anyone who reads a “strengthening recovery” into a 0.2 percent of GDP uptick in growth, from 0.3 to 0.5 percent, is either sloppy or desperate. Since the difference between 0.3 and 0.5 percent is little more than a margin-of-error change to GDP growth, I am inclined to conclude that at least some of the involved economists are sloppy.
One reason for this is that there have been forecasts of an improvement at the time of the announcement of every new austerity package in Europe over the past few years. I am planning a larger research paper to expose these errors; in the meantime, it is important to ask why economists think that the current austerity policies will have any other effect than the others that have been implemented since 2009.
More on that in a moment. It is important that we do not let the political leaders off the hook. I am firmly convinced that they are desperately looking for any sign that austerity is working – and that their desperation has reached such levels that they are inviting to a conspiracy of the desperate and the willing. It is interesting, namely, to see all the optimistic forecasts that are surfacing now. Politicians who should know better than most of us that austerity does not work, give a surprising amount of attention to those forecasts.
Their desperation is cynical yet understandable. Almost every political leader in Europe has invested his entire political career in supporting austerity. Now he is witnessing more and more critics lining up with The Liberty Bullhorn, pinning the unfolding social disaster on austerity advocates.
The obvious reaction should be to question austerity. After all, I cannot be the only one to ask how much farther the EU is willing to push its member states. For example, how much more can Greece take before the country explodes?
Europe’s leaders are no doubt aware of how close some parts of the continent are to social unrest. So long as austerity-minded politicians cannot provide people with an economic recovery, they know they are accountable for whatever happens.
As an alternative, they use forecasts of willing economists to convince people that the recovery is just about to happen, no matter how microscopic it might be. The Guardian again:
The modest improvement in output over recent months comes against a backdrop of rising unemployment, the lowest wage rises on record … According to the Office for National Statistics unemployment rose by 15,000 to 2.52m in the three months to the end of March. Wages were 0.8% higher in March than a year ago and only 0.4% better if bonuses are taken into consideration, which is the lowest rise in incomes since records began in 2001.
Again, calling this a “strengthening recovery” is clear signs of desperation. There were times when any growth under two percent set off alarm bells, among economists as well as politicians. Now, numbers a fraction as high are raised to the skies as signs of a “strengthening” recovery. From the Sydney Morning Herald:
The dogged recession across the eurozone has snared key economy France, with the latest EU figures released Wednesday [May 15] showing a full year-and-a-half of contraction as tens of millions languish in unemployment. In Brussels, French President Francois Hollande tipped ‘zero’ growth on the national level, blaming an EU-wide, German-led austerity trap — and hitting out at banks for holding back on lending as he and fellow leaders battle to unlock taxable assets hidden in offshore bank vaults or breathe life into training programmes for Europe’s disillusioned youth.
And his recipe is to take it all out in the form of higher taxes instead. Yep. That will really make things better… The fact of the matter is that France desperately needs a complete reversal of its economic policy, with long-term credibility to go with it. The same holds for the entire euro zone, which according to the Sydney Morning Herald is in deep trouble:
official figures showed a 0.2 per cent contraction between January and March, in the longest recession since the single currency bloc was established in 1999. EU data agency Eurostat said output across the 17 states that share the euro — which are home to 340 million people — fell by 1.0 per cent drop compared to the same quarter last year. France notably slid into recession with a 0.2 per cent quarter-on-quarter contraction, with unemployment already running at a 16-year high.
French president Hollande blamed the bad economic news…
on “the accumulation of austerity politics” and a “lack of liquidity” within the banking sector leading to a euro-wide loss of confidence. Fresh from winning France a two-year period of grace from the Commission to bring its public finances back within previously-understood EU targets, Hollande argued that nascent plans to divert state and private investment towards projects intended to get Europe’s youth working would make a difference.
In other words, more government programs on top of government programs that don’t work. If government was the answer, there would not be a crisis in Europe today.
Instead, as the Sydney Morning Herald reports, Europe is heading for yet more of the same, though some economists seem stubbornly unwilling to accept the permanent nature of the crisis:
Following a string of disappointing survey results in recent weeks, Ben May of London-based Capital Economics warned: “We doubt that the region is about to embark on a sustained recovery any time soon.” The latest official European Commission forecast for 2013 published earlier this month tipped a 0.4-per cent contraction, but May said that was way off course with “something closer to a two-per cent decline” likely. His firm’s pessimism was backed by Howard Archer of fellow London-based specialist analysts, IHS Global Insight. “We expect the eurozone to suffer gross domestic product (GDP) contraction of 0.7 per cent in 2013 with very gradual recovery only starting in the latter months of the year,” said Archer.
What reason does he have for expecting a recovery? This is the standard mistake that mainstream economists and econometricians make: they rely heavily on models that are inherently prone to draw the economy toward long-term full employment equilibrium. When they “inject” a change to economic activity, such as an austerity package, their model automatically makes the assumption that this sudden and uncharacteristic change – called a “shock” – will be absorbed and the economy will move on.
Every new austerity package is treated the same way, both by the econometricians who design the models and by the economists who provide the analytical framework. Their take on the European crisis is therefore a series of individual shocks, not a systemic re-shaping of the entire economy. As a result, they always predict a recovery and return to some long-term stable growth path.
To the best of my knowledge there is not a single macroeconomic model out there that has yet incorporated the systemic effects of austerity. Therefore, the economics profession will continue to make systemic forecasting mistakes – and advise politicians based on those mistakes.
Don’t get me wrong. I am not blaming economists for the errors that politicians end up making. But our profession must begin to recognize its almost chronic inability to deal with economic crises. Our forecasting methods can handle regular recessions but are frustratingly inept at dealing with situations that become inherently unstable, such as the current European disaster.
In fairness, I am not the only economist with an unequivocal criticism of austerity. On March 5, Joseph Stiglitz explained in Economywatch.com:
While Europe’s leaders shy away from the word, the reality is that much of the European Union is in depression. Indeed, it will now take a decade or more to recover from the losses incurred by misguided austerity policies – a process that may eventually force Europe to let the euro die in order to save itself.
Strange conclusion. The euro is not the cause of the crisis. But Stiglitz is probably letting his ideological preferences get in the way of good economic judgment. Otherwise he would do the same analysis has I have and conclude that the crisis is caused by the welfare state.
That said, Stiglitz is eloquent in his criticism of austerity:
The loss of output in Italy since the beginning of the crisis is as great as it was in the 1930’s. Greece’s youth unemployment rate now exceeds 60 percent, and Spain’s is above 50 percent. With the destruction of human capital, Europe’s social fabric is tearing, and its future is being thrown into jeopardy. The economy’s doctors say that the patient must stay the course. Political leaders who suggest otherwise are labeled as populists. The reality, though, is that the cure is not working, and there is no hope that it will – that is, without being worse than the disease.
Well said. But what alternative is Stiglitz proposing? Certainly not that the welfare state must go:
The simplistic diagnosis of Europe’s woes – that the crisis countries were living beyond their means – is clearly at least partly wrong. Spain and Ireland had fiscal surpluses and low debt/GDP ratios before the crisis. If Greece were the only problem, Europe could have handled it easily.
