This Is A Welfare State Crisis

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.

Structural Reform Euro-Speak for Austerity

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.

Euractiv again:

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.

ECB Guarantee Did Not Save Spain

By now, everyone around the world has probably heard that Spain is de facto in fiscal default – i.e., bankrupt. The IMF, whose report Fiscal Monitor number 1301 presented the numbers showing that Spain is practically in default, does not offer an explicit analysis of the default scenario itself, but it gives a very illuminating background to the proliferating economic tragedy in Europe.

I will do an analysis of the Fiscal Monitor report later; for now, let’s return to Spain and the notable fact that the country has gone into effective bankruptcy despite the commitment by the European Central Bank to buy up every euro’s worth of Spanish treasury bonds. This commitment meant two things:

  1. owners of Spanish bonds would always be able to sell them, thus putting a mild downward pressure on the interest rate; and
  2. the Spanish government would be able to finance its own debt in perpetuity – all it would have to do would be to issue more debt, i.e., to ask the ECB to print more money.

This is a slight simplification, as the Spanish government would still have to meet certain fiscal criteria, such as continued austerity. But at the same time, if a central bank issues a guarantee to buy all bonds that its government issues in order to bring down the interest rate on those bonds, you cannot condition your promise on fiscal austerity. As soon as the government must take fiscal steps to maintain the central bank’s purchasing guarantee, the guarantee loses its inherent value. It is no longer worth any more than the bonds it is supposed to guarantee.

In other words, meaningless.

Assuming that the ECB does not make meaningless promises, the Spanish de facto default is all the more remarkable – and comes with serious warnings to everyone with money in Spain: get out or face a Cypriot Bank Heist seizure of your assets.

Here is what Jeremy Warner said in the Daily Telegraph a couple of days ago:

Next year, the [Spanish] deficit is expected to be 6.9 per cent [of GDP], the year after 6.6 per cent, and so on with very little further progress thereafter. Remember, all these projections are made on the basis of everything we know about policy so far, so they take account of the latest package of austerity measures announced by the Spanish Government.

Which means that we can expect an increase in the deficit ratio in the future, as forecasters often forget to incorporate the negative effects of austerity on GDP.

The situation looks even worse on a cyclically adjusted basis. What is sometimes called the “structural deficit”, or the bit of government borrowing that doesn’t go away even after the economy returns to growth (if indeed it ever does), actually deteriorates from an expected 4.2 per cent of GDP this year to 5.7 per cent in 2018.

This is important, because it shows that there is a structural change going on in the Spanish economy. People are paying permanently higher taxes and get permanently less back from government for that money. The private sector has been permanently diminished and an entire generation of young Spaniards has been sentenced to a life on welfare.

By 2018, Spain has far and away the worst structural deficit of any advanced economy, including other such well known fiscal basket cases as the UK and the US. So what happens when you carry on borrowing at that sort of rate, year in, year out? Your overall indebtedness rockets, of course, and that’s what’s going to happen to Spain, where general government gross debt is forecast to rise from 84.1 per cent of GDP last year to 110.6 per cent in 2018. No other advanced economy has such a dramatically worsening outlook.

But Greece did, and they ended up losing one quarter of the GDP.

Unfortunately, Jeremy Warner does not see the damage done by austerity:

And the tragedy of it all is that Spain is actually making relatively good progress in addressing the “primary balance”, that’s the deficit before debt servicing costs.

The “progress” consists of increasing taxes and reducing spending in an entirely static fashion. There is no analysis behind the austerity efforts of the long-term effects they will have on the economy. For example, the increase in the value-added tax that was enacted last year reduced the ability of consumers to spend on other items. This reduced private consumption and forced lay-offs in retail and other consumer-oriented industries. The laid off workers went from being taxpayers to being full-time entitlement consumers. As they did they reduced the tax base and cut tax revenues for the government in the future.

This point aside, Warner explains well the bankruptcy side of the issue:

What’s projected to occur is essentially what happens in all bankruptcies. Eventually you have to borrow more just to pay the interest on your existing debt. The fiscal compact requires eurozone countries to reduce their deficits to 3 per cent by the end of this year, though Spain among others was recently granted an extension. But on these numbers, there is no chance ever of achieving this target without further austerity measures … it seems doubtful an economy where unemployment is already above 25 per cent could take any more. … All this leads to the conclusion that a big Spanish debt restructuring is inevitable.

Debt restructuring, of course, being the same as bankruptcy. In a matter of speaking, Greece did a “bankruptcy light” when they unilaterally wrote down their debt. In the case of Spain it would probably mean a much bigger debt writedown than in Greece.

Back to Warner:

Spanish sovereign bond yields have fallen sharply since announcement of the European Central Bank’s “outright monetary transactions” programme. … But in the end, no amount of liquidity can cover up for an underlying problem with solvency. Europe said that Greece was the first and last such restructuring, but then there was Cyprus.

And toward the end Warner issues a fair warning about a repetition of the Cyprus Bank Heist:

Confiscation of deposits looks all too possible. I don’t advise getting your money out lightly. Indeed, such advise is generally thought grossly irresponsible, for it risks inducing a self reinforcing panic. Yet looking at the IMF projections, it’s the only rational thing to do.

Spain is the fourth largest euro-area economy, with ten percent of the euro zone GDP. If we add Greece, Cyprus and an all-but-certain Portuguese de facto bankruptcy, we would now have 14 percent of the euro area economy declared practically insolvent.  As Jeremy Warner so well explains, the point where this bankruptcy becomes a fact is one where the macroeconomy in a country is permanently unable to bear the burden of government.

This means that 14 percent of the euro-zone economy will be at a point where it is acutely unable to fund the welfare state.

What conclusions will Europe’s elected officials draw from that? It remains to be seen, though it is not far fetched to assume that no one will be ready, willing or courageous enough to remove the welfare state.

