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.
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.
Most of this blog’s focus is on the European crisis, for two reasons: first, Europe is ahead of America on the downslope into industrial poverty, and we can learn a great deal from their terrible mistakes; and secondly, we are beginning to see the contours of what Europe will look like on the other side of the crisis, and it is not pretty. In fact, a Europe where fascism and totalitarianism get a bigger playground is a Europe that could very well destabilize an already volatile world.
For the most part, we are doing better here in the United States. Our economy is in better shape than the European, especially the euro zone, and our political system is more resilient and stable than what the Europeans are living with. But that does not mean we cannot screw it up here; if the Europeans could squander a half-century long streak of growing prosperity by committing themselves to poor policy judgments, then there is in fact a moderate risk that we might do the same.
As I mentioned earlier, the fight over funding the federal government was not a sign of weakness, but a sign of the strength of the American democracy. The problem with the fight was not that it took place, but that Republicans and Democrats agreed to reopen the federal government without reaching a deal on how to handle the debt. From now to January, the U.S. Treasury is once again free to borrow money on overtime. Stubborn spenders in the White House and Congress evaded the deficit problem, agreed to punt for a few months and let ObamaCare go into effect.
Long term, this may have been a good outcome for the Republicans as voters now get to feel the full impact of ObamaCare on their lives. However, from a macroeconomic viewpoint it was not at all what we needed. The deficit punting is going to feed expectations of a future debt default – and expectations of inflation.
Global investors are already worried about the U.S. debt. They have forced the federal government to pay more for its debt than what some European countries pay. The reason for this is in good part that the European Central Bank has created a very risky bond buyback program, where it promises to purchase any euro-denominated bond issued by a debt-troubled Eurozone country. While a bad idea long-term, this program has calmed investors for now – and it has made investors believe that countries in the turbulent eurozone are less likely to default on their debt than the United States is – even though their immediate debt crisis actually is worse than ours.
There is, however, one problem that we may see emerging here before it gets to Europe: inflation. The default-related risk premium that investors demand on U.S. Treasury bonds will probably increase in the next couple of months as investors factor in the leadership transition at the Federal Reserve. As I explained recently, Ben Bernanke’s successor Janet Yellen appears to be more lenient toward inflation than her two most recent predecessors. The basis for her leniency seems to be the continued existence of a large federal budget deficit. She has been quoted as preferring higher inflation to tightening the Fed’s funding of the budget deficit.
In other words, Congress and President Obama would have to do even less to balance the budget.
Higher inflation would benefit the federal government in the short run as some tax revenues would increase faster. The Wyoming state government would not benefit as much directly from inflation, primarily because we do not have a multi-bracket income tax. However, there is an indirect gain: higher inflation is normally associated with a weaker exchange rate for the U.S. dollar, which would benefit natural resources exporters and boost severance tax revenues.
This makes inflation an attractive escape route for spendoholic politicians who simply cannot bring themselves onto a route toward smaller government. Congress should be very observant here, and hear the warnings that others are issuing – not just us “inflation hawks” in the economics profession, at think tanks and on public-policy blogs. A good place to go to is China, whose government has recently shown an increased interest in U.S. Treasury bonds. As of July 2012, China (including Hong Kong) owned approximately 7.9 percent of the federal debt. However, in the past year they have purchased one-fifth of the new external debt issued by the Treasury, boosting their total debt share to almost 8.5 percent.
This increased Chinese investment comes at the same time that China is having serious domestic debt problems. Their GDP growth is slowing down – quarterly numbers indicate slower growth in China than in the United States – while their inflation rate is notably high. This is a substantial change from past high-growth decades.
Here is the kicker. A rise in the U.S. inflation rate would exacerbate the Chinese recession problems: with a dollar depreciation, U.S. exporters will compete more strongly on the global market and Chinese manufacturing costs will rise relative to American manufacturers.
By expanding their holding in U.S. Treasury bonds, the Chinese achieve two goals. They prop up the dollar vs. their own currency and they increase their political leverage vs. Congress. The other day we got a sign of their attempts at the latter: the Chinese government’s own credit rating agency downgraded the U.S. government to A-.
While not a credible downgrade from a strict market viewpoint, it was a clear political signal to Congress to get serious about the federal debt. If Congress starts shrinking the deficit they will reduce their reliance on the Federal Reserve as one of the main funders of the deficit; by reducing the need for more deficit funding from the Fed, Congress would greatly reduce the risk for monetarily driven inflation.
But it is not just China that appears to be aware of the prospect of American inflation. From Yahoo Finance:
Marc Faber, publisher of The Gloom, Boom & Doom Report, told CNBC on Monday that investors are asking the wrong question about when the Federal Reserve will taper its massive bond-buying program. They should be asking when the central bank will be increasing it, he argued. “The question is not tapering. The question is at what point will they increase the asset purchases to say $150 [billion] , $200 [billion], a trillion dollars a month,” Faber said in a ” Squawk Box ” interview. The Fed-which is currently buying $85 billion worth of bonds every month-will hold its October meeting next week to deliberate the future of its asset purchases known as quantitative easing. Faber has been predicting so-called “QE infinity” because “every government program that is introduced under urgency and as a temporary measure is always permanent.” He also said, “The Fed has boxed itself into a position where there is no exit strategy.”
This reinforces the point I have been making about Janet Yellen and the spending-addicted lawmakers on Capitol Hill, and the equally spending-addicted man in the White House. She is, essentially, a carte blanche to Congress and the President to heed the battle cry: “Damn inflation, full spend ahead!”
