And down goes another welfare state…:
Fitch Ratings has downgraded Italy’s Long-term foreign and local currency Issuer Default Ratings (IDR) to ‘BBB+’ from ‘A-’. The Outlook on the Long-term IDRs is Negative. Fitch has simultaneously affirmed the Short-term foreign currency IDR at ‘F2′ and the common eurozone Country Ceiling for Italy at ‘AAA’.
Already before this, Italy was paying more than seven percent on its treasury bonds. This will bump up their borrowing costs yet another notch. And since the European Central Bank has promised to buy any EU member-state bonds denominated in euros, this will increase their commitment and their obligation to print even more money.
The downgrade of Italy’s sovereign ratings reflects the following key rating factors: The inconclusive results of the Italian parliamentary elections on 24-25 February make it unlikely that a stable new government can be formed in the next few weeks. The increased political uncertainty and non-conducive backdrop for further structural reform measures constitute a further adverse shock to the real economy amidst the deep recession.
It would be interesting to hear what the Fitch analysts have to say about what Italy has done thus far in terms of austerity. Effectively, they are asking for more of the same, obviously a bad idea.
There is actually a bit of irony in this. Without a “stable” government Italy will sail on as it is, and no new austerity measures will be implemented. This gives the economy a little bit of breathing space, which – at least in theory – could inspire a small recovery. That in turn would be good for future tax revenues and help toward reducing the budget deficit.
In reality, there is little to hope for here. Pressure from the EU will bring a new prime minister into office sooner rather than later, and regardless of who that person is, Italy will continue down its path of austerity. The only other option would be to leave the euro – an option that not even the Greeks could make use of. Therefore, we can expect more recession in Italy, which means weaker tax revenues, more demand for tax-paid entitlements – and thus a perpetuation of the budget problems.
That will surprise the Fitch analysts and somewhere in the future could bring about yet another downgrade. In fact, as the Business Insider reports, Fitch is already surprised by how poorly the Italian economy is performing:
Q412 data confirms that the ongoing recession in Italy is one of the deepest in Europe. The unfavourable starting position and some recent developments, like the unexpected fall in employment and persistently weak sentiment indicators, increase the risk of a more protracted and deeper recession than previously expected. Fitch expects a GDP contraction of 1.8% in 2013, due largely to the carry-over from the 2.4% contraction in 2012. Due to the deeper recession and its adverse impact on headline budget deficit, the gross general government debt (GGGD) will peak in 2013 at close to 130% of GDP compared with Fitch’s estimate of 125% in mid-2012, even assuming an unchanged underlying fiscal stance.
Nope. No peak there. Too many people have made too many predictions of peaks for the Greek government debt, and yet they were always overrun by reality. Expect the same to happen in Italy.
So long as the Italian government continues to try to defend its welfare state, it is going to run a deficit. So long as Italy runs a deficit, the EU and the ECB will demand more austerity measures. With more austerity, the current crisis will continue to get worse. How much worse is impossible to say: this type of crisis is historically new and has to do with the fact that the welfare state has matured, warped the economic incentives of a sufficiently large number of people and thus eroded its own economic foundation.
The Greek crisis is a perfect example of how open-ended this type of crisis is. It has been going on for five years now, the country has lost a quarter of its GDP and it is not over yet for them.
The European crisis is gaining more and more attention. Two days ago George Friedman, founder of the global intelligence research firm Stratfor, wrote an interesting article about the fragile state of affairs in Europe:
The global financial crisis of 2008 has slowly yielded to a global unemployment crisis. This unemployment crisis will, fairly quickly, give way to a political crisis. The crisis involves all three of the major pillars of the global system — Europe, China and the United States.
Just a quick note: the initial crisis was financial on the surface, but underneath it was the crisis of the welfare state, a system of entitlements and taxes that has been structurally unsustainable for a long time. For each recession since the oil crisis in 1979 the European welfare states have been nudged a little bit closer to the point where they become acutely fiscally unsustainable. With this recession came the point where Europe’s big entitlement systems finally overburdened their host organism, the private sector.
As the welfare state began falling apart, the EU-ECB-IMF troika set out to save it with harsh, depression-inducing austerity policies. The medicine made the patient worse, which is why there is an unforgiving unemployment crisis sweeping across Europe – with, yes, a political crisis on its tail.
Mr. Friedman does not see the welfare state’s role in this, but his analysis is nevertheless important. He points out that the exact nature of the crisis varies from country to country, but…
there is a common element, which is that unemployment is increasingly replacing finance as the central problem of the financial system. … Last week Italy held elections, and the party that won the most votes — with about a quarter of the total — was a brand-new group called the Five Star Movement that is led by a professional comedian. Two things are of interest about this movement. First, one of its central pillars is the call for defaulting on a part of Italy’s debt as the lesser of evils. The second is that Italy, with 11.2 percent unemployment, is far from the worst case of unemployment in the European Union. Nevertheless, Italy is breeding radical parties deeply opposed to the austerity policies currently in place.
This is exactly the point that I have been making for more than a year now. Glad to see others are paying attention.
The core debate in Europe has been how to solve the sovereign debt crisis and the resulting threat to Europe’s banks. The issue was who would bear the burden of stabilizing the system. The argument that won the day, particularly among Europe’s elites, was that what Europe needed was austerity, that government spending had to be dramatically restrained so that sovereign debt — however restructured it might be — would not default.
Then Mr. Friedman reveals that he has been glancing at this blog – how else would he reach the conclusion that austerity is bad for the economy…? No one else makes that point:
One of the consequences of austerity is recession. The economies of many European countries, especially those in the eurozone, are now contracting, since austerity obviously means that less money will be available to purchase goods and services. If the primary goal is to stabilize the financial system, it makes sense. But whether financial stability can remain the primary goal depends on a consensus involving broad sectors of society. When unemployment emerges, that consensus shifts and the focus shifts with it. When unemployment becomes intense, then the entire political system can shift.
It is unclear how austerity would save the financial system – the banks – even from the perspective of someone who truly thinks austerity is good for the economy. All that austerity does, according to its many supporters, is to reduce the budget deficit which raises the price of treasury bonds and reduces, perhaps even reverses, the upward pressure on interest rates.
The only link to the banking system is that they have invested heavily in treasury bonds and that austerity – if it worked according to its theory – would then improve their balance sheets. It appears to be the case that banks did indeed load up with treasury bonds prior to this recession, an aggravating circumstance that – given the destructive nature of austerity – could prolong or even accelerate the recession. Mr. Friedman does not clarify if he shares this view of where the banks fit in to the crisis picture.
He does, however, make the important observation that the Italian election is more of an accelerator than a brake pedal in the ongoing European crisis:
Only four countries in Europe are at or below 6 percent unemployment: the geographically contiguous countries of Germany, Austria, the Netherlands and Luxembourg. The immediate periphery has much higher unemployment; Denmark at 7.4 percent, the United Kingdom at 7.7 percent, France at 10.6 percent and Poland at 10.6 percent. In the far periphery, Italy is at 11.7 percent, Lithuania is at 13.3 percent, Ireland is at 14.7 percent, Portugal is at 17.6 percent, Spain is at 26.2 percent and Greece is at 27 percent. … more than half of Germany’s exports go to other European countries. Germany sees the European Union’s free trade zone as essential for its survival. Without free access to these markets, its exports would contract dramatically and unemployment would soar.
And with the escalating crisis in the EU, the German economy is in trouble. The latest forecast is that the German GDP will contract for this year, but let’s not forget that the situation gets worse with each forecast, as forecasters see that the real world is faring worse than they predicted.
