Posts Tagged euro

Hollande’s budget

Posted by George Irvin in EU on October 1, 2012

François Hollande’s Prime Minister, Jean-Marc Ayrault, claims the new budget (unveiled on 28 September) is ‘fair, economically efficient and allows France to meet its priorities’.  In the carefully chosen words of the Guardian’s economics editor, Larry Elliott, the claim is ‘total moonshine’!

It is true that more than half the €37bn in planned budgetary savings is designed to come from increased taxes on rich households and large companies whilst—in contrast to Britain—cuts in government expenditure spare the poor and the elderly. Particularly welcome is the new 75% tax band for those earning over €1nm a year. But whatever gloss one puts on it, the budget is about reducing the deficit from the current 4.5% to 3% new year—and to near zero by 2017. With the French economy stagnating over the past 9 months and persistent unemployment of 10% or more for over a decade, budgetary austerity—however achieved—is most definitely not the answer.

The success of this budget depends on two key assumptions. The first is that greater budget discipline will bring a return to private sector growth, or to use Paul Krugman’s expression, greater discipline will inspire the ‘confidence fairy’. Thus, the growth rate in 2013 is assumed to be 0.8% rising to 2% annually for the period 2014-2017.  But elsewhere in Eurozone austerity is resulting in growing unemployment and stagnation. And a stagnating economy causes budget deficits to widen. For France to reach even the above modest growth target and to reduce its deficit, a strongly reflationary budget would be needed, particularly under conditions of generalised austerity throughout Europe.

Secondly, Monsieur Hollande’s Prime Minister claims that reducing the budget deficit will enable France to retain the confidence of financial markets and therefore to enjoy continued access to cheap credit. This too is nonsense. Throughout Europe, young people are increasingly angry about unemployment and growing job insecurity. As the French economy continues to stagnate, scenes now seen in the streets of Athens and Madrid will spread to Paris. Financial markets may be impressed by austerity in the short term, but in the longer term nothing rattles financial markets more than political unrest. An austerity budget today sets France firmly on the road to unrest in the coming years.

Why then has Monsieur Hollande reneged on his election promise to reject austerity? Why indeed is France going to ratify a so-called Budgetary Pact (TSGC: Traite sur la stabilité, la gouvernance et la coordination) which entrenches the Golden Rule of eventually reducing the annual structural deficit to zero. Some economists of the PS (Parti Socialiste) know perfectly well that such a rule is not merely illogical, but adopting it means abandoning discretionary fiscal policy altogether (having already ceded monetary policy to the ECB.)  The pact has already created much discord in the PS and its governing allies; eg, Europe-Ecologie-les-Verts (EE-LV) voted against it in late September, resulting in the departure of the MEP Daniel Cohn-Bendit.

The answer is as simple as it is perplexing. François Hollande wishes to please the Germans. He wishes to please not just Frau Merkel—whose coalition will collapse next year—but the German social-democrats (SPD) whose economic beliefs are not so different from those of Merkel’s CDU.  Crucially, Hollande’s argument is that if France is to retain its leading role within Europe and the Eurozone, in the short term it cannot afford to anger either the financial markets (and follow Italy and Spain into spiralling borrowing costs and insolvency) or the northern European austerians.

What is perplexing is that the combination of an austerity budget today and the Budgetary Pact (TSGC) tomorrow ultimately condemns France to long-term economic stagnation. This in itself will kill Monsieur Hollande’s European aspirations. Ironically, some of today’s socialist ministers who in 2005 voted against the EU Constitutional Treaty (eg, Bernard Cazeneuve and Laurent Fabius) now support the TSGC. Indeed, Elizabeth Guigou (Minister in the 2003 Jospin government), who  is on record as strongly opposing the Pact, is now willing to vote for it.  The so-called ‘sovereignty problem’, much discussed by both the left and right in France, is in reality a red herring.

The fundamental issue is about economics. Unless the left of the French socialists forces a change of course, the PS and the centre-left in France will ultimately suffer grave damage. What is need is not austerity, but a massive stimulus to get France—and more generally the EZ—moving again.

Sadly, throughout Europe, the timidity of the social-democratic response to the economic crisis is resulting in unemployment and disillusion of a scale which threatens to destroy social democracy within a generation.

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How long must we wait?

