Tagged: Government Debt

Debt and Growth: A Quick Look

There is an ongoing debate here in the United States about our federal debt. Obviously, we cannot keep raising the debt-to-GDP ratio, and although the federal deficit has shrunk dramatically in the past couple of years, there is a strong likelihood that we will return to growing deficits some time beyond 2018. This obviously means that the debt will accelerate again; what will happen to the debt ratio is a question for future inquiry.

As things look now, the U.S. economy is slowly rising out of the recession at growth rates 2-3 times what the Europeans are seeing. That is somewhat good news when it comes to our debt ratio, a variable that has more than symbolic meaning. Countries with high debt-to-GDP ratios pay more on their debts than countries with low ratios. The reason is simple: a country with a low debt ratio is more likely to have enough of a tax base to both fund its current spending and meet its debt obligations. GDP, obviously, is the broadest possible tax base, so the larger it is relative government debt, the safer it is to buy a country’s Treasury bonds.

The next step in this reasoning would be to ask if the debt ratio itself has any relation to GDP growth itself. In other words, does the burden of government debt on an economy slow down its growth? If the answer is yes, then rising debt creates a vicious circle including higher interest rates, the need for higher taxes and stagnant growth.

Many would say that this vicious circle obviously exists and that no further investigation into the matter is needed. However, those who say so disregard the fact that the United States, with a debt ratio above 100 percent of GDP (we cannot count just the debt “held by the public” because all debt costs money one way or the other) has a faster-growing GDP than the EU does, where the aggregate debt-to-GDP ratio for all 28 member states is 87 percent.

Therefore, as always it is good to take a look at some data. The following figure reports Eurostat data for 27 EU member states (excluding Croatia which became a member just this year) over the period 2000-2013. The data is broken down to quarterly levels and not adjusted seasonally (this vouches for “genuine” observations). The left vertical axis reports debt-to-GDP ratios while the right axis reports inflation-adjusted GDP growth numbers, quarterly over the same quarter the previous year. Since this gives us a very large number of pairs of observations, the data is organized into deciles. Each contains 148 pairs of observations – debt ratio and GDP growth for the same quarter – except for the last decile which contains 149 observations. Each decile reports average numbers for each variable for that decile:

Debt GDP Q 00-13

*) The astute observer will notice that I am only reporting 1,481 observation pairs when 27 countries observed over 14 years, four times per year, should actually produce 1,512 observation pairs. The lower number reported here is due to two factors: only one data series is available for the fourth quarter of 2013, and both series for Malta are missing for the first few quarters.

While this is not an actual econometric study (that would take a lot more time than I have on my hand for this blog) the analysis nevertheless reports an interesting correlation. First, when the debt ratio rises above 60 percent, growth slows notably. The 60-percent debt level is often referred to in the public debate over government debt as a threshold governments should not cross. I have sometimes dismissed this level as arbitrarily chosen, and I maintain that any simple focus on this ratio for legislative purposes is indeed arbitrary. In fact, if we look at the other end of the spectrum a debt level below 40 percent appears to have very strong positive effects on growth. If we are going to have legislation about a debt ratio cap, then why not use 40 percent?

That said, the observed correlation calls for deeper investigation. Unlike some simplistic pundits (you know who you are…) I am not going to draw the immediate conclusion that high debt ratios cause low growth. Let us remember that GDP is the denominator of the debt ratio; if the denominator grows slowly for any reason, and government keeps deficit-spending as usual, then the debt ratio is going to rise for purely arithmetical reasons. However, as mentioned earlier, large deficits themselves can very well drag down GDP growth, raising the debt ratio for causal reasons.

More on that later.For now, let’s conclude this little exercise with two questions that I hope to answer soon:

1. Is there a correlation between large debt and big government spending? If so, the low growth in high-debt-ratio countries could have its explanation.

2. What happens if we delay one of the two variables one quarter? This classic, basic statistical method could tell us a lot about the causes and effects between debt and growth. I am going to take a stab at it as soon as time allows.

Needless to say, any future inquiry would have to include the United States. This one does not, simply because the raw data used here did not include U.S. numbers. Now that I have this data in a configured file of my own it is easy to add U.S. data.


The Relentless Growth of Debt

The Great Recession has been a rockier ride for the economies of the Western world than any other economic crisis since the Great Depression. We are still not out of it, and there is no way of telling when Europe will recover – if ever. While the U.S. economy continues its moderate recovery, there are still no credible signs of a turnaround in Europe, where there is almost no GDP growth and very slow growth in consumer spending.