In other words, Mr. Friedman is right on the euro here, and he reinforces his point by explaining how the structure of the euro zone might actually aggravate the current crisis:
The euro is a tool that Germany, with its outsized influence, uses to manage its trade relations — and this management puts other members of the eurozone at a disadvantage. Countries with relatively low wages ought to have a competitive advantage over German exports. However, many have negative balances of trade. Thus, when the financial crisis hit, their ability to manage was insufficient and led to sovereign debt crises, which in turn further undermined their position via austerity, especially as their membership in the eurozone doesn’t allow them to apply their own monetary policies.
This is indeed a very important analysis of the role that the euro plays in the crisis. Germany, says, Mr. Friedman, has by design or by intent rigged the euro zone so as to be to its own foreign-trade advantage. So long as the weaker economies were on board with the stability and growth pact this was a game Germany could not lose. But once the debt flood gates opened in Greece, and the EU rushed in with its austerity demands, it was only a matter of time before the crisis would hit Germany.
The euro zone’s artificial terms-of-trade relations work both ways, with menacing symmetry.
Mr. Friedman then moves on to a discussion about the geo-political consequences of the economic crisis:
Portugal, Spain and Greece are in a depression. Their unemployment rate is roughly that of the United States in the midst of the Great Depression. A rule I use is that for each person unemployed, three others are affected, whether spouses, children or whomever. That means that when you hit 25 percent unemployment virtually everyone is affected. At 11 percent unemployment about 44 percent are affected. … in Greece, for example, pharmaceuticals are now in short supply since cash for importing goods has dried up. Spain’s local governments are about to lay off more employees. These countries have reached a tipping point from which it is difficult to imagine recovering. In the rest of Europe’s periphery, the unemployment crisis is intensifying. The precise numbers matter far less than the visible impact of societies that are tottering.
I would disagree about the role of the numbers. But be that as it may. Mr. Friedman is expressing great concern about what the future holds for the countries in Europe that are now effectively in a depression. I am entirely on board with his statement that it will be difficult for Greece and Spain to come back from this, though I also know that the day they decide to structurally eliminate their welfare states things will get a lot better.
That is, however, little more than a dream right now. In the way of such fundamental reforms lies, e.g., the stubborn and very destructive support among Europe’s political elites for a continuation of austerity.
Mr. Friedman sees a glimmer of hope on that front, though he does not quite define it that way:
The idea that the Germany-mandated austerity regime will be able to survive politically is difficult to imagine. In Italy, with “only” 11.7 percent unemployment, the success of the Five Star Movement represents an inevitable response to the crisis. Until recently, default was the primary fear of Europeans, at least of the financial, political and journalistic elite. They have come a long way toward solving the banking problem. But they have done it by generating a massive social crisis. That social crisis generates a political backlash that will prevent the German strategy from being carried out. For Southern Europe, where the social crisis is settling in for the long term, as well as for Eastern Europe, it is not clear how paying off their debt benefits them. They may be frozen out of the capital markets, but the cost of remaining in it is shared so unequally that the political base in favor of austerity is dissolving. This is compounded by deepening hostility to Germany. Germany sees itself as virtuous for its frugality. Others see it as rapacious in its aggressive exporting, with the most important export now being unemployment. Which one is right is immaterial. The fact that we are seeing growing differentiation between the German bloc and the rest of Europe is one of the most significant developments since the crisis began.
A good analysis indeed. Turning again to Italy, Mr. Friedman concludes:
The Five Star Movement’s argument in favor of default is not coming from a marginal party. The elite may hold the movement in contempt, but it won 25 percent of the vote. And recall that the hero of the Europhiles, Mario Monti, barely won 10 percent of the vote just a year after Europe celebrated him.
In other words, there may be enough political strength building against austerity. I pointed to this after the Greek election in June last year. And already in May last year I explained that the real winners in the welfare-state crisis are the fascists. I am glad to see that Mr. Friedman’s analysis is catching up with mine:
Fascism had its roots in Europe in massive economic failures in which the financial elites failed to recognize the political consequences of unemployment. They laughed at parties led by men who had been vagabonds selling post cards on the street and promising economic miracles if only those responsible for the misery of the country were purged. Men and women, plunged from the comfortable life of the petite bourgeoisie, did not laugh, but responded eagerly to that hope. The result was governments who enclosed their economies from the world and managed their performance through directive and manipulation. … when we look at the unemployment rates today, the differentials between regions, the fact that there is no promise of improvement and that the middle class is being hurled into the ranks of the dispossessed, we can see the patterns forming. … Whether it is the Golden Dawn party in Greece or the Catalan independence movements, the growth of parties wanting to redefine the system that has tilted so far against the middle class is inevitable.
Indeed. The problem now is where Europe is heading next. If Mr. Friedman is right in that the support for austerity is coming to an end in Europe, then there are only two ways forward: the freedom-pursuing way to a structural termination of the welfare state, or the authoritarian route led by parties like Golden Dawn. (There are others to factor in, such as the party duo governing Hungary; the Front National in France; the new nationalist coalition in Britain; and the nationalist parties in Scandinavia.)
I have warned of Europe’s authoritarian future for some time now. I wish I did not feel reinforced by Mr. Friedman’s analysis in that being my default forecast for Europe. Nevertheless, as time goes by, the crisis deepens and nothing is done to stop it, the authoritarian alternative gains momentum.
There is a dark cloud hanging over Europe. Let’s hope it won’t spread its darkness beyond the Old World.
So, the Italians did basically the same thing as the Greeks did back in June: they cast a protest vote against EU-imposed austerity. The protest was actually even stronger in Italy, a fact to be taken very seriously by anyone who respects and appreciates the fact that the people delegate power to their elected officials – not the other way around.
The problem for Italy, and for Europe in general, is that not everyone appreciates the sovereignty of the people. From the EU Observer:
The European Commission has urged any future government in Italy to keep on implementing deficit-cutting measures, despite the fact that over half the electorate voted for anti-austerity parties. “Last Friday the Italians were speaking quite clearly about debt-reduction commitments as well as a series of other commitments. These Italian commitments remain in force and the commission expects compliance,” commission spokesperson Olivier Bailly said on Tuesday (26 February).
Take another look at those words: “the commission expects compliance”… Listen to them. What attitude toward the people do they convey?
There is only one word for it: totalitarianism. When government expects the people to comply with its will, democracy has lost. It may still exist pro forma, as a shiny showroom item in the hallways of politics and power. But its role as the conveyor of the will of the people is long gone. Only when the people give the right answer to the question posed by the government, is their voice allowed to echo through the legislative chambers.
The Italian election was about the question: should government continue to raise taxes and cut spending? The EU Commission expected – demanded – an affirmative answer, so when the Italian people defied the will of the Almighty Commission in Brussels, the Commission got irritated. More than likely, they are already deeply involved in the negotiations to piece together an administration that, contrary to the will of the people, will continue with the destructive austerity policies.
That would be the only administration that the EU can accept.
Back to the EU Observer:
[Mr. Bailly's] comments come after elections in Italy – the eurozone’s third biggest economy – failed to result in a majority for the upper house of the country’s parliament. The centre-left coalition of Pier Luigi Bersani, who had pledged to continue Monti’s work, won the lower house by a whisker. The resulting stalemate has put former comedian Beppe Grillo, who ran on an anti-austerity ticket and has called for a referendum on euro membership, in kingmaker position.
In some sense, this is like Jay Leno starting a political party that manages to wedge itself in between Democrats and Republicans in Congress. Grillo does have some serious support, and he might actually use his political power to try to weaken Italy’s ties to the European Union. The power of the EU will very likely win that struggle, but if Grillo’s party and the other anti-austerity parties are given little to no influence over the fiscal policies in Italy over the next couple of years, things could easily turn for the worse.
