The answer to the question whether or not Greece will stay in the euro will probably be given this week. New socialist prime minister Tsipras is not giving the EU what it wants, jeopardizing his country’s future inside the currency union:
Talks between Greece and eurozone finance ministers broke down on Monday with an ultimatum that Athens by Friday should ask for an extension of the current bailout programme which runs out next week. Greek finance minister Yanis Varoufakis said he would have been willing to sign off on a proposal made by the EU commission, which was more accommodating to Greek demands, but that the Eurogroup offer – to extend the bailout programme by six months – was unacceptable. The battle is about more than just semantics. EU officials say Greece cannot cherrypick only the money-part of a bailout and ignore the structural measures that have to be implemented to get the cash. “If they ask for an extension, the question is, do they really mean it. If it’s a loans extension only, with no commitments on reforms, there is an over 50 percent chance the Eurogroup will say no,” one EU official said. Failure to agree by Friday would leave very little time for national parliaments in four countries – notably Germany – to approve the bailout extension. It would mean Greece would run out of money and be pushed towards a euro-exit. … As for the prospect of letting Greece face bankruptcy to really understand what’s at stake, an EU official said “there is no willingness, but there is readiness to do it”.
The mere fact that there is now official talk about a possible Greek exit from the euro is a clear sign of how serious the situation is. It is also an indication that the EU, the ECB and the governments of the big EU member states have a contingency plan in place, should Greece leave the euro.
My bet is that Tsipras is gambling: he wants out of the euro, but with a majority of Greeks against a reintroduction of the drachma he cannot go at it straightforwardly. He has to create a situation where his country is given “no choice” but to leave. This is why he is negotiating with the EU in a way that he knows is antithetical to a productive solution.
The reason why Tsipras wants out is simple: he is a Chavista socialist and wants to follow in the footsteps of now-defunct Venezuelan president Hugo Chavez. That means socialism in one country. (A slight rephrasing of the somewhat tarnished term “national socialism”.) In order to create a Venezuelan-style island of reckless socialism in Europe, Tsipras needs to get out of the euro zone.
Should he succeed, it is likely that other countries will follow his example, though for different ideological reasons. However, there is more at stake in the Greek crisis than just the future of the euro zone. Tsipras is riding a new wave of radical socialism, a wave that began moving through Europe at the very depth of the Great Recession. Statist austerity was falsely perceived as an attempt by “big capitalism” to dismantle the welfare state. It was not – quite the contrary: statist austerity was a way for friends of big government to preserve as much as possible of the welfare state.
However, socialists have never allowed facts to get in the way of their agenda. And they certainly won’t let facts and good analysis get in the way of their rising momentum. What started mildly with a socialist victory in the French elections in 2012 has now borne Tsipras to power in Greece and is carrying complete political newcomers into the center stage of Spanish politics. But this new and very troublesome wave of socialism is not stopping at member-state capitals. It is reaching into the hallways of EU politics as well. As an example, consider these words on the Euractiv opinion page by Maria João Rodrigues MEP, Vice-Chair of the Socialists and Democrats Group in the European Parliament, and spokesperson on economic and social policies:
The Greek people have told us in January’s elections that they no longer accept their fate as it has been decided by the European Union. For those who know the state of economic and social devastation Greece has reached, this is only a confirmation of a survival instinct common to any people. The Greek issue has become a European issue, and we are all feeling its effects.
This is a frontal attack on EU-imposed austerity, but it is also a thinly veiled threat: unless Europe moves left, the left will move Europe.
Back to Rodrigues:
European integration can only have a future if European decisions are accepted as legitimated by the various peoples who constitute Europe. Decisions at European level require compromises, as they have their origins in a wide variety of interests. But these compromises must be perceived as mutual and globally advantageous for all Member States involved, despite the commitments and efforts they entail. The key question now is whether it will be possible to forge a new compromise, enabling not only to give hope to the Greek people, but also to improve certain rules of today’s European Union and its Economic and Monetary Union.
This should not be misinterpreted as a call for return of power to the member states. The reason why is revealed next:
We need a European Union capable of taking more democratic decisions and an Economic and Monetary Union which generates economic, social and political convergence, not ever-widening divergence. If Europe is unable to forge this compromise, and if the rope between lenders and borrowers stretches further, the risks are multiple: financial pressures for Greece to leave the euro; economic and social risks of continued stagnation or recession, high unemployment and poverty in many other countries; and, above all, political risks, namely further strengthening of anti-European or Eurosceptic parties in their aspiration to lead national governments, worsening Europe’s fragmentation.