Posted by George Irvin in EU on August 22, 2012

Nouriel Roubini famously described the long decline of the euro as a ‘slow motion train wreck’. Mind you, economists disagree on exactly when the wreck will happen. Professor Vincente Nabarro has argued that the euro will survive for as long as it serves the purposes of the German (and European) elite while, in the Financial Times, Wolfgang Münchau mischievously suggests the crisis could last another 20 years given Germany’s proclivity for muddling through. By contrast, Megan Green at RGE sees the confluence of crises in Greece, Spain, and Italy during September and October, 2012, as potentially lethal. But all agree that—sooner or later—it will happen.

In Greece, the coalition government will have to agree a package of measures with the troika to secure the latest tranche of bailout money. The problem is twofold: first, Mr Samaras has asked for an extra two years to impose further austerity measures required by the troika, a request which the Germans have already rejected. Secondly, the Greek Parliament must approve the measures, failing which another general election would almost certainly need to be called.

Even if one assumes that Greeks can be paper over their differences once again (or else that Greek default does not produce catastrophic contagion), Portugal is likely to remain locked out of the financial markets and thus forced into a second round of difficult negotiations with the troika. Because the ESM comes into existence in September—assuming the Germans Constitutional Court rules in its favour—Spain too will require negotiations with the new body both on bailing out its private banks and on sovereign bond purchases.

Elsewhere, the campaign in Italy for the April 2013 general election will begin in earnest and Mr Berlusconi can be expected to launch his political comeback on an anti-euro platform, having said quite plainly earlier this year that either Italy gets bailed out or it leaves the EZ. However one views Berlusconi, there should be no doubt about the seriousness of this threat. In September too, France’s President Hollande will advance a budget which is bound to be controversial, while at the same time the Dutch will hold a general election likely to lead to a euro-sceptic coalition.

The situation might not be so dangerous were it not for growing euro-scepticism in Germany. While a majority of Germans may still favour remaining in the euro, over a third of those questioned favour a return to the old currency, the highest percentage in the large EZ countries. Public opinion, moreover, is strongly against what is perceived as further German ‘aid’ to the Club-Med countries (which is reality is ‘aid’ to their own banking system). Spurred by such neo-liberal economists as Hans-Werner Sinn, centre-right German politicians continue to insist that: (a) neither commonly backed Eurobonds nor bank insurance are an option; (b) further ECB sovereign bond purchases are dangerous, and (c) there can be no bank recapitalisation without EZ banking union, and such banking union must be preceded by political union.

But the strong EZ banking union required is not what the German centre-right has in mind, and even were it to accede on this point, German actions (and inactions) to date mean that the chance of achieving political union is growing ever more remote. Nor can we expect much to change were the SPD to enter into a new grand coalition in late 2013. After all, it was the previous SPD-CDU coalition which embedded austerity into the German constitution in the form of the debt-brake law, and the then SPD Finance Minister Peer Steinbrük—now a strong candidate to lead the party into the 2013 election—famously dismissed the Keynesian notion of a pan-European economic stimulus package. Moreover, the ex-central banker, Thilo Sarazzin , whose 2012 book Europa braucht den Euro nicht (Europe doesn’t need the euro) has been a best-seller, is a well-known SPD member.

Without a fundamental shift in the German position—not just on the above issues but on domestic demand reflation and trade imbalances–the euro seems doomed. Since there is no sign of such a shift, Europe sits on its hands awaiting the inevitable economic shock. One source has put the cost to Germany in the first year alone as a 10 per cent collapse in GDP. Perhaps this is the sort of price which, sooner or later, all of us will pay as a result of accepting the deep flaws in the initial structure of the common currency.

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Can Holande walk the walk?

Posted by George Irvin in EU on April 28, 2012

At the moment, the Euro Area is stagnating, unemployment is rising and the entire banking system is dangerously fragile—in Nouriel Roubini’s phrase, we are watching a slow motion train wreck. But if the opinion polls are right, François Hollande will very soon be President of the French Republic and economic policy in the Euro Area (EA) could become decisively more progressive. ‘Austerity’ could be ditched and Europe could go for growth and jobs.

Hollande can talk the talk, but can he ‘walk the walk’? Whether genuine change is possible depends on a number of factors difficult to evaluate; eg, how markets will react, how Hollande manages the relationship with Germany in the coming months, whether the German SPD can form a government after the 2013 general election and, crucially, whether social-democrats in the EU scrap the current economic orthodoxy. Let us consider each in turn, bearing in mind the speculative nature of any such discussion.