That is too bad, because it means – again – that Europe is stuck in a permanent state of industrial poverty. Hopefully, America’s elected officials will watch, learn and do the right thing.

Europe Drowning in Debt

The European economy is in bad shape. On May 3 the EU Observer reported:

The eurozone economy will contract by 0.4% in 2013, Economics commissioner Olli Rehn said Friday. Presenting the EU commission’s Spring Economic Forecasts, Rehn said that the bloc would return to growth in 2014 by a slower-than-expected 1.2%. Meanwhile, the average debt levels will hit 96% in 2013.

Looking at the 27 EU member states, things are looking almost as bad: inflation-adjusted GDP growth is forecast to be 0.4 percent this year, though that will probably be adjusted downward in the next few months. EU institutions that publish economic forecasts have a tendency to downgrade their forecasts as the present catches up with the future.

At the same time, total general government debt in the 27 EU countries is heading the other way: from 2010 to 2012 those countries added 1.4 trillion euros to their total debt. In terms of growth rates, EU-27 have added debt at frightening rates over the past few years:

2008: 6.1 percent

2009: 12.8 percent;

2010: 12.3 percent;

2011: 6.7 percent;

2012: 6.7 percent.

Due to an almost total absence of GDP growth, the ratio of debt to current-price GDP has grown at stunning rates:

Debt to GDP EU27

To reinforce the persistent nature of the economic crisis, the EU Observer also reports:

France has moved centre stage in the crisis, after EU economic affairs commissioner Olli Rehn said that the country would fall into recession in 2013 and needs two more years to bring down its budget deficit. Presenting the Commission’s Spring Economic Forecasts on Friday (3 May), Commissioner Rehn described Paris’s forecasts, based on a mere 0.1 percent growth rate, as “overly optimistic.”

It is hard to see how France has ever been out of the Great Recession. From 2008 through 2012 the French economy averaged 0.06 percent in real GDP growth. During the same period of time its debt-to-GDP ratio went from 68.2 percent to 90.4 percent.

This explains why, as I reported recently, the French government is panicking over the prospect of more austerity. They know it has not worked for their southern neighbors and they are not going to stir up the same kind of political turmoil as those policies did in, e.g., Greece. The socialist French government knows that parties like Front National – often perceived, wrongly so, to be ideologically close to the Greek Nazis, Golden Dawn – as well as radical communists could make significant political gains if the French people were subjected to the same bone-crushing fiscal measures as the Mediterranean EU members have implemented.

The French resistance to more austerity caused the EU Commission recently to declare that the War of Austerity is over. It is not, of course, or else there would be a complete course change throughout southern Europe. Furthermore, the EU Commission would not be continuing to pressure Paris over balancing its budget in the midst of a recession. The EU Observer again:

The eurozone’s second largest economy would run deficits of 3.9 percent in 2013 and 4.2 percent in 2014, he said, calling on Francois Hollande’s government to draw up a “front loaded” package of cuts and labour market reforms to stop “persistent deterioration of French competitiveness.” For its part, Paris maintains that it will reduce its deficit to 2.9 percent in 2014, fractionally below the 3 percent limit in the EU’s Stability and Growth Pact. Hollande in March announced that an additional €20 billion worth of tax rises and €10 billion in spending cuts would be included in his budget plans but said no further cuts would be made.

Because if he tries, the socialist government is going to end up in real trouble. Many of the prime minister’s cabinet members are truly fearful of more austerity, for various reasons.

But wait, there’s more:

Crisis-hit Cyprus, which has now finalised a 10 billion bailout, is set to be worst hit by recession with an 8.7 percent fall in output. Meanwhile, the average national debt pile is expected to peak at 96 percent of GDP in 2014, with six countries – Belgium, Ireland, Greece, Italy, Cyprus and Portugal – having debts larger than their annual economic output. Rehn indicated that Spain would also be given an additional two years to bring its deficit down to the 3 percent threshold, while Slovenia would also need more time.

So long as Europe keeps its welfare state, it has no way out. The welfare state is what is driving Europe’s crisis today, and it will continue to do so for as long as the welfare state exists. Nothing is changing for the better. Europe is drowning in its entitlement-driven government debt. The continent is stuck, and the talk about austerity being over is politically motivated hot air.

I stand my my diagnosis: austerity policies exacerbated the financial crisis into a welfare state crisis and turned Europe into an economic wasteland. What used to be a thriving industrialized continent is now facing an endless future of industrial poverty.

Europe’s Crisis Gaining Momentum

It is beginning to dawn on the European political elite that their superstate project, their welfare state and their currency union are on a runaway train heading for disaster. Media is beginning to pick up on that as well. Here is a nice summary by Benjamin Fox at the EU Observer:

February 22 was a black Friday wherever you were in Europe. The morning brought the publication of dismal economic data to the effect that the eurozone will remain in recession in 2013.

Only a statistical illiterate would have thought otherwise.

Then, at 10pm Brussels time as the the markets closed, ratings agency Moody’s quietly issued a statement stripping the UK of its AAA credit rating. For those lulled into a false sense of security through a recent combination of relatively benign financial markets and the euro strengthening against sterling and the yen, it was a rude awakening.

That surge was due mainly to one thing: the commitment by the European Central Bank to print an infinite amount of euros to back its worst-rated treasury bonds. That commitment told global investors that “you can get seven percent return on Spanish treasury bonds and always get your investment back from us – come Hell or High Water!” Of course the euro is going to experience a temporary surge under such ridiculous, and totally unsustainable conditions.

EU Observer again:

Reading the European Commission’s Winter Forecast is a singularly dispiriting experience. The bald figures are that the eurozone is expected to remain in recession with a 0.3 percent contraction in 2013. The words “sluggish … weak … vulnerable … modest … fragile’” litter the 140 pages of charts and analysis.