The fine print in this seemingly generic message is: more entitlement spending to reduce income differences – called “economic and social convergence” in modern Eurocratic lingo – and a central bank the policies of which are tuned to be a support function for fiscal expansion. The hint of this is in the words “If the rope between lenders and borrowers stretches further”: member states should be allowed to spend on entitlements to reduce income differences, and if this means deficit-spending, the ECB should step in and monetize the deficits.
Rodrigues offers yet another example of the same argument:
[Many of] Greece’s problems were aggravated by the behaviour of the European Union: Firstly, it let Greece exposed to speculative market pressures in 2010, which exacerbated its debt burden. Secondly, when the EU finally managed to build the necessary financial stabilisation mechanisms, it imposed on Greece a programme focused on the reduction of the budget deficit in such an abrupt way that the country was pushed into an economic and social disaster. Moreover, the austerity measures resulted in a further increase of Greece’s debt compared to its GDP.
It is apparently easy for the left to look away from such obvious facts as the long Greek tradition of welfare-state spending. But that goes with the leftist territory, so it should not surprise anyone. More important is the fact that we once again have an example of how socialists use failed statist austerity to advocate for even more of what originally caused the crisis, namely the big entitlement state. They want to turn the EU and the ECB into instruments for deficit-spending ad infinitum to expand the welfare state at their discretion.
To further drive home the point that what matters is the welfare state, Rodrigues moves on to her analysis of Greece:
What Greece needs now is a joint plan for reform and reconstruction, agreed with the European institutions. This plan should replace the Troika programme, while incorporating some of its useful elements. Crucially, it should foresee a relatively low primary surplus and eased conditions of financial assistance from other eurozone countries, in order to provide at least some fiscal room for manoeuvre for the country. In return, the plan should set out strategic reforms to improve the functioning of the Greek economy and the public sector, including tax collection, education, employment and SMEs services as well as ensuring a sustainable and universal social protection system.
There is no such thing as a “sustainable and universal social protection system”. When Europe’s new generation of socialist leaders get their hands on the right policy instruments they will turn all government-spending faucets wide open. Deficits will be monetized and imbalances toward the rest of the world handled by artificial exchange-rate measures (most likely of the kind used by now-defunct Hugo Chavez).
If this new wave of socialism will define Europe’s future, then the continent is in very serious trouble.
A short-term measure of the strength of the momentum will come later this week when we will know whether or not Greece will remain in the currency union. Beyond that, things are too uncertain to predict at this moment.
Sweden has joined the club of runaway monetary policy. From Reuters:
Sweden shocked markets on Thursday by introducing negative interest rates, launching bond purchases and saying it could take further steps to battle falling prices. The central bank joins a list of those including the European Central Bank, the U.S. Federal Reserve and the Bank of England, to resort to unconventional monetary policy steps to confront an unusual combination of economic problems.
No. The Federal Reserve has reversed course. And together with The Bank of England the Fed has been helped by the fact that it is operating in an economy with moderate taxes and relatively relaxed fiscal policy. The ECB has opened the monetary flood gates in an economy that is plagued by statist austerity and more or less zero growth.
In fact, the slight uptick in economic activity in the third quarter of 2014 that I reported on earlier this week is closely correlated to the all-out liquidity bombardment that the ECB began early summer last year. On the margin there are those who will take advantage of declining interest rates. According to data from the ECB, euro-denominated loans to non-financial corporations declined noticeably in 2014. In the group of loans with a 5-10 year rate fixation, the interest on loans above 1 million euros fell by more than one percentage point, from 2.9 percent to 1.73 percent. Other collateral loan categories saw smaller declines, but the downward trend is unmistakable.
It is likely that the same thing will happen in Sweden; the question is what effect lower interest rates will have on economic activity. In the EU, gross fixed capital formation – a.k.a., business investments – did actually increase in 2014. However, broken down by quarter, the annual growth rate (i.e., over the same quarter the previous year) looks much different:
- Q1 2014 up 3.78 percent;
- Q2 2014 up 2.35 percent;
- Q3 2014 up 1.86 percent.