How will markets react to a progressive government in France? The knee-jerk reaction is to invoke Mitterrand’s experience in 1981-3 when financial turbulence forced the social-democratic left to change course within two years and into ‘cohabitation’ within five. And, yes, it must be added that financial markets are far more powerful today. Nevertheless, there are important differences. First, the once-powerful French Communist party (PCF) is no longer of any significance, so there is no red revolution to fear. It is easily forgotten, too, that Mitterrand’s policy failed largely because of rising inflation which rocketed in 1983; inflation is no longer a serious threat today.

An even more important difference is that, with every passing day, politicians and financial ‘experts’ are becoming aware that fiscal austerity leads to a dead end. Far from leading to budget balance, deep expenditure cuts leads back to recession which makes things worse—as we see in Greece, Portugal and Ireland and will soon see in Spain too. Hollande’s message is simple: in a recession, fiscal rectitude is achieved through state-led growth—it is higher national income that generates higher savings, not the other way ‘round. Even the IMF appears to agree.

Doubtless there will be capital flight from France as a result of higher taxes on the rich, but it is unlikely to be massive. Young middle-class French people migrate not because of high taxes but because there are too few jobs, and the extra income from higher taxes on the rich—and from clamping down on tax dodges—can be used to create jobs. Unlike the early 1980s, the French today are far more aware of the inequities of neoliberalism and the time-bomb of unemployment. But if Hollande wants jobs and growth, his proposed ‘stimulus’ will need to be far more than 1% of French GDP.

Hollande’s most difficult task upon coming to power will be calming the Germans while renegotiating the so-called Stability Treaty. There are two issues here. First, Angela Merkel, by openly backing Sarkozy, has declared war on the Hollande camp, presumably because she believes that by so doing she can preserve her own brittle CDU-FDP coalition government. But even assuming she can remain in power until the German general election deadline of September 2013, her popularity is on the wane and numerous polls suggest the most likely electoral outcome to be either an SPD-Green coalition or else a ‘grand coalition’ without Merkel.

The second—and crucial— issue is that of the Stability Treaty. This Treaty requires countries wishing to borrow from the European Stability Mechanism (ESM) to adopt a German-style ‘debt brake’ law limiting their structural fiscal deficit to 0.5% of GDP. As shown in detail elsewhere , the debt brake law is only possible in Germany because of the country’s current account surplus—it is economic nonsense to think such a law can resolve the problem of deficit countries. (This is not a matter of Keynesian economics but follows from simple National Accounting identities.)

Although many EA governments are in the process of ratifying it, the Treaty is deeply unpopular—-and not just in Greece, Portugal and Ireland. In Italy, Signor Monti has made it clear that he thinks it foolish and that jointly-backed Eurobonds constitute a better solution. Belgium’s Guy Verhofstatd agrees and even Sr Barroso appears to support this position. In demanding that the Treaty be changed, François Hollande would have the support not just of the EA periphery but of some of its major players and many of its economic experts. One should bear in mind that the poll indications for Italian Parliamentary elections to be held next spring suggest a centre-left coalition will emerge. Whether the Germans and their Dutch and Austrian allies could long hold out against a majority of the larger EA economies is doubtful.

In short, the victory of François Hollande on the 6th of May might well mark a turning point for the economic future not just of France, but of the EU and of Europe as a whole. While the chain of events outlined above is necessarily speculative, what is certain is that the coming 15 months will see fascinating changes take place. After all, two centuries ago France’s revolution embedded the Enlightenment values of liberté, égalité, fraternité which inform the European centre-left today, values which today’s Europe disregards at its peril. Without a growth strategy, the euro—and the European project—is doomed.

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The big bailout scam

Posted by George Irvin in EU on April 11, 2011

Suppose that my rich neighbour down the road mortgaged his mansion up to the hilt to bet on the horses, ran up millions in debt and asked me, an ordinary punter, to pay off his debts plus interest. Suppose that foolishly I accepted, and while I struggled to pay it off while barely able to feed my family and pay off the mortgage, my super-rich neighbour acquired an even bigger mansion. To make matters worse, he used all sorts of clever dodges in the Caymans to pay negligible taxes, while if I failed to pay mine I knew I’d be sent to prison.

It may sound like total madness, but that’s pretty well what’s happening to a growing number of Europeans (including Brits) today.