This Italian election is yet another challenge for Brussels and its disdain for the will of the people. Its first reaction reveals that it has learned nothing from Ireland, Greece, Spain and other countries where people have voted against the EU in one way or another. On the contrary, its reaction has been to try and seize even more power over fiscal policy – the issue that defined the Italian election.
It probably won’t get that power, at least not officially, so the Eurocrats and EU-friendly politicians in member states are doing their best to close ranks after this show of defiance from the Italian people:
The commission’s Bailly … admitted that Monti’s reform path had yet to produce results. It would be “an illusion” to think that 15 months of reforms – Monti took over in November 2011 – would would lead to “joy, happiness and jobs.” Staying with austerity would eventually lower debt, which is a “brake” on growth, he added.
If that was the case, the American economy would be shrinking at the speed of sound. Yet it is growing two percentage points faster than the European economy – not a fantastic growth rate by any standards, but nevertheless a fact worth noting.
And now for the austerity choir:
Eurogroup chief Jeroen Dijsselbloem said Italy’s reforms are “crucial” for the entire eurozone, while Guido Westerwelle, the foreign minister of pro-austerity Germany, said Rome must “continue the solid policies of reform and consolidation.” Others worried about the political implications of the vote. European Parliament President Martin Schulz noted that “what happens in Italy affects all of us.” He said that unpopular reforms are being associated with the EU capital. “I take it very seriously that a lot of Italian people expressed a kind of protest against measures which are [seen] in Italy publicly as measures of the European Union. We should here in Brussels take this very, very seriously,” he explained.
And do what? Make the austerity measures look Italian?
It remains to be seen what government eventually is formed in Rome, but the very fact that the Eurocracy comes out as one voice and demands more austerity, regardless of what the people wanted, is a sign that Europe’s history of parliamentary democracy is in the balance. Austerity – a fiscal policy strategy to save the welfare state in times of recession – is worth more to the tax-paid elite in Brussels.
This is bad news for Europe. It is not far-fetched to conclude that Europe as we know it will not survive the EU. The only hope is that for each national election where the EU tries to dictate the outcome, more and more people will demand an orderly retreat from this totalitarian super-state project.
Watching Europe trying to get out of its recession is like watching a man trying to ride a bike in zero gravity. No matter how hard they try to pedal forward, they are completely and utterly stuck in one and the same spot. That GDP growth spurt that was going to jolt the European economy back to life is turning into little more than a fairy tale. In fact, reality is going in the exact opposite direction. From the EU Observer:
The eurozone economy will shrink by a further 0.3 percent in 2013, the European Commission said Friday (22 February), revising down a more optimistic previous estimate that had predicted 0.1 percent growth for this year. The data also indicates that average government debt rose by 5 percent in 2012 to 93.1 percent as a proportion of GDP. The average debt level is expected to peak at 95.2 percent in 2014, well above the 60 percent threshold set out in the bloc’s Stability and Growth Pact.
Please note that the growth rate is adjusted down by 0.4 percentage points, a relatively large adjustment for such a short period of time. The reason is probably not faulty economic models, as the EC gets its data from their own statistics bureau, Eurostat. It is more likely that the reason has to do with political meddling with the non-formal forecasting process – or, to be blunt: politicians and bureaucrats have written in their own delusional beliefs in the virtues of austerity into a forecast that otherwise would show the naked truth about said austerity.
As for the 60 percent debt level, it is entirely artificial without the slightest scientific foundation. It was imposed on the EU by a group of politicians and bureaucrats who designed the Stability and Growth Pact and wanted to look fiscally conservative. The 60-percent level was one of two arbitrary features of the Pact, the other being the requirement that EU member states cap their deficits to three percent of GDP. This latter feature is, by the way, the main culprit behind the panic-driven austerity assaults on the budgets in, e.g., Greece, Spain, Italy and Portugal. Needless to say, that has made it even harder for the member states to meet the goals of the Stability and Growth Pact.
Back to the EU Observer:
News on government budgetary positions was more positive. The average deficit in the eurozone had fallen by 1.5 percent to 3.5 percent, with the commission expecting a further 0.75 percent improvement to bring the eurozone average under the 3 percent threshold. Announcing the figures, Economic Affairs Commissioner Olli Rehn admitted that “the hard data is still very disappointing” adding that the progress made by national governments to cut budget deficits was “not yet feeding into the real economy.”
Yes they are. They are just not feeding in like Mr. Rehn thinks they should. Instead of making the economy grow, which is Mr. Rehn’s delusional belief, his spending cuts and tax increases are perpetuating and even aggravating the recession.
As for the improvement on the budget deficit front, it is an expected, temporary effect resulting from last year’s spending cuts and tax increases. Things will turn for the worse again once the latest austerity round proliferates through the economy.
To get the full story of what it is Mr. Rehn does not get, download this paper and check out Figure 3 on page 15. Given how obvious these macroeconomic mechanisms are, it is very surprising that Eurocrats like Mr. Rehn are still getting away with their austerity fantasies.
Or maybe they are not. Perhaps things have gotten so bad in so many countries now that people are prepared to throw out the balanced-budget requirements in order to allow for prosperity to start growing again. The Italian election will give us a big hint, explains another story from the EU Observer:
Italian voters are heading to the polls on Sunday and Monday (24-25 February) in a closely-watched race that could bring the country back to the brink of a bailout. Outgoing Prime Minister Mario Monti, a respected former EU commissioner and economics professor, may be the favourite among EU leaders watching from the side lines, but at home, he appears to have failed to convince voters that his reforms and sober politics are what the country needs today.
It is hardly a sign of sobriety when someone recommends higher taxes and spending cuts in the midst of a recession.
In a significant catch-up effort – thanks to his media empire and promises to pay back taxes introduced by Monti – former leader Silvio Berlusconi was just five percent behind [center-left candidate] Bersani in the 8 February survey. … For its part, Italy’s leading investment bank, Mediobanca, has predicted that if Berlusconi wins, the country would face an immediate backlash on financial markets and could be forced to ask for financial assistance from the European Central Bank.
For what reason? Berlusconi would in all likelihood abandon the austerity policies, and if he follows through on its promises to not only reverse the tax cuts but do it retroactively, he will in fact inject a stimulus into the economy of a kind that could get the Italian economy growing again. That in turn would ease the budget pressure and increase confidence among investors in, e.g., Italian treasury bonds.
If, on the other hand, Bersani wins he might form an alliance with Monti to please the Eurocrats. That in turn would increase the likelihood of more austerity hammering down on the Italian economy. Given its size, that will have clearly negative effects on the economy of the euro zone.
As will the continuing commitment to austerity in France, where the socialist government has been forced to adjust its budget deficit forecast. From the increasingly influential pan-European news site The Local:
The figure for this year, when France was due to get back within the EU’s ceiling of 3.0 percent of output, is worse than the 3.5 percent previously tipped, and leaves Socialist President Francois Hollande looking for special leeway from Brussels. European Union Economy and Euro Commissioner Olli Rehn told a press conference that France could be given more time to meet its commitments, much as Spain and others have been over the three years of the debt crisis. “If the expected negative economic headwinds bring significant, unfavourable consequences for public finances, the (EU’s) Stability and Growth Pact allows for the deadline (for France) to be pushed back to 2014,” he said.
