Never before has Europe’s monetary union seemed so fragile.
Day by day, fears are growing that Greece or another weak country may default on its sovereign debt obligations, forcing the richer countries in Europe to ride to the rescue or risk having one or more of its most vulnerable members leave the 16-nation euro zone.
Many European economists discount such a fracture as a remote possibility. But that doesn’t mean Europe has safely emerged from crisis.
Instead, it faces a longer-term challenge to restore the fiscal credibility of at least half the countries that use the euro. The true test for the world’s largest common currency zone, analysts say, will be whether it can withstand the economic, political and social strains once the European Central Bank begins to raise interest rates in response to economic improvements in Germany, France and other Northern European countries.
At that point, the laggards on the union’s fringe ”” Portugal, Ireland, Italy, Greece and Spain (the so-called Piigs) ”” will face even tougher choices to cope with what looks like several more years of stagnant economies, high unemployment and gaping budget deficits.
The great economist, Irving Fisher, said in 1933:
[blockquote][i]The difference between a normal business-cycle recession and an extreme business-cycle fluctuation — a depression — is OVER-INDEBTEDNESS.[/i][/blockquote]
[i]“It takes a crisis to learn a lesson,†Mr. Lane said. “Could it be that by getting countries to change their behavior you might get improved cooperation within the euro zone?”[/i] Perhaps. More interestingly, the behaviour they are expected to change — huge government deficits and ever-growing debt to support a wide range of social entitlement programs — is more ore less the same approach the current US administration is attempting to establish here. You cannot solve over-indebtedness by taking on more debt.
This is a significant problem and almost everyone that matters is in delusional denial. The collapse of Iceland, the #101 economy in the world, with a GDP one-third that of Kansas, almost brought down the British banking system. The real worry is a cascade effect. Let’s look only at Europe for the moment.
[b]Britain (#6)[/b] Not only financially, but socially things are headed downhill rapidly in the UK. Nearly 85% of all their business financing now comes through borrowing, which is a sign of an economy in which people are very reluctant to take risks. In the US it’s about 40%, with the balance coming from equity positions. Interest payment becomes a huge burden, especially when a government is raising taxes at every opportunity. Add to this the utter unwillingness of Britain to address its Moslem problem, very weak demographics, a crushing burden of entitlement programs, confiscatory taxes, and overweening regulations coming from the EU … Britain is in deep, deep trouble.
[b]Italy (#7)[/b] Italy’s demographics are absolutely terrible, and that makes it increasingly difficult to satisfy potent political pressure to continue their numerous social entitlements. Because it is on the Euro, Italy has no central bank that can ‘print’ money, and if the government attempt to run big deficits they must float their paper in Euros at a punishing spread above German paper. Over 90% of Italian business financing is through debt. They (and the government) can barely meet interest on existing debt. Something is going to fail spectacularly. We just don’t know what or when.
[b]Russia (#8)[/b] is but a husk, entirely dependent on energy sales to a declining Europe. Their population is declining by nearly two million per year and it is aging rapidly. For any economic or military viability it must attempt to reconstitute a significant part of its old empire, particularly Ukraina. Any financial numbers from Russia are highly suspect and it is rapidly sliding towards the status of being a criminal enterprise with a flag and a restless army. What a mess.
[b]Spain (#9)[/b] Spain’s demographics are even worse than Italy’s, and its property boom was much more severe. In spite of a very old population, unemployment is in the mid-20s and the government cannot pay its existing pension or unemployment obligations. Deflation is rampant — collapsed property prices and widespread defaults — yet Spain is full of debtors who have absolutely no idea how they will meet obligations. The government cannot inflate because it is tied to the Euro. Political pressure is mounting to get out of Europe. Apart from wine and olive oil, what have you ever bought from Spain? It’s going off the rails.
To [b]Greece (#27)[/b] and [b]Ireland (#35)[/b] I would add [b]Austria (#25)[/b] to finish our depressing list of European problem economies. But there is also Asia.
[b]Japan (#2)[/b]is unable to deal with horrible demographics. Japanese exports have dropped by 40% in the last year. The national savings rate has fallen from about 25% some twenty years ago to levels lower than those prevailing in the US today. Their population is aging rapidly and they are drawing down savings rather than adding to them. Japan’s pool of capital is disappearing.
Government debt levels in relation to GDP are monumental and there’s an ever smaller population of younger workers available to service the interest on that debt. That says nothing of paying down any principal or even meeting the rising social costs of a very old population in a culture that reveres its elders. When interest rates rise from current low levels – probably when the government has to roll over its long-term debt – Japan is quite likely to become an economic basket case.
[b]China (#3)[/b] is desperate to keep expanding its export trade (and China’s exports are [i]declining[/i]) because its banking sector is as weak as wet paper: full of totally uncollectible sweetheart loans made to favored firms,institutions, and government agencies. Capital is funneled to the central government, which then distributes it via several state-controlled banks to politically-favored enterprises and local governments at essentially zero interest. The mal-investment and misallocations of that capital are mind-numbing.