How did we get here? In Britain, the 2008 credit crunch produced a massive recession which played havoc with government finances. In Ireland the government took over the entire debt of its banking system, while in Greece, the rich paid minimal taxes and successive governments, unwilling to challenge them, indulged in creative accounting.  That’s somewhat simplified, but it’s the essence of the story.

Everywhere in Europe, voters are being told that decent pensions and universal welfare provision are no longer affordable and that we must all tighten our belts. Governments can no longer borrow because the credit rating agencies might downgrade their bonds. First it was Greece and Ireland, today it is Portugal, and tomorrow perhaps Spain, then Italy, and then … who knows?

But ordinary punters are starting to wake up. Instead of enduring years of economic depression, the Greeks and the Irish will probably have to default, as will the Portuguese if their economy reacts the same way to belt-tightening.[1]   And what if Spain has to be bailed out, still less defaults? That would spell a major hit for banks in Germany, France, the UK (and elsewhere), all of which could easily add up to another major financial crisis.

Are we really so vulnerable? The answer is indeed yes—-because so little has been done to address the underlying causes of the 2008 crisis.

While the recent Basle Three agreement requires banks to carry a slightly higher cash cushion, nothing has been done to re-establish the division between investment banking and commercial high-street banking, a division which disappeared with the repeal in the US of Glass–Steagall in 1999. Except for a temporary ban on naked short sales in Germany, the derivatives trade remains mainly unregulated.[2]  Credit default swaps (a form of insurance on risky financial products) are still sold over-the-counter rather than through an official market, the US President having failed to follow up his 2009 promise to re-regulate these.[3]

Meanwhile, the trillions poured into the big banks since 2008, instead of going to cash-starved small business or being used to build infrastructure and to create jobs, have largely helped fuel a new stock market bubble.[4] The extraordinary rise in the value of companies such as Facebook and Zynga provides a worrying parallel with the dotcom bubble of 2000.

Tax dodging is now a major growth industry—witness the latest GE scandal. As for making the bankers pay by introducing some form of Tobin tax, there’s been much talk but little action.

Perhaps most galling of all is the injustice of using Keynesian economics to justify the need for state intervention in banking bailouts while claiming today that the profligate state caused the problem, as politicians now argue in London, Brussels and Frankfurt.[5] How long will sensible people go on accepting this nonsense before venting their anger on our ruling classes?[6]

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(An earlier version of this piece first appeared at http://www.social-europe.eu/2011/04/the-big-bailout-scam)

1 http://www.bbc.co.uk/news/business-12864413

2 http://online.wsj.com/article/SB10001424052748703957904575252611852571860.html

3 http://www.cnbc.com/id/30731157/Regulating_Wild_West_CDS_Market

4 http://www.marketoracle.co.uk/Article19523.html

5 See Ha-Joon Chang, ‘The revival—and the retreat—of the state?’ Red Pepper, Apr/May 2011.

6 http://www.france24.com/en/20110312-300000-protest-job-insecurity-portugal

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Could the euro disappear?

Posted by George Irvin in EU on December 1, 2010

Let me make it clear that I strongly support the euro; I’m a Brit who believes in European integration and who has little time for Euro-sceptics. But I can also see the writing on the wall. The euro—and with it the whole EU integration project—is in grave danger. It is entirely possible that in five years’ time, travelling from Paris to Berlin and thence to Madrid or Rome will entail queuing to change money and struggling through customs posts once again.

Why should the euro be in danger? After all, the Eurozone taken together is in quite good shape, considering the fact that we’ve been though the worst recession since the 1930s. The 16 euro-states’ budget deficit in 2010 as a percentage of GDP is 6.9% (versus 10.2% for the USA); the ratio of public debt to GDP is 84%, far lower than the US figure of 94%.[1] So what’s the problem?

The problem is the peculiar architecture of economic governance. Since tax receipts fall and spending rises in a recession, government deficits necessarily swell and must be financed by borrowing. Because the Eurozone has no federal treasury and cannot emit federal bonds, smaller member states whose domestic bond markets are too narrow must go to the international market to sell their own Eurobonds.

In normal times, member-states’ government bonds are considered a safe bet by the market. But as past financial crises show clearly, bond markets tend to be driven by the herd instinct; ie, once the rumour circulates that one country’s bonds are at risk, everyone joins in. This is commonly known as ‘contagion’, and there’s lots of it about today. Witness the fact that not just Greece, Ireland, Portugal and Spain are under threat, but in the past week Belgium and Italy have been added to the list.