It is bad enough that the Europeans are committing macroeconomic suicide. It is bad enough that the Old World has chosen to try to preserve the welfare state with a combination of austerity and exceptionally loose monetary policy. The United States does not need to follow in their footsteps.
If Congress does not change its spend-til-no-end mind, the Federal Reserve will, as Faber explains above, continue ad infinitum to print money and give it to the Treasury to spend. Eventually, inflation catches on, and once it does, an entire generation of Americans, who have no living memory of double-digit inflation, will learn the hard way what happens when you try to keep a welfare state on artificial monetary life support.
Two days ago I reported on France’s rising unemployment and the potential for a large-scale repetition of the Greek crisis. I concluded that so long as the French economy continues to lose up to one percent of its taxpayers to unemployment every year, the government does not stand a chance at balancing its budget. Any attempts at doing so will one way or the other set a downward macroeconomic spiral in motion that, as Greece has demonstrated, can continue to the next Big Bang.
Unlike its southern neighbor Spain, France still has time to save itself from the Greek tragedy. However, their room to take appropriate action is limited by three factors:
1. The mere size of government as it is today heavily stifles private entrepreneurship. Even if the French government did nothing from hereon to try to balance its budget, the French economy would have a long, slow and frail journey to growth, full employment and rising prosperity. This makes it very difficult to defend continuing EU-imposed budget-balancing measures.
2. The socialist ideology of President Hollande, the prime minister and his cabinet prevents the current French government from thinking clearly about alternatives to big-government intervention whenever there is a problem. Since the only sustainable path out of France’s crisis goes through reforms to reduce the size of government, the people that French voters elected to lead the country are ideologically predisposed to reject such a solution. Even if they tried to develop the right kind of solutions it is highly unlikely that they would get very far before their voters, party grassroots and left-leaning media would cry foul and call them ideological hypocrites. Unfortunately, that alone can be a strong deterrent against the right kind of reforms.
3. A rescue plan to have France evade the Greek dungeon would require that most of the rest of the euro-area economy is in reasonably good shape.
Even if lightning struck twice and the French socialists managed to get their act together, the third condition will stand in their way like a concrete road block. Made in Germany. Behold this report from the EU Observer:
In December 2012, leaders from 25 EU countries all signed up to a pact championed by German Chancellor Angela Merkel. The so-called fiscal compact is supposed to discipline countries into spending within their means and reducing their budget deficits and overall debt. In Germany, the “debt brake” will fully come into force in 2019, when the federal state and the regions (laender) are legally bound to stop making new debt.
This is a charade of royal proportions. The EU has had a ban on member-state debt beyond three percent of GDP since 1992, Effectively, the Stability and Growth Pact, which has been in place over two decades now, has made “excessive” debt illegal. As we all know, that has not prevented EU member states from building excessive debt. But that does not prevent the Eurocracy from making what is already illegal, really illegal.
Back to the EU Observer, which reports some worrying signs from inside the German government conglomerate:
Germany is in a much better position when it comes to deficits and debts than its southern neighbours. But still the federal government currently has a debt running at 75 percent of the gross domestic product – above the 60 percent threshold enshrined in EU rules. But in the multi-layered German state, cities fear it will be they who will ultimately foot the bill for Germany’s exemplary balance sheet.
This is crucial:
Ulrich Maly, the mayor of Nuremberg, told journalists in Berlin on Tueday (1 October) that more and more tasks are being moved from federal and regional to the local level, but without any extra funding. … As head of the association representing 3,400 German towns and cities, Maly tabled a series of requests to the upcoming German government, warning of the unfair burden being placed on townhalls in reducing the country’s budget deficit and debt.
Let’s take this in slow motion. The federal government creates a welfare state, then asks states and local governments to participate in the execution of the welfare state’s entitlement programs. To encourage full participation from lower jurisdictions the federal government sends them money. States and local governments get used to the cash and think nothing more of it. Until the day comes when the federal government has made more spending promises than its taxpayers can afford.
All of a sudden the federal government has to make choice:
a) Do they raise taxes? or
b) Do they reduce spending?
The German government tried alternative (a) but tax-paying voters put an end to that. That is in no way surprising, and incumbent prime minister Angela Merkel is trying hard to avoid tax hikes. But choosing alternative (b) is tougher than one might think. Merkel could just slash spending across the board, but if she did she would be accused of wanting to dismantle the German welfare state. That is a battle she does not want to take, probably because she – like most of today’s European “conservatives” – has embraced the welfare state and wants to keep it.
Merkel avoids a battle over the welfare state if she can come across as not cutting any entitlement programs. But since the entitlement programs are the cost drivers for the German government – just as they are for any welfare-state government – she cannot fend off the deficit wolves without somehow reducing the cost of those same entitlements.
Her solution: pass on more obligations to local governments, so the federal government does not have worry about them. But don’t increase spending – have the cities do more with the same or even less money. That way you look like you are protecting the welfare state while also balancing the federal budget.
Does this seem cynical? Understandable. After all, it is cynical. But this is the way politics works when our elected officials set up policy goals that are entirely incompatible, and where the pursuit of one goal, such as the welfare state, hampers the pursuit of another goal, in this case the balanced budget.
This does not stop Merkel’s political opponents from exploiting the apparent inconsistency in her policies. The EU Observer again:
With social expenditure – such as for the integration of disabled people or kindergardens [sic] – taking up over half of cities’ budgets, the question will be “what kind of country do we want,” the Social Democrat said. ”The debt brake will put political choices in the spotlight. It will be a question of what we can still afford if we’re supposed to make no new debt. Do we want inclusion of disabled people – which will cost several billion euros – or do we abandon this human right?”