Some examples of GDP growth numbers from the Forecast: Britain +0.9 percent in 2013; Austria +0.7 percent; Germany +0.5 percent; France +0.1 percent; Netherlands -0.6 percent; Italy -1.0 percent; Spain -1.4 percent; Portugal -1.9 percent; Greece -4.4 percent.

There are a couple of exceptions with slightly higher growth rates, primarily Sweden and Poland. Both economies are heavily dependent on exports and compete increasingly for the same low-paying manufacturing jobs. Due to a better working labor market and a more friendly tax environment my bet is Poland will eke out a victory in that competition, which would further depress the Swedish growth number.

That aside, there is a lot to be seriously worried about in the Commission’s Winter Forecast numbers. The overall standstill in GDP is very worrying, as 2013 represents the fifth year of a crisis that was originally relatively manageable but which has been made far worse by disastrous austerity measures. Since the Eurocracy – both political and administrative – remains committed to austerity, it is basically impossible to find any scenario that would allow Europe’s troubled economies to pull out of this endless recession.

I have warned about this before, and I recently drew the conclusion that Europe is in a state of permanent decline and that this permanent decline involves a drastic reduction in the standard of living for young Europeans – their prosperity is, so to speak, on hold. I also recently explained that Europe now represents what we could define as industrial poverty, that it is becoming an economic wasteland plagued by high unemployment, a static standard of living and overall lost opportunities for everyone except a small, political elite that – thus far – can live high on the hog in the Eurocratic ivory tower.

Perhaps I should take joy in the fact that my analysis has been spot on all the way. But that would be cynical, and I am not prone to either cynicism or schadenfreude. I am sincerely angered by what big government has done to Europe, and I fear that the only way out of this situation is a political Balkanization of the entire continent. That means a disorderly fragmentation, with outlier countries being ruled by fascists or stalinists (In Greece, both are about the same influential size in parliament) and panic forcing a return to national currencies under great financial and fiscal turmoil.

I would of course like to see Europe make an orderly retreat from the EU project, and I wholeheartedly support Euroskeptic heroes like Nigel Farage in fighting to secure that orderly retreat. However, as things look right now I predict that the economic crisis that is sweeping like a bonfire across Europe will burn down the better of the European economy before Mr. Farage and his fellow Euroskeptics gain enough momentum to put out that fire with free-market reforms and structural reductions to Europe’s enormous government.

Unfortunately, there is a lot to back up that last prediction. One example: the Greek economy is going to contract by another 4.4 percent in 2013. The Greek have already lost one quarter of their GDP since the crisis began in 2009. This is nothing short of economic free-fall, a recession that has escalated into full-scale depression, fueled by the destructive forces of austerity.

Back to Benjamin Fox in the EU Observer:

Spain’s budget deficit has cleared 10 percent. The average eurozone country now has a debt to GDP ratio of 95 percent – a figure that observers had previously thought was applicable only to Italy and Greece.

Those observers thought austerity would improve economic conditions in the countries where it is applied. It does not, it never has and it never will.

Mr. Fox then notes that the crisis is spreading beyond its “origin”, Greece:

While the Greek economy will contract by a further 4.4 percent this year – by the end of 2013 Greek economic output will have fallen by more than a quarter in five years – the clear indication from the Winter Forecast is that Athens is no longer in the eye of the storm.  Paris and Madrid now have that unwanted place. France was one of a handful of countries called out for censure by commissioner Rehn on Friday. The French budget deficit remains stubbornly high, falling by a mere 0.6 percent to 4.6 percent in 2012. The commission’s projections have it remaining above the 3 percent threshold in 2013 and 2014. Ominously, Rehn told reporters that the commission would prepare a full report on France’s public spending after Paris prepares its next budget plan, adding that President Francois Hollande’s government needs to “pursue structural reforms alongside a consolidation programme.”

The Eurocrats may get away with destroying 25 percent of the Greek economy. But before they set out to do the same to France, they should consider the law of big numbers. France is the second largest euro-zone economy. If you destroy one quarter of that economy, you will accelerate the current European crisis from a looming depression into something that could even be more devastating than the Great Depression.

Mr. Rehn and his Eurocrat cohorts are not playing with fire. They are playing with a macroeconomic Hiroshima.

Benjamin Fox at the EU Observer does not quite seem to get the magnitude of the problems he is reporting, but that does not take away from his reporting them:

Some of the figures that leap off the pages of the Spanish assessment are truly alarming. Spain’s budget deficit actually increased to 10.2 percent in 2012, although the data does not include the savings from spending cuts and tax rises at national and regional level in the final weeks of the year, estimated to be worth 3.2 percent. Even then, the country will still have averaged a 10 percent deficit over the last four years. By the end of 2014, its debt pile will have nearly doubled to 101 percent of GDP over the space of five years.

Well, the good old Keynesian multiplier will tell you that if you contract government spending by 3.2 percent of GDP in that short of a time period, you can expect the private sector to contract by at least as much over the next 4-6 quarters. However, a recent IMF study showed that the multiplier works faster for reductions in government spending than for any type of increase in macroeconomic activity. Therefore, the negative repercussions of these Spanish austerity measures could begin to make themselves known in the Spanish economy already in the first quarter of this year.

Such a contraction in private-sector activity will erode the tax base and increase demand for tax-paid entitlements. As a result, the deficit will bounce back up again and probably exhibit a net increase.

In other words, what Mr. Fox sees as a mysterious persistence in deficits is really a logical consequence of the economic policies of the Spanish central and regional governments.