It is entirely understandable that the Europeans have not yet seen the light in the tunnel. Their focus during the recession has been to bring down government budget deficits, prioritizing a balanced budget over any other economic goal. But underneath the efforts to balance the budget there is another, less visible but nevertheless unrelenting agenda: to save the European welfare state.

The EU has propagated for, and imposed, austerity policies upon member states not because a balanced budget is inherently good, but because it makes the welfare state look fiscally unsustainable. During the 1980s, when Lady Thatcher led Britain back to the 20th century, Europe’s conservatives used budget deficits as an argument against big, redistributing entitlement programs. They had a point: government debt as share of GDP has been growing all over the Western world for almost half a century now. The following tables illustrate this. They report data from CESIFO, a German research institute, with the numbers illustrating a relationship between government debt as share of GDP in two different years. For example, in the first table, the number reported for Japan is 6.04 under the column title “1970 to 1990″. This means that the Japanese government’s debt in 1990, as share of GDP, was 6.04 times higher than it was in 1970. In other words, if the Japanese government’s debt in 1970 was ten percent of GDP, it would be 60.4 percent of GDP in 1990.

Consequently, any report of a number larger than 1.00 means that the debt ratio in that country has increased:

Debt ratios

Country selection is based entirely on data availability; not all countries have reported comparable data for the periods in question. However, for each period, the selection shows the same consistent trend of growing government debt. In the first period, from 1970 to 1990, debt grew in eleven of 13 countries. In the second period, 1975-1995, debt grew in 14 out of 16 countries. In period three, 1980-2000, 14 out of 17 countries experienced debt growth. Finally, in the fourth period debt grew in 22 out of 28 countries.

The unrelenting growth in debt is closely associated with the welfare state. A good example: the Danish record-breaking growth in debt between 1975 and 1995 originates in an out-of-control expansion of entitlement programs in the 1970s and early ’80s. In the late ’80s Denmark went through a very painful period of austerity, with massive tax increases that in some ways crippled private consumption. Debt growth stopped, though, and in the early ’90s focus shifted toward tax cuts. As a result, the Danish debt ratio declined from 1995 through 2005.

Does the Danish example show that the welfare state is compatible with economic growth and prosperity? No, it does not. More on that in a later article. For now, enjoy the debt ratios and consider what they tell us about our generation’s sense of entitlement, especially vs. future generations.

Greek Bailout, Episode III

Never bark at the big dog. The big dog is always right.

If your goal is to restore growth and full employment in a crisis-ridden economy, don’t use austerity. It does not work. I have explained this for two years now – in blogs, research papers and numerous debates – and I am pleased to say that my work has been recognized. One step forward on that front is my book, out in July. But more important than the recognition of my work is the constant reminders of austerity failure that reality provides. In addition to raw, statistical evidence of decline and stagnation all over Europe, the German government is now de facto conceding defeat on the austerity front. From British newspaper The Guardian:

Germany has signalled it is preparing a third rescue package for Greece – provided the debt-stricken country implements “rigorous” austerity measures blamed for record levels of unemployment and a dramatic drop in GDP. The new loan, outlined in a five-page position paper by Berlin’s finance ministry, would be worth between €10bn to €20bn (£8bn-16bn), according to the German weekly Der Spiegel, which was leaked the document. Such an amount would chime with comments made by the German finance minister, Wolfgang Schäuble, who, in a separate interview due to be published on Monday insisted that any additional aid required by Athens would be “far smaller” than the €240bn it had received so far.

So how can the German government be admitting it has lost the austerity fight against the economic crisis, when it actually demands more austerity by the Greek government? Simple: the German government together with assorted Eurocrats from Brussels have sold last two fiscal-disaster packages as “the” fix for the crisis. If only Greece agreed to this-or-that austerity measure, and then got a loan, then the Greek economy would be on a fast track to a recovery.

By now proposing not a second, but a third bailout for the Hellenic welfare-state wasteland the German government is de facto admitting that the prior two packages did not at all deliver as promised.

Which, of course, is an outstanding reason to try the same policies a third time while expecting a different outcome…

The Guardian again:

The renewed help follows revelations of clandestine talks between Schäuble and leading EU figures over how to deal with Greece, which despite receiving the biggest bailout in global financial history, continues to remain the weakest link in the eurozone. The talks, said to have taken place on the sidelines of a Eurogroup meeting of eurozone finance ministers last week, are believed to have focused on the need to cover an impending shortfall in the country’s financing and the reluctance Athens is displaying to enforce long overdue structural reforms.