This would be the perfect point to explain to the German people that not even their economy can carry the welfare state any farther. The addition of new entitlements on the top of already existing ones, while people expect existing entitlements to grow, is a formidably bad idea. It goes to show that to the statist there is no such thing as a government big enough.
But it also goes to show how illiterate the backers of the welfare state actually are when it comes to basic macroeconomics. They choose to believe whatever they need to believe in order to motivate a sustained, even growing, welfare state.
And just to show how desperate the situation is getting in Germany, the EU Observer introduces us to…
Eva Lohse, a member of Merkel’s Christian Democratic Union and mayor of Ludwigshafen, … [Lohse] warned that the townhall has virtually no money left for infrastructure projects. ”Reducing deficits and debt actually means that somebody else is doing it, not that the task is gone. So whoever does it also needs to have the proper funding for it. We have bridges crumbling down in the middle of our towns – this is unacceptable,” Lohse said.
In effect, there is a glaring lack of understanding of basic macroeconomics on both sides of the ideological aisle in German politics. This lack of insight will delay or entirely rule out appropriate policy solutions. Both the “conservatives” and the social-democrats in Germany will continue to try and preserve the welfare state while balancing the budget in the midst of zero or negative GDP growth. This is a recipe for decline, putting Germany in the same category of struggling welfare states as France, namely one step behind Spain and two steps behind Greece.
Germany still enjoys a lot of economic strength, but with the country’s fiscal policy makers focused on the unworkable combination of the welfare state and a balanced budget that strength can evaporate quickly. Right now, the case for German economic decline is actually stronger than the case for Germany economic recovery. And with German economic decline other euro-zone countries are in grave danger. Greece and Spain won’t get more bailouts, and France and other less-disaster-stricken economies will not have the same strong support anymore from trade with Germany as they have had historically.
Inevitably, our conclusion from this must be that Europe is continuing its slide into the cold, dark dungeon of industrial poverty.
The deep, persistent European economic crisis is continuing. A few days ago I showed how – predictably – the Greek government is increasing its debt at almost the same rate as before the partial debt default in early 2012. Another sign of the relentlessness of the crisis is that it is slowly but inevitably penetrating the French economy. One symptom is a steadfast increase in unemployment. Here are the latest quarterly data from Eurostat (since this is quarterly data we use seasonally adjusted numbers):
The steady uptick in unemployment coincides to some degree with the socialist government’s deep desire to draw every drip of blood they can from France’s already struggling taxpayers. That policy has backfired, but that does not mean the French government is going to turn to more job-creating policies any time soon.
On the contrary, precisely because of the rising unemployment there is tremendous pressure on the government budget. This pressure has led the EU to express major deficit concerns, and after some batting back and forth between Paris and Brussels the French government has now decided to do exactly what the Eurocrats are asking for. The EU Observer reports:
France’s budget plans are “responsible and prudent” Olli Rehn said Wednesday (26 September) in a sign of rapprochement between the EU and the eurozone’s second largest economy. Speaking to reporters in Brussels following talks with French finance minister, Pierre Moscovici, the EU’s economic affairs chief praised what he described as a “huge effort to restore public finances.” However, he warned Paris to keep up plans to reform the country’s labour market and welfare system commenting that the “ambitious reforms over the last year should be maintained.” The meeting comes a day after Moscovici presented plans to save an additional €18 billion from next year’s budget to the National Assembly in Paris.
There is nothing wrong with labor market reforms that reduce the influence of unions and make it easier for employers and employees to sign whatever contracts they want. France has one of the most heavily regulated labor markets in the industrialized world, and any step in the direction of deregulation is going to make a decisive difference for the better.
Strictly theoretically, there is nothing wrong with welfare reforms either. The problem is that the way the EU is pushing those reforms, they would be implemented at a point when the French economy is burdened with 10+ percent unemployment and punitively high taxes. When people are kicked out of welfare rolls, or receive dramatically less support from them, many won’t be able to find a job to replace welfare as income. That is a recipe for social unrest and political turmoil, as is alarmingly evident from the Greek, Spanish and Portuguese austerity experiences.
A far better way forward is to cut taxes proportionately to the reductions in welfare spending, and to cut the taxes in such a way that you maximize job creation. This will create a predictable, macroeconomically sustainable path from big, onerous government to economic freedom.
Sadly yet predictably, we won’t see any of that in the EU, especially not in France. Back to the EU Observer:
Rehn has had an uneasy relationship with French President Francois Hollande’s socialist government. Last month, the commissioner used an interview in the French media to warn Paris that raising taxes would “destroy growth and handicap the creation of jobs.” For his part, Hollande has accused the EU executive of attempting to “dictate” policy. The EU executive has also been frustrated by France’s failure to bring down its budget deficit below the 3 percent threshold laid out in the bloc’s stability and growth pact, giving the country a two year extension to meet the commitment in May.
Again, look at the steady upward trend in seasonally adjusted unemployment figures above. Who in his right mind thinks a government that is losing almost one percent of its taxpayers to unemployment every year would stand any chance at reducing its budget deficit? Then again, the Eurocracy is not populated with independent-minded people. It is staffed to the brim with bureaucratic yes-men.
To make matters even trickier for the French government, its new-found realization that taxes actually hurt the economy has led it to shifting its austerity policies over toward spending cuts. The EU Observer again:
Moscovici conceded that France would run a higher than forecast 4.1 percent this year, falling to 3.6 percent in 2014 and to 3 percent in 2015. Meanwhile, 20 percent of new budget savings in 2014 would come from tax rises with all savings coming from spending cuts in 2015. The government would also reform the pension system and cut labour costs to increase competitiveness, he said.