One of the many social disasters that will characterize the permanent European decline is very high, very costly unemployment. Mr. Fox notes this:

The headline rate of 11.7 percent unemployment across the eurozone is bad enough, but it is the sharp rise in long-term joblessness that is most concerning. Forty five percent of the EU’s unemployed have been out of work for more than a year, and in eight countries this figure rises to over one in two. In Spain, Greece and Portugal, where the unemployment rate is above 15 percent and youth unemployment sits close to one in two…

That’s 50 percent youth unemployment. Consider what that means for the loyalty of the young toward their country – and its political, economic and cultural leaders.

…millions of Europeans risk being locked out of the labour market for good. In the foreword to the Winter Forecast, Marco Buti, head of the commission’s economics department, rightly acknowledges the “grave social consequences” resulting from the unemployment crisis. But it is more dangerous than that. As the commission paper concedes “long-term unemployment is associated with lower employability of job seekers and a lower sensitivity of the labour market to economic upturns.” The longer people are out of work, the more likely it is that high unemployment rates become a structural feature of the European economy.

Not to mention their proneness to support extremist political parties. Support for Golden Dawn, the Greek Nazis, does not come solely from the police and the military.

I am sometimes asked what I think Europe can do about this crisis. I have tossed and turned that question around, and I am sad to say that my answer is very short: “very little”. That said, here are some desperate measures that could at least give Europe a chance:

1. Fiscal cease-fire. Stop with the austerity measures right now.

2. Labor-market deregulation. Most of Europe suffers from very rigid hire-and-fire laws. Give Europe’s employers a chance to take on new workers without having to make a de facto life-time commitment to them.

3. Flatten the tax structure. One of Europe’s most discouraging features is the steep marginal income taxes. Give job creators a chance to keep more of their money.

4. Orderly EU retreat. Let the Euroskeptics design a plan to dismantle the entire EU project and liberate the nation states – and, most important of all, their peoples – from this authoritarian, growth-stifling, freedom-eating bureauacracy.

5. Bye, bye to the welfare state. Europe needs a long-term plan – unique to each country – to get rid of its entitlement-based welfare state. Some ideas for America can perhaps be of inspiration for Europe as well.

These are, again, some very short points. I do not see fertile ground for either of them at this point, let alone for a more elaborate plan. However, there may still be hope to save individual countries, such as Britain, if right-minded political leaders can gain more influence.

But even if Britain and a couple of other countries escape the fury of the current crisis, the political, economic and social landscape of Europe will look very different in five years than it does today. And it won’t be for the better of Europe’s suffering masses.

Danish Banker Sees End of Euro

Just as the Eurocrats thought they had managed to talk down the euro crisis and save their beloved currency union, a little Danish boy steps out of the crowd and points out that the emperor still has no clothes. From Bloomberg.com (via Zerohedge):

Lars Seier Christensen, co-chief executive officer of Danish bank Saxo Bank A/S, said the euro’s recent rally is illusory and the shared currency is set to fail because the continent hasn’t supported it with a fiscal union.

I spent six years in Denmark. Danes are serious professionals, they are upfront, free-spirited and they have no problem speaking the truth. Culturally, When you hear this from a man in this position within the private sector in Denmark, you better listen.

“The whole thing is doomed,” Christensen said yesterday in an interview at the bank’s Dubai office. “Right now we’re in one of those fake solutions where people think that the problem is contained or being addressed, which it isn’t at all.”

Exactly. The main reason why the euro appears to be stable at this point is that the European Central Bank has put a cooler on the bonfire-like debt crisis by promising to buy any euro-denominated treasury bond, anywhere, any time. Technically, the promise was limited to the most troubled eurozone countries, but by implication it extends to all member states.

This uncapped promise has allowed international investors to go back into high-yield euro-denominated treasuries from primarily Greece, Portugal, Spain and Italy. Secondarily, they can also invest with similar confidence in French treasuries, which are next on the troubled-bonds list. Thereby the ECB removed a major reason for investor flight out of the euro, temporarily strengthened the currency and created the false impression that the crisis is over.

It is not. Bloomberg.com again, which paints a picture of declining GDP and a new phase in the debt crisis:

The European Central Bank forecasts the euro-area economy will shrink 0.3 percent this year … [and while] the euro has strengthened, the economies of Germany, France and Italy all shrank more than estimated in the fourth quarter. Ministers from the 17-member euro area met during the week to discuss aid to Cyprus and Greece as a tightening election contest in Italy and a political scandal in Spain threaten to reignite the region’s debt crisis.

Greece has suffered from a shrinking GDP for years now. Since the recession-turned-depression started they have lost roughly a quarter of their economy. That is extreme, but it shows the devastating consequences of combining austerity with an entirely artificial currency union. Furthermore, it should be a warning sign to the Eurocrats as well as other member states to not adopt the same kind of fiscal policy in their countries. Yet that is precisely what seems to be in the making: the “aid” to Cyprus and – again – to Greece will consist of a buyout of treasury bonds combined with austerity requirements.

There can be only one outcome: more of the same crisis.

As Bloomberg.com continues, it illustrates the dire situation of the European economy, a situation that according to Danish banker Christensen is going to be the undoing of the euro:

France is grappling with shrinking investment, job cuts by companies such as Renault SA and pressure from European partners to speed budget cuts. While Germany expanded 0.7 percent last year…

That’s a pathetic “growth” rate for an economy like the German.

…France posted no growth and Italy probably contracted more than 2 percent, the weakest in the euro area after Greece and Portugal, according to the European Commission. The economy is on the brink of its third recession in four years and the highest joblessness since 1998. Prime Minister Jean-Marc Ayrault said Feb. 13 the country won’t make its budget-deficit target of 3 percent of gross domestic product this year as the economy fails to generate growth and taxes.

The pursuit of a balanced budget is the enemy of growth. So long as the political leaders of Europe’s big welfare states do not want to concede that their countries can no longer afford their big, onerous, sloth-encouraging entitlement programs, there will be no change in the course of the European economy. The welfare states will continue to drive up deficits and drive down growth. The EU will continue to demand austerity, which will further drive down growth and widen the deficit gaps in government budgets. Europe will stagger and stumble, but there is no chance it will ever recover under its current big, redistributive goernment.