The joint European/IMF bailout plan agreed earlier this year provided some €750bn (€860bn if Greece is included) in potential relief to afflicted countries—with plenty of nasty strings attached, one must add. The plan covers the period 2010-14, but the combined borrowing requirement over 2011-14 of Italy, Spain, Portugal, Greece and Ireland totals nearly €650bn and is growing. Add to this Belgium’s public debt of about €350bn, and the total is €1tr, far larger than the bailout package. The size of the package is unlikely to increase because of political resistance and possible required changes to the Lisbon treaty; per contra, what is likely to increase is the troubled states’ borrowing requirements. The financial markets have already done their sums, the main reason they are betting against the longer-term success of the rescue.

What are the options? First, Chancellor Merkel and President Sarkozy recently agreed on a sovereign debt default mechanism for troubled Eurozone countries thus forcing bondholders to share the bailout pain. Doubtless such a scheme will appeal to taxpayers and sacked public-sector workers alike, but as Paul De Grauwe has noted forcefully, legitimating sovereign debt restructuring makes speculative runs more likely, not less so; ie, the new mechanism increases potential turbulence.[2]

Of course, it is not just the troubled states that are being rescued; it is the major banks holding troubled Eurobonds that are in danger. Everybody knows—except apparently the German electorate—that when Germany ‘bails out’ Greece, the main beneficiaries are German banks (just as the main beneficiary of the recent UK ‘bailout’ for Ireland will be RBS). As ever, these are deemed to be ‘too big to fail’. To ensure their solvency, the European Central Bank (ECB) has been lending them money at a typical rate of 1 percent, money which is then on-lent to Greece or whomever in the form of bond purchases yielding 5 percent or more.

The problem here (quite apart from the big commercial banks making huge profits) is that the resources of the ECB are finite. It simply cannot conjure up another trillion euros if required. Of course it could do so by engaging in Quantitative Easing (QE)—a form of monetisation—but politicians think this will lead to inflation.

And here lies another trap. Although core inflation in the Eurozone remains very low, once energy and food are added back into the measure the rate goes up. In the next few years, food and energy inflation (both largely imported) are likely to accelerate. And if the ECB prints money, politicians—most of whom still believe in the simple ‘quantity theory of money’—will take the blame.

Finally, there is the fundamentalist solution preached by the deficit hawks: make all the ClubMed countries (including those not bordering the Mediterranean) cut their spending and balance their budgets! But there are two problems here. First, budget balancing might be feasible for one country when the world economy is buoyant, but in a world where the OECD economies are stagnating, asking many countries to balance their budget is not feasible. As a recent IMF study shows, ‘expansionary fiscal contraction’ is not the answer.[3]

So what is the answer? The answer is twofold: first, the ECB, not member states, should be able to issue Eurobonds, an idea which has recently gained limited traction. Secondly and more important, in the long term there must be a Eurozone Federal Treasury, akin to the US Federal Treasury. As the President of the ECB, Jean-Claude Trichet, said in the summer “Nous sommes une fédération monetaire. Nous avons maintenant besoin l’équivalent d’une fédération budgetaire” (Le Monde, June 1st).[4] He repeated this warning to a European Parliamentary Committee on 30 November.

To date, Europe’s political class has been unwilling to listen. They argue, inter alia, that Germany’ constitutional court would never cede fiscal sovereignty. Indeed, the tradeoff between monetary and fiscal sovereignty was at the heart of the Maastricht Compromise of 1992. It is most certainly not in Germany’s interest to allow the euro to flounder. Let’s hope Europhiles wake up before it’s too late.

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[1] See FT Alphaville 23 Nov 2010; http://optionalpha.com/european-national-debt-2010-as-a-percentage-of-gdp-9001.html
[2] See P De Grauwe ‘A mechanism of self-destruction in the Eurozone’ 9 November 21010; http://www.ceps.eu/book/mechanism-self-destruction-eurozone
[3] See http://www.social-europe.eu/2010/11/expansionary-fiscal-contraction-and-the-emperor%E2%80%99s-clothes/
[4] See G. Montani, ‘European Economic Governance and fiscal sovereignty’; http://www.thenewfederalist.eu/European-Economic-Government-and-Fiscal-Sovereignty

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Ireland and the euro

Posted by George Irvin in EU on November 22, 2010

Another EU debt crisis and another inadequate bailout with more strings attached. In the coming year we shall almost certainly see more Club Med countries attacked by the bond markets, and told by their Eurozone/IMF masters that the only alternative is to accept dramatic cuts and to slash ‘unaffordable’ welfare spending. In the absence of fundamental Eurozone reform, piecemeal fire-fighting will fail.

