Ambrose Evans-Pritchard writes of European austerity policies in The Telegraph:

“Spain must tighten by 4.5pc of GDP this year though unemployment has surged to 24.4pc — from 7.9pc in 2008 — and the public sector is not unduly large. Italy must tighten 3.5pc this year, though it is near primary budget surplus. There is no credible economic theory to justify this pace of tightening. It is beyond any known therapeutic dose.”

What is going on here?  Europe is diving into recession, and yet every policy lever is being thrown in a direction to suppress growth.  The ECB is not cutting rates; banks are being told to raise capital reserves so they are reducing loans and hoarding cash; and public spending is being cut back more sharply than we have ever seen.

The only reason for this is the old-fashioned Dickensonian moralist view:  pain is good for you, and teaches valuable lessons.  So if a country’s government has misbehaved by spending too much, its people must be made to feel pain, so that they never support such a government again.  The pain will be salutary, imposing a price for past overspending and teaching lessons.  Moreover, those imposing the pain (mainly German but also Dutch and English elites) feel the satisfaction of Protestant (Puritan?) leaders in forcibly imposing virtue on those they see as having strayed.

Need we say how crazy this is?  People did not individually enact government policies.  Ordinary workers and retirees are not responsible for rampant tax evasion by the rich or for state corruption in Greece and Italy.  In Spain, moreover, the government did a better job maintaining fiscal balance than France; its problems arose form a huge property bust following loose lending by German and other European banks, not excessive state spending.   Imposing pain on these folks simply leads to radicalization and the rise of extremist left and right parties, as we have seen all too well in recent elections.  Imposing pain on these people leads to nationalist anger, not contrition.

The basic problem of the Euro is that banks led widely believing economic growth everywhere was as secure as in France or Germany or the Netherlands.  When those bets proved wrongly placed (like bets on the endless upward price trend of American housing), someone was going to have to go bust.  Yet the Euro zone gave investors the illusion that they would be bailed out by the Eurozone as a whole.  It is the binding power of this illusion that is causing everyone to struggle with the fact of inescapable losses.

Worse yet (can it be worse?), the austerity policies advocated as an alternative to real Eurozone fusion have not produced a reduction in state debts.  Quite the contrary; since the beginning of their efforts to impose as much austerity as politically possible, Greece, Spain, and Italy have seen their GDP’s decline and their state debts increase; the opposite of what is needed.  The adoption of austerity policies has thus pushed countries further into the death spiral of rising debts and falling GDP, rather than pulling them back from the brink.  Ireland and Portugal and Greece are little economies where economic setbacks could easily be managed by the EU.  Italy and Spain are not; they are major pillars of the EU.  Yet both economies are expect to contract by 1.5-2.5% next year, while piling up their huge debts.

We are back in the 1930s, with tottering state finances and banks facing large losses on their debts, and it is becoming increasingly clear that policy-makers have NOT learned the lessons of that period.  Instead, they are pushing policies that will take us to 1936 – a sustained second-burst of recession leading into depression, and the rise of radical nationalist parties.   One can only hope they see the error of their ways before we return to 1939.

About jackgoldstone

Hazel Professor of Public Policy at George Mason University
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4 Responses to Sado-Monetarism

  1. Fred Hapgood says:

    Here is something I do not get. What are the anti-austerity policy recommendation? What is the alternative? A general default? (I’m not rolling my eyes or anything. Possibly a general default is exactly right, but I would like to see it spelled out.) Is the idea that the right thing is that Germany should shoulder these debts without receiving anything back in the way of assurances — through behavioral changes — that we won’t all end up here again by piling up more debt? Again, I am just asking. What is it that you want all these countries to do?

    I can imagine a policy that argues for a general default, accepting the collapse of international credit markets, and then working out a way of living on local income sources. I am not saying this is a good idea or a bad idea, but it is comprehensible. I’m looking to hear about a better idea that is just as comprehensible.

    If anyone can come up with one you can …


    • Sadly you are all too right – a comprehensible plan that involved less chaos was possible a few years ago. An orderly Greek default followed by Eurozone bonds with German backing and new powers for the ECB to print Euros, plus orderly debt reductions (extending maturities, lowering rates) in southern European countries, could have prevented further credit deterioration in Spain and Italy. But Germany spent too long denying Greece would have to default, or that there were deeper problems in European banks, or that more radical measures were needed. During the last two years. What we need now is EITHER Germany taking responsibility for European debts first and working on policies for greater discipline of other countries budgets later (Germany wants the reverse), OR partial bankruptcies of overly indebted nations with inflationary policies that will reduce the real debt and real losses (Germany wants no inflation and everyone is resisting any kind of write-down of debts). But since key players are resisting both of these admittedly painful and risky options, the alternative may well be a chaotic collapse of banks and sovereign debt structures. European leaders keep putting on bandaids and administering oxygen hoping the European economies will get well; but in fact the patient is critical. One commentator said “calling cancer a cold does nothing to cure the cancer.” If you want a comprehensible solution, it is surgery to remove the cancer — meaning cut out the debts that are killing banks and nations by orderly partial default and inflation. When borrowing exceeds income by a large amount, which is where we are today, that is the only course of action.

      • Fred Hapgood says:

        The most likely outcome of all this for Greece is a comprehensive default followed by a general
        expulsion from the international credit markets. This might or might not happen but it is surely highly likely — likely enough to be taken seriously, which means we ought to be thinking about what happens next if. I see lots of commentary that goes this far and then stops, often with the commentator making a reference to “political chaos” as way of throwing up his hands. I would to push the analysis a little further. What sort of political economy will emerge, perhaps after “chaos” ,perhaps not, from this situation? Obviously agriculture will return to the central position it had in Greece fifty years ago. It will not be based on petroleum; it will probably not be based on herbicides and pesticides — these will all be way too expensive. What you will have will be
        an intensely organic, highly crafted, really cheap, traditional agriculture. Sounds like something that might find its market. What do you think?

      • Might be an ideal niche for Greece; there is already a very profitable Greek business making high-end expensive organic bedding.

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