In a nutshell, all you Europeans: this  is as good as it gets.

And just to add some more salt in Europe’s self-inflicted wounds, Bloomberg. com tops off with a stark reminder of the economic reality the Europe is stuck in:

“People have been dramatically underestimating the problems the French are going to get from this. Once the French get into a full- scale crisis, it’s over. Even the Germans cannot pay for that one and probably will not.” … Spain, which plans to sell three- and nine-month bills tomorrow and bonds maturing in 2015, 2019 and 2023 on Feb. 21, faces a sixth year of slump. Output is forecast to contract for a second year in 2013 with unemployment at 27 percent amid the deepest budget cuts in the nation’s democratic history. Public-sector debt is at record levels, having more than doubled from 40 percent of gross domestic product in 2008. The European Commission, which is due to update its forecasts this week, sees it rising to 97.1 percent of GDP next year.

This is the crisis that the ECB is trying to cover with an endless monetary commitment to defend the euro. But the deficits do not go away, and economic growth does not return. In its desperate fight to save the euro and the welfare state, Europe’s political leaders will bleed the former dry and deplete the latter of any money to honor its entitlement commitments.

I stand by my verdict: Europe is in permanent decline,  it is turning itself into an economic wasteland of industrial poverty that over time will be left behind by North America and Asia.

Hate Tax Coming to Britain

The vastly unsuccessful French hate tax has driven scores of highly productive French professionals and entrepreneurs into financial diaspora. As things look right now, the French government can be happy of the 75-percent marginal income tax bracket does not lead to a net loss of revenue.

You would expect politicians in other countries to pay close attention to what the French are doing – and learn. However, since the advocates of hate taxes on high-income earners are socialists almost by definition, it would be illogical to expect them to take a logical look at the consequences of hate-taxing the rich. To them, the confiscatory principle behind the tax is an ideological motivator that has nothing to do with economic results.

There is, however, a large segment of people in the middle of the political spectrum who are not ideologically married to hate taxes, who are open to economic arguments but who may be swayed in favor of such taxes just because they are concerned about the government’s budget. Those people are the make-or-breakers of already highly taxed economies: on the one hand, a hate tax will break the back of the last segment of productive citizens; on the other hand, avoiding the hate tax opens for reforms that can actually improve an economy and put it back on its right track again.

Unfortunately, it seems as though the French hate tax initiative could have planted the seed of a global trend. South Africa is considering following in the French footsteps, and there are now voices in Britain in favor of similar policies. From the Daily Express:

Calvin Coolidge, the far-sighted American President of the 1920s, once said that “collecting more taxes than is absolutely necessary is legalised robbery.” Tragically, his wise words appear to have been lost on our political class, whose members spend much of their time dreaming up new ways to grab our cash. As the appetite of the state machine becomes ever more ravenous, so the tax system grows ever more oppressive. Now the Liberal Democrats want to expand the scope of this confiscatory regime even further.

The British Liberal Democrat party has long claimed that its reason to exist is that British politics needs a strong middle-of-the-road party, a compromise between conservative Tories and social-democrat Labor. That has changed over time, of course, as the Tories have drifted in toward the middle and the Liberal Democrats have become an increasingly clone-like copy of the main stream of the Labor party.

Nevertheless, it is noteworthy that this is the party that now proposes a hate tax. It verifies the theory that there is a critical mass in the center of politics that can be swayed by socialists into supporting anti-rich taxation, typically in the name of fiscal responsibility.

QED, as the Daily Express reports:

A plan drawn up by the party’s Federal Policy Committee proposes a wide-ranging new so-called “wealth tax”, targeted at anyone with assets estimated to be worth more than £2 million in total. The sum would include not just property but all possessions, including shares, paintings, jewellery, cars, and furniture, on which the owners have probably already paid tax.

Imagine the bureaucracy needed to assess the values of all these various kinds of property. Of course, the Liberal Democrats have already thought of this, as they suggest that “tax inspectors would be given unprecedented new powers to go into homes and check the valuations of personal effects.” So much for personal integrity, something European liberals typically claim to be staunch supporters of.

Daily Express again:

This is not the first time the Lib Dems, always eager to differentiate themselves from the Tories, have demanded an attack on the affluent. The party has long been wedded to the idea of a “mansion tax”, focused on houses worth more than £2million, while last autumn the Deputy Prime Minister [Liberal Democrat] Nick Clegg urged the introduction of “an emergency wealth tax on Britain’s richest” as part of the “economic war” against the deficit.

Just wait for that term to make it Stateside. It almost sounds like the campaign slogan of an Andrew Cuomo or a Martin O’Malley running for the Democrat ticket in 2016. Especially Governor O’Malley would be ready to validate virtually any tax policy under the guise of a “war against the deficit”. During his tenure as chief executive of Maryland, O’Malley has raised a tax on average every ten weeks.

Back to Britain, where the Daily Express makes a formidable point about hate taxes:

Enthusiasts for this sort of aggressive taxation like to pretend that only the very richest will be hit. But the lesson from history is that, once a new tax is established, ever larger numbers are sucked within its destructive embrace. That is certainly true of the upper rate of income tax. Only 30 years ago, just 3 per cent of taxpayers fell into this category. Now, through the cynical process of failing to raise thresholds in line with inflation, more than 15 per cent of earners are upper rate taxpayers. Soon, more than five million people, including ordinary middle- class people, will be paying income tax at 40 per cent. The same is true of so many other taxes, such as inheritance duties, which were once aimed at the only the wealthiest but now catch huge swathes of the population in their net.

Americans should take note and remember the Alternative Minimum Tax. The problems caused by the AMT will be absolutely nothing compared to what a “war on the deficit” and its hate-the-rich taxes would do to our economy.