I don’t know where Stiglitz gets his data but here are the debt/GDP ratios for Ireland and Spain in 2003-2008:
| 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | |
| Ireland | 29.3% | 28.7% | 27.3% | 25.5% | 26.1% | 44.9% |
| Spain | 44.9% | 44.3% | 43.2% | 41.3% | 39.0% | 44.2% |
In terms of actual euros, the general government debt in Ireland shot up by almost 84 percent from 2003 to 2008. In other words, it was only thanks to strong growth in current-price GDP that the Irish did not see their debt ratio grow faster than it did. They were expanding their government as fast as they could, and certainly more than was healthy for the economy: in 2010 the debt-to-GDP ratio had reached 87 percent, i.e., close to double what it was two short years earlier.
The Spanish situation followed a similar pattern, though with less dramatic numbers than the Irish. The lesson to be learned from this is not that these economies could afford their big governments, but that their big governments survived only because there was enough current-price GDP growth to pay for them. As soon as GDP slacked off, the cost of the welfare state quickly became completely unbearable.
Stiglitz refuses to see this. He goes on to advocate even more government, without a hint of explanation of how the world’s already highest-taxed nations would be able to pay for that:
Europe needs greater fiscal federalism, not just centralized oversight of national budgets. To be sure, Europe may not need the two-to-one ratio of federal to state spending found in the United States; but it clearly needs far more European-level expenditure, unlike the current miniscule EU budget (whittled down further by austerity advocates). … There will also have to be Eurobonds, or an equivalent instrument.
More welfare state spending, more government, more debt, more of the same that brought about the crisis in the first place.
Instead of wanting more of the same and providing politicians with rosy outlooks, practitioners of economics should re-examine the results of their own contributions over the past few years. The ability of hundreds of millions of people to maintain their current standard of living, even support their families, depends on it.
Inflation Crushing Argentine Currency
Europe is bogged down in what looks more and more like a permanent state of industrial poverty. I have likened their future to what South America became during the 20th century: a cluster of countries with their good days of prosperity behind them.
This is not entirely a fair comparison, since both Brazil and Chile have made great strides toward rising above the industrial poverty that otherwise holds the continent in a tight grip. But as a general rule, it is entirely reasonable. Just like South America lost its course in the mid-20th century, Europe is going down in the early 21st century.
Europe’s only chance is to totally dismantle their welfare states and start over on free-market terms. I do not see that happening, just as it has not happened in countries like Venezuela and Argentina. (Chile is a different story.) Especially the Argentine example is useful as a general forecast reference for Europe: they have done everything they can to keep their welfare state in place, with the inevitable result that there is not enough tax revenues to pay for all the entitlements.
As a desperate measure to continue the welfare state despite inadequate tax revenues, the Argentine government has turned to money printing. As I reported in September last year, this is causing runaway inflation. For 2012 the inflation rate reached 30 percent, a downright destructive level.
The Argentine government has had plenty of time to see the writing on the wall – the country’s credit rating was downgraded in November last year – but chose not to. Instead, inflation is now destroying their currency and people are hoarding dollars as a last-resort measure to survive. Bloomberg Business reports:
A lot of U.S. dollars are tucked away somewhere in Argentina, most likely in stacks of $100 bills. Seven years ago, the U.S. Treasury, working with the Federal Reserve and the Secret Service, estimated that in the early 1990s Argentines held $20 billion in cash, a number that by 2006 had grown to “perhaps $50 billion or more.” That year there was a total of about $768 billion worth of dollar-denominated cash in the world, which means that someone in Argentina held at least one out of every 15 cash dollars.
This is an interesting number. Anecdotes out of Europe from the first few years of the euro alleged that assorted mafia organizations were dumping the dollar and going for the euro instead. Its highest denomination is 500 compared to the 100 maximum denomination of the dollar. Since the two currencies are largely equally valued, it made a lot more sense for those in more illicit businesses to carry euros. This would have released lost of high-denomination dollar cash, which could then be unloaded in perennially dollarized Argentina.
Back to Bloomberg:
Demand for large dollar cash transfers to Argentina since 2006 … has outstripped demand for dollar cash overall in the world. So it seems safe to say that today Argentines hold probably well more than $50 billion, and well more than one in every 15 dollars. (This is why the government of Cristina Kirchner is so furiously digging at the country’s undeclared wealth. Not to bring home what Argentines hold abroad, but to uncover some of those dollars Argentines have—literally—at home.)
She has two reasons for doing this. First, the dollar holdings are likely the result of financial activities not reported to the tax collectors. With a deficit equal to $14 billion, the Argentine president’s mouth is watered by the prospect of taxing undeclared dollar holdings: if the government could seize 28 percent of those holdings, it would be enough to eliminate the budget deficit
In one year. The following year, of course, the deficit would be back again. And since you can only confiscate the same dollar once, this would be a stupid solution to a stupid problem.
The second reason for President Kirchner to want to seize dollar holdings from Argentine families is that the country’s own currency is plunging almost as fast as Obama’s presidential credibility. By confiscating people’s dollar holdings she could try to force them into increasing demand for the Argentine dollar. Zerohedge has an interesting illustration of how the Argentine currency has lost value vs. the U.S. dollar on the informal currency market: a year ago the formal and the informal exchange rates were within striking distance of one another; today the informal market pays twice as much for a U.S. dollar than the official exchange rate does.
This is a scathing free-market verdict over the Argentine currency, but indirectly also an acknowledgement by rational economic men that their government is on a fast track to destroying their economy. By hoarding dollars they stand a fighting chance to survive when their domestic currency collapses.
It is worth noting that currency collapses tend to happen in countries with big, entitlement-loaded welfare states. We need not look farther than what is happening in Europe, where the European Central Bank has made a promise to print an unlimited amount of euros to pay for the debts of the euro zone’s welfare states. As a result of this, the general opinion among financial investors and analysts has now shifted away from assessing the strength of the euro to forecasting its demise.
There is really only one reason for a central bank to run amok with its printing presses, and that is to finance a government deficit. That deficit, in turn, is almost always the result of a runaway welfare state. Therefore, the safest way to a sound currency and restraint in money supply is to eliminate the welfare state.
Europe needs to learn this. They have already started on the reckless path to excessive money printing. Thus far it has not come to the point where it causes inflation – the extra cash has not yet reached the transmission mechanisms between the monetary and real sectors of the economy. But when it does, Europe will rapidly ratchet down the South American slope.
ECB Guarantee Did Not Save Spain
By now, everyone around the world has probably heard that Spain is de facto in fiscal default – i.e., bankrupt. The IMF, whose report Fiscal Monitor number 1301 presented the numbers showing that Spain is practically in default, does not offer an explicit analysis of the default scenario itself, but it gives a very illuminating background to the proliferating economic tragedy in Europe.
I will do an analysis of the Fiscal Monitor report later; for now, let’s return to Spain and the notable fact that the country has gone into effective bankruptcy despite the commitment by the European Central Bank to buy up every euro’s worth of Spanish treasury bonds. This commitment meant two things:
- owners of Spanish bonds would always be able to sell them, thus putting a mild downward pressure on the interest rate; and
- the Spanish government would be able to finance its own debt in perpetuity – all it would have to do would be to issue more debt, i.e., to ask the ECB to print more money.
This is a slight simplification, as the Spanish government would still have to meet certain fiscal criteria, such as continued austerity. But at the same time, if a central bank issues a guarantee to buy all bonds that its government issues in order to bring down the interest rate on those bonds, you cannot condition your promise on fiscal austerity. As soon as the government must take fiscal steps to maintain the central bank’s purchasing guarantee, the guarantee loses its inherent value. It is no longer worth any more than the bonds it is supposed to guarantee.
In other words, meaningless.