Ireland’s pre-emptive drastic austerity measures taken last year were meant to have solved its problems. Harvard’s Kenneth Rogoff told the New York Times that “if you want to escape default, the Irish path is the only way to go”.[1] The aim of public expenditure reduction was to reassure the financial markets that the government was serious about cleaning up the damage to the banking system caused by the collapse of the country’s huge property bubble. According to Jean-Claude Trichet, speaking earlier this year, Ireland’s cuts provided a role model for Greece.[2]

But now it’s all gone wrong. Self-imposed austerity has meant that Irish GDP has contracted by over 10% since 2008 and its GNP even more so; the latest unemployment figure stands at 14% and rising; the budget gap is enormous and the country’s largest banks need bailing out. As in the past, with jobs disappearing, the young are emigrating.[3]

At the heart of the crisis is double denial: in Ireland, while the Finance Minister, Brian Lenihan, has spent weeks denying that his country needed help, Ireland has turned increasingly to the ECB for money it could not find on acceptable terms elsewhere. Denial too in Europe: the Eurozone and the IMF have come to the rescue with a package of €90bn (to which Britain, whose banks hold nearly half of Irish banks’ debt, has contributed about €10bn). But the stringent conditionality imposed will push a stricken economy deeper into misery.

Eurosceptics claim it’s all the fault of the euro: if only Ireland had kept the punt and could devalue, they argue, all would be well. The argument is faulty for two reasons. First, there are numerous examples of countries with their own currencies which have been pushed into IMF receivership: Mexico in 1995, Asia in 1997, Russia, and so on. Secondly, Ireland is devaluing ‘indirectly’ through pushing down wages: that’s what the phrase ‘internal devaluation’ means.

No, it’s not the euro that’s at fault; the problem is that Europeans don’t want to accept that currency union means genuine economic and political union. In the USA, the individual states may have considerable autonomy (just as Canadian provinces or German laender do), but their economic survival is ultimately the responsibility of the federal government which issues bonds and can borrow on international markets. Think of what would have happened to Louisiana after Katrina had it been dependent on selling its own dollar bonds to the international market to raise money!

Others will argue, not without reason, that Europe has no polis, no shared political identity and culture. They tend to forget that until the mid-19th century, Americans identified far more with their home state or region than with Washington—and some still do. A shared political identity needs to be forged; it is the product of a vision which transcends local boundaries. At the moment, economic crisis is eroding any sense of European community we might have. That’s what ultimately could kill the euro.

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[1] http://www.nytimes.com/2010/06/29/business/global/29austerity.html?_r=1&sq=if%20you%20want% 20to%20escape%20default&st=cse&adxnnl=1&scp=1&adxnnlx=1290434558-Nc2uIzAqCkib8Yb+o/ZaA

[2] http://www.guardian.co.uk/business/2010/sep/23/ireland-austerity-budgets-comment

[3] http://www.guardian.co.uk/commentisfree/2010/nov/21/ireland-economy-collapse-emigrants

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Why Club-Med cuts won’t work

Posted by George Irvin in EU on October 4, 2010

It is conventionally assumed that the Eurozone crisis arose because Club-Med governments have been too profligate. If only they had been as cautious as northern European countries, the argument runs, they would have retained their export competitiveness. A recent carefully researched paper, popularly known as the RMF Report and compiled by academics at the University of London, SOAS, shows this view to be entirely without foundation. [1]

Inter alia, the Report investigates the relationship between Club-Med current account (external) deficits, government deficits and the countries’ total stock of debt. Club-Med governments have not been wildly profligate: Greece, Spain and Portugal all have government deficits lower than the UK, and with the exception of Greece, their net public debt-GDP ratios are running at 60% or less.

The key point, however, is that much of Club-Med debt is held by the private sector: nearly 90% of all debt in Spain, 85% in Portugal and over 50% in Greece. Moreover, less than half of all Spanish debt has been contracted abroad (in contrast to Portugal and Spain where the overseas proportion is much higher). Secondly, a far higher proportion of private debt is relatively short-term, meaning it will need to be refinanced sooner than much of the public debt.