This is not very surprising, given that the French government has been forced to acknowledge that the nation’s economy will not grow as fast as they had suggested it would. This concession is hardly surprising, given the harsh fiscal measures that President Hollande and his fellow socialists in the National Assembly have imposed on the French economy.
In fact, the situation is beginning to look a bit panicky in Paris. Another story from The Local:
France needs an extra €6 billion in revenues next year, the budget minister said on Monday, and the European Central Bank said it had to act fast to cut spending and retain credibility after slashing the 2013 growth forecast. … Budget Minister Jerome Cahuzac … did not specify how this would be achieved saying taxes “are already very high in France.”
Really…? Does that mean that even socialists acknowledge that a 75-percent hate tax on high incomes is a bad idea? Or is 76 percent the “very high” limit?
Regardless of whether the French want to have stupidly high taxes or very stupidly high taxes, the pressure is on them to keep the austerity pressure on the economy. The Local again:
French ministries have been informed how much to cut spending in order for the government to generate €2 billion in savings this year. “Economies in public spending are inevitable,” Cahuzac said. “We have started to do it, we will continue to do it,” he added. Benoît Coeure, a Frenchman who sits on the managing board of the European Central Bank, said on Monday that Paris had to take strong action to convince its European Union partners that it was serious about keeping to the EU’s deficit norms.
Surprisingly, in the midst of all this, President Hollande does not want more austerity…
arguing they would only slow growth and further aggravate the country’s finances.
But a 75-percent hate tax on the “rich” does not slow growth, right? Regardless, it seems like the French government is now forced to walk a thin rope. On the one hand, budget minister Coeure says that:
“As for credibility on the short-term, France must absolutely respect its commitment to cut the structural deficit,” … “In the medium-term, it has to take quick and concrete decisions to achieve spending cuts, so that France reassures its European partners,” he said.
On the other hand we have president Hollande’s realization that austerity might not be such a good idea after all. What to do? Well, the Eurocracy is going to maintain its pressure on Hollande and the French government, especially now that Mr. Rehn has made clear that he believes the crisis is basically over and Europe has austerity to thank for it. He is not going to let go of his story that easily, which means he will keep Hollande in check and force him to “pet the horse” as the Danes say, i.e., do as he is told.
If at the same time the Eurocrats’ favorites form the next administration in Italy, the forces of austerity will continue to prevail. Under their boot, Europe will solidly establish itself as an economic wasteland, mired in industrial poverty. The balanced budgets will shine their glory over rusting steel mills, crumbling hospitals and the masses of the unemployed.
There seems to be a growing awareness among Europe’s political leaders that austerity has wreaked havoc on their continent. Yet very little is being done to end this reckless fiscal practice, and the reason is more than likely that those same politicians are ideologically committed to preserving the welfare state. The only purpose of austerity is, namely, to try to squeeze the big, unsustainable welfare state into an ever smaller economy.
This creates a contradiction between economic policy goals. On the one hand, “everyone” is dedicated to generating more GDP growth in Europe; on the other hand, “everyone” is equally dedicated to maintaining austerity. Since austerity is a very strong contributing factor behind the recession, Europe’s political leaders will have to make a choice: save the welfare state, or save the prosperity of the European people.
I, for one, am increasingly convinced that they have already made up their mind: it’s the welfare state, come Scylla or Charybdis. This has put Europe on a path of permanent decline, with devastating effects for the young.
Sadly, we get almost daily evidence of this. The latest story is from Italy, where according to the EU Observer finance minister Vittorio Grilli is trying to make the impossible case that austerity will be over once austerity has brought the economy back to full employment:
The Italian economy will run a balanced budget in 2013 before returning to growth the following year, the country’s outgoing finance minister has told the European Parliament. Speaking with MEPs on the Parliament’s Economic committee on Monday (21 January), Finance Minister Vittorio Grilli said that “we expect to have a current account surplus by 2014″.
Something must have gotten lost in translation here. Are we talking about the government budget or foreign trade?
That aside, take note of the following:
Grilli added that the Italian economy would grow by over 1 percent in 2014 after two consecutive years of recession, but described this projection as “not really adequate” adding that “the country needs to enact a series of structural reforms.” However, he said that once the structural deficit had been eliminated there was “no reason to go any further with austerity.”
There are two definitions of a structural budget. The first one says that it is the deficit that remains when the economy is in full employment. According to the second definition, the structural deficit is what averages out over one business cycle. Since no two business cycles are the same, it is pointless to use the second definition, which leaves us with the full-employment definition.
This, in turn, raises a pertinent question: if Grilli wants to eliminate the structural deficit before he ends his austerity programs, then how is Italy going to get to the full employment point where we will know whether or not the structural deficit has been eliminated?
My question is not just a theoretical exercise. There is plenty of evidence that Italy is deep into a recession, and as has been very well established, you don’t get a country out of recession by hammering it with austerity policies.
Consider the following data. On each point the Italian economy has to return to its 2005 levels before we can safely say that it is out of its recession:
- Social benefits as share of GDP: 25.4 percent in 2005; 28.4 percent in 2009 (latest year available);
- Youth unemployment: 24 percent in 2005; 29.1 percent in 2011;
- Real GDP growth: Average 2004-2008 was 1.06 percent per year; average 2009-2013 including forecast is -0.86 percent per year;
- Government as share of GDP: 47.9 percent in 2005; 51.4 percent in 2010.
The last number is particularly important. When viewed in the context of the meager – to say the least – GDP growth rates, the growth in the relative size of government tells us two things.
First, there have been no real efforts at reforming away government spending programs in Italy. On the contrary, the austerity policies that have been in place over the past few years have served the purpose of preserving the welfare state and its big spending programs. As a result, the burden that government places on the private sector will not get lighter in the next few years. That alone basically rules out an economic recovery.
Secondly, the GDP share of government in Italy was down to 49.9 percent in 2011, a 0.5-percent reduction over 2010. In 2010 the Italian economy grew by 1.8 percent, but growth fell back to 0.4 percent in 2011 with a preliminary -1.4 percent in 2012. These numbers clearly indicate that the reduction in government GDP share in 2011 was not caused by a sustained trend in GDP growth, but instead the result of austerity-driven spending cuts executed in 2010. In 2011 and 2012 those cuts took effect and turned the economy downward again after the “growth spurt” in 2010.
A further indication that the Italian government is not retreating from the economy is that general government revenue as share of GDP is slowly trending upward. It was 43.4 percent in 2005 and 46.1 percent in 2011. When government revenue as share of GDP is growing, and government spending as share of GDP is falling, then government is taking more from the economy while giving less back.
This organized net drainage of resources from the private sector into government is also known as austerity.
The bottom line, then, is that:
a) the Italian finance minister has set a policy goal that means “full employment first, then a stop to austerity”;
b) every conceivable indicator shows that Italy is neither near nor on a trajectory toward full employment; and that
c) austerity will continue to stifle any economic recovery in the Italian economy.
Since austerity serves the purpose of preserving the welfare state, one has to ask: is this ideological behemoth so important to Europe’s politicians that they are willing to drive their economies into the deepest of depression ditches just in order to be able to say “I saved the welfare state”?
While Greece and Spain are fighting for their economic and political survival, Italy is having its own major problems. The un-elected, EU-appointed prime minister, Mario Monti, has just resigned. This has caused a major upset in Italy, with shock waves likely to spread north of the Alps. From the Daily Telegraph:
The FTSE Mib in Milan fell by as much as 3.5pc to 15,157.72 on Monday after the technocrat prime minister said he would resign as soon as crucial budget legislation was approved. Italian borrowing costs also rose. The yield on 10-year government bonds climbed by almost 0.3 percentage points to 4.8147pc, while the cost of insuring Italian debt against default rose by 27 basis points to 285bps. This means that it now costs £285,000 a year to insure £10m of debt over five years. … The resignation also sparked a wider sell-off. Madrid’s IBEX 35 index fell 2.3pc, hit also by rising bond yields in debt-laden Spain.