There are some strict conditions under which austerity biased entirely toward spending cuts could benefit the economy. However, those conditions are hard to meet and without elaborating in detail on them (I will at some point) I can safely say that France is far from meeting them.
Their ability to bring the budget deficit under control will be weakened further as they continue to try to balance their budget in the face of rising unemployment. You don’t need to go far to find evidence of where France is heading – just look at Greece.
As I have reported recently, the European crisis is still cooking. Despite five years of austerity, deficits have not gone away. They are so persistent, in fact, that the European Central Bank has been forced to create an unlimited bond buyback program for troubled welfare states: whatever amounts of Greek, Italian, Spanish, Portuguese or any other euro-denominated Treasury bond anyone wants to sell, the ECB promises to buy them without the buyer losing any money.
This program is not making the welfare-state debt crisis easier, but worsening it. Its ultimate consequence could be high and persistent inflation; in order to see why, let us begin with acknowledging another consequence, namely that you can now buy 100,000 euros worth of ten-year Greek Treasury bonds, get 10,290 euros in interest over a year and then be guaranteed to get your money back as if you had bought a Swiss Treasury bond at 1.09 percent. Two weeks ago I explained the potential consequences of this bond buyback program:
In short: there will come a point when the international bond market will test the ECB’s cash-for-bonds promise. Just to give an idea of how much money the ECB could be forced to print, here is a list of government debt by the most troubled euro zone countries: Government debt 2012
Italy 1,988 bn
Ireland 192 bn
France 1,833 bn
Spain 884 bn
Portugal 204 bn
TOTAL 5,101 bn
Greece, notably, does not report its government debt to Eurostat. Nevertheless, here alone we are talking about five trillion euros worth of government debt. If the ECB had to execute on its bonds buyback program for only ten percent of that, it would have to rapidly print 500 billion euros. To put this in perspective, according to the latest monetary statistical report from the ECB, M-1 money supply in the euro zone is 5.3 trillion euros. Of this, 884 billion euros is currency in circulation while the rest is overnight deposits. If the ECB had to print money to meet a run on the bonds in the countries listed above, it would find itself having to expand the M-1 money supply by up to ten percent in a very short time window (theoretically over night). This is to be compared to the 7.7 average annual growth rate of M-1 in May, June and July of 2013.
For all you statists out there, this means increasing growth in M-1 money supply from 7.7 percent to 17.7 percent. By comparison, the Federal Reserve has increased the U.S. M-1 money supply by an average of 11.5 percent per year over the past 12 months (measured month past year to month current year). The growth rate has dropped in recent months, though, falling to 9.1 percent in August.
A temporary boost in euro money supply to stave off a run-on-the-Treasury wave of bond sales would hurl the euro boat into very rocky waters for some time, but if the buyback program really works as intended, the relentless cash pumping by the ECB will eventually calm things down. The problem for the ECB – just as for the Federal Reserve – is that it is a lot harder to reduce money supply than to increase it. Basically, once the cash is out there in private hands, people are not voluntarily going to give it back to the government.
That is, if the buyback program works as intended. It is a very risky program, especially if it would be extended to other euro-zone countries as well. France alone has 1.8 trillion euros in debt, and even though they are technically not covered by the bond buyback program at this time, they could be the next link in the euro chain to come under stress. Their ridiculous tax policies of late will guarantee very weak GDP performance in the next couple of years. I would be very surprised, frankly, if the French economy manages to grow, on average, in 2013 and 2014.
With zero GDP growth, or worse, tax revenues will not grow as the French government intended. They are still wrestling with a deficit – their taxpayers simply cannot keep up with the cost of the welfare state – and with the new, socialist-imposed extra tax burden that deficit is going to be even more persistent.
Since president Hollande and his socialst cohorts in the French National Assembly have pledged to end austerity, they have opened the door for more government spending. This obviously adds insult to injury for an economy already under great stress. It is therefore increasingly likely that the ECB will have to extend its bond buyback program to cover frog-issued bonds as well.
Given the size of the French economy, and debt, this would put the buyback program to the test. Not immediately, but eventually. Today France is paying lower interest rates on its national debt than the United States, but the trend is upward. After almost two years of declining interest rate costs, early this year the trend shifted direction. Interest rates have been going up since February of this year, and the ten-year French Treasury bond now pays almost a half a percent more than it did this past spring.
When the Spanish government started having problems with selling its bonds, it had to increase the interest rate from four to six percent in less than a year. That is a 50-percent spike in the yield demanded by investors, and at the time back in 2011 it took both the ECB and the Spanish government by surprise. Let’s hope no one is surprised if France finds itself in a similar situation 12-18 months from now.
If the ECB thus finds itself saddled with the responsibility to – at least in theory – have cash ready for almost seven trillion euros worth of government debt, it will have to abandon its prime goal, namely price stability. While the United States has proven that you can increase money supply five, six even eight times faster than GDP without causing high inflation, this does not mean that there is no inflation threat attached to money printing. However,
- if the freshly printed money goes out to the private sector in the form of reckless lending – as in China – then there is an inflation price to pay (the Chinese are looking at six or more percent inflation this year); or
- if the fresh new cash goes into the hands of entitlement recipients, thus feeding private consumption without a corresponding increase in private productive activity,
then high, persistent inflation is knocking on the door.