In Spain, private profligacy has mainly to do with a sharp rise in private investment resulting from the housing boom. In Portugal and Greece, by contrast, private investment growth was much less important; in essence, private savings have contracted to finance rising consumer demand. Nor is there anything surprising in these patterns—until 2008, the UK experienced both a private housing boom and a private savings collapse to sustain consumer demand.

All-round austerity starting with government deficit reduction has become the official answer to the problems of the Eurozone. But as the case of Ireland demonstrates, severe cuts reduce aggregate demand and induce further economic contraction, thus lowering government revenue faster than expenditure.

The main argument used by Eurozone deficit hawks—since devaluation is no longer possible—is that public cuts will restore the competitiveness of Club-Med countries. Once again, the problem is that where everyone practices fiscal retrenchment, aggregate demand throughout the Eurozone contracts. Because so much of the Eurozone’s trade takes place within it (ie, is ‘intra-trade’), what may benefit one country taken singly cannot benefit all simultaneously. Competitive wage-cutting has much the same effect as beggar-thy-neighbour devaluation did in the 1930s. And with the poor performance of the US economy increasing competitive pressures in the rest of the world, Club-Med countries cannot easily increase net exports outside the Eurozone.

In effect, we face three possible Eurozone scenarios.[2] The first is a decade of very low growth and high unemployment all ‘round. The danger is that in a decade’s time, Europeans will be so thoroughly disillusioned with the European project that it will fall apart politically.

The second scenario is default—whether partial or full. A partial default or debt restructuring exercise will, minimally, involve losses for creditor banks in Germany and France and necessitate further bailouts. Maximally, debtor-led full default would lead some Club-Med countries to leave the Eurozone, entailing the possible demise of the single currency. Alternatively, growing German resistance to ‘bailouts’ and a serious falling out with Paris over its export-led growth model might lead Germany to quit the euro and revert to its beloved DM.

The third scenario is fundamental reform of the Eurozone: the establishment of a genuine European Treasury with a substantial budget and fiscal powers and reform of the ECB, starting with the emission of federal Eurobonds. It is becoming increasingly clear that if the euro is to be saved, this is the path Europeans will need to adopt. By contrast, universal fiscal retrenchment enforced by levying fines on ‘profligate countries’ fails to address the real issues. But will European political leaders listen?

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[1] See Lapavitsas, C et al (2010) ‘The Eurozone between austerity and default’, RMF, University of London, SOAS <http://www.researchonmoneyandfinance.org/media/reports/RMF-Eurozone-Austerity-and-Default.pdf>

[2] See http://www.skidelskyr.com/site/article/europes-debt-crisis-and-implications-for-policy/

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Understanding the Eurozone’s structual imbalances

Posted by George Irvin in EU on March 18, 2010

In an earlier piece, I argued that the ‘Club Med crisis’ reflects Eurozone trade imbalances similar in nature to the more serious trade imbalance which exists between the US and  China. By definition, the solution to this problem cannot be for all countries to become net exporters like Germany. Rather, what is needed is a rebalancing of trade.

This can best be accomplished though two broad measures. First, like China, Germany must stimulate domestic demand so that domestic consumption and investment rise faster than exports. Secondly, the Eurozone must recognise the need for better economic governance.

The latter should not be about enforcing ‘more fiscal discipline’ on the periphery at the cost of peripheral wages, but rather about giving the ECB a broader remit (growth and employment rather than inflation targeting) and establishing a Federal Budget large enough to redistribute surpluses—just as happens in the United States.

Eurozone Current Account Balances as %GDP

Source: IMF (in Lapavitsas et al, 2009)

Two-thirds of German trade is within the Eurozone, while the Eurozone’s trade with the rest of the world is roughly in balance. The accompanying graph clearly shows Germany’s surplus to be mirrored by the ‘Club Med’ deficit.  No devious plot is implied; this situation arises because somebody’s surplus is by definition somebody else’s deficit.

Obviously, small surpluses and deficits are not the problem.  Rather, it is when the surpluses and deficits become large and entrenched over many years that action must be taken. Clearly, reform of economic governance is required if the Eurozone is to prosper in the long term. Just as the China-US trade imbalance is best resolved by increasing aggregate demand in China and recycling surpluses rather than by means of expenditure contraction in the US (the cost of which would be further recession), the Eurozone trade imbalance cannot be resolved by inducing recession in the Mediterranean.

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