It is a bit unclear what the “structural” element of those reforms would be, but if the history of Greek bailouts is any indication we can safely assume that the “reforms” would be higher taxes and lower entitlement spending. While less spending is highly desirable, it has to come in the form of predictable reductions – and they have to be coupled with targeted tax cuts that give those dependent on government a fighting chance to provide for themselves once the government handouts are gone.

Such reforms are not rocket science. Two years ago I put together five such proposals in a book. I would not expect the Greek government to have read it, or that any Eurocrat would have seen it… but the basic idea – permanent spending cuts coupled with targeted tax cuts – is so common-sensical that you would expect someone in Europe to propose it as a guideline for getting Greece, and Europe, out of its crisis.

So far, though, I have not seen a single proposal for “structural reform” in Greece along these lines.

Perhaps it is understandable, at the end of the day, why no such ideas are floating around in the public debate. After all, the end result is a dismantling of the welfare state, an idea as alien to Europeans as a monarchy is to Americans. But so long as Europe’s political leaders remain married to the welfare state, they will also have to continue to come up with non-solutions to the crisis. One of those solutions is another debt write-down. The Guardian again:

Most of the debt overhang now haunting the country belongs to European governments and at 176% of GDP – up from 120% of national output at the start of the crisis – is not only a barrier to investment but widely regarded as being at the root of its economic woes. “They are missing the point: Greece does not need a third bailout, it needs debt restructuring,” said the shadow development minister and economics professor, Giorgos Stathakis. “Even in the IMF, logical people agree there is no way we can have any more fiscal adjustment when the whole thing has reached its limits,” he said. “There is simply no room for further cuts and further taxes and that is what they are going to ask for.”

It is precisely this attitude that traps Greece in a perpetual crisis. Its plunge into industrial poverty over the past five years was not caused by a financial crisis, as public economic mythology suggests. The plunge was the work of the welfare state, which over a long period of time had drained the private sector of money, entrepreneurship, investments and productivity. When the global recession hit, the excessive cost of the welfare state was exposed full force. Trying first and foremost to save the welfare state, Eurocrats from the EU and the ECB joined forces with economists from the IMF to squeeze even more taxes out of the private sector. At the same time, the rapidly growing crowds of unemployed and poor were deprived of more and more of the only thing that had kept them going: welfare-state handouts.

The result was that those who saw their handouts shrink were even less able to find a job than they had been before. Rising taxes killed the job market for them.

At the core, the Greek crisis is one of a welfare state that costs vastly more than the private sector of the Greek economy can afford, even on a good day. The debt that the good professor and fellow economist Stathakis wants to have forgiven is the result of this historic mess of irresponsible entitlements and burdensome taxes.

If Greece does not fix its welfare-state problem, it does not matter how much debt that is forgiven. It will continue to accumulate more debt, and then what? Another round of debt forgiveness?

Again, this basic insight is missing from the European discussion on what to do with Greece. Even the IMF is apparently concentrating on the debt burden, suggesting, according to the Guardian, that “without additional debt relief by eurozone governments, Greece’s debt burden could smother the country’s economy.” That is exactly wrong: the economy is being smothered by the welfare state, which austerity measures are aimed at saving.

At least there is some common sense in the debate. The Guardian concludes:

China, Brazil, Argentina, India, Egypt and Switzerland have been among the countries expressing grave doubts that the assistance would work, arguing that Greece might end up worse off after the austerity programme.

Thank you for that. Let’s now hope that more people see this and that we can get some traction for a reform program that combines entitlement phase-out with targeted tax cuts. It is the only way to save Greece from generations of industrial poverty – and it is the only way to save the rest of Europe from the same fate.

Austerity Leaves Ireland in Stagnation

On Monday I explained that Greece has begun a transition from depression to stagnation. The transition is visible in macroeconomic data: the decline in GDP and private consumption, both of which have been going on for years, are not as fast anymore, and unemployment seems to be plateauing. Government debt is still growing, though, especially when measured as a ratio to GDP. In the second quarter of 2013, the latest number available, the quarter-to-quarter increase in the ratio was faster than it was in any of the three preceding quarters.

The transition from depression to stagnation is largely made possible by two factors. First, the Greeks have lost one quarter of their economy, which includes an enormous drop in standard of living. Most Greeks have had to forfeit consumption that people in other industrialized countries take for granted. What remains is essentially the bare-bones kind of consumption that you realistically cannot sustain without in an industrialized country. At this “core consumption” level of economic activity, it is harder for people to cut away anything more. As a result, they will increase their efforts to protect what they have left.