This could be good for the European economy, provided that Italy could gain more economic independence from the EU – and leave the currency union. This, however, is highly unrealistic. The EU is recklessly exploiting the current crisis to grab more power from member states and will certainly continue to do so. It has only one recipe for how to deal with the crisis, and that is more austerity and more budget power transferred to Brussels. As this blog reported yesterday, that recipe is going to turn Europe into an economic and political disaster zone.
Therefore, now that the EU has lost its man in power in Italy, its reaction could very well be worse for Italy than the problems that Mr. Monti himself was causing. His strict focus on making the government finances look good has been harmful to the Italian economy, something that is revealed in another piece in the Daily Telegraph:
The nation is richer than Germany in per capita terms, with some €9 trillion of private wealth. It has the biggest primary budget surplus in the G7 bloc. Its combined public and private debt is 265pc of GDP, lower than in France, Holland, the UK, the US or Japan. It scores top of the International Monetary Fund’s index for “long-term debt sustainability” among key industrial nations, precisely because it reformed the pension structure long ago under Silvio Berlusconi. “They have a vibrant export sector, and a primary surplus. If there is any country in EMU that would benefit from leaving the euro and restoring competitiveness, it is obviously Italy,” said Andrew Roberts from RBS.
Which is precisely why that is not going to happen. The Germans and the Eurocracy in Brussels have fought together, tooth and nail, to keep Greece in, simply because its exit would, they say, make the euro zone look like it’s in trouble. Why would they ever let go of an economy that is doing better?
That said, the Daily Telegraph article speculates that the shoe might be on the other foot come 2013:
“The numbers are staring them in the face. We think the story of 2013 is not about countries being forced to leave EMU but whether they choose to leave.” A “game theory” study by Bank of America concluded that Italy would gain more than other EMU members from breaking free and restoring sovereign control over its policy levers. Its International Investment Position is near balance, in stark contrast to Spain and Portugal (both in deficit by more than 90pc of GDP). Its primary surplus implies it can leave EMU at any moment it wishes without facing a funding crisis.
True, but its GDP growth from 2009, including forecasts for 2013, averages -0.86 percent. That’s worse than, e.g., Germany, France and the United Kingdom. It is also worse than some smaller economies like Estonia, Sweden and Poland and on par with troubled Hungary.
Italy’s problem is that its EU-appointed prime minister has concentrated all his efforts on making the government finances look good. In doing so he has taken focus off the private sector and thus helped the economy essentially come to a grinding halt.
The Daily Telegraph does not see this problem. They are focused on making a case for an Italian secession from the euro. I am not opposed to that, but it has to come on realistic terms. Here is the case outlined by the Telegraph:
A high savings rate means that any interest rate shock after returning to the lira would mostly flow back into the economy through higher payments to Italian bondholders – and it is often forgotten that Italy’s “real” rates were much lower under the Banca d’Italia. Rome holds a clutch of trump cards. The one great obstacle is premier Mario Monti, installed at the head of a technocrat team in the November Putsch of 2011 by German Chancellor Angela Merkel and the European Central Bank – to the applause of Europe’s media and political class.
And herein lies the real problem. The Eurocracy wants to maintain control over its member states – and tighten that control. The Daily Telegraph recognizes this when they refer to now-ousted Monti as…
a high priest of the EU Project and a key author of Italy’s euro membership.
Refreshingly, the Telegraph also recognizes that the euro is weighing down on the Italian economy. It is inspiring to see a British newspaper that is willing to go to this great length to criticize the EU power grab and how that power grab has been so devastatingly manifested in the common currency project. At the same time, the newspaper also recognizes the problems associated with any speculations about where a member state such as Italy is heading:
The sooner he goes, the sooner Italy can halt the slide into chronic depression. Markets are, of course, horrified that he will resign once the 2013 budget is passed, opening the door to political mayhem early next year. Yields on 10-year Italian debt spiked 30 basis points to 4.85pc on Monday. … The immediate risk for bond investors is a fractured parliament, with a “25pc” chance of victory by the eurosceptic forces of Mr Berlusconi, the Northern League and comedian Beppe Grillo, now running near 18pc in the polls. “We’re doomed if there is no clear majority in parliament,” said Prof Giuseppe Ragusa from Luis Guido Carli Unversity in Rome.
The reactions by markets are worth noting but of limited importance so long as we can expect the Eurocracy – and the German government – to do whatever is in its powers, and more, to prevent an Italian euro secession. The immediate question is not what the price will be of the uncertainty rising around Italy’s currency membership, but what price Italy and the rest of Europe will pay in terms of lost member-state sovereignty. For every new chapter that is written on the European crisis, the Eurocrats seem to have advanced their position just a little bit more.
Given what the EU leadership, the ECB and the German government have done thus far to keep the euro zone together, it is truly frightening to imagine what they would do if there was any realistic chance that Italy would leave the euro.
Only time, and upcoming Italian elections, will tell.
As the European economic crisis continues and even grows deeper, the EU responds with measures that are anything from irrelevant to entirely counter-productive. The austerity policies that the EU and the ECB are forcing upon troubled member states belong in the latter category, right out at the edge of political sanity. Almost as ridiculously self-defeating is the new EU bailout scheme for deficit-ridden state governments. Referred to as a “rescue fund”, this program is going to buy treasury bonds from governments in order to keep the interest rates down on the loans that those governments have to take to cover their deficits.
This rescue fund has not yet been activated, but that could very well happen soon. EurActiv has the story:
Spanish Prime Minister Mariano Rajoy kept financial markets guessing yesterday (29 October) over whether he will seek a credit line from the eurozone’s rescue fund but said he would do so “when I think it is in the interests of Spain”. … [Italian Prime Minister Mario] Monti said it was vital that the European Central Bank’s bond-buying programme to support troubled states be activated, a strong hint that Spain should take the plunge, since he also said Italy did not need a bailout. “It is of paramount importance that the instrument is put to work, that it does not remain theoretical,” Monti said. Monti said earlier this month that if Spain were to request a credit line from the eurozone’s rescue fund, triggering ECB intervention, it would calm financial markets. While Rajoy maintained his ambiguity, he omitted previous demands to know more details of the ECB’s bond-buying plan before making up his mind.
The “rescue fund” is self-defeating and counter-productive for two reasons. First, it pumps out newly printed euros – i.e., increases money supply – at a time when demand for money is very low. The short-term effect of this is a depreciation pressure on the euro: when the euro falls vs. other big currencies, import prices start rising. This creates an import-price driven inflation threat at a time when the economy is at the trough of a recession.
Long term, printing money creates a domestic inflation pressure. It is unlikely that this will happen throughout the euro zone, but if this bailout scheme – sorry, “rescue fund” – is going to continue to buy, e.g., Spanish treasury bonds in perpetuity, the effect will be similar to that which has brought about dangerous levels of inflation in countries like Argentina and Venezuela.
Which brings us to the second reason why the rescue fund idea is self-defeating. The fund essentially promises to feed government spending with expanding money supply. (It is extremely unlikely that the fund can sustain for any period of time if funded by tax revenues.) The practical meaning of this is that welfare states like Greece, Spain, Portugal and Italy can continue to dole out entitlements – work-free income – to large groups of their citizens. These entitlements are then used to pay for daily expenses, which of course keeps consumer demand at a reasonable level. But the flip side is that the more people are allowed to remain on entitlements, the fewer people will participate in the work force. As fewer participate in the work force, there will be less production to go around, which means less supply compared to demand – an inflation driver right there – and fewer taxpayers.