It’s much worse than anything the US could even imagine, because government-controlled banks are China’s attempt to solve domestic political problems, most notably national unity. The south of China could easily be independent of the north and everyone concerned knows that. It’s really quite possible China’s modern economy will turn out to be the biggest Ponzi scheme in history.
If it does, we should be very concerned, because when China gets into serious trouble the central government almost always begins a war to “unify†the nation.
So, have a Happy New Year. The day itself shouldn’t be too troublesome. The subsequent 364, however, look to be somewhat challenging.
And a very happy new year to you too Bart, from Kansas. Say hi to Dorothy for me.
Bart, thank you for the vote of confidence. Leaving that aside, I wondered at your abandonment of Keynsian economics. I had always thought that the lesson of the 1930s (as per Liaquat Ahamed’s latest book Lords of Finance) was that by cutting spending and raising taxes the governments deepened the recession.
I never ascribed to Keynesian economics, in part because as applied in the US they lengthened the Depression considerably, compared to Europe, Australia, Canada, and elsewhere. As in the current situation, FDR’s applications of notional money went not to those areas needing it the most, but to areas he wished to consolidate or increase the Democrat vote. (see David Kennedy’s history, amongst others).
In the US the ’30s Depression lingered because once the government had seized the real money (gold) and replaced it with fiat currency their Keynesian approach delayed inevitable bankruptcies only for awhile, and in so doing drew much more wealth down the drain with them. FDR’s own Secretary of the Treasury lamented in 1938 or ’39 that for all the money poured into the economy unemployment was just as high as it had been in the “depths” of the Depression.
But Bart, how do you explain the vast economic expansion that enabled and undergirded the war effort? This was financed by debt. And horrible though the war was, it did lead to full employment including breakthroughs in the employment of women. Suddenly there was the money, the will and the work.
I am however enough of a supplysider to believe with you that cutting taxes is essential. How to combine this with the modern social security state is the question. The former seems to imply some contraction of the latter.
It was the Great Depression in the US, just the Depression everywhere else. It was indeed the War that got America back to work.
Hmmm. Hope that’s not sign.
“I am however enough of a supplysider to believe with you that cutting taxes is essential. How to combine this with the modern social security state is the question. The former seems to imply some contraction of the latter.”
One can begin by cutting regulation and litigation, and the bureacracies that support them.
Get rid of the Dept. of Education. Let states handle schools. Get rid of the EPA (if west virginia wants to use coal fired power plants instead of paying more for something cleaner, so be it). Get rid of Administration for Children and Families (ACF) (this belongs to the states) ditto the Administration on Aging (AoA) , the Administration on Developmental Disabilities the Advisory Council on Historic Preservation the African Development Foundation the Agency for Healthcare Research and Quality (AHRQ) the Animal and Plant Health Inspection Service , the Arthritis and Musculoskeletal Interagency Coordinating Committee.
And that’s just the low hanging fruit.
Next, make it costly to bring junk lawsuits. Whomever loses the lawsuit needs to pay the legal costs for both parties.
The above should decrease both the size and expense of government and the parasitical sector, and will decrease the expense to the productive sector of the burdens of bureacrats and their lawyers. The effect of being freed of this burden would be far better than any tax cut and will improve the government balance sheet, rather than worsen it (as tax cuts would do).
Terry: Wars are everywhere and always inflationary. Believe me. I’ve studied economic history in considerable detail back to UR — destroyed in 2050 BC — and if there is a universal truth to economics, that’s it.
Inflation always feels like fun, and those [i]first[/i] in line for new inflationary dollars always benefit the most. In WW2 America this approach was magnified by two factors: price controls and rationing. People had almost nothing they [i]could[/i] spend that money on, so [b]they paid off debt, and saved[/b] it. The entire 1950s boom was the direct product of [b]financing from those savings[/b] — not debt.
Going into the Great Depression the US was the largest [i]CREDITOR[/i] nation in the world, we had the strongest gold standard, and individual Americans owed a pittance compared to today. Today we are the world’s greatest [i]DEBTOR[/i]. We pretend we can borrow forever, and that it won’t matter, but is of primordial importance that we regain some semblance of humble financial discipline.
Keynesian stimulus in 1934 might have been of some value, and of relatively minor harm, because of the very different conditions prevailing at the time. Today it is more of the same. Give the drunk another bottle of cheap vodka.
[b]What is dying in this depression is the welfare-entitlement state.[/b] It is currently a wounded beast, and therefore at its most dangerous.
[blockquote]What is dying in this depression is the welfare-entitlement state.[/blockquote]
That is the most encouraging thing that I have read in a long time. Thanks Bart. I hope you are right. Lead and gold are probably the best investments we can make right now. I have been waiting for about a year now for the collapse of the currency. They have not fixed the derivatives problem, so the same conditions exist that were present in 2008. The main difference is that we have wasted a few Trillion Dollars since then and we are in the process of digging another multi-Trillion Dollar money pit called Health Care Reform…all while playing the nation building game in Iraq and Afghanistan.
The United States of America is truly a remarkable nation in the history of the world. What other nation could sustain such a staggering burden for so long? I don’t think that we will survive this, but your words give me hope that the welfare state may collapse before the nation is entirely ruined.