Secondly, years of austerity has recalibrated the Greek welfare state. The reason why it ran enormous deficits for years is that its tax rates could not produce enough revenue for the spending that the welfare state required. This was a problem before the Great Recession but it exploded into pure urgency as the crisis started unfolding. Instead of trying to turn around the implosion of the economy, the EU and the Greek government decided to recalibrate the welfare state: taxes were raised to produce more revenue at a lower GDP, and spending programs were cut to spend less at that same lower GDP. Each new austerity program effectively constituted another recalibration. Eventually, during last year, the recalibration efforts caught up with the imploding GDP, and austerity tapered off.

Once you release an economy from its austerity stranglehold it will transition from decline to stagnation. However, it will not recover – other than marginally – for one very simple reason: the welfare state is now recalibrated to balance the budget at an abysmally low activity level. Therefore, as soon as economic activity picks up the government budget will suck in excessive amounts of money from the private sector, creating substantial surpluses early on in the recovery. Politicians who have fought the people to subject them to round after round of austerity will not be inclined to cut taxes; they will see the surpluses as yet another sign that “austerity worked”. While they throw victory parties, the economy continues to putter along at permanently higher unemployment and a permanently lower standard of living.

This is exactly what happened in Sweden in the ’90s (I have an entire chapter on that crisis in my upcoming book Industrial Poverty) and the Greek situation is not much different.

Yet despite glaring evidence to the contrary, there are people out there who willingly and eagerly claim that in the austerity war on the crisis, austerity won. In an opinion piece for the EU Observer, Derk Jan Eppink, Member of the EU Parliament from Belgium and vice president of the Parliament’s Conservatives and Reformists group, has this to say:

Irish Premier Enda Kenny has announced his country will exit its bailout programme in December. When he took office in 2011, Ireland’s budget deficit was over 30 percent of GDP. Narrowing it to projections of 7.3 percent this year and 4.8 percent next, Kenny has restored market confidence in Dublin’s ability to sort out its long-term debts. Investors are again willing to buy Irish bonds, raising funds and lowering borrowing costs. In mid-2011, interest on Irish debt stood at 15 percent. Now it is below 4 percent and Ireland has raised sufficient cash balances to cover all its debt payments next year. Standard & Poor’s and Fitch have both returned their Irish rating to investment grade. Without repairing its ability to manage its debts, Ireland’s government could not function for very long as a provider of essential public services. Irish recovery could not have happened without the fiscal consolidation which commentators attack as “austerity.”

It is interesting to notice what metrics Mr. Eppink uses to measure the Irish “success”. The austerity program has recalibrated the Irish welfare state to produce a budget balance at a vastly lower activity level than before the crisis. This means that the Irish government has no incentive to run a fiscal policy that brings the economy back to its higher activity levels; as in the Greek case, its tax-and-spend ratios will actually discourage private-sector growth beyond what is needed for the newly calibrated budget balance.

What this means in practice is easy to see in Eurostat employment numbers. Irish unemployment has fallen over the past two years, with total unemployment down from 15.1 percent in January 2012 to 12.3 percent in November 2013; during the same period of time youth unemployment declined from 31.1 percent to 24.8 percent. This looks like a solid recovery, especially since one in four unemployed aged 15-24 is no longer unemployed. However, if we cross-check these numbers with the employment ratio we get a somewhat different picture:

  • In the years before the crisis the employment ratio for 15-64 year-olds was 65-70 percent; in the third quarters of 2010, 2011, 2012 and 2013 it has averaged 59.7 percent, with no visible trend either up or down;
  • In the years before the crisis Irish unemployment for the group aged 15-24 was 45-55 percent; in the third quarters of 2010, 2011, 2012 and 2013 it has averaged 30.9 percent, with no visible trend either up or down.

It is troubling when unemployment falls but employment ratios remain steady. It means that people are either leaving Ireland in desperation or, more likely, that they are leaving the work force. A closer look at the enrollment in various income-security programs would probably give a detailed answer. (I will try to return to that later.)

A glance at GDP data also indicates stagnation rather than recovery. In the third quarter of 2013 the Irish seasonally adjusted, constant-price GDP grew by 1.7 percent over the same quarter in 2012. However, the four preceding quarters GDP contracted. There was more growth in the Irish economy in 2011 than what appears to be the case in 2013. Private consumption has been falling six of the last eight quarters, with entirely negative numbers thus far for 2013.

There is only one conclusion to draw from these numbers: there is no Irish recovery under way. If anything, the end of the Irish austerity campaign has marked the starting point of economic stagnation for the Irish economy just as it has in Greece.

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.