If the ECB starts buying back Treasury bonds en masse, the latter effect could kick in:
1. Troubled governments know that the ECB will guarantee their bonds, thus significantly reducing their incentives to shrink their deficits;
2. The ECB has attached austerity demands to the buyback program, but those demands have proven totally ineffective against government deficits, thus practically voiding those austerity demands of meaning;
3. Persistent, high and socially stressful unemployment has shifted the fiscal balance in troubled welfare states on a permanent basis, with fewer taxpayers and more entitlement takers; in order to maintain political and social stability national politicians will avoid more cuts in the welfare state;
4. As the welfare state’s spending programs remain and more people join them as a result of the economic crisis, government spending will rise while tax revenues are stalled or even decline.
By allowing an increasing share of the population to live on entitlements, Europe’s troubled welfare-state governments will create an imbalance between productive and improductive economic activity strong enough to drive up inflation.
Add to this the imported inflation that inevitably comes in from other countries when the ECB’s new, massive money supply eventually weakens the currency.
The involvement of the ECB in trying to keep Europe’s welfare states afloat is troubling for many reasons. The prospect of the bond buyback program bringing about inflation is not a very healthy one. But for every year that goes by without the EU doing anything to reform away its welfare states, the scenario outline here, which is somewhat speculative today, moves closer and closer to becoming reality.
Two of the modern world’s eternal questions are:
- When is government big enough for a statist? and
- How big is a welfare-state black hole?
The first question should be on the top of the agenda every time you talk to a statist, be it an American liberal, a European social democrat or any other breed of Homo Collectivus. As for the second question, we have an interesting little case study called Greece. Its welfare state has gobbled up two so called bailouts already, better known as rescue cash supplied by primarily German taxpayers. Each one of those bailouts, managed by the European Union, the European Central Bank and the International Monetary Fund, came with stern warnings to the Greeks to get their fiscal house in good order, and equally stern promises to German taxpayers that this was the last time they’d have to rescue another welfare state in the EU.
The Greek government, of course, did what it was told to do in order to get the bailout cash. It cut spending, raised taxes and laid off thousands of government workers. But because of the higher taxes private-sector economic activity contracted; because of reduced government spending consumers dependent on entitlements had less to spend; because of reduced government subsidies to select product, such as pharmaceutical products private companies on those markets lost sales. Last but not least, the laid-off government workers could not find private-sector jobs, for all the reasons just given.
This does not mean that the welfare state itself is worth keeping. Quite the contrary, the best way forward is to do away with the welfare state entirely. The Greeks have not yet decided to do so, but are instead trying their best to preserve it. They are trying to keep the very entitlement systems that have discouraged work and entrepreneurship for decades; as a result they also have to keep the taxes that, for decades, have added yet another layer of discouragement toward work and entrepreneurship. However, since the current crisis their GDP has been reduced by a staggering 25 percent, which means that they have to squeeze their welfare state into a much tighter tax base. That does not work, of course, especially with unemployment closing in on 30 percent for the entire workforce – and 60 percent for young workers – so the Greek government really only has one choice: to run perpetual deficits.
This is where the German taxpayer enters the scene again. They have already borne a big chunk of the burden of throwing more than 200 billion euros in two bailout packages down the hole of the Greek welfare state. But these packages, which together are about equal to the Greek GDP when it was at its top before the crisis, have proven to be totally inadequate. The Greek welfare state still runs a deficit, its debt is still piling up – and GDP is still contracting.
While this should not surprise anyone who has working knowledge of macroeconomics, it should really not be more difficult than common sense to put the pieces together: if you take money away from people and businesses, they are going to want to spend less and hire fewer people; if you continue, year in and year out, to do the same thing to the private sector, it will continue to respond in the exact same way.
As a result, government will get less tax revenues and have to spend more on entitlements such as unemployment benefits and poverty relief. The bailout cash only helped bankroll these entitlements, but when each of the one-time infusions ran dry the Greeks were back to the same situation again.
Long story short: austerity does not change the structure of the welfare state, but preserves instead the very programs that drive the deficit. Therefore, no one should be surprised that the German taxpayer is now once again called upon to bail out the Greek welfare-state consumer. The EU Observer reports:
A month before general elections in Germany, finance minister Wolfgang Schaeuble has broken the taboo of admitting that Greece will need a third bailout when the current one runs out, in 2014. “There will have to be another programme in Greece,” Schaeuble said on Tuesday (20 August) during a campaign rally in the northern-German town of Ahrensburg. As part of a third programme, he mentioned another lowering of the interest rates on the loans the eurozone has given to Greece. “They are not out of the woods yet,” he said.
Of course, when the first bailout was announced everyone promised that “there will be at least two more bailouts down the road”… Oh, that’s right. They promised quite the opposite.
EU Observer again:
Earlier this year, Germany’s insistence not to deal with a funding gap of almost €10 billion for 2015-2016 delayed the negotiations on the second bailout for Greece, as the International Monetary Fund (IMF) was reluctant to sign off on a programme that does not get the country out of its financial mess once and for all.
You have to sympathize with the IMF, whose management has to go to its main funders, primarily the United States, and ask for more and more bailout money. That can’t be an easy job. But at least they are not dealing directly with taxpayers (and as far as the U.S. government goes, they’ll just sell another stack of IOUs to China…) which is exactly what Germany’s Chancellor Angela Merkel has to do.
But on the more serious front, it is good that the IMF is asking for workable solutions to bring the Greek crisis to an end. Unfortunately, short of dismantling the welfare state there are no such solutions at hand. Since no one in either the IMF, the EU or the ECB is willing to try to sell the phase-out of the welfare state to the Greek government – let alone Greek voters – there will be no end to the Greek crisis until the country effectively collapses. Nobody can accurately predict when that will happen, but when it does, things will get ugly.