Assuming that the ECB does not make meaningless promises, the Spanish de facto default is all the more remarkable – and comes with serious warnings to everyone with money in Spain: get out or face a Cypriot Bank Heist seizure of your assets.
Here is what Jeremy Warner said in the Daily Telegraph a couple of days ago:
Next year, the [Spanish] deficit is expected to be 6.9 per cent [of GDP], the year after 6.6 per cent, and so on with very little further progress thereafter. Remember, all these projections are made on the basis of everything we know about policy so far, so they take account of the latest package of austerity measures announced by the Spanish Government.
Which means that we can expect an increase in the deficit ratio in the future, as forecasters often forget to incorporate the negative effects of austerity on GDP.
The situation looks even worse on a cyclically adjusted basis. What is sometimes called the “structural deficit”, or the bit of government borrowing that doesn’t go away even after the economy returns to growth (if indeed it ever does), actually deteriorates from an expected 4.2 per cent of GDP this year to 5.7 per cent in 2018.
This is important, because it shows that there is a structural change going on in the Spanish economy. People are paying permanently higher taxes and get permanently less back from government for that money. The private sector has been permanently diminished and an entire generation of young Spaniards has been sentenced to a life on welfare.
By 2018, Spain has far and away the worst structural deficit of any advanced economy, including other such well known fiscal basket cases as the UK and the US. So what happens when you carry on borrowing at that sort of rate, year in, year out? Your overall indebtedness rockets, of course, and that’s what’s going to happen to Spain, where general government gross debt is forecast to rise from 84.1 per cent of GDP last year to 110.6 per cent in 2018. No other advanced economy has such a dramatically worsening outlook.
But Greece did, and they ended up losing one quarter of the GDP.
Unfortunately, Jeremy Warner does not see the damage done by austerity:
And the tragedy of it all is that Spain is actually making relatively good progress in addressing the “primary balance”, that’s the deficit before debt servicing costs.
The “progress” consists of increasing taxes and reducing spending in an entirely static fashion. There is no analysis behind the austerity efforts of the long-term effects they will have on the economy. For example, the increase in the value-added tax that was enacted last year reduced the ability of consumers to spend on other items. This reduced private consumption and forced lay-offs in retail and other consumer-oriented industries. The laid off workers went from being taxpayers to being full-time entitlement consumers. As they did they reduced the tax base and cut tax revenues for the government in the future.
This point aside, Warner explains well the bankruptcy side of the issue:
What’s projected to occur is essentially what happens in all bankruptcies. Eventually you have to borrow more just to pay the interest on your existing debt. The fiscal compact requires eurozone countries to reduce their deficits to 3 per cent by the end of this year, though Spain among others was recently granted an extension. But on these numbers, there is no chance ever of achieving this target without further austerity measures … it seems doubtful an economy where unemployment is already above 25 per cent could take any more. … All this leads to the conclusion that a big Spanish debt restructuring is inevitable.
Debt restructuring, of course, being the same as bankruptcy. In a matter of speaking, Greece did a “bankruptcy light” when they unilaterally wrote down their debt. In the case of Spain it would probably mean a much bigger debt writedown than in Greece.
Back to Warner:
Spanish sovereign bond yields have fallen sharply since announcement of the European Central Bank’s “outright monetary transactions” programme. … But in the end, no amount of liquidity can cover up for an underlying problem with solvency. Europe said that Greece was the first and last such restructuring, but then there was Cyprus.
And toward the end Warner issues a fair warning about a repetition of the Cyprus Bank Heist:
Confiscation of deposits looks all too possible. I don’t advise getting your money out lightly. Indeed, such advise is generally thought grossly irresponsible, for it risks inducing a self reinforcing panic. Yet looking at the IMF projections, it’s the only rational thing to do.
Spain is the fourth largest euro-area economy, with ten percent of the euro zone GDP. If we add Greece, Cyprus and an all-but-certain Portuguese de facto bankruptcy, we would now have 14 percent of the euro area economy declared practically insolvent. As Jeremy Warner so well explains, the point where this bankruptcy becomes a fact is one where the macroeconomy in a country is permanently unable to bear the burden of government.
This means that 14 percent of the euro-zone economy will be at a point where it is acutely unable to fund the welfare state.
What conclusions will Europe’s elected officials draw from that? It remains to be seen, though it is not far fetched to assume that no one will be ready, willing or courageous enough to remove the welfare state.
That is too bad, because it means – again – that Europe is stuck in a permanent state of industrial poverty. Hopefully, America’s elected officials will watch, learn and do the right thing.
Europe Drowning in Debt
The European economy is in bad shape. On May 3 the EU Observer reported:
The eurozone economy will contract by 0.4% in 2013, Economics commissioner Olli Rehn said Friday. Presenting the EU commission’s Spring Economic Forecasts, Rehn said that the bloc would return to growth in 2014 by a slower-than-expected 1.2%. Meanwhile, the average debt levels will hit 96% in 2013.
Looking at the 27 EU member states, things are looking almost as bad: inflation-adjusted GDP growth is forecast to be 0.4 percent this year, though that will probably be adjusted downward in the next few months. EU institutions that publish economic forecasts have a tendency to downgrade their forecasts as the present catches up with the future.
At the same time, total general government debt in the 27 EU countries is heading the other way: from 2010 to 2012 those countries added 1.4 trillion euros to their total debt. In terms of growth rates, EU-27 have added debt at frightening rates over the past few years:
2008: 6.1 percent
2009: 12.8 percent;
2010: 12.3 percent;
2011: 6.7 percent;
2012: 6.7 percent.
Due to an almost total absence of GDP growth, the ratio of debt to current-price GDP has grown at stunning rates:
To reinforce the persistent nature of the economic crisis, the EU Observer also reports:
France has moved centre stage in the crisis, after EU economic affairs commissioner Olli Rehn said that the country would fall into recession in 2013 and needs two more years to bring down its budget deficit. Presenting the Commission’s Spring Economic Forecasts on Friday (3 May), Commissioner Rehn described Paris’s forecasts, based on a mere 0.1 percent growth rate, as “overly optimistic.”
It is hard to see how France has ever been out of the Great Recession. From 2008 through 2012 the French economy averaged 0.06 percent in real GDP growth. During the same period of time its debt-to-GDP ratio went from 68.2 percent to 90.4 percent.
This explains why, as I reported recently, the French government is panicking over the prospect of more austerity. They know it has not worked for their southern neighbors and they are not going to stir up the same kind of political turmoil as those policies did in, e.g., Greece. The socialist French government knows that parties like Front National – often perceived, wrongly so, to be ideologically close to the Greek Nazis, Golden Dawn – as well as radical communists could make significant political gains if the French people were subjected to the same bone-crushing fiscal measures as the Mediterranean EU members have implemented.
The French resistance to more austerity caused the EU Commission recently to declare that the War of Austerity is over. It is not, of course, or else there would be a complete course change throughout southern Europe. Furthermore, the EU Commission would not be continuing to pressure Paris over balancing its budget in the midst of a recession. The EU Observer again:
The eurozone’s second largest economy would run deficits of 3.9 percent in 2013 and 4.2 percent in 2014, he said, calling on Francois Hollande’s government to draw up a “front loaded” package of cuts and labour market reforms to stop “persistent deterioration of French competitiveness.” For its part, Paris maintains that it will reduce its deficit to 2.9 percent in 2014, fractionally below the 3 percent limit in the EU’s Stability and Growth Pact. Hollande in March announced that an additional €20 billion worth of tax rises and €10 billion in spending cuts would be included in his budget plans but said no further cuts would be made.