ECB Near Crisis Panic

More signs of desperation out of Europe. Der Spiegel reports:

The European Central Bank wants to spur lending by banks in Southern Europe, but conventional methods have shown little success so far. On Thursday, ECB officials will consider monetary weapons that were previously considered taboo.

The only way to get the European economy going again is to cut taxes, phase out the welfare state and build economic freedom from the ground. But that is about the last thing the clowns in Brussels and Frankfurt want to hear, because in their world, shrinking government – like eating children – is wrong.

Der Spiegel again:

From Mario Drahgi’s perspective, the euro zone has already been split for some time. When the head of the powerful European Central Bank looks at the credit markets within the currency union, he sees two worlds. In one of those worlds, the one in which Germany primarily resides, companies and consumers are able to get credit more cheaply and easily than ever before. In the other, mainly Southern European world, it is extremely difficult for small and medium-sized businesses to get affordable loans. Fears are too high among banks that the debtors will default.

Now, please pay attention to this. We have been told for more than four years now that the current crisis was caused by banks engaging in irresponsible lending. We have been told that it was their credit losses that somehow brought the global economy into a recession and hurled parts of Europe into a depression.

You’d think that with this in mind, with a depression that has wiped out tens of millions of jobs and sent youth unemployment above 20 percent in 20 countries, the last thing that the European Central Bank would wish for is another round of reckless lending.

Well, in a world governed by common sense that would certainly be true. But today’s Europe is not governed by common sense. It is governed by uncommon senselessness. Der Spiegel again:

For Draghi and many of his colleagues on the ECB Governing Council, this dichotomy is a nightmare. They want to do everything in their power to make sure that companies in the debt-plagued countries also have access to affordable loans — and thus can bring new growth to the ailing economies. The ECB has already gone to great lengths to achieve this objective. It has provided the banks with virtually unlimited high credit and drastically lowered the collateral required from the institutions. The central bank has also brought down interest rates to historical lows. Since early November, financial institutions have been able to borrow from the ECB at a rate of 0.25 percent interest. By comparison, the rate was more than 4 percent in 2008.

Private businesses in Greece, Spain, Portugal and the other worst-hit countries are considerably smarter than the big wigs who run the ECB. They are not lending, because they know that in an economy like the Greek one, where GDP has been shrinking for five years in a row, or the Portuguese where GDP is as big today as it was ten years ago, there simply is no market for new investments and business expansion. If anything, business still need to downsize. Which, as Der Spiegel reports, they are still doing:

The only problem is that all those low interest rates have so far barely been put to use. Lending to companies in the euro zone is still in decline. In October, banks granted 2.1 percent less credit to companies and households than in the same period last year.

Apparently willing to ignore elementary banking theory, Mr. Draghi and the Central Bankers are searching for new policy measures. According to Der Spiegel, their search is taking them to the most obscure closets in the ECB attic:

One scenario that drives fear into the hearts of all savers is the so-called negative interest rate. It would mean that the banks would have to pay a fee for the money they park, currently without interest, at the ECB — a kind of penalty interest rate. The idea is to create an incentive for the institutions to loan out extra money to other banks, in Southern Europe for instance.

In other words, they want banks to pump more liquidity into the euro-zone economy. Let’s remember that this is an economy that has been flooded with liquidity over the past few years. One liquidity flood gate is the M1 money supply, which is growing at a speed that is about four times as high as the rate of growth in euro-zone GDP. Another is the bond bailout program where the ECB has pledged to buy any amount of government bonds, for any euro-zone welfare state deemed in trouble.

Now they want to send even more liquidity into an already over-liquified euro-zone economy. But what has not worked yet will not work better now just because it is tried a third time. Instead, this will lead to excess amounts of liquidity floating around in the banking system, which history tells us is a great beginning of a great speculation disaster.

But as Der Spiegel explains, this is not all that the ECB has in mind:

The ECB already lent a helping hand to banks with long-term, cheap loans at the end of 2011 and during early 2012, lending financial institutions a total of €1 trillion for the exceptionally long period of three years — a step it has so far only taken one time. Central bank head Draghi spoke at the time of using “Big Bertha,” a reference to a World War I-era howitzer, to battle the crisis. … [The] ECB is still thinking about a new form of long-term credit. Only this time, the loans would only have a term of one year and they are also supposed to have a specific purpose affixed to them. Banks would only be able to obtain the cheap money if they obliged themselves to pass that money on to companies.

And why would banks want to do that when they are already sitting on more idle cash than they have use for?