The problem for Germany’s taxpayers is that they cannot afford yet another Greek bailout. Since the majority of Germany’s political parties have lined up behind another Greek bailout in one form or another, voters in next year’s German election could switch in large numbers to EU-skeptical parties, such as Alternative fur Deutschland. That would be a change for the better and a signal to all troubled European welfare states to start re-thinking what they cannot afford. Because one thing is certain: if there is a third Greek bailout, it won’t be the last.
Never bark at the big dog.
I have been saying this for 18 months now: the current economic crisis is not a bank crisis – it is a welfare state crisis. The bank bailouts that so many have blamed for the large deficits in Europe are often smaller than the banks’ holdings of government bonds. The losses the banks took on, e.g., real estate speculation were moderate enough for them to handle, if the treasury bonds they also held had remained solid, reliable low-risk anchors in their portfolios.
Then the welfare states were downgraded, one by one. Even the United Kingdom had to take a credit downgrade. Greece, Spain, Portugal, Italy… they all sank toward junk status. Since they in many cases had invested a lot more in treasury bonds than what they needed in bailout, the bailouts did not do much to stabilize their portfolios. Since the banks were already over-exposed to risk they had to restrict their investments in treasury bonds.
This is where the European Central Bank (ECB) stepped in and promised an endless stream of euros in a buyback guarantee for all troubled euro-zone treasury bonds. Whoever wanted to sell it was basically going to be able to send their bonds to the ECB and get a check in the mail the next day. As a result the European bond market stabilized and the notoriously over-spending welfare states could merrily get back to printing treasury bonds.
Not a thing has been done about the underlying problem: the welfare state and its perpetual spending excesses.
Now the chickens are coming home to roost. City AM reports:
Outspoken Bank of England official Andrew Haldane warned yesterday that the bursting of a bond bubble is the biggest threat to the world’s financial stability. Haldane, the Bank’s executive director of financial stability, told the Treasury Select Committee that central banks’ massive asset-buying programmes have created significant risks.
In other words:
“If I were to single out what for me would be the biggest risk to global financial stability right now, it would be a disorderly reversion in government bond yields globally,” Haldane told the MPs. “We’ve intentionally blown the biggest government bond bubble in history. We need to be vigilant to the consequences of that bubble deflating more quickly than we might otherwise have wanted.”
Even more problematic is that an orderly way out of this would require an end to endless borrowing. That end is nowhere near in sight. The only thing that has changed so far is that the on-the-brink nations in southern Europe are not suffering from economically lethal interest rates. That, however, is entirely due to the ECB stepping in with its printing presses and bond buyback program.
But, as City AM notes, it is not just the deeply troubled countries that have seen interest rates rise:
The yield on 10-year UK gilts was 1.65 per cent on 1 May, yet has risen to 2.14 per cent. Specifically, it is feared that the US Federal Reserve could be set to taper its latest bout of QE.
It will be interesting to see how far this will go.
On April 24 I reported that the chairman of the European Commission, Jose Manuel Barroso, was going out and about telling Europe and the world that years of crippling austerity policies were coming to an end. I warned against believing him, especially because the EU was unrelenting in its demands on member states with budget problems to stick to austerity programs.
My warning still stands, for a number of reasons I will outline below. There is growing evidence, though, that the Commission is trying to divest itself of austerity, and the reason is ostensibly that they have come to realize that austerity has become politically toxic. But this does not mean they have abandoned the economic thinking behind austerity, only that they have decided to dress it in new political attire.
A report from Euractiv explains what the Commission now wants for Europe:
The European Commission will further shift the EU’s policy focus from austerity to structural reforms to revive growth when it presents economic recommendations for each member state tomorrow (29 May), officials said. In its annual assessment as guardian of the EU’s budget rules, the Commission will say that while fiscal consolidation should continue, its pace can be slower now that a degree of investor confidence in the euro has been restored.
First of all, investors are more pessimistic about Europe now than they were before the austerity campaign began. This means, among other things, that they believe that either will austerity continue or its effects will linger on in the European economy for a long time to come.
Secondly, the only reason why there seems to be restored confidence in the euro is that the ECB has artificially propped up the value of the treasury bonds of troubled states. The ECB has de facto pledged to buy up every single treasury bond from Greece, Spain, Italy and Portugal. In other words, the confidence is not in the currency but in the short-term soundness of owning Greek, Spanish and Portuguese treasury bonds.
It is really very simple. Normally, investors who lose confidence in, e.g., a treasury bond would demand a very high interest rate to even consider buying it. This drove the interest rate on Spanish treasury bonds up north of seven percent, a rate that means the bond is teetering on the edge of the financial junk yard. At that point, only the boldest investors put any substantial money into it.
Then came the ECB and its guarantee to buy back bonds – in theory an unlimited amount – from anyone who owns Spanish, Italian, Portuguese or Greek bonds. (Technically the guarantee was more limited than that, but the expectation quickly spread that it would apply to all troubled euro countries.) Needless to say, investors suddenly saw a practically unprecedented opportunity to make some really big money: seven percent return on treasury bonds with a 100-percent buyback guarantee.
In order to avail themselves of this unique opportunity, investors had to buy euros. The rise in demand for the money give-away party hosted by governments in southern Europe meant that more people needed more euros. The decline in the euro’s exchange rate stopped and the currency suddenly looked stable.