The Daily Express concludes, aptly:

If state control and hatred of the rich really worked, then North Korea would be the most prosperous nation on earth, not a land of misery.

This is a very important point – there is no better place in the world to study the contrast between statism and capitalism than on the Korean peninsula. We should not have to go to such extremes to explain why statism does not work, but on the other hand, if friends of freedom do not take the incrementalist strategy of the left seriously, the only question remaining to answer is how small the difference will be between our society and North Korea before the left is satisfied.

That, in turn, is like asking an American liberal or a European social democrat: when is government big enough? So far I have not heard even a shred of an answer to that question. What I do hear, though, is a cacophony of new ideas for how to expand government, ideas that are produced increasingly by mainstream “moderates” in European as well as American politics.

The fact that hate taxes on the “rich” are back in vogue, despite their abysmal failure in the ’70s, is a testament to how uninterested in reality statists are. It is also a testament to the seductive power of socialist rhetoric, in particular in bad economic times. It is easy to tell someone who is just out of school and has no opportunities on the job market that “the rich took the money you never had and ran with it”. If wrapped in slick rhetoric and sold with the right kind of ad campaign, this kind of hateful politics can easily win the day.

It is the responsibility of every friend of liberty to fight the growth of government, to resist the advancement of hate taxes – and to offer a credible, reliable and realistic path to limited government.

Braking the Federal Debt

As both Europe and America continue to struggle with big government debt, the debate rages on about how to rein in, and eventually reduce, the debt of the U.S. government. In recent years several proposals for balanced-budget constitutional amendments have seen the light of day. Most of them have suffered from serious practical problems, but there is at least one approach that has some merit to it. Simply put, this approach applies a brake to the federal debt, forcing Congress into a gradual change of its fiscal policy to rein in the debt.

This approach is familiar to Europeans but has only recently made it into the American arena. While still not the perfect solution, it adds some tangible policy instruments that could actually help turn our nation’s focus where it needs to be: on runaway government spending.

That said, it is very important that during this debate we never lose track of that very item. All contributors to the issue should be aware that debt is only a macroeconomic symptom, not a disease. A recent article at Reason.com exemplifies the risk of losing focus. The article is good and well worth reading, but only when put in its proper context. Over to Reason.com:

American progressives are fond of gazing across the pond at Europe and wishing the U.S. would emulate it. So as soon as President Obama started announcing from all reaches of the country that Congress “must” eliminate the debt ceiling, progressive cheerleaders echoed his demands, pointing out that most European countries did not have a debt ceiling. But Europe worshippers are drawing the wrong lesson from across the Atlantic. Despite public protests against austerity cuts, many European countries are instituting constitutional reforms requiring balanced budgets in the form of “debt brakes”—a far stronger way to control the national debt than a debt ceiling.

Before we continue, let us note that the EU has been under a technically strong collective debt ceiling since the Maastricht Treaty (later Lisbon Treaty) became the constitution of the EU some two decades ago. That debt ceiling did not primarily cap debt, but focused first and foremost on the budget deficit. The cap limited a member state’s national government deficit to three percent of that state’s GDP.

There were real sanctions built in to this cap, so in a technical sense it was stronger than the American debt ceiling mechanism. However, it became clear pretty soon after the euro was created (a few years after the Lisbon Treaty went into effect) that too many member states ran too large deficits to merit any meaningful enforcement. Back then, the Eurocrats in whose hands the enforcement power had been placed would simply have nothing else to do than to play whack-’em-all with Europe’s deficit-ridden member states. As a result, the three-percent rule was reduced to the “guideline” it is now being thought of.

Herein lies one reason why Greece got off on such a runaway ride with its government budget. But the practical political and administrative problems with enforcing Europe’s deficit cap are ancillary problems: the real culprit is the system of government spending called the welfare state. As soon as government makes promises to its citizens that are unrelated to its ability to pay – the very essence of the welfare state – then government is on an unstoppable path to perpetual budget problems.

Either you let the welfare state run amok (Greece) or you wage war on the private sector to keep the welfare state alive (Sweden). All the debt and deficit control mechanisms in the world won’t solve the underlying problem.

However, that does not mean those mechanisms are useless. They can actually be of some help. Let’s get back to the Reason article and see how:

The [federal debt] ceiling has been raised 68 times since 1960-including 18 times under Ronald Reagan, and by nearly $5 trillion under Barack Obama. Not surprisingly, government spending has gone through the roof along with the size of the public debt. … The debt ceiling didn’t start as a political distraction. Under the Constitution, any government spending or borrowing has to be authorized by Congress. For the first 150 years of America’s existence, that is, most of the republic’s life, Congress authorized debt for specific purposes such as funding wars or building the Panama Canal. In 1939, however, in order to give President Roosevelt flexibility to conduct World War II, Congress gave up its power to approve specific debt issuance but set a maximum aggregate borrowing limit for Treasury. Voila, the debt ceiling was born.

That was about the worst time to make such a reform. FDR was determined to lay the foundations of a European welfare state in America. He did not accomplish much on the health-care front, but when it comes to regulatory restrictions on businesses (for “progressive” purposes) as well as Social Security, he got away with a lot.

A welfare state is defined by its entitlement programs where the amount to be spent is determined by a right. That right is created – invented – by government which gives it to a select group of citizens. The right gives them either in-kind entitlements such as education or health care, or cash entitlements such as welfare or general income security. Either way the cost of the entitlement is determined by variables totally unrelated to the ability of taxpayers to fund those entitlements.

Because of the lack of spending caps in the welfare state’s entitlement programs, government needs more than just taxes to fund them. Enter government debt. In other words, the real problem here is not the debt, but the welfare state.