As the taxpaying population shrinks, whether in absolute or relative terms, the government’s need for more rescue-fund bailout cash persists and even increases. The EU digs itself into a hole of endless money supply expansion, and its only collateral will be treasury bonds that will be in such abundant supply that you would have to pay people to take them off your hands.
It is rather disturbing that the prime ministers of Italy and Spain can discuss the “rescue fund” so casually, without even hinting at any of the problems associated with it.
Perhaps they are blinded by the short-term effect on interest rates that this and similar schemes can have. EurActiv again:
Rome’s borrowing costs have fallen since July, partly due to the European Central Bank’s pledge to buy unlimited quantities of bonds if necessary to help states that request aid and accept strict conditions, but also on hopes that Monti may stay on after next year’s general election.
But, says the report, there are other factors at work that erode any gains from this reckless “rescue fund” commitment:
Italian and Spanish bond yields rose on Monday, partly due to uncertainty in the eurozone’s recession-stricken third and fourth largest economies. But Italy paid less than a month ago to sell €8 billion of six-month bill. The euro also slipped on doubts over whether Greece, the country that triggered Europe’s debt crisis, can agree to a deal on new austerity measures and its international lenders can figure out how to make its huge debts sustainable.
And that is precisely the question that no one wants to answer. The reason is simple: if Europe’s political leaders were to actually take a close look at the crisis they are struggling with, they would inevitably reach the conclusion that the cause is the welfare state and its conglomerate of over-promising, work-discouraging entitlement programs. That, however, would require a fundamental course correction in European politics, in the public policy debate and in how Europeans in general live their lives.
Nevertheless, the only way out for Europe is to structurally reform away its welfare state. Otherwise, the entire continent will be crushed under the pressure from, on the one hand, those who want to raise taxes to save the welfare state and, on the other hand, those who want to save the welfare state with austerity-driven spending cuts. Both strategies are destructive and entirely counter-productive: higher taxes depress private-sector activity and erode the tax base; spending cuts reduce government spending without cutting taxes, thus raising the government’s net burden on the private sector.
There is ample evidence around Europe of what austerity does to a country. In addition to the most obvious disaster, Greece, the Spanish crisis offers a disturbing but important case study. The national government is doing its very best to force austerity upon the regions, something that works well – from a strictly administrative viewpoint – in a centralized nation-state like Greece (or Sweden, which was put through the grinders of austerity in the ’90s). But Spain is not a traditional nation state: its provinces are autonomous to a point where the country more resembles a federation than anything else.
Because of their relative independence, the Spanish provinces are pushing back against the national austerity agenda. I discussed this problem in September. A more elaborate analysis is offered by Helena Spongenberg of the EU Observer:
The result of Sunday’s regional elections in northern Spain has given Madrid a bit of breathing space and support for the austerity measures needed to put the fifth largest economy in the European Union back on track. But it has also given the conservative government a bit of a headache when it comes to Spain’s continued unity.
In addition to the problems with keeping Catalonia from seceding, the national government has to deal with the two northern provinces of Galicia and the Basque Country. Both held regional elections on October 21, and as Spongenberg explains, partly as a result of the election outcomes the two regions respond quite differently to the austerity efforts:
The past year’s austerity measures taken by the current Spanish government – led by President Mariano Rajoy’s centre-right Partido Popular – got the thumbs up in Galicia. … [It] was feared that voters in Galicia would take their anger of Madrid’s severe budget cuts out at the polls, as it happened at the regional election in Andalusia in March when the Social Democrats defeated PP. The fears were unfounded and PP has even increased its absolute majority gaining 41 (previously 38) seats out of 75 in the Galician Parliament. … The election in the Basque Country, however, turned out as expected – or rather, as feared by the government in Madrid. Two out of three lawmakers in the Basque Parliament are now Basque nationalists – 48 seats out of 75. … The moderate nationalist party PNV was the overall winner with 27 seats, and is set to form a minority government in Vitoria … PNV backs further regional autonomy from Madrid, but [PNV leader] Urkullu also promised in the election rally to bring a new law on Basque independence to a referendum in 2015.
Spongenberg sees this as a temporary mandate for the national government to…
…go ahead with further austerity measures. But Rajoy can hardly relax for long. Spain is in its second recession since the crisis began in 2008; an economic bailout of the country is imminent; another general strike is set for November 14th; and the separatists in Catalonia are expected to win the elections on November 25th.
The question that Spanish voters should ask themselves is whether or not the welfare state is so dear to them that they are willing to risk the unity of their country to save it. That is, after all, the essence of what the national government is saying when it continues to impose austerity on the Spanish economy.
As I explained above, there is no alternative in relying on the “rescue fund” as an alternative to austerity. Not only does the “rescue fund” come with all the negative consequences outlined here, but the Spanish government will in all likelihood have to double down on its austerity policies in order to get any money. That would create a double-whammy for the Spanish economy: short-term destruction of growth and jobs, and long-term threats of inflation.
It is sad to see an entire continent commit macroeconomic suicide. It is even sadder when it is happening in the name of an ideology. But the saddest part of it all is that the alternative – structural reform to end the welfare state – could so easily be done, with excellent results for everyone, especially the poor, needy and unemployed.
For a first glimpse of how this can be done, from an American perspective, click here.
It is getting increasingly difficult to keep up with the unraveling of the European super-state project. Every day brings more news about the fiscal stress and its political fallout across the euro zone. But there is no reason to get frustrated: we here at the Liberty Bullhorn will keep up, and not just report, but also analyze the events as they unfold.
Today we hear yet more evidence of escalating desperation among Europe’s political elite. On the one hand we have yet more panic-driven budget cuts in one of the euro zone countries; on the other hand we have signs of a dawning insight spreading among the Eurocracy that the combination of a maintained euro zone and austerity is actually doing a great deal of harm to the entire continent.
Let’s begin with the latest round of panic-driven budget cuts. This time it is Italy that is desperately struggling to close a gaping hole in its budget:
Italian Prime Minister Mario Monti won a confidence vote on Tuesday (7 August) linked to another €4.5 billion worth of spending cuts aimed at convincing investors that Italy’s economy is sound. But fresh data shows a worsening recession and rising borrowing costs. The bill – which comes on top of previous spending cuts amounting to a total of €26 billion by 2014 – was approved with 371 MPs, while 86 said No and 22 abstained. The €4.5 billion worth of cutbacks will be implemented by the end of this year. The remaining €21.5 billion are to be spread out over the next years.
Some commentators here in the United States continue to claim either that there are no spending cuts in Europe, or to the extent that there are cuts, they are merely cosmetic. It would be interesting to hear how these cuts can be defined as mere cosmetics:
Thousands of hospital beds are to be slashed and 20 percent of top public officials to be fired as part of the austerity drive.
It is puzzling, to say the least, to see a growing wall of denial here in America about what is actually happening in Europe. It is bothersome that in the face of stark evidence, some commentators with influence over the public policy discourse – and over many key players in Congress – continue to deny that Europe’s welfare states are indeed cutting spending. There are a couple of possible explanations why these influential libertarians remain in denial about Europe; one is that they simply fail to understand the distinction between productive spending cuts and harmful spending cuts – a distinction I analyze at length in this paper. By refusing to grasp this distinction they conclude, falsely, that all spending cuts are the same. But all spending cuts are not the same: spending cuts associated with maintained or even increased taxes are particularly harmful.
