Tonight brings an odd pairing: Lord Skidelksy, the highly respected biographer of Keynes, and Ambrose Evans-Pritchard, who is generally of the Austrian persuasion, both continuing, as each has, to object to the extreme measures in the process of being implemented in the eurozone.
Now before you say that they are both Brits, and therefore suspect on this topic, consider: Evans-Pritchard’s column was triggered by a letter signed by 100 Italian economists objecting to the eurozone fiscal program, and our own Swedish Lex, who commented via e-mail:
I wrote to you a couple of months back saying that the country to watch is Italy (a lot more than the other Club Meds). If support in Italy for the euro disappears, then France would be unable to explain to its citizens why it should defend the euro hardship when Italian industry and workers were moving towards preparing for a post euro and neo lira era. No France = no euro. That process may be beginning now although I am not an expert on Italy. The Italian political leadership is, as usual, rather dysfunctional so Sarkozy and Merkel do not exactly have an Italian rock of statesmanship and rationality to lean on in these difficult times.
When will it dawn on Germany that it risks being confronted with a string of European countries that will be competing for the same exports but with hugely discounted new national currencies (compared to the new platinum D-Mark)?
Yves here. Swedish Lex’s comments are admittedly speculation, but we are dealing with a volatile setting.
Lord Skidelsky, writing in the Financial Times, reminds readers that policymakers risk aping the mistakes of the early 1930s:
The implicit premise of the coming retrenchment is that market economies are always at, or rapidly return to, full employment. It follows that a stimulus, whether fiscal or monetary, cannot improve on the existing situation. All that increased government spending does is to withdraw money from the private sector; all that printing money does is to cause inflation…
But this story alone does not explain the conversion to austerity. Politicians clamouring for cuts in public spending do not cite Chicago University economists. They talk about the need to restore “confidence in the markets”. The argument here is that deficits do positive harm by destroying business confidence. This collapse of confidence may come in several forms – fear of higher taxes, fear of default, fear of inflation. Deficits thus delay the natural (and rapid) recovery of the economy. If markets have come to the view that deficits are harmful, they must be appeased, even if they are wrong. What market participants believe to be the case becomes the case, not because their beliefs are true, but because they act on their beliefs, true or false…
The parallel with what happened in 1931 is irresistible. In February of that year, Philip Snowden, the Labour government’s chancellor of the exchequer, set up the May Committee to recommend cuts in public spending. The committee projected a budget deficit of £120m, later raised to £170m, the latter figure amounting to about 5 per cent of gross domestic product, and proposed raising taxes and reducing spending to “balance the budget”. The international financial crisis caused by the collapse of the Austrian Credit-Anstalt bank in July 1931 brought huge pressure on the government to act on the May Report. In a notable display of patriotic fervour, the financial and political establishment united to demand cuts in unemployment benefits to “save the pound”….
….the effect of the outbreak of public frugality in 1931 was curiously roundabout. Cuts in salaries produced a “mutiny” of naval ratings at Invergordon, suggesting that the empire was crumbling. This was enough to force Britain off the gold standard. A combination of sterling depreciation and lower interest rates revived exports and started a housing boom. But there was never a complete recovery until the war. Such evidence for the success of the cuts is the stuff of castles in the sky.
We are about to embark on a momentous experiment to discover which of the two stories about the economy is true. If, in fact, fiscal consolidation proves to be the royal road to recovery and fast growth then we might as well bury Keynes once and for all. If however, the financial markets and their political fuglemen turn out to be as “super-asinine” as Keynes thought they were, then the challenge that financial power poses to good government has to be squarely faced.
Now to today’s offering from Ambrose Evans-Pritchard. Note he argues that failing to ease up on the austerity timetable will lead to eurozone rupture:
The rebellion against the 1930s fiscal and monetary policies of the Euro-complex is gathering pace.
Il Sole has published a letter by 100 Italian economists warning that the austerity strategy imposed by Brussels/Frankfurt risks tipping Europe into a self-feeding downward spiral. Far from holding the eurozone together, it will cause weaker countries to be catapulted out of EMU….
My rough translation:
“The grave economic global crisis, and its links to the eurozone crisis, will not be resolved by cutting salaries, pensions, the welfare state, education, research …….. More likely, the `politics of sacrifice’ in Italy and in Europe runs the risk of accentuating the crisis in the end, causing a faster rise in unemployment, of insolvencies and company failures, and could at a certain point compel some countries to leave monetary union.
“The fundamental point to understand is that the current instability of monetary union is not just the result of accounting fraud and over-spending. In reality, it stems from a profound interweaving of the global economic crisis and imbalances within the eurozone …..
It blames the crisis on the “deflationary economic policies” of the richer states. “Especially Germany, geared for a long time to holding down salaries in relation to productivity, and to the penetration of foreign markets, gaining European market share for German companies…
They say the policy has led to growing surpluses in Germany, offset by growing debts in Southern Europe. The adjustment mechanism has not only failed. Matters have got worse, and worse.
“This is the deeper reason why market traders are betting on a collapse of the eurozone. They can see that as the crisis drags on this will cause tax revenues to fall, making it ever harder to repay debts, whether public or private. Some countries will progressively be pushed out of the eurozone, others will decide to break away to free themselves from a deflationary spiral… It is the risk of widespread defaults and the reconversion of debts into national currencies that is really motivating bets by speculators….
Just to be clear, I do not share their Krugmanite view that huge fiscal deficits are benign. In my view, it is imperative that the whole western world reduces debt in a orderly fashion over 10 to 15 years. Pacing is crucial. Too fast can be self-defeating. Too slow is not an option.
My objection with the EU’s mix of policies is that extreme fiscal austerity is being imposed on a string of countries without offsetting monetary stimulus. (Yes, I know, some will say that I am mixing apples and oranges).
Ireland, Spain, and Portugal have already tipped into outright deflation. Ireland’s nominal GDP has contracted 18.6pc since the peak. They are falling deeper into an Irving Fisher debt-deflation trap.
This is reactionary folly…
As for Germany, frankly it is hard to know what to say. It is astonishing that Chancellor Merkel should unveil an €80bn package of fiscal retrenchment without consulting with the rest of Europe. This has raised the bar for everybody else, forcing them into yet further contractionary policies to keep up…
EMU has become an infernal machine. This will not be the last letter by angry economists.