Reason explains:

However, what began as wartime “necessity” evolved into peacetime political cover that no longer required Congress to justify increasing specific borrowing. It simply authorized spending and let the Treasury Department sort out the necessary borrowing. The results of this bargain speak for themselves. Since 1940 Congress has run a deficit nearly every year (62 of 72 years). The federal budget has grown from roughly 15 percent of GDP in 1950 to about 25 percent today. And America has now borrowed over $16.4 trillion-roughly equal to the size of the entire U.S. economy!

However, once again: let’s not be seduced into focusing all our attention on the debt. When we do, it is easy to make the following mistake, which Reason cannot avoid:

America has not been alone in racking up such a large credit card bill. Greece—the land with debt-to-GDP above 150 percent—leads the way among her Eurozone peers. And countries like Italy (127 percent), Portugal (120 percent), Ireland (117 percent), and Spain (77 percent), followed a similar pattern of unfettered debt accumulation. Even the uber-responsible Germans let their debt rise to 80 percent of GDP. These debts have crippled the European economy in recent years.

No. Debts do not cripple the economy. Sure, debts cost money for taxpayers in the form of interest payments. However, those interest payments go back into the economy by entering the pockets of creditors, most of whom are actually domestic.

In fact, one could make a credible argument that it is better if government borrows to fund its spending than taxes us, because we can choose whether or not we want to lend government our money. We cannot choose whether or not to pay taxes.

The reason why Europe’s economies are struggling is that they have allowed government to take control over far too many of people’s needs. In addition to the assortment of government “services” that we get here in America, Europeans also typically get universal child care; tuition free, government-only universities; heavily subsidized pharmaceutical products; single-payer health care; massively inefficient mass transit systems; and general income security for working adults.

In all these areas, government has crowded out the private sector and seized a destructive monopoly. This has dramatically reduced efficiency both in producing and delivering the services. That slows down GDP growth, which in turn reduces job creation and earnings among those who actually can find a job. More people depend on government entitlements, either as unemployed or as employed with low earnings, low enough to make them eligible for – you guessed it – government entitlements.

This raises the cost of government, which goes up even more as government scrambles to find all the tax revenues it needs to pay for all its spending programs. Stifling taxes add to the growth-hampering effects of government and the economy enters a vicious downward spiral of low growth, gradually increasing dependency on government, an eroded tax base, higher taxes… and eventually austerity.

Debt, again, is only a symptom of the underlying problem. Which, again, does not mean we should not try to put a cap on it – so long as the efforts do not take our focus off the fiscal virus that made the patient sick in the first place.

Back to Reason:

One method for debt control that has gained popular support is the Swiss “debt brake.” Adopted into Switzerland’s constitution in 2001, the debt brake requires a balanced budget, but measured over a multiyear period. In technical terms, it requires the nation’s “structural deficit” to be nil over the course of a business cycle so that surpluses generated during boom periods can defray the deficits during bust periods to keep the overall debt manageable. Implicit in the debt brake idea is the recognition that constraining debt is important to honorably meet national debt obligations and avoid default—whose very prospect American liberals raise to justify their calls for scrapping the debt ceiling. Germany, for example, has now adopted the Schuldenbremse (debt brake) concept as well, specifying that its structural deficit cannot exceed 0.35 percent of GDP in any given year. This does not cap aggregate debt, but the idea is that if the federal government is not running huge deficits every year, the national debt won’t grow.

Sweden used this debt-brake model back in the ’80s. It did not prevent the enormous deficits in the early ’90s. That said, the idea has some merits that, if put to work properly, could actually help us rein in government spending. It is possible, even probable, that a debt brake could shift the fiscal policy debate in our country away from what we can do to increase government spending to what we can do to reduce it.

The best American approach to the debt-brake mechanism is the one proposed by Compact for America. It is worth a serious look.

Argentina Hit By 30 Percent Inflation

Sadly, the world is full of failing welfare states. One of them is Argentina, where the out-of-control welfare state is causing runaway inflation. This, together with bad GDP growth numbers, has led to a credit downgrade that expels Argentina’s treasury bonds from the reliable end of the market, confining it to shady backstreets together with other C- and CC-rated bonds.

As if this was not bad enough, the government of Argentina is engaging in a macroeconomic form of accounting fraud byt trying to conceal its 30-percent annual price increases in manipulated data. This has rightfully caused a confrontation between Argentina and the IMF, whose credit line is in part dependent on the debtor country complying with certain statistical standards.

Aside some real yelling and screaming from Buenos Aires, the IMF demands seem to have a little bit of an impact on the Argentine government. It is not all for the better, but at least the Fund has caught president PMS Kirchner’s attention. From MyFoxNY:

Argentina announced a two-month price freeze on supermarket products Monday in an effort to break spiraling inflation. The price freeze applies to every product in all of the nation’s largest supermarkets — a group including Walmart, Carrefour, Coto, Jumbo, Disco and other large chains. The companies’ trade group, representing 70 percent of the Argentine market, reached the accord with Commerce Secretary Guillermo Moreno, the government’s news agency Telam reported.

This is pure cosmetics. You don’t do away with inflation by banning the last agent in the chain from compensating himself for price increases further back in the process. Wal-Mart and the other supermarket chains are still going to have to compensate their suppliers for higher costs of production and transportation.

There are only two possible results from this: empty shelves in the stores or product reconfiguration. The former is the Soviet solution, the latter the Venezuelan version. After Hugo Chavez caused 30-percent inflation in Venezuela he went after the retailers and food producers when they reconfigured their products. His aggressive policies actually escalated the crisis to the Soviet level, causing food shortage in Venezuela.

It remains to be seen what the outcome will be in Argentina. But one thing is clear: you cannot escape the devastating consequences of inflation by banning people from raising prices.

MyFoxNY again:

Polls show Argentines worry most about inflation, which private economists estimate could reach 30 percent this year. The government says it’s trying to hold the next union wage hikes to 20 percent, a figure that suggests how little anyone believes the official index that pegs annual inflation at just 10 percent.