Productive spending cuts roll back government permanently, combining less spending with deregulation and lower taxes. The problem for Europe is that it won’t give itself enough time to execute such cuts. Instead they pull out the fiscal chainsaw and slash the budget across the board – as fast as they can. This does, of course, have seriously negative consequences for a nation’s economy, as is evident in Greece today, as was evident in Sweden in the ’90s and in Denmark in the ’80s.
As the EU Observer reports, Italy is having a similarly bad experience with panic-driven budget cuts:
Meanwhile, fresh data shows that Italy’s gross domestic product shrunk by 0.7 percent in the April-June period compared to the previous three months. Italy’s borrowing costs for the benchmark 10-year bond are also above six percent, less than one percent short of what is considered bailout territory. Monti in recent months relentlessly pushed for a “semi-automatic” intervention by the eurozone’s bailout funds and the European Central Bank (ECB) when countries, such as Italy and Spain, do the right thing but pay too much interests on their bonds.
The Italians are faithfully executing their austerity-driven budget cuts, just as dictated by the ECB and the EU, under the auspices that as they do the cuts the world’s financial investors will regain confidence in their treasury bonds and interest rates will go down. That is, of course, not happening. Any student of macroeconomics with any insight into phenomena such as the paradox of thrift will know that austerity – the combination of across-the-board, right-now spending cuts and sustained or increased taxes – will in fact prolong an economic crisis. If harsh enough, austerity will send the economy hurling into a depression.
Investors on the world’s market for treasury bonds know about the paradox of thrift. That is why, as the EU Observer reports, the spending cuts executed…
…by the Italian technocrat – a respected economics professor and a former EU commissioner – have so far failed to impress markets.
A major reason why the ECB and the EU are forcing ailing euro-zone welfare states into these reckless, destructive austerity policies is that they are trying, very desperately, to save the common currency. They rightly conclude that excessive borrowing in countries like Greece have negative ramifications for all of the euro zone, but they also, and wrongly, conclude that austerity is the way to eliminate that borrowing. Therefore, they have bet the future of the entire euro zone on the hope that these austerity policies will work. Which they don’t.
As the austerity policies fail in country after country within the euro zone, the common currency itself grows weaker and weaker. This is now, slowly, dawning on the Eurocrats who have thus far adamantly protected their political super-state project. But reality has a way of getting to you no matter how much you try to shield yourself from it. Therefore, it is not surprising that we now hear, in another EU Observer story, that one of the very architects of the euro zone is slowly coming around:
Former European Central Bank (ECB) chief economist and German central banker Otmar Issing has warned that the eurozone may split up – another voice in the chorus talking about a Greek exit from the common currency. ”Everything speaks in favour of saving the euro area. How many countries will be able to be part of it in the long term remains to be seen,” Issing wrote in his latest book, entitled: “How we save the euro and strengthen Europe.” Seen as one of the founding fathers of the euro, as he was at the ECB when the euro was launched in 1999, Issing contradicted the current ECB chief who last week insisted that the euro was irreversible. … The role of the ECB as a firefighter in the euro-crisis is also something Issing dismisses: “The less politicians address the root of the problems, the more they look with their expectations and demands to the ECB, which is not made for this. It is a central bank and not an institution to rescue governments threatened by bankruptcy.”
In other words: stop bailing out failing welfare states. He does not point to the welfare state as the root cause of the fiscal problems around the euro zone, but at least he admits that it is not the role of a central bank to print money at the request of spendoholic politicians.
Again, as the EU Observer story continues, we hear how more and more Eurocrats and high-ranking European politicians are admitting that the euro zone is about to break up:
Issing’s book come just a few days after the head of the Eurogroup of finance ministers, Jean-Claude Juncker, said that the area would “manage” a Greek exit, even if it was not desirable. German economy minister Philipp Roesler last month said the prospect of Greece leaving had “lost its terror,” while regional politicians in Bavaria are demanding for the country to exit by the end of the year.
A Greek euro exit is not just palatable, but necessary. This growing support of a break-up of the euro zone could very well originate in a growing realization among Europe’s leaders that if Greece is not allowed to leave, the country will continue to nudge closer to an extremely dangerous political and economic breaking point. As the EU Observer explains, the politicians in Athens are forced there by the IMF, the EU and the ECB – holding hostage those who critically depend on the Greek welfare state for their daily survival:
Dow Jones newswire reported that the troika of international lenders is delaying its return to Athens to October, rather than September, amid continued struggles by the Greek government to seal a deal on €11.5 billion worth of spending cuts. The cuts are needed for more money from the €130 billion bailout to flow to the troubled country, upon a troika report saying the Greeks are doing the right things. In the meantime, the country is rapidly running out of cash. A €3.1 billion bond held mostly by the ECB matures on 20 August, posing an immediate liquidity risk to the twice-bailed-out nation. Deputy finance minister Christos Staikouras told Skai tv that the spending cuts must be finalised by 14 September when eurozone finance ministers are meeting in Cyprus for an informal gathering. The cuts were due to be sealed in June, but after two successive elections, Greece has missed all the deadlines for this year. ”We are looking everywhere,” conservative Prime Minister Antonis Samaras told reporters in Athens.
The breaking point that Greece is heading for is more dangerous than anything Europe has seen since the Berlin Wall crisis in 1961. It is putting the very democratic system of government in jeopardy. When a welfare state tries to balance its budget by means of austerity, the ultimate victims will be democracy and freedom. Hopefully, it is this insight that is now dawning on Europe’s otherwise stalwartly arrogant leaders.
If so, there is still hope that Europe can turn around before the entire continent goes over the cliff and down into the abyss of authoritarianism and industrial poverty.
One of the most urgent questions of our time is: what will become of the European Union? Its currency union is in deep trouble, an increasing number of its member states are in dire fiscal straits with urgently unsustainable debt, and its form of government suffers from a democracy deficit as bad as the Greek budget deficit. Having emerged from a truly optimistic effort at bringing former political and military adversaries together, the EU has lost its roots as a project of international cooperation. Instead, it has morphed into a political project with its own life and ambitions where democracy is being sacrificed on the altar of super-statism.
Few people have been as outspoken about this problem as Nigel Farage, Member of the European Parliament for the UK Independence Party:
It is a bit of a stretch to say that the EU is intentionally anti-democratic, but there is absolutely no doubt that Farage is right in that the EU is effectively anti-democratic. He makes a very good point that when the EU evolves as an organization, it does so in a way that further increases its democratic deficit.
And there is more to come. In fact, the current fiscal crisis is beginning to merge with Europe’s democracy crisis, in a way that is causing open tensions even between politicians in different EU countries. An article in Bloomberg.com makes the point well:
Disagreements within the 17-nation euro area are undermining the future of the European Union, said Italy’s Prime Minister Mario Monti as the stand-off on European Central Bank support for Italian and Spanish debt hardened. “The tensions that have accompanied the euro zone in the past years are already showing signs of a psychological dissolution of Europe,” he told Germany’s Spiegel magazine in an interview published yesterday.
The solution to the fiscal crisis in each of the troubled euro countries lies at the national level, where the decision can – and should – be made on how to reform, or preferably dissolve, the welfare state (the root cause of Europe’s fiscal crisis). Instead, the mindset among Europe’s politicians is increasingly that they need to save the euro and the EU even if the price is national economic, constitutional and political sovereignty.
This tension between democratic national governments and the EU is put on full display further down in the Bloomberg.com article:
[Italian Prime Minister] Monti also appealed for European governments not to be overly bound by their parliaments. “Of course every government has to follow its parliament’s decisions,” he told Spiegel. “But every government also has the duty to educate the parliament” or risk making a euro-area breakup more likely.