But wait – there is more:

The ultimate means the ECB has for keeping market interest rates low is to purchase large quantities of bonds from investors. Other central banks including the Fed in the United States, the Bank of England and the Japanese central bank are already using this instrument more or less successfully. The idea behind “quantitative easing” is that a central bank purchases government or company bonds on the market and, by doing so, drives down prices — e.g. interest rates.In contrast to the ECB’s previous bond buying, the new program would not be aimed at easing financing for individual countries.

Somehow the boneheads at the ECB seem to believe that all the euro zone lacks is access to credit. You’d think they would take into account the fact that there is absolutely no growth in any macroeconomically relevant sector of the economy. You’d think that when consumer spending is standing still; when corporate investment is standing still; when unemployment is still slowly trending upward; you’d think they would get the picture. But no. Somehow Mr. Draghi and the Central Bankers got to where they are now in their careers while harboring the delusion that a shrinking or stagnant economy will get started again if more people go into more debt. 

I somehow suspect that this is the result of an over-consumption of Austrian economic theory, but I will leave that topic for a later discussion. What matters here and now is that the ECB’s tentative plans to open yet more liquidity floodgates is a big sign of the political desperation that is spreading through the government hallways of Europe.

Desperate people do desperate things. When the desperate people are politicians with a lot of power, the consequences of their desperate actions can be devastating. It remains to be seen what more destruction Europe’s leaders can bring to their continent than they already have (please wait patiently to early 2014 and you will be able to get a full picture of Europe’s disaster in my new book “Industrial Poverty”) but given what the ECB is now contemplating, we have to assume that anything is possible and nothing is impossible.

EU Goes After Credit Rating Firms

The original idea with modern government was to provide protection for life, liberty and property. Later on, partly thanks to social conservatives, the first seeds of the welfare state were planted. Among the earliest entitlement programs were public education, retirement benefits and poverty relief. From the Preussan income-security model under Bismarck the radical left got their ideas for the first cornerstones of the modern welfare state.

Over the course of the latter half of the 20th century, governments in the industrialized world ran amok with their welfare states. As I explain in my forthcoming book “Industrial Poverty” (due out early 2014) this has now led to a situation where government is causing a new form of poverty under a depressing regime of perennial economic stagnation.

This long-term change of the role of government calls for intense debate, carefully executed research and just in general a lot of scrutiny of what government is doing to our societies, our economies – and the entire Western Civilization.

Part of that scrutiny lies in the hands of those who monitor the financial health of government. Independent credit rating institutions, such as Standard & Poor, Moody’s and Fitch, are at the forefront of this business. Their job is to inform its clients and, indirectly, the general public of how well – or how poorly – government is managing its finances.

This may seem to be a business totally unrelated to the broader change of the role of government I just discussed. However, the relation is much closer than most people think: the bigger and more economically burdensome a government becomes, the more likely it is to be a bad steward of taxpayers’ money.

On top of that, as we have seen over the past couple of years it is dramatically important that we have credit rating institutions that can tell us when a government is reaching the end of its credit line. We know from the partial Greek debt default that governments do indeed default on their debt, and that lending to them is no longer a risk-free affair. The reason for this is, again, that government has sprawled in all possible – and impossible – directions, with piles of spending commitments that it could never afford.

By constantly monitoring the finances of our governments, these credit rating institutions keep the elected officials of our modern welfare states on their toes. Our politicians should take their ratings seriously and do their best to avoid being downgraded.

Instead there have been initiatives, primarily in Europe, to discredit or legislatively intimidate the credit rating industry. This new and rather ugly trend in politics has its origin in the fact that several welfare states have lost their stellar AAA rating in recent years. Politicians who are used to being able to do essentially what the heck they want, suddenly find themselves facing an industry they have a very hard time dealing with. Like an elephant in a china shop, they continue to behave as if they were above all checks and balances. Euractiv.com reports:

The “Big Three” agencies that rate European Union government debt could be fined after failing to fix poor practices from the past, the sector’s regulator said on Monday (2 December). Credit ratings are a key part of the financial system, helping investors assess the likelihood that they will recoup their money. But the financial crisis led to unease that the market is relying to heavily upon them.

Nonsense. This was the first time governments got knocked by these rating institutions. Thin-skinned politicians who take themselves far too seriously could not live with the criticism. Instead they went after their critics. Euractiv again:

The European Securities and Markets Authority (ESMA) published results of an investigation into how Moody’s, Standard & Poor’s and Fitch compiled ratings on sovereign bonds between February and October this year. ESMA is the EU agency responsible for authorising and supervising rating agencies in EU countries, some of which have objected strongly to their ratings by agencies.

