Summary: There are two paths for Europe. The path it is on, leading to a painful future and fundamental change. And the other path, with unknown risks and pain — but offering the potential for a better future. The path chosen by Europe’s leaders reveals much about them. The outcome will reveal much about Europe’s peoples.
Two major reports this week describe the perilous condition of the world economy. Both are well worth reading. Both raise serious doubts about the path that Europe is traveling.
- “Global Recovery Stalls, Downside Risks Intensify“, World Economic Outlook Update of the IMF, 24 January 2012
- “The European Crisis Deepens“, Peter Boone (associate at the London School of Economics) and Simon Johnson (ex-Chief Economist of the IMF, Prof Economics at MIT), Peterson Institute for International Economics (PIIE), January 2012
The PIIE report goes into greater detail about treatment for Europe’s ills, giving the solutions recommended by our banking class — that dominate these discussions in the West. Especially note two aspects, one recommended — and one omission.
(1) Liquidate the people of the GIIPS and the institutions which serve them
The second ingredient is a far more aggressive program to reduce budget deficits and improve competitiveness in the periphery. These nations need to be highly competitive if they are to generate growth soon given the large risks overhanging their economies. This requires large wage cuts, public-sector spending cuts, changes in tax policy to attract investment and business, and stable politics.
… In a nation with a flexible exchange rate, adjustment is usually achieved with budget cuts and a sharp devaluation. Since euro area nations have forgone their right to devalue, they need to regain competitiveness through price and wage cuts, while even more sharply cutting budget spending. In essence, they need to increase volatility of their wages, prices, and budgets if they are prepared to forgo similar changes that could be achieved through the exchange rate.
The available evidence from the outcomes of the troika programs in Portugal, Ireland, and Greece, as well as the recently announced budget plans in Italy and Spain, suggests current policies will fail at this task.
… However, so far, there is little political will to take these necessary measures. Europe’s economy remains, therefore, in a dangerous state.
Boone and Johnson recommend very conservative policy changes. Large cuts in wages, Large cuts in public sector spending. Changes tax policy to help the rich and businesses. To be forced through by severe pressure from the nations of northern Europe and the institutions they control (eg, IMF and ECB). Bismarck would consider these too far right-wing.
{Secretary of the Treasury Andrew Mellon} only one formula: liquidate labor, liquidate stocks, liquidate the farmers, and liquidate real estate…. It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people.
— Herbert Hoover in his Memoirs, bravely shifting the blame for the Great Depression
Institutions which benefited from the European regime of the past decade have failed cataclysmically. Now the people of the PIIGS must pay with many years of austerity. Much like the last days of France’s ancien regime. It’s probably a viable solution, as competent rulers can herd their people like sheep. Usually.
But not always. Perhaps Boone and Johnson should read de Tocqueville’s The Old Regime and the Revolution, and about the leading up to the Tennis Court Oath in 1789. People can be pushed to far by elites who refuse to contribute to overcoming a nation’s problems.
(2) There is another solution: devaluation
“No question is so difficult to answer as that to which the answer is obvious.”
— George Bernard Shaw
As usual, these measures are described as necessary, with no alternatives even mentioned. But there is tried and proven solution — painful but effective. The periphery, or most of it, must leave the eurozone. Combined with a partial default (direct or by redomination of the bonds) that would restore their competitiveness and open a pathway to a better future.
But Germany has benefited most from the eurozone, and breaking that would hurt them. Their banks insolvent, due to their holdings of periphery bonds. Its currency — whether euros or Deutschmarks — would soar, stifling its exports. Their plan — so far working — requires painful austerity for the periphery and a lower euro (boosting German’s exports). As the initial phase of the EMU (leverging up, 1999-2008) benefited Germany, so does the current deleveraging.
But it’s a fool’s paradise. Austerity will induce a recession, which will increase the deficits in the GIIPS, undoing any benefits from the austerity. All the while eroding support for the eurozone. No matter how many of the banks’ unprofitable securities the ECB takes off their books. No matter how large the profits the ECB generates for Europe’s banks (eg, the LTRO allows banks to borrow at 1% and invest in higher yielding government bonds).
The pressure will inevitably grow on the periphery nations; then real change will come. Unification, which will end the current gravy train for Germany. Or fragmentation of the eurozone, which also ends the Germany gravy train.
No matter what Wall Street thinks: the banks are not Europe. Funneling money to the banks stabilizes the situation but fixes nothing. Europe’s people might have a say in shaping its destiny before this cycle ends. When they become sufficiently brave or desperate to speak up.
(3) For more information: Other posts about the crisis of Europe
- The post-WWII geopolitical regime is dying. Chapter One , 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
- Can the European Monetary Union survive the next recession?, 11 July 2008
- The periphery of Europe – a flashpoint to the global economy, 8 February 2010
- A great speech by the PM of Greece. How soon until an American President says similar words?, 3 March 2010
- Governments cannot go bankrupt, 2 April 2010
- Our government’s finances are broken. How do we compare with our peers?, 8 April 2010
- The EU does Kabuki for Greece. Is it the next domino to fall?, 14 April 2010
- About the Euro crisis: the experts are wrong; the German people are right., 7 May 2010
- Former Central Bank Head Karl Otto Pöhl says bailout plan is all about ‘rescuing banks and rich Greeks’, 20 May 2010
- The Fate of Europe, nearing the point of decision, 13 September 2011
- Europe drifts towards the brink of a cataclysm, 26 September 2011
- Delusions about easy fixes for Europe, dreaming during the calm before the storm, 30 September 2011
- Every day the new world emerges, yet we see it not. Like today, as Europe begs China for loans, 15 September 2011
- Is Europe primed for chaos, as it was in July 1914?, 7 October 2011
- We see the outlines of the next cure for Europe. Will it work?, 14 October 2011
- Today Europe’s leaders took another step towards the edge of the cliff, 27 October 2011
- Where to from here, Europe? Some experts share their views., 8 November 2011
- Status report on Europe’s slow re-birth (first, the current system must die), 10 November 2011
- Europe begins its endgame. Watch and learn, for Europe’s problems are the world’s., 11 November 2011
- Will Italy stay in the Euro-zone?, 14 November 2011
- Looking ahead to see the new shape of Europe, 22 November 2011