In other words, the largest annual increase was recorded before the ECB declared a negative interest rate. It remains to be seen what happened in the fourth quarter, but even if there was an increase somewhere in the same territory as earlier in 2014, the big question is what the lasting impact is going to be on GDP growth and employment. One indicator of this is private consumption, which seems to have benefited a bit more from the ECB’s desperate interest rate cuts. Again measured as annual increases by quarter:
- Q1 2014 up 0.68 percent;
- Q2 2014 up 1.27 percent;
- Q3 2014 up 1.4 percent.
For the two years Q3 2012 to Q3 2014 the annual increase was, on average, 0.3 percent. Nothing to be jubilant about, but the modestly accelerating trend during 2014 indicates a stabilization (rather than some sort of genuine recovery).
What does this mean for Sweden? The problem with that particular country is that its private-consumption increase is inflated by recklessly high household debt levels. These levels, in turn, are held up by mortgage loans with absolutely irresponsible terms, such as interest-only payments or basically life-long maturity periods. As I explained in my book Industrial Poverty, if Swedish household debt had remained a constant share of disposable income from 2000 and on, its private-consumption growth rate would almost have stalled.
Put bluntly: Sweden appears to be in reasonable economic shape only because households have increased their debt as share of disposable income from 90 percent 15 years ago to 180 percent today.
What this means is, plain and simple, that it is exceptionally irresponsible to make more credit available at even lower costs. But it also means that on the margin, the Swedish Riksbank will get less new economic activity out of every negative interest point than the ECB gets; the higher the household debt, the less inclined banks are to let people pile on new debt.
Unfortunately, the Riksbank president, Mr. Stefan Ingves, does not see this problem. Reuters again:
“Should this not be enough, we want to be very clear that we are ready to do more,” said Central bank governor Stefan Ingves. “If more is needed, we are ready to make monetary policy even more expansionary.” The central bank said this would mean further repo-rate cuts, pushing out future rate hikes and increasing the purchases of government bonds or loans to companies via banks.
As the Reuters story also explains, the Riksbank is ready to move into debt monetization – unthinkable only a year ago:
The Riksbank said it would “soon” make purchases of nominal government bonds with maturities from 1 year up to around 5 years for a sum of 10 billion Swedish crowns ($1.17 billion). But with the ECB printing 60 billion euros a month in new money the Riksbank’s much more limited program may have little effect on bond yields – already at record lows. “In terms of GDP, the mini-QE program amounts to about 0.25 percent,” banking group Morgan Stanley said in a note. “Therefore, this measure should be seen more as a signal that the Riksbank is ready to do more and remain dovish for the foreseeable time.”
In other words, here again the marginal payoff is going to be small. The only exception would be if the Swedish government decides to throw out its balanced-budget rules and start a major spending drive funded by the Riksbank. This seems unthinkable today – just like negative interest rates and a QE program seemed unthinkable a year ago.
Quantitative Easing is not a recession remedy. It is a defensive monetary strategy. So is the negative interest rate. Together, these two measures declare that a government and its central bank has reached the end of the road in trying to get their economy moving again. The big problem for Europe, Sweden included, is that they have come to this point almost seven years after the Great Recession started. With a recovery being half-a-decade overdue, with tapped-out monetary policy and fiscal policies restrained by ill-designed balanced-budget measures, Europe is firmly planted on the road straight into industrial poverty.
Sweden, with its imbalanced real estate market and very deeply indebted households, is on the same road, only with a more volatile ride.
In December I took a first look at the European Commission’s “Report on Public Finances”, with the intention of returning to this important document later. It has been almost a month, longer than I expected, but here we are.
In my first review of the report I explained that the strict focus by Europe’s political leadership on government finances has led to a systemic error in their fiscal policy priorities:
Austerity, as designed and executed in Europe, was aimed not at shrinking government but making it affordable to an economy in crisis. The end result was a permanent downward adjustment of growth, employment and prosperity. In order to get their economy out of this perennial state of stagnation, Europe’s leaders need to understand thoroughly the relations between government and the private sector.
