Eurozone Follies: Confusing Callousness for Courage
As Spain (momentarily?) reels again as rates rise over doubts it can roll over its debt, it is time to step back and note that the eurozone can almost surely solve its problems in the medium term if it truly wants to. Surprise? It shouldn’t be. But rarely has there been such poor management of economic affairs since the Great Depression. Readers should know this: there is a path to successful resolution. Yet one would be forgiven for thinking there is not after reading or watching the media.
The best piece of evidence that something could indeed work is the action beginning in December from the constructively crafty Mario Draghi, new head of the European Central Bank, the successor to the arrogant and stubborn Jean-Claude Trichet. Trichet, remember, raised interest rates in mid-2011 for fear that inflation was on its way back.
As is by now widely celebrated, Draghi was able to inject up to a trillion in euros to banks at low interest cost, which in turn they used to buy sovereign debt. Suddenly, the markets calmed, rates on debt for Spain and Italy fell, and there was breathing room. Perhaps as interest charges fell, they could pay off the debt coming due with room to spare. In such an environment, Europe even came to terms with Greece on a new bailout — albeit onerous ones for the Greeks.
This all could have been done earlier and more directly had the ECB been run by far-seeing people. But German bankers and politicians kept the ECB from being more aggressive back in early 2010, when it should have been doing what the U.S. Federal Reserve had done back in 2008. There should be more from Draghi going into the spring, but of course there are new fears he may cut back.
What should be clear is that the big reason why countries like Spain and Greece may not be able to pay their debt are those high rates, not public spending profligacy. Greece had even run a surplus. The average deficit compared to GDP in the eurozone was 0.5 percent in 2006. Then the recession devastated tax revenues and burst property bubbles. Even so, Italy, for example, has a rather tame deficit even today. But because it has a high debt to GDP ratio, much of it short term, a rise in rates spearheaded by speculative fears becomes very expensive in the near term. Indeed, if governments made an error, it was taking on too much short-term debt that needed constant rolling over, and the U.S. is no exception. Remember when the Clinton administration, with the encouragement of Alan Greenspan, eliminated its 30-year benchmark Treasury bond?
In contrast to the narrow-minded ECB, as noted, the Federal Reserve immediately poured money into the U.S. and world economy (by cutting rates sharply, buying Treasury securities, and guaranteeing money market liabilities and other instruments) when Lehman Brothers fell apart — and to a lesser degree earlier. Even when Europe established a new facility, the European Financial Stability Facility, to lend money in 2011, Germany restricted it from borrowing from the ECB. The EFSF should be expanded, without question. Some resist that idea, most prominently Germany, although Germany is now under recessionary pressure itself and seems to be relenting somewhat. That is unconditional good news.
The success of the Draghi plan shows how unfortunate the stringency has been. Nations that set their own monetary policy, like the U.K., have not had a run-up in rates because the central bank can in effect print money, and has. These nations can also devalue their currencies. Even the U.S. dollar has fallen, if probably not enough.
The essence of the euro crisis is that members cannot devalue or control their own monetary policy. But the ECB could have done so. If it had recognized its obligations, the crisis would not have been nearly as great. (There are some legal restrictions as well, which I believe could have been disregarded, much as Germany and France once disregarded the legal restriction of a deficit ratio of 3 percent without suffering the prescribed penalties.)
Even so, a more enlightened and courageous ECB would still not have been enough. The eurozone needed fiscal stimulus, much like the Obama stimulus provided, though Europe needed more (the U.S. needed a second round as well). Instead, however, Europe got the opposite: austerity. In return for a Greek bailout from obstinate and ostrich-like Europe, its rates soaring partly because the ECB wouldn’t serve as lender of last resort as it does in other nations like the U.K. and U.S., the EU tough guys demanded public spending cutbacks, firing of thousands of public workers, reduced minimum wages, and on. Greece is now essentially in a depression imposed with remarkable callousness by the core eurozone members.
Portugal, Spain, and Italy also have had austerity explicitly or implicitly imposed on them as part of a bailout deal. All are in recession today.
Those who imposed the austerity, led by the Dutch, the Germans, and to a degree the Sarkozy supporters in France, assumed a dog would be able to catch its tail. Austerity meant weakening incomes, as Keynes long ago taught us, and lower incomes meant lower tax revenues. When you missed your deficit target, you had to cut spending again, which led to weakening tax revenues again. Government spending couldn’t drop fast enough to meet a deficit target in any of those countries.
Almost everyone knew this was about to happen. But the imposers of austerity believed this would wring these economies of excessive debt, reduce interest rates and wages, and create a new platform from which to grow. Thus, they believed in family economics, not country economics. Tightening the belt may often work at home, but it means disaster for a country .
Research from the IMF also strongly suggests that austerity’s pain is delivered unequally. Wages go down farther than profits and stay down longer. Long-term unemployment rises and many do not return to work.
Here’s the kicker: Germany is now in recession because austerity economics has so undermined the economies of those that import goods from it. It, too, is suffering. Did it really think it was immune to the process? Its success depended in the 2000s on the very free-spending economies it now disparages. Now the beggar-thy-neighbor consequences of their export-led growth model are at last taking a toll.
It is possible that Greece will say to heck with it, we won’t pay our debts and would rather leave the euro. That would produce harsh pain all around. But the Germans don’t want a breakdown of the euro — they benefit too much from a fixed euro that is too low given its unit labor costs. If Germany were independent, its currency would have soared already. Someone has to earn enough money to pay for the goods you make. Germany’s repressed wages would never have provided it the market adequate to supports its manufacturing growth. Such export-led growth models are not sustainable.
What Europe needs is a far more generous ECB and the end of austerity economics for now. It also needs Germany and others to raise government spending to stimulate the region. And finally, everyone should get over their obsessions with tiny Greece. Europe should treat the troubled country as an obligation, much as the U.S. carried the economies of the deep South for so long after World War II. Make Greece the ward of the state, supply it transfer social funds, help it get its house in better order, but don’t suppress the spirit and hopes of democracy.
The deepening, austerity-induced recession in Europe will also take a toll on the U.S. If it makes it still harder for the southern periphery to pay its debts as bond investors get scared off, a new financial crisis could occur. This would affect the U.S., which has exposure to European debt, especially in money market mutual funds. A new recession is not impossible in America.
Will Europe wake up? Will Germany be forced to face reality as it too suffers recessions? Can someone come forward with the guts to take a constructive stand other than Draghi, who disguises it in technicalities and sometimes talks up austerity himself? Perhaps they are now expanding their “firewall,” the money available for a bailout. Good news. But others are complaining Spain is backtracking on austerity. That is the return of the ostrich.
It is a fascinating historical period — or would be if it weren’t so potentially tragic. The eurozone now practices pre-Depression economics. Cutting debts through spending contraction will reduce interest rates and labor costs enough to restore business investment, they say. Economies self-adjust! That is their song — or their swan song. And we heard it most loudly in the early 1930s. The approach won’t work. Worse, it is already clearly not working. But many persist. They say, accept the necessary pain. They even say, share the pain, the best societies do. But pain is not shared under austerity economics, it is borne by the less advantaged.
Perhaps the explanation of this perverse economic policy is simply that the elite won’t suffer themselves — the middle and working class will. But eventually everyone will. The world has suffered the insensitivity of elites many times before. Think of those World War I generals sending their working class soldiers to their deaths by the millions. Perhaps not death this time. But it is the same elitist distance from reality, the same elitist insensitivity. And it is called courage by them and by many in the media.