That is, in a nutshell, what happened in 2012 and early 2013. It is a sordid story, and the political cynicism in it is only reinforced by the fact that the European Commission is using it as an excuse to try to get out of its commitment to austerity. But as we shall see, it is wise not to believe them.
Because highly indebted governments cannot afford to kickstart growth through public spending, they must reform the way their economies are run – by making labour markets more flexible or by opening up product and services markets. ”The main message will be that the emphasis is shifting to structural reforms from austerity,” one senior EU official said. The recommendations, once approved by EU leaders at a summit in late June, will become binding and are expected to influence how national budgets are drafted for 2014 and onwards.
Let us put aside for a moment the ridiculous notion that government spending is a good kick-starter of economic growth. When the EU Commission talks about structural reforms it means deregulation of markets. This may sound like a big leap in the direction of economic freedom, but it really isn’t. Deregulation is always good, but it cannot do the trick on its own. Deregulation of the labor market is Euro-speak for loosening up hire-and-fire laws, thus making it easier for employers to take on workers without a life-long commitment.
This would make a difference for the better, if employers were screaming for more workers. But the reason why there is not more job creation in Europe is not that hire-and-fire laws are in the way of job creation – the reason is that private employers do not see their sales go up. On the contrary, in many countries the private sector is stagnant; the entire economy for the euro area is expected to grow by a microscopic 0.1 percent this year. This translates directly into stand-still sales for millions of businesses, large and small, across Europe.
Why take on more employers when there is no new business for them to take care of?
The other deregulation effort mentioned above is to increase competition on regular consumer-product markets. The idea is to drive prices down, thus give people’s real wages a boost and thereby encourage more consumer spending.
This structural reform could have substantial effects. I remember reading a study back in graduate school (about 1998 or ’99) that showed that disposable income of Danish households was 20 percent higher than otherwise thanks to deregulation efforts a decade earlier. I am not going to vouch for the results of this study as I don’t have it available, but economic theory rather clearly supports the notion that a high degree of competition on consumer markets is good for the economy.
However, once again we run into the problem of a stagnant economy. The Danish economy was thriving back in the ’90s, which made it easy to reap the harvests of deregulation. This does not mean you should not deregulate in a deep recession, but I would caution against believing in this as the sword that will solve the Gordian knot. It takes longer for competition to affect prices in a stagnant market than in a growing market: a stagnant market does not invite nearly as many new sellers as a market characterized by growing sales. It takes longer to recover the costs of investing in sales infrastructure and in establishing a market brand on a stagnant market, compared to one that is booming.
It is therefore safe to conclude that deregulation, while welcome, will have little positive effect on the European economy.
Which brings us back to the austerity issue. I suspect that the EU Commission is basing its deregulation proposals on some glossy forecast of growth. That growth in turn will, they think, grow the tax base and boost government revenues, which in turn will eliminate budget deficits and make austerity redundant.
The ten-thousand euro question, then, is: what will the EU Commission do when they discover that their deregulation efforts have not had nearly the effect they were hoping for? Let us not forget that they are still very much committed to balanced budgets in all euro-area member states (and theoretically in all other EU states as well, though not as adamantly since they have their own currencies). If tax revenues fall short of what the EU Commission needs to declare austerity cease-fire, it is as certain as Amen in church on Sunday that they will return to austerity.
Another piece of evidence to the same conclusion is the fact that they have not even abandoned austerity, just slowed down the pace at which it is being implemented. Euractiv again:
The 17 countries that share the euro will have halved the pace of budget consolidation in 2013 compared to 2012, as the overall budget deficit of the eurozone fell by 1.5% of GDP in 2012 but will only shrink a further 0.75% this year, the European Commission forecast this month. … Unless policies change the overall eurozone consolidation will be only 0.1% of GDP in 2014, the Commission said … The Commission has already indicated that it will give France, the eurozone’s second biggest economy, and Spain, the fourth largest, two extra years to bring their budget deficits below the EU ceiling of 3% of GDP, and other countries are also expected to get a year’s extension.
The flattening-out effect is probably under-estimated. The reduction in deficit-to-GDP in 2012 is the accounting-style effect of a slew of austerity programs in Spain, Greece, Italy, Portugal, the Netherlands and France. Once these programs have gone into effect – which they now have – they will start spreading their venom into the economy. Governments take more money from the private sector and give less back. Private sector activity is depressed, resulting in lower GDP growth. The tax base shrinks compared to the forecast that the EU Commission had in mind, and the deficit-to-GDP ratio starts rising again no later than 2014.
Bottom line is that the EU Commission has not given any country a pass on austerity, only some leeway to take a couple of extra years to shove the bitter pill down the throats of their voters. Austerity remains the top item on their agenda.
And just to reinforce this point, Euractiv explains that in exchange for more leeway on austerity…
both France and Spain will have to commit to broad structural and labour-market reforms intended to make their economies more competitive and help create jobs.
In other words: austerity first, then maybe some reforms to boost the tax base. If the reforms don’t work, the governments of both France and Spain will be forced back into the fiscal torture chambers again.
One final note. Nowhere in this does the EU Commission speak of structural reforms that actually reduce government spending on a permanent basis. Which makes the welfare state the elephant in the room that no one is talking about.
Except, of course, The Liberty Bullhorn. Here, on the other hand, we already have a plan for doing away with the welfare state.
By now, everyone around the world has probably heard that Spain is de facto in fiscal default – i.e., bankrupt. The IMF, whose report Fiscal Monitor number 1301 presented the numbers showing that Spain is practically in default, does not offer an explicit analysis of the default scenario itself, but it gives a very illuminating background to the proliferating economic tragedy in Europe.