This is a kind of prioritization that has guided European fiscal policy for two decades now. Under the Stability and Growth Pact, EU member states in general are forced to adopt a fiscal policy that inherently has a contractionary – austerity – bias. But it is not the kind of austerity that reduces the size of government. It is the kind that tries to shrink a budget deficit in order to keep government finances in good order and save the welfare state from insolvency.
So long as contractionary fiscal policy – austerity – is focused on balancing the budget and saving the welfare state, it won’t reduce the size of government. For that, it takes specifically designed austerity measures. Those measures are indeed possible, even desirable, but they cannot be launched unless government is allowed by its own constitution to prioritize less government over a balanced budget.
Unfortunately, the Stability and Growth Pact does not permit that member states prioritize shrinking government over budget balancing. Instead, the Stability and Growth Pact forces them to always pay attention to deficits and debt, but never worry about running too large surpluses. Part A of the Pact caps government deficits at three percent of GDP and debt at 60 percent of GDP. At the same time, there are no caps on budget surpluses; since a surplus is excess taxation, and since excess taxation drains the private sector for money in favor of a government savings account, this means that governments can drain the private sector for all the money it wants to without violating the European constitution.
Unlike a budget surplus, which is contractionary in nature, a budget deficit is, at least in theory, always stimulative. However, by capping deficits the European constitution restricts the stimulative side of fiscal policy, while at the same time leaving the contractionary end unrestricted.
In addition to the technical aspects of this contractionary bias, there is also the political mindset that is born from a legislative construct of this kind. Lawmakers and elected cabinet members – primarily treasury secretaries – are concerned with avoiding deficits, thus quick to resort to contractionary policy measures, but pay little attention to the need for counter-cyclical policies. Over time, this political mindset becomes “one” with the Stability and Growth Pact to the extent where parliaments do not think twice of passing budgets that impose harsh contractionary measures in order to balance a budget.
Think Europe in 2012. And read chapters 4a and 4b in my book Industrial Poverty to get an idea of how deep roots in Europe’s legislative mindsets that this “gut reaction” bias toward contractionary measures has actually grown.
With its contractionary bias, Europe’s fiscal policy has permanently downshifted growth in Europe. This in turn has perpetuated the budget problems that said contractionary policies were intended to solve. It left the European economy fragile and frail, vulnerable to a tough recession. All it took was the downturn in 2008-09 with its spike in deficits – and once the fiscal-policy gut reaction kicked in, there was nowhere to go for Europe other than into the dungeon of budget-balancing contractionary measures; statist-driven austerity; mass unemployment; and perpetual budget problems.
Never did Europe’s leaders think twice of trying to actually release its member states from the shackles of the Stability and Growth Pact. Never did they think twice of permitting a widespread downward adjustment of the size of government.
The Commission’s “Report on Public Finances” cements this statist approach to contractionary fiscal policy. It has an entire section that suggests further collaboration and coordination among EU member states on the fiscal policy front. So long as the Stability and Growth Pact remains in place, such coordination would be a thoroughly bad idea. All that such coordination would accomplish is to cement statist austerity as the prevailing “fiscal policy wisdom” ruling the economy that feeds 500 million people.
I will return in more detail to this report. In the meantime, do take a minute and read my paper Fiscal Policy and Budget Balancing: The European Experience. It is part of a five-paper series of discussion papers on the ups and downs of a balanced-budget amendment to the United States constitution.
When the euro was introduced more than 15 years ago it was marketed as the rock-solid currency that would beat the sterling, the U.S. dollar and the Swiss franc as the world’s safe haven for investors.
Part of the foundation for that ambitious, but not unattainable, goal was the convergence criteria that were supposed to align fiscal policy in all euro-zone countries. Those criteria, which went into effect in 1993, were elevated to constitutional status and still guide fiscal policy in the form of the Stability and Growth Pact. One of the three pillars of the pact was a ban on deficit monetization: the European Central Bank was not allowed to print money to buy up treasury bonds.
During the Great Recession the first two pillars of the Pact have crumbled; now the third one is about to fall apart as well. From the EU Observer:
The euro has begun 2015 at its lowest level in more than eight years, as markets expect the European Central Bank to present plans to buy government bonds in the coming weeks. The single currency was trading at $1.19 on Monday (5 January), its lowest rate since 2006, after ECB president Mario Draghi gave an interview stating that the bank was preparing a programme to buy up government securities in its latest bid to stimulate greater consumer demand and avoid deflation.