Let’s note that the regulator of credit rating here is the same entity whose credit will then be rated. Imagine if we individuals could determine how Equifax, TransUnion etc rate our credit…

Sovereign ratings became politically charged at the height of the euro zone crisis when S&P infuriated Greece in 2011 by cutting the rating of its debt while the country’s EU bailout was being renegotiated. This led to the third of three EU laws to regulate rating agencies in as many years. From next month, the agencies can only release changes to sovereign ratings according to a pre-set calendar to improve transparency.

There is nothing wrong with how S&P handled the Greek situation. The bailout did not solve the crisis; it did nothing to alter the course of the crisis and only served the purpose of prolonging an already unsustainable situation. To use that as a reason for regulatory changes to the ratings industry is to go after the kid who points our that the emperor has no clothes.

“ESMA’s investigation revealed shortcomings in the sovereign ratings process which could pose risks to the quality, independence and integrity of the ratings and of the rating process,” ESMA Chairman Steven Maijoor told reporters. “They should speed up their processes and make sure they get their house in order.”

What shortcomings? More than likely, this is bureaucrat-speak for changes to what these rating institutions can and cannot say, with the explicit purpose to make sure government can continue to borrow money without risking credit downgrades. This would correlate well with some of the Basel III regulations that the world’s welfare states have imposed on the financial industry.

EU Debt Problem Worse than U.S.

The latest news on the U.S. fiscal crisis is that President Obama is changing is mind on negotiations with Congressional Republicans. The man who would rather negotiate without preconditions with Iran’s Islamist thug regime than democratically elected American legislators has been pushed to the negotiation table by the looming threat of October 17. That is the date when, according to the Obama administration, the U.S. Treasury runs out of money and will default on its debt. Therefore, in order to avoid having to do the unconstitutional, namely to not make debt payments, Obama chooses to sit down with the only people on the face of the planet that he would never negotiate with.

In theory, if the president had ordered the Treasury not to make debt payments he could have been impeached. We will not know for a long time what has been going on behind the scenes in DC over the past couple of weeks, but it is noteworthy that the president suddenly decided that it was better to show a glimpse of leadership on the federal budget situation. It is an open question what the outcome will be, but at least there are talks and different views are being vetted, allowed to clash and then pave the way to an informed compromise. It may not be the best compromise in terms of fiscal policy, but the very fact that there is a vigorous debate in Washington, DC – and that the sides involved can take such harsh stances that the federal government shuts down for a while – is ultimately a sign that the American constitutional republic is in fact working.

As I explained recently, while the Europeans may be laughing at the American “bickering” and government shutdown, their own fiscal house is far from in good order. While there is a hot political fight over how to get the U.S. debt under control, the Europeans seem to have given up entirely on that front. Consider these numbers from Eurostat, reporting changes in debt-to-GDP ratio from first quarter of 2011 to first quarter of 2013:

EU 27 debt to GDP ratio change

Source: Eurostat; seasonally adjusted numbers.

Over the past two years, 23 out of the EU’s 27 member states (not counting rookie member Croatia) have increased their debt-to-GDP ratio. Portugal is worst: in the first quarter of 2011 their government debt was 95.1 percent of the Portuguese GDP; in the first quarter of 2013 it was 127.2 percent of GDP, an increase by 32.1 percentage points in two short years.

For the EU-27 as a whole, debt has increased from 80.2 percent to 85.9 percent. This is partly due to the fact that almost all of Europe’s economies are standing still, but the main reason is of course that the variables that drive spending in Europe’s welfare states are still in place. Much of government spending in a welfare state is on autopilot, driven by eligibility variables in entitlement programs. In Denmark, e.g., conventional wisdom among economists is that the legislature can directly affect about three percent of the annual government budget – the rest is governed primarily by welfare-state entitlement programs.

Needless to say, there is a connection between a GDP that stands still and a welfare state that has to dole out more money through its entitlement systems. But this only reinforces the point that Europe has a big debt problem: if structural spending systems run away with the government budget, you don’t sit around with your arms crossed. You dismantle those spending systems.

If you don’t, you will keep on borrowing. Which, again, is precisely what the welfare states in Europe do. Of the 27 EU states, 25 increased their debt in euros – only Hungary and Greece had a nominally smaller debt in Q1 of ’13 than in Q1 of ’11 – and the decline in the Greek debt was entirely due to the partial default almost two years ago. In terms of growth, their debt is back on an out-of-control path.

In total, the 27 EU states have borrowed another 1.1 trillion euros over the past two years. Five countries now have a debt that exceeds 100 percent of their GDP: Greece, Italy, Portugal, Ireland and Belgium. This is compared to two countries, Greece and Italy, two years ago. France is heading in that direction, with a ratio that has increased from 84 percent in 2011 to 92 percent today.