Because if he tries, the socialist government is going to end up in real trouble. Many of the prime minister’s cabinet members are truly fearful of more austerity, for various reasons.
But wait, there’s more:
Crisis-hit Cyprus, which has now finalised a 10 billion bailout, is set to be worst hit by recession with an 8.7 percent fall in output. Meanwhile, the average national debt pile is expected to peak at 96 percent of GDP in 2014, with six countries – Belgium, Ireland, Greece, Italy, Cyprus and Portugal – having debts larger than their annual economic output. Rehn indicated that Spain would also be given an additional two years to bring its deficit down to the 3 percent threshold, while Slovenia would also need more time.
So long as Europe keeps its welfare state, it has no way out. The welfare state is what is driving Europe’s crisis today, and it will continue to do so for as long as the welfare state exists. Nothing is changing for the better. Europe is drowning in its entitlement-driven government debt. The continent is stuck, and the talk about austerity being over is politically motivated hot air.
I stand my my diagnosis: austerity policies exacerbated the financial crisis into a welfare state crisis and turned Europe into an economic wasteland. What used to be a thriving industrialized continent is now facing an endless future of industrial poverty.
EU Orders Bank Deposit Confiscation
It is rather telling that the Cypriot bank-deposit confiscation idea surfaces in Europe, at this time. The Eurocracy is no doubt getting desperate when it comes to saving their super-state project with it common currency and its welfare state. No one should doubt that the confiscation idea was conceived in closed, anonymous, tainted-window offices at the heart of the EU power machine.
More on that in a moment. First, let’s listen to a voice on what this totally game-changing deposit confiscation can lead to for the Cypriot economy. From EUBusiness.com:
Russians are preparing to withdraw billions of euros from Cyprus and the island will plunge into a recession lasting for decades due to the onerous terms of a EU bailout, economists warned on Monday. “The Russians are already indicating they want to withdraw their money. Why should they stay? They will go somewhere where they can be protected; we can’t protect them,” economist Simeon Matsi told AFP. “We have indications that billions (of euros) will be withdrawn, we already know of about three billion that is ready to move. They are already asking lawyers to draw up documents to withdraw money.”
It’s ironic. Wealthy Russians make tons of money in an economy where protection of property right is precarious. They then take their money to Europe, the birthplace of the ironclad definition of property rights – only to see their property be subjected to an unprecedented confiscation campaign from government.
As a condition for a desperately-needed 10-billion-euro ($13 billion) bailout for Cyprus, fellow eurozone countries and international creditors Saturday imposed a levy on all deposits in the island’s banks. Deposits of more than 100,000 euros will be hit with a 9.9 percent charge, while under that threshold the levy drops to 6.75 percent. The controversial tax is seen hitting Russian pockets hard, with experts estimating that Russian deposits in Cypriot banks amount to at least 15.4 billion euros ($20 billion) of the estimated 67 billion euros of deposits held by Cyprus banks.
If the EU could apply the 9.9 percent confiscation to all the 67 billion euros, they would only get two thirds of the money they are after. If the Russians withdraw their money before the confiscation kicks in, they only collect a bit more than half of what they are after. And that is under the assumption that there are no other major withdrawals, an assumption that is obviously unrealistic.
Talk about creating a bank run… but the long-term consequences for the Cypriot economy are far more ominous:
Economist Castas Apostolides said the Cypriot government went unprepared into negotiations with the eurogroup. “We should have called Europe’s bluff,” he said. “A bank haircut on deposits is unacceptable; they should have walked out because without a business sector there is no Cyprus economy,” Apostolides said. “Cyprus will be unable to exit recession for the next 20 years. Our children will pay for this mistake.”
Indeed. One of the most important pillars of economic freedom is the credit system. It allows for a functional separation of property rights and rights of use, without destroying or eroding the status of the former. A credit system can only function if people feel that their property – their bank deposits – are always protected. If bank deposits are not protected, there will be no money for the banking system to lend. If they have no money to lend, there will be no credit available for small businesses to grow.
But even larger businesses can start feeling uneasy. They often bank internally – set up their own internal credit system for funding investments – but they, too, need to have their money deposited somewhere. Unless they own their own bank they need to expose themselves to the same world as the rest of us. When government can arbitrarily come up with a reason to confiscate ten percent of your deposits, even large corporations are going to get nervous.
Once that uneasiness sets in, people and corporations with large assets will start comparing risks on a broader scale. One immediate question is: are your bank deposits safe in other EU member states? The EU Business again:
An analysis by IHS Global Insight said there was a “potential for contagion from the move to impact bank sectors in other troubled economies on the periphery of the eurozone.” “A mass of withdrawals from eurozone periphery banks could heat up the debt crisis once again after the international financial community had decided that lending to countries such as Spain and Italy would not require the extremely high risk premia it had earlier demanded,” it said. “The financial markets’ immediate bad reaction to the part funding of the Cypriot rescue by taxing bank depositors has highlighted the concerns that it could be opening a nasty can of worms.” UBS Investment Bank managing director Reinhard Cluse said the deal “raises the obvious question whether the depositor bail-in in Cyprus is a ‘one-off’ or whether it will eventually be repeated elsewhere in the future”.
Let us not forget that the reduction of the risk premiums for investments in Spanish and Italian treasury bonds happened only after the European Central Bank had promised to buy an unlimited amount of their treasury bonds. In other words, the ECB did precisely what it is not allowed to do according to the EU constitution, namely bail out countries with unmanageable government debts.
The ECB allowed itself to break the constitution – and the EU accepted it – to achieve a political goal, namely to save the common currency and the Spanish and Italian welfare states. In other words, the respect for the rule of law is already rather scant in the hallways of European power. It is therefore not very surprising that this bank-deposit confiscation idea was concocted in those very same hallways. Euractiv reports:
Cypriot President Nicos Anastasiades said yesterday (17 March) he had no choice but to accept a painful tax on the country’s bank deposits in return for international aid, saying the alternative was bankruptcy.
For government, mind you.
In a nationally televised address, the president called it the least painful option under the circumstances before going on to accuse eurozone finance ministers of forcing Cyprus into this deal, Euronews reported. Breaking with previous EU practice that depositors’ savings are sacrosanct, Cyprus and international lenders agreed at the weekend that savers in the island’s outsized banking system would take a hit in return for the offer of €10 billion in aid. … The news stunned Cypriots and caused a run on bank machines, most of which were depleted within hours. Electronic transfers were halted. Outside Cyprus, the move unnerved depositors in the eurozone’s weaker economies and investors fearing a precedent that could reignite market turmoil.
There you go. Once the Eurocrats have gotten away with doing this to one country, they will most certainly do it elsewhere. They have done it with austerity, and they have already set a precedent for not caring too much about the rule of law.
It is easy for the Eurocrats to concoct all these power-grab schemes. It is a lot harder for the nationally elected officials to deal with the wrath of the people – as Greek and Italian voters have shown. When it comes time to confiscate people’s bank deposits, things get even more tense, which explains why, according to Euractiv, the Cypriot president is making a desperate promise:
Anastasiades promised those savers they would be compensated by being given shares in banks guaranteed by future natural gas revenues. Cyprus is expecting the results of an offshore appraisal drilling this year to confirm the island is sitting on vast amounts of natural gas worth billions.