Unless the ECB is planning to buy bonds directly from European consumers, there is no direct connection between Draghi’s bond purchases and consumer spending. If he is hoping to depress interest rates even further and thereby stimulate consumption, then he has very little to play with. In most euro-zone countries interest rates are plunging toward zero – credit is practically available for free.
The problem is not lack of liquidity. The problem is lack of faith in the future. More on that in a moment. Now back to the EU Observer:
Speaking to German daily Handelsblatt on Friday (2 January), Draghi said the ECB was preparing to expand its stimulus programmes beyond offering cheap loans to banks and buying private sector bonds. “We are in technical preparations to adjust the size, speed and compositions of our measures in early 2015,” said Draghi, who will convene the next meeting of the bank’s Governing Council, where the support of a majority of its 25 members would be needed for a decision to be taken, on 22 January.
That will be four days before the Greek elections, which could bring the euro-secessionist Syriza to power. Syriza is a leftist hard-liner party with Venezuela’s defunct president Hugo Chavez as their political and economic role model. They would not think twice of reintroducing the drachma if they had enough political clout to do it.
By promising to buy up government bonds, the ECB could make a direct appeal to Greek voters – or at least to an incoming Syriza prime minister – that the ECB will buy all their government debt if only they choose to stay in the currency union. That, in turn, will basically give a new Syriza government the bargaining chip they need vs. Brussels to end austerity and return to the spending-as-usual policies that reigned before the Great Depression.
Precisely the situation the Stability and Growth Pact was supposed to prevent.
And again, as always, there is the change in tone among forecasters – the same kind of change that has become so frequent in recent years:
Draghi added that the risk of negative inflation had increased … Eurostat’s monthly inflation data to be published on Wednesday is likely to show that prices fell by 0.1 percent in December, the first decline since 2009. … Market analysts are forecasting another difficult year for the single currency bloc, predicting that the euro will continue to weaken against the dollar over the course of 2015, as a result of a combination of very low inflation and weak economic performance. … The eurozone economy is forecast to have grown by a mere 0.8 percent in 2014, and to grow by a meagre 1.2 percent in 2015, well below the US.
Unless there is a radical change in fiscal and welfare-state policies across the euro zone, its GDP won’t even grow by one percent for 2015.
A bond-buying program by the ECB won’t change that. All it will do is allow governments to return to deficit spending, which is not a desirable alternative to the austerity policies of the past few years. Europe needs structural reforms in the direction of free markets, limited government, low taxes and cheap energy. Nothing else will help.
Belgium is one of Europe’s most troubled welfare states, though its problems have been overshadowed by the macroeconomic disasters along the Mediterranean. Its fiscal problems are older than most EU member states, and it was the first country to attract sociological interest based on the fact that there were families – regular working class families – where three generations were perennially unemployed.
Today, Belgium is attracting interest because of a new report from the International Monetary Fund. The EU Observer reports:
The Belgian government is planning “many welcome measures to address the critical macroeconomic challenges facing the Belgian economy”, but it can do more, the International Monetary Fund (IMF) said on Monday (15 December). On the same day Belgian unions organised a general national strike, the IMF presented its findings from a ten-day mission to the country. “The planned reforms of social security and budgetary measures are a step in the right direction”, the IMF wrote.
As with other welfare states in Europe, Belgium suffers from disturbingly low growth. As a result, tax revenues cannot keep up with entitlement spending and the budget deficit becomes structural. GDP growth has been as disappointing in the Belgian economy over the past few years as it has elsewhere in Europe (annual growth rates, reported quarterly):
The Great Recession took a big toll on the Belgian government’s finances. Its budget went from a 156 million euro surplus in 2007 to a 19.1 billion euro deficit in 2009, equal to 5.6 percent of GDP.
From there, the deficit has declined slowly but steadily, reaching the EU’s magic three-percent of GDP mark in 2013. Due to the almost clinical absence of GDP growth, the decline has been accomplished by means of welfare-state saving austerity. As the EU Observer explains, these policies are likely to continue, with some tax reshuffling to spice it up:
The centre-right government of Charles Michel, the first coalition without socialists since 1988, started work in October. It plans spending cuts and increasing the pension age from 65 to 67 by 2030. However, the IMF says that Belgium should also reform its tax system. … when it comes to labour tax, Belgium ranks top with a rate of over 40 percent. The IMF suggests that labour tax should be lowered and compensated with a higher tax on capital.