These are all bad numbers. But what is worse is that there is no debate in Europe about how to stop this debt growth. The austerity policies put in place by the EU, the ECB and the IMF have been embraced as fiscal policy gospel by Europe’s political leaders. Since austerity has been in place for four years now in some countries, and since the outcome has been utterly disappointing, it is high time for Europe to reconsider its current path.

For that to happen, though, you need an open and honest debate. America has an open and honest debate. Europe does not.

Guess who will prevail in the end…

Greek Debt Out of Control Again

I recently expressed my deep concerns regarding the unstable political situation in Greece, concluding that the government’s attempt to ban or otherwise neutralize the neo-Nazi Golden Dawn party is a very risky game. while morally the right thing to do, and politically probably necessary, the potential for a violent backlash is very high. One reason is that many Golden Dawn supporters appear to be supporting the party because they want Greece out of either the currency union or both the EU and the euro.

Their motive is not hard to understand: it has now been five years since Greece entered the economic crisis, and at least four of those years have to the average Greek been dominated by EU-imposed austerity. In package after package, the EU, the ECB and the IMF have dictated bone-crushing spending cuts and prosperity-destroying tax hikes. Since Greece is a welfare state, government is deeply involved in almost every aspect of people’s lives. When it goes on an austerity rampage the effects are by necessity both far-reaching and painful for Greek families.

Today, Greece stands with one foot in the EU and one foot in social and economic chaos. Political extremism is growing, both in the form of terrorizing socialist political violence and growing political intimidation from Golden Dawn. At the same time, unforgiving austerity policies, aimed at stabilizing government debt, have been a complete and utter failure, Greece’s government budget is suffering from chronic deficits, partly because one quarter of the tax base, a.k.a., GDP, has vanished during the austerity years, and partly because a much larger portion of the Greek population depends on the welfare state now than was the case before the crisis.

The question is what the EU-ECB-IMF troika is going to do next. Before we seek an answer to that, let’s take a look at the Greek debt trajectory. This figure shows the Greek government’s debt as percentage of GDP per quarter since 2008:

Greek Debt 1

The debt ratio rises steadily through 2011, then drops dramatically at the beginning of 2012. That is the point when the Greek government, aggressively “encouraged” by the Troika, wrote down its own debt.

When the write-down – effectively a partial default – was executed the Greek government owed 170 euros for every 100 euros of Greek GDP. That ratio was considered entirely unsustainable at the time, especially since the quarter-to-quarter increase in the ratio was at 3.3 percent. But the problem for the EU-ECB-IMF Troika is that the rise in the Greek debt ratio has not changed since the partial default – at least not for the better. Through the first quarter of this year the debt-to-GDP ratio has grown by 4.1 percent per quarter, putting the ratio at 160.3 for the first quarter of 2013.

Before the end of this year Greece will probably have a debt ratio that exceeds what it was at the partial-default point. Here are two scenarios:

Greek Debt 2

The blue line represents a scenario where the Greek debt ratio continues to grow as it has during 2012 and 2013 thus far. The red line extends with a growth trajectory based on the ratio growth rate from 2010 and 2011, namely 3.3 percent per quarter.

As we can see, the difference is negligible. And even if we disregard the exceptionally high debt ratio growth from the first quarter of 2012 (9.3 percent) we still end up with a post-default debt ratio growth of 2.5 percent per quarter. In other words, it is only a matter of time before Greece is back in the same situation as it was in 2011, only this time with an even more tense political situation, an even higher level of economic despair among the people and a youth unemployment rate at a completely destructive 60 percent.

So, back to the question: what is the Troika going to do next? Part of the answer lies in Angela Merkel’s decisive victory in last week’s German elections. Merkel wants to save Greece, keep the currency union intact and put a smiley face on every EU citizen. As far as she is concerned, the Troika should continue to help Greece.

At the same time, Greece’s self-proclaimed saviors are running out of options. The partial debt default was evidently a disaster that has, at best, bought the Greek government one year of breathable air. No one this side of a lunatic asylum would try another debt default. But austerity has also been utterly ineffective. The Greek economy simply refuses to produce the result that the designers of austerity expected.

What to do? Well, the only workable solution is so radical it will never win even a remotely serious consideration from the Troika – at least not its two European comrades, the EU and the ECB. That solution would involve Greece leaving the EU, reinstating its own national currency, and a dedicated program to reform away the welfare state.

It is almost a given that the EU won’t let any of that happen. But that brings us back to what options the Troika has left.

Well, what options do they have left?