And if that is not the case? If the reserves are not “vast”? Let’s not forget that the global-market price of natural gas has dropped significantly over the past year, as new resources have come on line, primarily in North America. And more is to come. By the time the Cypriot report is done it could turn out that only a fraction of the reserves is commercially viable.
At that point, what will the Cypriot government do? Can it even survive such a crisis, on top of a massive bank run?
Ultimately, the bank customers in Cyprus are just another cluster of victims of the reckless European attempt at saving what cannot be saved: the European welfare state. Let’s not forget that this entire thing did not start with a financial crisis, but with government deficits. The financial trouble in 2007-2008 would have been contained if it was not for the fact that banks over the previous decade had invested profusely in treasury bonds. The philosophy was that such assets would offset the rising risks elsewhere.
When governments like Greece, Portugal and Spain started having serious debt problems the low-risk end of bank balance sheets basically evaporated.
Bottom line: had the governments of Europe not borrowed so much money to save their unsustainable welfare states, the banks would have been able to handle the crisis on their own.
Downgrading Another Welfare State
And down goes another welfare state…:
Fitch Ratings has downgraded Italy’s Long-term foreign and local currency Issuer Default Ratings (IDR) to ‘BBB+’ from ‘A-’. The Outlook on the Long-term IDRs is Negative. Fitch has simultaneously affirmed the Short-term foreign currency IDR at ‘F2′ and the common eurozone Country Ceiling for Italy at ‘AAA’.
Already before this, Italy was paying more than seven percent on its treasury bonds. This will bump up their borrowing costs yet another notch. And since the European Central Bank has promised to buy any EU member-state bonds denominated in euros, this will increase their commitment and their obligation to print even more money.
The downgrade of Italy’s sovereign ratings reflects the following key rating factors: The inconclusive results of the Italian parliamentary elections on 24-25 February make it unlikely that a stable new government can be formed in the next few weeks. The increased political uncertainty and non-conducive backdrop for further structural reform measures constitute a further adverse shock to the real economy amidst the deep recession.
It would be interesting to hear what the Fitch analysts have to say about what Italy has done thus far in terms of austerity. Effectively, they are asking for more of the same, obviously a bad idea.
There is actually a bit of irony in this. Without a “stable” government Italy will sail on as it is, and no new austerity measures will be implemented. This gives the economy a little bit of breathing space, which – at least in theory – could inspire a small recovery. That in turn would be good for future tax revenues and help toward reducing the budget deficit.
In reality, there is little to hope for here. Pressure from the EU will bring a new prime minister into office sooner rather than later, and regardless of who that person is, Italy will continue down its path of austerity. The only other option would be to leave the euro – an option that not even the Greeks could make use of. Therefore, we can expect more recession in Italy, which means weaker tax revenues, more demand for tax-paid entitlements – and thus a perpetuation of the budget problems.
That will surprise the Fitch analysts and somewhere in the future could bring about yet another downgrade. In fact, as the Business Insider reports, Fitch is already surprised by how poorly the Italian economy is performing:
Q412 data confirms that the ongoing recession in Italy is one of the deepest in Europe. The unfavourable starting position and some recent developments, like the unexpected fall in employment and persistently weak sentiment indicators, increase the risk of a more protracted and deeper recession than previously expected. Fitch expects a GDP contraction of 1.8% in 2013, due largely to the carry-over from the 2.4% contraction in 2012. Due to the deeper recession and its adverse impact on headline budget deficit, the gross general government debt (GGGD) will peak in 2013 at close to 130% of GDP compared with Fitch’s estimate of 125% in mid-2012, even assuming an unchanged underlying fiscal stance.
Nope. No peak there. Too many people have made too many predictions of peaks for the Greek government debt, and yet they were always overrun by reality. Expect the same to happen in Italy.
So long as the Italian government continues to try to defend its welfare state, it is going to run a deficit. So long as Italy runs a deficit, the EU and the ECB will demand more austerity measures. With more austerity, the current crisis will continue to get worse. How much worse is impossible to say: this type of crisis is historically new and has to do with the fact that the welfare state has matured, warped the economic incentives of a sufficiently large number of people and thus eroded its own economic foundation.
The Greek crisis is a perfect example of how open-ended this type of crisis is. It has been going on for five years now, the country has lost a quarter of its GDP and it is not over yet for them.
Europe’s Crisis Gaining Momentum
It is beginning to dawn on the European political elite that their superstate project, their welfare state and their currency union are on a runaway train heading for disaster. Media is beginning to pick up on that as well. Here is a nice summary by Benjamin Fox at the EU Observer:
February 22 was a black Friday wherever you were in Europe. The morning brought the publication of dismal economic data to the effect that the eurozone will remain in recession in 2013.
Only a statistical illiterate would have thought otherwise.
Then, at 10pm Brussels time as the the markets closed, ratings agency Moody’s quietly issued a statement stripping the UK of its AAA credit rating. For those lulled into a false sense of security through a recent combination of relatively benign financial markets and the euro strengthening against sterling and the yen, it was a rude awakening.
That surge was due mainly to one thing: the commitment by the European Central Bank to print an infinite amount of euros to back its worst-rated treasury bonds. That commitment told global investors that “you can get seven percent return on Spanish treasury bonds and always get your investment back from us – come Hell or High Water!” Of course the euro is going to experience a temporary surge under such ridiculous, and totally unsustainable conditions.
EU Observer again:
Reading the European Commission’s Winter Forecast is a singularly dispiriting experience. The bald figures are that the eurozone is expected to remain in recession with a 0.3 percent contraction in 2013. The words “sluggish … weak … vulnerable … modest … fragile’” litter the 140 pages of charts and analysis.
Some examples of GDP growth numbers from the Forecast: Britain +0.9 percent in 2013; Austria +0.7 percent; Germany +0.5 percent; France +0.1 percent; Netherlands -0.6 percent; Italy -1.0 percent; Spain -1.4 percent; Portugal -1.9 percent; Greece -4.4 percent.
There are a couple of exceptions with slightly higher growth rates, primarily Sweden and Poland. Both economies are heavily dependent on exports and compete increasingly for the same low-paying manufacturing jobs. Due to a better working labor market and a more friendly tax environment my bet is Poland will eke out a victory in that competition, which would further depress the Swedish growth number.
That aside, there is a lot to be seriously worried about in the Commission’s Winter Forecast numbers. The overall standstill in GDP is very worrying, as 2013 represents the fifth year of a crisis that was originally relatively manageable but which has been made far worse by disastrous austerity measures. Since the Eurocracy – both political and administrative – remains committed to austerity, it is basically impossible to find any scenario that would allow Europe’s troubled economies to pull out of this endless recession.
I have warned about this before, and I recently drew the conclusion that Europe is in a state of permanent decline and that this permanent decline involves a drastic reduction in the standard of living for young Europeans – their prosperity is, so to speak, on hold. I also recently explained that Europe now represents what we could define as industrial poverty, that it is becoming an economic wasteland plagued by high unemployment, a static standard of living and overall lost opportunities for everyone except a small, political elite that – thus far – can live high on the hog in the Eurocratic ivory tower.
Perhaps I should take joy in the fact that my analysis has been spot on all the way. But that would be cynical, and I am not prone to either cynicism or schadenfreude. I am sincerely angered by what big government has done to Europe, and I fear that the only way out of this situation is a political Balkanization of the entire continent. That means a disorderly fragmentation, with outlier countries being ruled by fascists or stalinists (In Greece, both are about the same influential size in parliament) and panic forcing a return to national currencies under great financial and fiscal turmoil.