As the figure above clearly shows, there is no recovery under way in Europe. Belgium is no exception, which makes the IMF advice a problematic ingredient in the Belgian fiscal policy mix. More than anything, Belgium needs tax cuts, not a redistribution of the tax burden. It also needs massive, structural reforms to its welfare-state entitlements system, encouraging work and discouraging indolence. None of this is on the horizon, which makes it a safe bet to predict that the Belgian economy will not return to historic growth levels in the foreseeable future.
Since 2012 I have been predicting that Europe will transition from the downslope of the Great Recession into a state of long-term “stable stagnation” – a state best described as industrial poverty. (I define it here.) For the past 12-18 months GDP and other data have shown that the downslope is ending, and that the state of stagnation now has Europe in a firm grip. Weak signs of an economic recovery in Greece and Spain do not contradict this observation: the two countries hit the hardest by the recession are simply adjusting to the aftermath of some of the hardest austerity policies on record.
One of the characteristics of the crisis downslope was a barrage of credit downgrades of governments in EU member states – and Greece was far from alone here. Spain, Portugal and Ireland suffered five downgrades each, starting in 2009, sending Spanish treasury bonds to the financial junk yard by 2012. Italy was downgraded three times, starting in 2011, and France lost its AAA rating with Standard & Poor in January 2012. In November that year Moody’s downgraded France, followed by Fitch in July of 2013 and yet another downgrade by S&P in November last year.
Now Fitch is at it again. After having reduced France to AA+ in July last year the rating institute has now decided to kick the French down another notch. Explains Fitch:
When it placed the ratings on RWN in October, Fitch commented that it would likely downgrade the ratings by one notch in the absence of a material improvement in the trajectory of public debt dynamics following the European Commission’s (EC) opinion on France’s 2015 budget. Since that review, the government has announced additional budget saving measures of EUR3.6bn (0.17% of GDP) for 2015, which will push down next year’s official headline fiscal deficit target to 4.1% of GDP from the previous forecast of 4.3%.
The reason why Fitch focuses on the French government’s budget deficit is the prevailing notion that a big deficit is bad for the economy. In reality, the biggest threat is that a deficit will weaken or eventually destroy the ability of government to pay its obligations through welfare-state entitlements. Austerity policies in Europe have been aimed at closing deficits in order to save welfare states from pending default on entitlements: the idea has, simply speaking, been to make the welfare states more “affordable”. The affordability is measured in terms of budget balancing – a deficit is taken as a sign that the welfare state cannot support its spending obligations.
It is not entirely clear whether or not Fitch and others factor this into their ratings. The outcome, however, of their analysis is precisely that: a welfare state that is chronically unable to fund its entitlements will sooner or later be downgraded.
This is what has just happened to France. Back to the Fitch report:
The 2015 budget involves a significant slippage against prior budget deficit targets. The government now projects the general government budget deficit at 4.4% in 2014 (up from 3.8% in the April Stability Programme with the slippage led by weaker than expected growth and inflation) and 4.1% in 2015 (previously 3.0%), representing no improvement from the 4.1% of GDP achieved in 2013. It has postponed its commitment to meet the headline EU fiscal deficit threshold of at most 3% of GDP from 2015 until 2017.
And this despite enacted as well as announced increases in the tax burden on the French economy. As I noted a week ago:
In other words, no stronger growth outlook, no sustainable improvement in business investments or job creation. As a matter of fact, a closer look at the measures that Mr. Sapin refers to reveals a frail, temporary improvement that will not put France on the right side in any meaningful macroeconomic category
Even the part of the deficit that the government can reduce is largely due to a reduction in the annual EU membership fee. There is no underlying macroeconomic improvement behind the small deficit decline. With this in mind it is easy to see why the Fitch report expresses concern about the future of the French economy:
The weak outlook for the French economy impairs the prospects for fiscal consolidation and stabilising the public debt ratio. The French economy underperformed Fitch’s and the government’s expectations in 1H14 as it struggled to find any growth momentum, in common with a number of other eurozone countries. Underlying trends remained weak despite the economy growing more strongly than expected in 3Q, when inventories and public spending provided an uplift.