This provoked comments from German politicians echoing the strong points made by Nigel Farage:
Hans Michelbach, a lawmaker representing the coalition Christian Social Union, said in an e-mailed statement that elements of Monti’s comments are “anti-democratic” and incompatible with European principles. Michael Meister, the deputy leader in parliament of Merkel’s Christian Democratic Union, called for “not less, but more democracy in Europe,” Tagesspiegel newspaper reported after Monti’s remarks.
In other words, in the wake of the fiscal crisis and the tensions it has put on Europe’s super-state institutions, there are now tensions emerging at an even higher level, namely between the need for the super-state institutions to move ahead regardless of what the people say, and the demand among the European peoples to maintain democratic governments. Democracy is no doubt at risk, if Europe tries to solve its fiscal crisis with more statism instead of less. As the EU Observer reports, this risk seems to be of no consequence to the Eurocrats pushing for yet more power to the EU and the ECB:
EU officials have drawn up a far-reaching plan that would eventually turn the eurozone into an outright fiscal union, but acceptance by EU leaders – whose powers it reduces – will require a major leap of political faith. The seven-page document suggest that ultimately the 17-nation single currency area will need a treasury office and a central budget. Among the short-term changes required is the de facto handing over of budget power and economic policies to the EU level. … Budgets that breach fiscal rules would have to be altered.
This means a centralized welfare state, run from Brussels under fiscal rules that will force all euro countries to do what Greece is trying to do, namely balance a budget by raising taxes and cutting spending. But so long as the massive entitlement programs remain in place it is economically impossible for the EU to do at the super-state level what individual countries have failed to do at the national level.
The paper – drawn up by the presidents of the European Commission, European Council, Eurozone and European Central Bank – moots giving the European Central Bank the ultimate authority. In the medium term, so long as a “robust framework for budgetary discipline and competitiveness is in place, some form of debt mutualisation “could be explored.” Meanwhile, labour policies and tax polices – until now a no-go area for the European Commission – will no longer be exempt. An integrated economic eurozone will need “co-ordination and convergence in different domains of policy” says the paper explicitly mentioning “labour mobility” and “tax coordination.” ”Let me tell you here that fiscal union is about much more than just euro bonds. It also means more co-ordination in taxation policy and a much stronger European approach to budgetary matters,” said commission President Jose Manuel Barroso at the European Policy Centre in Brussels on Tuesday (26 June). ”Faced with this stark reality, standing still is not an option. A big leap forward is now needed.”
This is extremely dangerous. The Eurocrats are trying to cure lead poisoning by injecting the patient with lead. And just to make this entire process toward more super-statism more bizarre, an opinion piece in the EU Observer makes the case for yet another super-state project in Europe:
Apart from the cynicism of a public relations exercise talking about a “banking union” after tens of thousands have protested against bailing out banks with taxpayers’ money, leaders have also missed an opportunity to tell citizens what they are most worried about: will their pensions and savings be guaranteed if a country goes bust? A ‘social union’ might have been a better response. … Spain, Italy, Portugal, Ireland, Greece – all have to cut back drastically on their social spending to meet the fiscal targets and convince markets they will not go bust. Meanwhile, public anger is growing and the support for such measures is zero. … On the other hand, public support for a eurozone-wide social security scheme may also be hard to achieve. Social spending is still considered a purely national, non-EU matter. But the reality is that eurozone deficit and debt rules make cutbacks mandatory which in the end affect wages, pensions, hospital bills, subsidised cancer treatments, schools, science programmes. The most sensible thing to do would be to tell citizens that transferring some of these schemes at eurozone level may actually be a safer bet. That in the end people would get their pensions no matter what and that research programmes will not be cut overnight to meet deficit targets. But in order to do that, EU leaders would need something they have not shown in a long time: honesty and courage.
There you have it: a European welfare state. More of what caused the crisis, less of what can solve it. The losers at the end of the day are Europe’s taxpayers who will be paying more taxes for less government – just as they do now at the national level – and Europe’s voters who will have even less influence over the policies that set the terms for their personal finances, their access to health care and education, their retirement security… in the end their very lives.
Europe’s welfare states continue their slide into the fiscal abyss. Yesterday Euractiv.com reported that Moody’s has downgraded Italy to two credit rating points above junk status:
Moody’s surprised markets today (13 July) by downgrading Italy’s government bond rating by two notches to Baa2 and warned it could cut it further, piling on pressure just hours before the country launches its latest bond sale. The move left Italy’s rating just two notches above junk status and could raise already painful borrowing costs.
Since Greece essentially went over the cliff earlier this year, Spain has been forced to raise its interest rates to dangerously high levels. This makes Italy the third, but definitely not the last European welfare state to have to respond to poor credit ratings with higher interest rates.
As Euractiv.com explains, this is having a negative effect on the euro, which is already under stress:
The stark warning from Moody’s, which highlighted Italy’s vulnerability to political shocks in the eurozone and could deepen worries about the region’s debt crisis, knocked the euro down about a quarter of a cent to $1.2190 in Asian trade. ”Italy’s government debt rating could be downgraded further in the event there is additional material deterioration in the country’s economic prospects or difficulties in implementing reform,” the agency warned in a statement. ”Should Italy’s access to public debt markets become more constrained and the country were to require external assistance, then Italy’s sovereign rating could transition to substantially lower rating levels.”
According to Eurostat, Italy has one of the worst debt-to-GDP ratios in the industrialized world:
In other words, the downgrade should come as no surprise. Euractiv.com notes that the downgrade…
took its ratings for Italy below those from agencies Standard & Poor’s Ratings Services and Fitch Ratings. The timing could not be worse for Italy as it seeks to sell €5.25 billion in bonds later on Friday, including a new three-year issue.
According to Malaysia-based Business Times, the Italian government was rescued by its own domestic banks, a blessing that could very well turn out to be a curse.
Italian banks came to the rescue yesterday after the country suffered a ratings downgrade, but while Rome cut its three-year borrowing costs at auction, a rise in 10-year bond yields highlighted concern it may fall victim to Europe’s debt crisis. Moody’s cut Italy’s sovereign debt rating to Baa2 yesterday, citing doubts over Italy’s long-term resolve to push through much-needed reforms and saying persistent worries about Spain and Greece were increasing its liquidity risks. Solid domestic demand helped the Italian Treasury sell the top planned amount of 5.25 billion (RM20.37 billion) in bonds, paying less than a month ago on three-year paper.
Banks have already entrusted the Italian government with a lot of money. Again according to Eurostat, in two short years, from 2008 to 2010, financial institutions increased their share of total Italian government debt from 38.6 percent to 44.5 percent. That is an increase of more than 180 billion euro in two short years.
Government debt is no longer the virtually risk-free asset it used to be. Banks know this, which is why they want higher and higher interest rates to buy treasury bonds. At the same time as governments all over the industrialized world are forcing banks to be more risk averse, the same governments are also trying to get the very same banks to buy their increasingly risky bonds. It is now dawning on politicians that this paradox is coming back to bite them, so they are now trying to strong-arm financial institutions into buying their risky bonds despite the new risk regulations.
When banks in turn suffer from the increasingly risky investments in downgraded treasury bonds, they are eventually pushed to the brink of insolvency. That’s when the very same governments that forced their risky bonds upon those banks have to come and rescue the banks from the insolvency that those same governments brought upon them.
There is only one way out of this reckless game with taxpayers’ money: dispose of the welfare state. The welfare state is the root cause of government debt.