I would of course like to see Europe make an orderly retreat from the EU project, and I wholeheartedly support Euroskeptic heroes like Nigel Farage in fighting to secure that orderly retreat. However, as things look right now I predict that the economic crisis that is sweeping like a bonfire across Europe will burn down the better of the European economy before Mr. Farage and his fellow Euroskeptics gain enough momentum to put out that fire with free-market reforms and structural reductions to Europe’s enormous government.
Unfortunately, there is a lot to back up that last prediction. One example: the Greek economy is going to contract by another 4.4 percent in 2013. The Greek have already lost one quarter of their GDP since the crisis began in 2009. This is nothing short of economic free-fall, a recession that has escalated into full-scale depression, fueled by the destructive forces of austerity.
Back to Benjamin Fox in the EU Observer:
Spain’s budget deficit has cleared 10 percent. The average eurozone country now has a debt to GDP ratio of 95 percent – a figure that observers had previously thought was applicable only to Italy and Greece.
Those observers thought austerity would improve economic conditions in the countries where it is applied. It does not, it never has and it never will.
Mr. Fox then notes that the crisis is spreading beyond its “origin”, Greece:
While the Greek economy will contract by a further 4.4 percent this year – by the end of 2013 Greek economic output will have fallen by more than a quarter in five years – the clear indication from the Winter Forecast is that Athens is no longer in the eye of the storm. Paris and Madrid now have that unwanted place. France was one of a handful of countries called out for censure by commissioner Rehn on Friday. The French budget deficit remains stubbornly high, falling by a mere 0.6 percent to 4.6 percent in 2012. The commission’s projections have it remaining above the 3 percent threshold in 2013 and 2014. Ominously, Rehn told reporters that the commission would prepare a full report on France’s public spending after Paris prepares its next budget plan, adding that President Francois Hollande’s government needs to “pursue structural reforms alongside a consolidation programme.”
The Eurocrats may get away with destroying 25 percent of the Greek economy. But before they set out to do the same to France, they should consider the law of big numbers. France is the second largest euro-zone economy. If you destroy one quarter of that economy, you will accelerate the current European crisis from a looming depression into something that could even be more devastating than the Great Depression.
Mr. Rehn and his Eurocrat cohorts are not playing with fire. They are playing with a macroeconomic Hiroshima.
Benjamin Fox at the EU Observer does not quite seem to get the magnitude of the problems he is reporting, but that does not take away from his reporting them:
Some of the figures that leap off the pages of the Spanish assessment are truly alarming. Spain’s budget deficit actually increased to 10.2 percent in 2012, although the data does not include the savings from spending cuts and tax rises at national and regional level in the final weeks of the year, estimated to be worth 3.2 percent. Even then, the country will still have averaged a 10 percent deficit over the last four years. By the end of 2014, its debt pile will have nearly doubled to 101 percent of GDP over the space of five years.
Well, the good old Keynesian multiplier will tell you that if you contract government spending by 3.2 percent of GDP in that short of a time period, you can expect the private sector to contract by at least as much over the next 4-6 quarters. However, a recent IMF study showed that the multiplier works faster for reductions in government spending than for any type of increase in macroeconomic activity. Therefore, the negative repercussions of these Spanish austerity measures could begin to make themselves known in the Spanish economy already in the first quarter of this year.
Such a contraction in private-sector activity will erode the tax base and increase demand for tax-paid entitlements. As a result, the deficit will bounce back up again and probably exhibit a net increase.
In other words, what Mr. Fox sees as a mysterious persistence in deficits is really a logical consequence of the economic policies of the Spanish central and regional governments.
One of the many social disasters that will characterize the permanent European decline is very high, very costly unemployment. Mr. Fox notes this:
The headline rate of 11.7 percent unemployment across the eurozone is bad enough, but it is the sharp rise in long-term joblessness that is most concerning. Forty five percent of the EU’s unemployed have been out of work for more than a year, and in eight countries this figure rises to over one in two. In Spain, Greece and Portugal, where the unemployment rate is above 15 percent and youth unemployment sits close to one in two…
That’s 50 percent youth unemployment. Consider what that means for the loyalty of the young toward their country – and its political, economic and cultural leaders.
…millions of Europeans risk being locked out of the labour market for good. In the foreword to the Winter Forecast, Marco Buti, head of the commission’s economics department, rightly acknowledges the “grave social consequences” resulting from the unemployment crisis. But it is more dangerous than that. As the commission paper concedes “long-term unemployment is associated with lower employability of job seekers and a lower sensitivity of the labour market to economic upturns.” The longer people are out of work, the more likely it is that high unemployment rates become a structural feature of the European economy.
Not to mention their proneness to support extremist political parties. Support for Golden Dawn, the Greek Nazis, does not come solely from the police and the military.
I am sometimes asked what I think Europe can do about this crisis. I have tossed and turned that question around, and I am sad to say that my answer is very short: “very little”. That said, here are some desperate measures that could at least give Europe a chance:
1. Fiscal cease-fire. Stop with the austerity measures right now.
2. Labor-market deregulation. Most of Europe suffers from very rigid hire-and-fire laws. Give Europe’s employers a chance to take on new workers without having to make a de facto life-time commitment to them.
3. Flatten the tax structure. One of Europe’s most discouraging features is the steep marginal income taxes. Give job creators a chance to keep more of their money.
4. Orderly EU retreat. Let the Euroskeptics design a plan to dismantle the entire EU project and liberate the nation states – and, most important of all, their peoples – from this authoritarian, growth-stifling, freedom-eating bureauacracy.
5. Bye, bye to the welfare state. Europe needs a long-term plan – unique to each country – to get rid of its entitlement-based welfare state. Some ideas for America can perhaps be of inspiration for Europe as well.
These are, again, some very short points. I do not see fertile ground for either of them at this point, let alone for a more elaborate plan. However, there may still be hope to save individual countries, such as Britain, if right-minded political leaders can gain more influence.
But even if Britain and a couple of other countries escape the fury of the current crisis, the political, economic and social landscape of Europe will look very different in five years than it does today. And it won’t be for the better of Europe’s suffering masses.
Danish Banker Sees End of Euro
Just as the Eurocrats thought they had managed to talk down the euro crisis and save their beloved currency union, a little Danish boy steps out of the crowd and points out that the emperor still has no clothes. From Bloomberg.com (via Zerohedge):
Lars Seier Christensen, co-chief executive officer of Danish bank Saxo Bank A/S, said the euro’s recent rally is illusory and the shared currency is set to fail because the continent hasn’t supported it with a fiscal union.
I spent six years in Denmark. Danes are serious professionals, they are upfront, free-spirited and they have no problem speaking the truth. Culturally, When you hear this from a man in this position within the private sector in Denmark, you better listen.
“The whole thing is doomed,” Christensen said yesterday in an interview at the bank’s Dubai office. “Right now we’re in one of those fake solutions where people think that the problem is contained or being addressed, which it isn’t at all.”
Exactly. The main reason why the euro appears to be stable at this point is that the European Central Bank has put a cooler on the bonfire-like debt crisis by promising to buy any euro-denominated treasury bond, anywhere, any time. Technically, the promise was limited to the most troubled eurozone countries, but by implication it extends to all member states.