I will do an analysis of the Fiscal Monitor report later; for now, let’s return to Spain and the notable fact that the country has gone into effective bankruptcy despite the commitment by the European Central Bank to buy up every euro’s worth of Spanish treasury bonds. This commitment meant two things:
- owners of Spanish bonds would always be able to sell them, thus putting a mild downward pressure on the interest rate; and
- the Spanish government would be able to finance its own debt in perpetuity – all it would have to do would be to issue more debt, i.e., to ask the ECB to print more money.
This is a slight simplification, as the Spanish government would still have to meet certain fiscal criteria, such as continued austerity. But at the same time, if a central bank issues a guarantee to buy all bonds that its government issues in order to bring down the interest rate on those bonds, you cannot condition your promise on fiscal austerity. As soon as the government must take fiscal steps to maintain the central bank’s purchasing guarantee, the guarantee loses its inherent value. It is no longer worth any more than the bonds it is supposed to guarantee.
In other words, meaningless.
Assuming that the ECB does not make meaningless promises, the Spanish de facto default is all the more remarkable – and comes with serious warnings to everyone with money in Spain: get out or face a Cypriot Bank Heist seizure of your assets.
Here is what Jeremy Warner said in the Daily Telegraph a couple of days ago:
Next year, the [Spanish] deficit is expected to be 6.9 per cent [of GDP], the year after 6.6 per cent, and so on with very little further progress thereafter. Remember, all these projections are made on the basis of everything we know about policy so far, so they take account of the latest package of austerity measures announced by the Spanish Government.
Which means that we can expect an increase in the deficit ratio in the future, as forecasters often forget to incorporate the negative effects of austerity on GDP.
The situation looks even worse on a cyclically adjusted basis. What is sometimes called the “structural deficit”, or the bit of government borrowing that doesn’t go away even after the economy returns to growth (if indeed it ever does), actually deteriorates from an expected 4.2 per cent of GDP this year to 5.7 per cent in 2018.
This is important, because it shows that there is a structural change going on in the Spanish economy. People are paying permanently higher taxes and get permanently less back from government for that money. The private sector has been permanently diminished and an entire generation of young Spaniards has been sentenced to a life on welfare.
By 2018, Spain has far and away the worst structural deficit of any advanced economy, including other such well known fiscal basket cases as the UK and the US. So what happens when you carry on borrowing at that sort of rate, year in, year out? Your overall indebtedness rockets, of course, and that’s what’s going to happen to Spain, where general government gross debt is forecast to rise from 84.1 per cent of GDP last year to 110.6 per cent in 2018. No other advanced economy has such a dramatically worsening outlook.
But Greece did, and they ended up losing one quarter of the GDP.
Unfortunately, Jeremy Warner does not see the damage done by austerity:
And the tragedy of it all is that Spain is actually making relatively good progress in addressing the “primary balance”, that’s the deficit before debt servicing costs.
The “progress” consists of increasing taxes and reducing spending in an entirely static fashion. There is no analysis behind the austerity efforts of the long-term effects they will have on the economy. For example, the increase in the value-added tax that was enacted last year reduced the ability of consumers to spend on other items. This reduced private consumption and forced lay-offs in retail and other consumer-oriented industries. The laid off workers went from being taxpayers to being full-time entitlement consumers. As they did they reduced the tax base and cut tax revenues for the government in the future.
This point aside, Warner explains well the bankruptcy side of the issue:
What’s projected to occur is essentially what happens in all bankruptcies. Eventually you have to borrow more just to pay the interest on your existing debt. The fiscal compact requires eurozone countries to reduce their deficits to 3 per cent by the end of this year, though Spain among others was recently granted an extension. But on these numbers, there is no chance ever of achieving this target without further austerity measures … it seems doubtful an economy where unemployment is already above 25 per cent could take any more. … All this leads to the conclusion that a big Spanish debt restructuring is inevitable.
Debt restructuring, of course, being the same as bankruptcy. In a matter of speaking, Greece did a “bankruptcy light” when they unilaterally wrote down their debt. In the case of Spain it would probably mean a much bigger debt writedown than in Greece.
Back to Warner:
Spanish sovereign bond yields have fallen sharply since announcement of the European Central Bank’s “outright monetary transactions” programme. … But in the end, no amount of liquidity can cover up for an underlying problem with solvency. Europe said that Greece was the first and last such restructuring, but then there was Cyprus.
And toward the end Warner issues a fair warning about a repetition of the Cyprus Bank Heist:
Confiscation of deposits looks all too possible. I don’t advise getting your money out lightly. Indeed, such advise is generally thought grossly irresponsible, for it risks inducing a self reinforcing panic. Yet looking at the IMF projections, it’s the only rational thing to do.
Spain is the fourth largest euro-area economy, with ten percent of the euro zone GDP. If we add Greece, Cyprus and an all-but-certain Portuguese de facto bankruptcy, we would now have 14 percent of the euro area economy declared practically insolvent. As Jeremy Warner so well explains, the point where this bankruptcy becomes a fact is one where the macroeconomy in a country is permanently unable to bear the burden of government.
This means that 14 percent of the euro-zone economy will be at a point where it is acutely unable to fund the welfare state.
What conclusions will Europe’s elected officials draw from that? It remains to be seen, though it is not far fetched to assume that no one will be ready, willing or courageous enough to remove the welfare state.
That is too bad, because it means – again – that Europe is stuck in a permanent state of industrial poverty. Hopefully, America’s elected officials will watch, learn and do the right thing.