And, as if to top off the analysis:
Fitch’s near-term GDP growth projections are unchanged from the October review of 0.4% in 2014 and 0.8% in 2015, down from 0.7% and 1.2% previously. Continued high unemployment at 10.5% is also weighing on economic and fiscal prospects. The on-going period of weak economic performance, which started from 2012, increases the uncertainty over medium-term growth prospects. The French economy is expected to grow less than the eurozone average this year for the first time in four years.
And that is quite an achievement, given the notoriously weak growth in the euro zone.
Overall, this is yet more evidence of long-term stagnation in Europe. The bottom line: don’t ask when Europe will recover – ask what reason the European economy has to recover.
The one good thing about the rising levels of frustration in Europe over the crisis, is that the public debate is being enriched with voices whose message might actually make a difference for the better. Today, a group of leading German economists has decided to speak up against the lax monetary policies of the ECB. This is a welcome contribution, but their contribution would be stronger and more to the point if they also learned a thing or two about what has actually brought Europe into the macroeconomic ditch.
Reports Benjamin Fox for the EU Observer:
The European Central Bank’s (ECB) plans to pump more cheap credit into banks risk undermining the long-term health of the eurozone, according to Germany’s leading economic expert group. The ECB’s “extensive quantitative easing measures” posed “risks for long-term economic growth in the euro area, not least by dampening the member states’ willingness to implement reforms and consolidate their public finances”, the German Council of Economic Experts (GCEE) said in its annual report, published on Wednesday (12 November).
That monetary expansion is indeed a problem. In September 2014 the M1 money supply in the euro zone had grown by 6.5 percent over September 2013. Over the past 12 months the annual growth rate has averaged 5.86 percent, showing that monetary expansion in the euro zone is actually increasing. In fact, adjusted for the large expansions in M1 euro supply that resulted from an expansion of the monetary union, the current expansion rate appears to be the highest in the history of the euro (though that is just a preliminary observation – I am not completely done with the simulation).
If current-price GDP was growing at the same rate, then all the new money supply would be absorbed by transactions demand for money. But the euro-zone GDP is practically standing still, which means that all the new money supply is directed into the financial sector (theoretically known as “speculative demand for money”). That is where the real danger is in this situation.
Unfortunately, the German economists are not primarily worried that the ECB is destabilizing the European financial system. Their concern is instead that lax monetary policy discourages fiscal discipline among euro-zone governments. They appear to be stuck in the state of misinformation where budget deficits are keeping the euro-zone economy from recovering.
Benjamin Fox again:
The Bundesbank is also uncomfortable about the ECB’s increasingly activist role in the bond and securities markets. … But the German call for the Frankfurt-based bank to limit its intervention remains a minority position. Most governments in and outside the eurozone, together with the International Monetary Fund, want the ECB to provide increased monetary stimulus. Last week the Organisation for Economic Co-operation and Development (OECD) also urged the bank to “employ all monetary, fiscal and structural reform policies at their disposal” to stimulate growth in the currency bloc, including a “commitment to sizeable asset purchases (“quantitative easing”) until inflation is back on track”.
Can any economist at the ECB, the IMF or the OECD please explain how the ECB’s money pumping is going to create inflation in any other way than the traditional monetary kind? Nothing in either my academic training as an economist or my 14 years of practicing economics as a Ph.D. gives me the slightest clue how this is supposed to work.
In fact, the only inflation I can see coming out of this would be strictly monetary – and that is not what anyone in Europe wants. Monetary inflation, unlike inflation caused by rising economic activity, can run amok deep into the double digits, as it has in Argentina and Venezuela.
It is good that leading German economists are worried about the ECB’s activities. Time now for them to take the next step and study the true structure of the economic crisis.
Europe keeps struggling with its impossible balanced-budget endeavor.
In a desperate attempt to save the welfare state while also balancing the government budget they keep destroying economic opportunity for their entrepreneurs and households. This leads to panic-driven spending cuts combined with higher taxes, the worst alternative of all routes available to a balanced budget. The reason – and I keep emphasizing this ad nauseam – is that they desperately do not want to remove the deficit-driving spending programs.