This uncapped promise has allowed international investors to go back into high-yield euro-denominated treasuries from primarily Greece, Portugal, Spain and Italy. Secondarily, they can also invest with similar confidence in French treasuries, which are next on the troubled-bonds list. Thereby the ECB removed a major reason for investor flight out of the euro, temporarily strengthened the currency and created the false impression that the crisis is over.
It is not. Bloomberg.com again, which paints a picture of declining GDP and a new phase in the debt crisis:
The European Central Bank forecasts the euro-area economy will shrink 0.3 percent this year … [and while] the euro has strengthened, the economies of Germany, France and Italy all shrank more than estimated in the fourth quarter. Ministers from the 17-member euro area met during the week to discuss aid to Cyprus and Greece as a tightening election contest in Italy and a political scandal in Spain threaten to reignite the region’s debt crisis.
Greece has suffered from a shrinking GDP for years now. Since the recession-turned-depression started they have lost roughly a quarter of their economy. That is extreme, but it shows the devastating consequences of combining austerity with an entirely artificial currency union. Furthermore, it should be a warning sign to the Eurocrats as well as other member states to not adopt the same kind of fiscal policy in their countries. Yet that is precisely what seems to be in the making: the “aid” to Cyprus and – again – to Greece will consist of a buyout of treasury bonds combined with austerity requirements.
There can be only one outcome: more of the same crisis.
As Bloomberg.com continues, it illustrates the dire situation of the European economy, a situation that according to Danish banker Christensen is going to be the undoing of the euro:
France is grappling with shrinking investment, job cuts by companies such as Renault SA and pressure from European partners to speed budget cuts. While Germany expanded 0.7 percent last year…
That’s a pathetic “growth” rate for an economy like the German.
…France posted no growth and Italy probably contracted more than 2 percent, the weakest in the euro area after Greece and Portugal, according to the European Commission. The economy is on the brink of its third recession in four years and the highest joblessness since 1998. Prime Minister Jean-Marc Ayrault said Feb. 13 the country won’t make its budget-deficit target of 3 percent of gross domestic product this year as the economy fails to generate growth and taxes.
The pursuit of a balanced budget is the enemy of growth. So long as the political leaders of Europe’s big welfare states do not want to concede that their countries can no longer afford their big, onerous, sloth-encouraging entitlement programs, there will be no change in the course of the European economy. The welfare states will continue to drive up deficits and drive down growth. The EU will continue to demand austerity, which will further drive down growth and widen the deficit gaps in government budgets. Europe will stagger and stumble, but there is no chance it will ever recover under its current big, redistributive goernment.
In a nutshell, all you Europeans: this is as good as it gets.
And just to add some more salt in Europe’s self-inflicted wounds, Bloomberg. com tops off with a stark reminder of the economic reality the Europe is stuck in:
“People have been dramatically underestimating the problems the French are going to get from this. Once the French get into a full- scale crisis, it’s over. Even the Germans cannot pay for that one and probably will not.” … Spain, which plans to sell three- and nine-month bills tomorrow and bonds maturing in 2015, 2019 and 2023 on Feb. 21, faces a sixth year of slump. Output is forecast to contract for a second year in 2013 with unemployment at 27 percent amid the deepest budget cuts in the nation’s democratic history. Public-sector debt is at record levels, having more than doubled from 40 percent of gross domestic product in 2008. The European Commission, which is due to update its forecasts this week, sees it rising to 97.1 percent of GDP next year.
This is the crisis that the ECB is trying to cover with an endless monetary commitment to defend the euro. But the deficits do not go away, and economic growth does not return. In its desperate fight to save the euro and the welfare state, Europe’s political leaders will bleed the former dry and deplete the latter of any money to honor its entitlement commitments.
I stand by my verdict: Europe is in permanent decline, it is turning itself into an economic wasteland of industrial poverty that over time will be left behind by North America and Asia.
Braking the Federal Debt
As both Europe and America continue to struggle with big government debt, the debate rages on about how to rein in, and eventually reduce, the debt of the U.S. government. In recent years several proposals for balanced-budget constitutional amendments have seen the light of day. Most of them have suffered from serious practical problems, but there is at least one approach that has some merit to it. Simply put, this approach applies a brake to the federal debt, forcing Congress into a gradual change of its fiscal policy to rein in the debt.
This approach is familiar to Europeans but has only recently made it into the American arena. While still not the perfect solution, it adds some tangible policy instruments that could actually help turn our nation’s focus where it needs to be: on runaway government spending.
That said, it is very important that during this debate we never lose track of that very item. All contributors to the issue should be aware that debt is only a macroeconomic symptom, not a disease. A recent article at Reason.com exemplifies the risk of losing focus. The article is good and well worth reading, but only when put in its proper context. Over to Reason.com:
American progressives are fond of gazing across the pond at Europe and wishing the U.S. would emulate it. So as soon as President Obama started announcing from all reaches of the country that Congress “must” eliminate the debt ceiling, progressive cheerleaders echoed his demands, pointing out that most European countries did not have a debt ceiling. But Europe worshippers are drawing the wrong lesson from across the Atlantic. Despite public protests against austerity cuts, many European countries are instituting constitutional reforms requiring balanced budgets in the form of “debt brakes”—a far stronger way to control the national debt than a debt ceiling.
Before we continue, let us note that the EU has been under a technically strong collective debt ceiling since the Maastricht Treaty (later Lisbon Treaty) became the constitution of the EU some two decades ago. That debt ceiling did not primarily cap debt, but focused first and foremost on the budget deficit. The cap limited a member state’s national government deficit to three percent of that state’s GDP.
There were real sanctions built in to this cap, so in a technical sense it was stronger than the American debt ceiling mechanism. However, it became clear pretty soon after the euro was created (a few years after the Lisbon Treaty went into effect) that too many member states ran too large deficits to merit any meaningful enforcement. Back then, the Eurocrats in whose hands the enforcement power had been placed would simply have nothing else to do than to play whack-’em-all with Europe’s deficit-ridden member states. As a result, the three-percent rule was reduced to the “guideline” it is now being thought of.
Herein lies one reason why Greece got off on such a runaway ride with its government budget. But the practical political and administrative problems with enforcing Europe’s deficit cap are ancillary problems: the real culprit is the system of government spending called the welfare state. As soon as government makes promises to its citizens that are unrelated to its ability to pay – the very essence of the welfare state – then government is on an unstoppable path to perpetual budget problems.
Either you let the welfare state run amok (Greece) or you wage war on the private sector to keep the welfare state alive (Sweden). All the debt and deficit control mechanisms in the world won’t solve the underlying problem.
However, that does not mean those mechanisms are useless. They can actually be of some help. Let’s get back to the Reason article and see how:
The [federal debt] ceiling has been raised 68 times since 1960-including 18 times under Ronald Reagan, and by nearly $5 trillion under Barack Obama. Not surprisingly, government spending has gone through the roof along with the size of the public debt. … The debt ceiling didn’t start as a political distraction. Under the Constitution, any government spending or borrowing has to be authorized by Congress. For the first 150 years of America’s existence, that is, most of the republic’s life, Congress authorized debt for specific purposes such as funding wars or building the Panama Canal. In 1939, however, in order to give President Roosevelt flexibility to conduct World War II, Congress gave up its power to approve specific debt issuance but set a maximum aggregate borrowing limit for Treasury. Voila, the debt ceiling was born.
That was about the worst time to make such a reform. FDR was determined to lay the foundations of a European welfare state in America. He did not accomplish much on the health-care front, but when it comes to regulatory restrictions on businesses (for “progressive” purposes) as well as Social Security, he got away with a lot.
A welfare state is defined by its entitlement programs where the amount to be spent is determined by a right. That right is created – invented – by government which gives it to a select group of citizens. The right gives them either in-kind entitlements such as education or health care, or cash entitlements such as welfare or general income security. Either way the cost of the entitlement is determined by variables totally unrelated to the ability of taxpayers to fund those entitlements.
Because of the lack of spending caps in the welfare state’s entitlement programs, government needs more than just taxes to fund them. Enter government debt. In other words, the real problem here is not the debt, but the welfare state.
Reason explains:
However, what began as wartime “necessity” evolved into peacetime political cover that no longer required Congress to justify increasing specific borrowing. It simply authorized spending and let the Treasury Department sort out the necessary borrowing. The results of this bargain speak for themselves. Since 1940 Congress has run a deficit nearly every year (62 of 72 years). The federal budget has grown from roughly 15 percent of GDP in 1950 to about 25 percent today. And America has now borrowed over $16.4 trillion-roughly equal to the size of the entire U.S. economy!
However, once again: let’s not be seduced into focusing all our attention on the debt. When we do, it is easy to make the following mistake, which Reason cannot avoid:
America has not been alone in racking up such a large credit card bill. Greece—the land with debt-to-GDP above 150 percent—leads the way among her Eurozone peers. And countries like Italy (127 percent), Portugal (120 percent), Ireland (117 percent), and Spain (77 percent), followed a similar pattern of unfettered debt accumulation. Even the uber-responsible Germans let their debt rise to 80 percent of GDP. These debts have crippled the European economy in recent years.
No. Debts do not cripple the economy. Sure, debts cost money for taxpayers in the form of interest payments. However, those interest payments go back into the economy by entering the pockets of creditors, most of whom are actually domestic.
In fact, one could make a credible argument that it is better if government borrows to fund its spending than taxes us, because we can choose whether or not we want to lend government our money. We cannot choose whether or not to pay taxes.
The reason why Europe’s economies are struggling is that they have allowed government to take control over far too many of people’s needs. In addition to the assortment of government “services” that we get here in America, Europeans also typically get universal child care; tuition free, government-only universities; heavily subsidized pharmaceutical products; single-payer health care; massively inefficient mass transit systems; and general income security for working adults.
In all these areas, government has crowded out the private sector and seized a destructive monopoly. This has dramatically reduced efficiency both in producing and delivering the services. That slows down GDP growth, which in turn reduces job creation and earnings among those who actually can find a job. More people depend on government entitlements, either as unemployed or as employed with low earnings, low enough to make them eligible for – you guessed it – government entitlements.
This raises the cost of government, which goes up even more as government scrambles to find all the tax revenues it needs to pay for all its spending programs. Stifling taxes add to the growth-hampering effects of government and the economy enters a vicious downward spiral of low growth, gradually increasing dependency on government, an eroded tax base, higher taxes… and eventually austerity.
Debt, again, is only a symptom of the underlying problem. Which, again, does not mean we should not try to put a cap on it – so long as the efforts do not take our focus off the fiscal virus that made the patient sick in the first place.
Back to Reason:
One method for debt control that has gained popular support is the Swiss “debt brake.” Adopted into Switzerland’s constitution in 2001, the debt brake requires a balanced budget, but measured over a multiyear period. In technical terms, it requires the nation’s “structural deficit” to be nil over the course of a business cycle so that surpluses generated during boom periods can defray the deficits during bust periods to keep the overall debt manageable. Implicit in the debt brake idea is the recognition that constraining debt is important to honorably meet national debt obligations and avoid default—whose very prospect American liberals raise to justify their calls for scrapping the debt ceiling. Germany, for example, has now adopted the Schuldenbremse (debt brake) concept as well, specifying that its structural deficit cannot exceed 0.35 percent of GDP in any given year. This does not cap aggregate debt, but the idea is that if the federal government is not running huge deficits every year, the national debt won’t grow.
Sweden used this debt-brake model back in the ’80s. It did not prevent the enormous deficits in the early ’90s. That said, the idea has some merits that, if put to work properly, could actually help us rein in government spending. It is possible, even probable, that a debt brake could shift the fiscal policy debate in our country away from what we can do to increase government spending to what we can do to reduce it.
The best American approach to the debt-brake mechanism is the one proposed by Compact for America. It is worth a serious look.
Another Welfare State Downgraded
Two months ago I explained how Argentina’s president, Cristina Kirchner, was pushing her country deeper and deeper into a spiral of inflation and government debt. I noted that Argentina’s economy…
is spinning out of control, and it is all driven by the same old leftist agenda to use government spending to eradicate “income inequality”. This statist agenda has led to endless problems with government debt. For almost 15 years now these problems have been chronic. In 2005-2006 the IMF basically made a fire-and-rescue emergency run to Buenos Aires to initiate a debt restructuring process and prevent a complete meltdown of the Argentine economy. That restructuring process was basically complete in 2010 and you would have assumed that the country’s political leaders had learned their lesson.
They have not. President Kirchner has spent months fending off mounting accusations that her government is simply manipulating macroeconomic data to conceal an embarrassing growth record and, even worse, accelerating inflation. Part of the reason why she has been so desperate to prevent the economic truth from getting out is that her country has been on the brink of a credit downgrade. That did not work. According to the Daily Telegraph, Argentina is now sinking into the Greek hole:
Fitch cut its long-term rating for Argentina to “CC” from “B,” a downgrade of five notches, and cut its short-term rating to “C” from “B”. A rating of “C” is one step above default, AP reported.
And the situation is pretty bad indeed:
US judge Thomas Griesa of Manhattan federal court last week ordered Argentina to set aside $1.3bn for certain investors in its bonds by December 15, even as Argentina pursues appeals. Those investors don’t want to go along with a debt restructuring that followed an Argentine default in 2002. If Argentina is forced to pay in full, other holders of debt totaling more than $11bn are expected to demand immediate payment as well.
Political leaders in Argentina don’t like this one bit, saying that the ruling puts the 2002 debt deal in jeopardy. However, the real threat to that debt deal does not come from some judge trying to protect investors’ rights – it comes from endless government spending. Government has tried to pay for that spending with taxes, and when they could not jack up taxes anymore they took to borrowing. When they had borrowed so excessively that they effectively defaulted in 2002 (that was when the country went through so called debt restructuring, i.e., partial loan default) they took to a good old Latin American classic: printing moeney.
They have now exhausted all their means to fund irresponsible spending. But instead of behaving like grown-ups and taking responsibility, the Argentine president and her administration double down and, again, try to manipulate economic data. One of the inevitable results is a credit downgrade.
The Daily Telegraph has more details:
Argentina is in a deepening recession and is grappling with social unrest. Besides the court case, Fitch cited a “tense and polarized political climate” and public dissatisfaction with high inflation, weak infrastructure and currency. Fitch also said that Argentina’s economy has slowed sharply this year. Of the two other major rating agencies, Standard & Poor’s has a rating of “B-” for Argentina, five steps above default, and Moody’s rates it “B3 negative”, also five steps above default.
In other words, we can now add Argentina to the pile of already fiscally dinosauric welfare states. That pile is getting uncomfortably high, and what we have seen so far is only the beginning.
It’s time to repent, folks. It’s time to absolve of past entitlement sins and seek forgiveness for years spent behind the blindfolding veil of socialist ignorance.
It is time to let economic freedom ring.