The underlying problem is that the government has been flooding the economy with borrowed funds and printed money, paying for all sorts of work-free entitlements. When more and more spending in the economy is based on work-free income, you open up an imbalance between production and consumption.

This is one of three transmission mechanisms from reckless monetary and fiscal policies to consumer prices spiraling out of control. The second has to do with banks being flooded with cheap liquidity. This can encourage banks to start lending without due attention to the credit strength of their borrowers, simply because they are faced with tempting interest margins, ultimately created by a reckless government.

A third transmission mechanism involves the exchange rate, where a surge in domestic money supply causes a depreciation of the currency.

Which one of these transmission mechanisms has had the strongest influence thus far is yet to be determined. Preliminarily, it looks as though the first one is a major culprit, simply because of the perpetually bad government finances and the lavish nature of Argentina’s entitlement systems.

Argentina offers yet another example of how a runaway welfare state can bring devastation and destitution to a country. It is about time that policy makers in Europe and America pay attention – and start working on Ending the Welfare State.


Another Tax-Paid European Bailout

After last year’s battle to save the euro, little has been heard lately about the threat of a break-up of the currency. It is undoubtedly true that the European Central Bank and the EU together with the IMF managed to save the euro. But at what price? Here is an article on that topic from an interesting blog called Testosterone Pit – Where the Truth Comes Home to Roost:

The state-sponsored chorus about the end of the debt crisis in the Eurozone has been deafening. It even has feel-good metrics: the Euro Breakup Index for January fell to 17.2%—the percentage of investors who thought that at least one country would leave the Eurozone within twelve months. In July, it stood at 73%. For Cyprus, the fifth Eurozone country to ask for a bailout, the index fell to 7.5%. “A euro breakup is almost no issue anymore among investors,” the statement said.

In other words, the euro shines brightly over Europe, reflecting its golden glance in the eyes of millions upon millions who have lost their jobs and their livelihood to euro-saving austerity programs.

But there is more, as the Testosterone Pit reports. It has to do with Cyprus, next in line for a bailout from the EU:

Just then, in a fight over whether or not to bail out Cyprus, top Eurocrats exposed what a taxpayer-funded con game they thought these bailouts really were—and how fragile the Eurozone was. A debate has been raging in Germany about Cyprus. Not that the German parliament, which has a say in this, wouldn’t rubberstamp an eventual bailout, as it rubberstamped others before, but right now they’re not in the mood. Cyprus is too much of a mess. Bailing out uninsured depositors of Cypriot banks would set a costly precedent for other countries.

It gets better:

And bailing out Russian “black money,” which makes up a large portion of the deposits, would be, well, distasteful in Germany, a few months before the federal elections. For the tiny country whose economy is barely a rounding error in the Eurozone, it would be an enormous bailout. At €17.5 billion, it would amount to about 100% of GDP: €10 billion for the banks, €6 billion for holders of existing debt, and €1.5 billion to cover budget deficits through 2016.

If the Cypriots were left to fend for themselves, their banking industry would learn the lesson. But note also the budget deficit number that the TP reports. I have not confirmed it independently, but if GDP is as they say 17.5 billion euro, and the deficit coverage would amount to 1.5 billion euro, then the Cypriot government is running a budget deficit at 8.6 percent of GDP!

This is where the truly big questions are hidden. It is not far fetched to assume that this is about a welfare state gone haywire.  We will have to get back to that.

The TP again, with a very good point about how the Eurocrats always prefer to save the euro over defending the prosperity of Europe’s citizens:

As always, there is never an alternative to a bailout. “It’s essential that everybody realizes that a disorderly default of Cyprus could lead to an exit of Cyprus from the Eurozone,” said Olli Rehn, European Commissioner for Economic and Monetary Affairs. “It would be extremely stupid to take any risk of that nature.”

So instead of doing the right thing and allowing Cyprus to exit, the Eurocracy wants to pour yet more taxpayers’ money into yet another black fiscal hole.

At least this time, the Germans seem a bit skeptical, which is delaying the Cypriot bailout:

German Finance Minister Wolfgang Schäuble … [has been] saying publicly that it wasn’t certain yet that a default would put the Eurozone at risk—”one of the requirements that any bailout money can flow at all,” he said. Cyprus simply wasn’t “systemically important.” … at the meeting of Eurozone finance ministers a week ago … Cyprus was also on the agenda, but not much was accomplished, other than an agreement to delay the bailout decision until after the Cypriot general elections in February.

But the fight for more tax money to another bailout is not over:

ECB President Mario Draghi, bailout-fund tsar Klaus Regling, and Olli Rehn, all three unelected officials, had formed a triumvirate to gang up on Schäuble. … If Cyprus went bust, they contended, it would annihilate the flow of positive news that has been responsible recently for calming down the Eurozone. For weeks, all signs have pointed towards an improvement, they argued. Risk premiums for Spanish and Italian government debt have dropped significantly, and balances between central banks, which had risen to dangerous levels, have been edging down.

The Spanish and Italian risk premiums have fallen not because of the good news about the euro zone, but because the ECB has pledged to print astronomical amounts of money to guarantee every treasury bond issued in Rome and Madrid. The euro zone has stabilized because of this commitment, in other words the opposite causality compared to what the Eurocrats are suggesting.

It will take probably something similar to keep Cyprus in the euro zone, and since the Eurocrats do not think of anything other than to save the currency – no matter the cost – it is easy to predict that they will wrist all the German arms they need to in order to get the taxes they need for a Cypriot bailout.

Two questions: What austerity measures will come with the bailout to bring down the deficit from 8.6 percent of GDP to the magic three percent the EU considers acceptable? And: What will German taxpayers think of this when they go to the polls in a few weeks?