To break out of the shackles of their self-imposed welfare-statist version of austerity, some European politicians have suggested that the EU needs to revise the rules under which member states are brought into compliance with the Union’s balanced-budget amendment. This is not viewed kindly among the Eurocrats in Brussels. From Euractiv:
The European Commission will not let EU budget discipline rules be flouted, incoming economic affairs commissioner Pierre Moscovici said on Monday (29 September), days after his former colleagues in the French government said Paris would again miss EU targets. Last year, European Union finance ministers gave Paris an extra two years to bring its budget deficit below the EU ceiling of 3% of national output after France missed a 2013 deadline in what is called the ‘excessive deficit procedure’. But earlier this month, the French government said it would not meet the new 2015 deadline either and instead would reduce its budget shortfall below 3% only in 2017.
They certainly could meet the deadline, and they could do it even faster than proposed. All they would need to do would be to chainsaw the entire government budget until what is left fits within the three-percent rule. However, they know they cannot do that, for two reasons. The first is simple macroeconomics: so long as you do not cut taxes, any spending cuts will mean government takes more from the private sector and, relatively speaking, gives less back. That reduces private-sector activity and thus exacerbates the recession.
The second reason is that when half or more of the population depend on government for survival, you can only do so many spending cuts before they set the country on fire. The solution is a predictable way out of dependency, one that gives people an opportunity to become self sufficient without suffering undue, immediate financial hardship. That excludes tax hikes and sudden spending cuts – but on the other hand it mandates structural spending cuts that permanently terminate entitlement programs.
However, this solution to their unending economic crisis keeps eluding Europe’s policy makers.
When do you stop talking about an economy as being in a recession, and when do you start talking about it as being in a state of permanent stagnation? How many years of microscopic growth does it take before economic stagnation becomes the new normal to people?
Since 2012 I have said that Europe is in a state of permanent economic stagnation. So far I am the only one making that analysis, but hopefully my new book will change that. After all, the real world economy provide pieces of evidence almost on a daily basis, showing that I am right. Today, e.g., the EU Observer explains:
France has all but abandoned a target to shrink its deficit, as the eurozone endured a turbulent day that raised the prospect of a triple-dip recession. Figures published by Eurostat on Thursday (14 August) indicated that the eurozone economy flatlined between April and June, while the EU-28 saw 0.2 percent growth.
I reported on this last week. These numbers are not surprising: the European economy simply has no reason to recover.
The EU Observer again:
Germany, France, and Italy … account for around two thirds of the eurozone’s output. Germany’s output fell by 0.2 percent, the same as Italy, which announced its second quarter figures last week. France recorded zero growth for the second successive quarter, while finance minister Michel Sapin suggested that the country’s deficit would exceed 4 percent this year, missing its European Commission-sanctioned 3.8 percent target.
And that target is a step back from the Stability and Growth Pact, which stipulated a deficit cap of three percent of GDP. It also puts a 60-percent-of-GDP cap on government debt, but that part seems to have been forgotten a long, long time ago.
What is really going on here is a slow but steady erosion of the Stability and Growth Pact. Over the past 6-8 months there have been a number of “suggestions” circulating the European political scene, about abolishing or at least comprehensively reforming the Pact. The general idea is that the Pact is getting in the way of government spending, needed to pull the European economy out of the recession.
No such government spending is needed. The European economy is standing still not because there is too little government spending, but because there is too much. I do not believe, however, that this insight will penetrate the policy-making circles of the European Union any time soon.
Back to the EU Observer:
In an article in Le Monde on Thursday (14 August), [French finance minister] Sapin abandoned the target, commenting that “It is better to admit what is than to hope for what won’t be.” France would cut its deficit “at an appropriate pace,” he added in a radio interview with Europe 1. … Sapin’s admission is another setback for beleaguered President Francois Hollande, who made hitting the 3 percent deficit target spelt out in the EU’s stability and growth pact by 2013 one of his key election pledges in 2012. Paris has now revised down its growth forecast from 1 percent to 0.5 percent over the whole of 2014, and cut its projection for 2015 to 1 percent from 1.7 percent.
Let me make this point again: instead of asking when the European economy is going to get back to growth again, it is time to ask if the European economy has any reason at all to get back to growth. As I explain in my new book, there is no such reason so long as the welfare state remains in place.
Here is the first in a four-part series on austerity, its theory, its application and its consequences: