Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
Last weekend, on the eve of the G-20 meeting in Paris over the weekend, the Australian Treasurer was talking tough and giving ultimatums to our Northern friends – telling them that the “time for half measures is over. The time for action is here. So people will be looking for a comprehensive plan on October 23”. Of-course, in the Communiqué of Finance Ministers and Central Bank Governors of the G20 from the Paris meeting you don’t get any sense of urgency. Not once do they mention the word “unemployment”. The problem is that the world leaders remain in denial and still want us to believe that you can have “growth-friendly” cuts in spending. To increase spending you do not cut it.
The following graph uses the ECB data for 10 year bond rates (and I have expressed them in terms of the spread against the German benchmark bond). You can see that while the usual suspects are pointing higher and more quickly (Greece, Ireland, Portugal) the bond markets are now moving to Italy, Belgium, Austria and France.
In his daily newsletter Thaler’s Corner (October 18, 2011), Paris-based financial market expert – Erwan Mahe – said that:
Thanks to half-baked rescue plans and barely disguised renunciations, the eurozone is daily slipping into a core meltdown process. This sort of crisis has nothing to do with a nuclear plant’s core reactor, but the slow deterioration of Europe’s core, as the relentless wave of investor distrust toward government bonds, which has already put Greece, Ireland and Portugal underwater and seriously doused Italy and Spain, begins to pull down Belgium and threatens France, with Austria next in line … The core under attack!
We are no longer talking about just “peripheral” nations. The relentless process on eurozone sovereign debt markets can be plainly seen, following the first crisis of May-June 2010, after which the first Greek bailout plan was launched and the ECB intervened directly to calm secondary markets via its Securities Market Program (SMP).
A salutary observation.
The days of blaming the lazy, profligate or whatever other insulting description for the peripheral nations that the Germans can muster – are over.
The spreads are widening for the northern EMU economies now. You may argue that they widened across the EMU in late 2008 into 2009 and corrected again. Erwan Mahe says that this was time when “certain spreads widened due to a total absence of liquidity on financial markets. But even then, France’s spread vis-à-vis Germany amounted to just 60 bps, which compares with over 107 bps today. The spread hasn’t been this wide since 1992! That shows just how much ground we have lost”.
But then you read in the UK Guardian (October 18, 2011) – French debt rating at risk as Germany warns there is no quick fix for crisis – which was really an article telling the world that Germany wasn’t going to acceede to any deadlines from anyone.
The Guardian reported that “Germany’s finance minister, Wolfgang Schäuble, added to the uncertainty earlier in the day when he said detailed talks to solve the crisis were likely to go beyond a self-imposed deadline set for this weekend”.
All the talk has been that this time – after many failed attempts – the EU leaders would bring out the “big bazooka” which would ease the concern of the bond markets. The German finance minister downplayed that reality.
The Guardian said that his comments “dismayed investors concerned that Berlin and Paris have failed to grasp the magnitude of the eurozone’s debt crisis”.
In a sense, what the graph is depicting (that is, what the “dismayed investors” aka the bond markets are thinking) is not a definitive description of the crisis. The reality is that the bond markets can be played out of the game if the ECB maintains its support for each of the nations that are now finding it hard to fund themselves at reasonable rates in the private markets.
As Erwan Mahe says:
The two big peripheral nation markets, Spain and Italy, are already breathing via an artificial lung, and the ECB bond purchase programme is the only thing preventing death, while Belgium is pretty close to joining them.
And as long as the EU leaders dally around at their summits drinking fine wine and eating well but not doing very much else the ECB will have to continue in that role.
The ideas surrounding a new bailout fund where the EU members contribute directly to the scheme will not solve the problem. That plan will just further drain economies that desperately need all the government support they can get.
The EU Communique´ is just more of the same – hot air and little else.
You will read lots of “We are more determined than ever to reform the financial sector” and “We reaffirmed our shared interest in a strong and stable international financial system” and “We remain committed to take all necessary actions to preserve the stability of banking systems and financial markets” but not a single mention of unemployment and poverty.
The national treasurers and central bankers of the larger economies – entrusted to design and implement fiscal and monetary policy – at a time when the global economy is slowing and has been stagnating for nearly 4 years – and they cannot mention the word unemployment once. That is a statement of what is wrong.
The IMF Staff Note to the G-20 meeting – The Path From Crisis to Recovery was interesting. Once again more gobbledegook like:
In advanced G-20 economies, fiscal sustainability must be restored through credible medium-term consolidation plans. Countries with high debt and facing market pressure must press ahead with “growth-friendly” consolidation now. In others, fiscal policy should navigate between the perils of undermining credibility and undercutting recovery, and facilitate a pick-up in private demand. To alleviate prevailing market pressures in the euro area, the ECB should continue its extended liquidity operations and sustain the Securities Market Program (SMP) alongside the support provided by the European Financial Stability Facility (EFSF) for as long as necessary to stabilize issuance costs for banks and sovereigns.
I love the terminology that has crept into the IMF papers lately – “growth-friendly” consolidation – what the hell does that mean? Answer: nothing. They just cannot bear to admit that the only way out is for economic growth to quicken yet fiscal austerity will undermine that.
Fiscal consolidation to the IMF is fiscal austerity. It means discretionary cuts to public spending and/or tax hikes (although the IMF tends to frown on the latter). Any discretionary attempt to reduce net public spending (deficits) in the advanced economies will reduce growth.
There is no such things as “growth-friendly” consolidation.
Note also that they are not pushing the Ricardian Equivalence line strongly. In the past they have claimed that the private sector will pick up the spending slack left by the public austerity. Ricardian Equivalence refers to the notion (loosely) that households and firms are deliberately refraining from spending as much as they might at present because they sense the deficits will have to be paid back via higher future taxes and so are saving to make sure they can pay those taxes. It is a nonsensical mainstream proposition.
This concept has been used to justify the British government’s austerity program. The overwhelming evidence negates the validity of the concept. Private spending is flat because people are scared of unemployment, they are trying to pay down debt after the credit-binge, and firms are experiencing poor sales and so have no incentive to create new productive capacity.
Please read my blog – Pushing the fantasy barrow – for more discussion on this point.
You will note that the IMF is also still claiming that there is a credibility problem in the advanced world with respect to budget deficits. If you tease that out a bit what they are implying is that there is trade-off between credibility (that is, what the bond markets think) and growth (that is, what matters to the 99 per cent of us).
But they then acknowledge in the next sentence that the ECB can “alleviate prevailing market pressures in the euro area” by funding the governments directly. So what does credibility in the eyes of the bond markets have to do with anything? If the central bank (and/or treasury) can deal the bond markets out of the equation then the notion of credibility becomes non-operational.
The ECB’s actions do not alleviate the design flaws in the EMU but they do serve as a quasi-fiscal authority. The problem with the way the ECB is acting is that they are insisting that the member nations deflate demand in their economies and kill jobs and growth in return for this “fiscal” support. All that means is that they will have to continue to provide the support indefinitely while poverty rates rise across Europe with the entrenched unemployment.
The ECB would be far smarter to encourage member nations to stimulate growth and build private confidence so that within that security screen public deficits would fall and the “funding” needs would also decline.
But the real problem is not the rising interest-rate spreads – they are just the symptom (reflecting the institutional arrangements) of the underlying crisis – a failure to grow and produce jobs. Which is a reflection of a lack of aggregate demand.
An economy doesn’t experience growth in aggregate demand by cutting it.
The IMF realises that very clearly – but, of-course, temper their statements with their neo-liberal mantra. But nothing could be clearer than their statement of the “Key Risks”:
Downside risks have increased and are severe. The overarching risk is of a global “paradox of thrift” as households, firms, and governments around the world reduce demand, with many advanced economies unable to lower policy rates further. Immediate risks are centered in the major advanced G-20 economies, principally the euro area and the United States.
That is a most Keynesian message. Spending creates income which creates growth which creates employment.
If everyone is trying to cut spending or not spending enough then the rest of the causal train suffers. The austerity of one spending groups affects the next and the deflationary snowball multiplies.
You can see the inherent bias in the IMF statement though – “with many advanced economies unable to lower policy rates further”. This refers to their bias towards monetary policy as the principle source of stimulus.
One of the major lessons of this crisis (among many) is that monetary policy cannot stimulate aggregate demand very much at all. Try as they might – with all the QE schemes etc – and clearly being able to maintain low interest rates along the yield curve – the central banks have not been able to provide the stimulus to aggregate demand that is needed.
Conversely – it is clear that fiscal policy did provide a boost to growth in 2009-10 – but was shut-down too early because the likes of the IMF claimed the fiscal activism would lead to excessive interest rates and accelerating inflation. Neither has happened (notwithstanding the rise in inflation in the UK – which is a separate issue that I will consider in another blog).
The best the IMF can do with respect to “growth friendly” consolidation is this:
Credible medium-term fiscal plans, which would create space for providing further support for fledgling recovery, and well calibrated and appropriately paced fiscal adjustment in the near term to anchor investor confidence. This need to be supported by rapid implementation of structural reforms to raise growth and enhance debt sustainability
Note they are using the term “investor” here in the financial literature sense – that is, bond markets. An economist does not consider bond purchases or sales to be investment or divestment.
For an economist, investment is about adding to productive infrastructure – that is building equipment, plant etc – which increases in the capacity of the economy to produce real output.
The only credible “medium-term fiscal plans” is to ensure that growth wipes out the cyclical deficit component. I have seen no coherent analysis that suggests that structural deficits (the non-cyclical component) should also be wiped out.
The IMF note that the private debt burdens a large and dragging down growth – as households and firms try to reduce these debt positions. There is an urgent need for the private sector to save overall and get its balance sheet in a position where it can resume spending growth without the reliance on excessive credit.
That requires support from the government sector in the form of deficits.
The IMF provides some more:
Advanced G-20 economies must articulate credible medium-term fiscal consolidation plans with specific measures embedded in a realistic macroeconomic framework. This would create more policy space for near-term support to growth and employment if needed.
The advanced G-20 economies (outside the EMU) have all the policy space they need to support growth and employment. What they lack is the political will. There is no financial constraint on these governments. Their dysfunctional polities have created the situation where each thinks they have to cut net spending.
Even if you consider the reaction of bond markets, yields are low and the markets cannot get enough of public debt. The credibility issue is a “beat up” and reflect ideology rather than analytical nous.
The situation is different in the EMU because without ECB support the member nations can easily (and will) go broke. So without the ECB intervention, the bond markets have traction. In the other advanced nations the bond markets do not have the same traction.
But as I noted at the outset, central banks everywhere (including the EMU) can negate the actions of the private bond markets anytime they choose. That is exactly what the ECB is doing at present.
The real problem is a lack of demand which is causing growth to stagnate and unemployment and poverty to rise. All the meetings of the G-20 together will not solve anything while they refuse to deal with the fundamental cause of the problem.
If they really want to do something productive they should announce that they will use the central banks around the world to deal the bond markets out of the game and fund fiscal stimulus directly with a focus on job creation.
Putting wages back into the pockets of the unemployed is the surest way to get the growth process going again. Waiting for the private sector to miraculously start spending more at present is not going to work. The credit-binge has left too much private debt and saving ratios are returning to more normal levels now – which means that public net spending positions will have to return to more normal levels.
And historically, that means budget deficits will have to be maintained more or less continuously for the indefinite future. The leaders of the advanced world are doing us all a dis-service by acting in denial of that history.
They are not only fuelling the bond market reactions (as captured in the spread graph above) by pretending there is a “sovereign debt” crisis but by deliberately reducing economic growth they are also frustrating the private sector attempt to consolidate its balance sheet.
If fiscal support is provided the private sector can consolidate (reduce its debt exposure) and start to spend more (from growing wage income). That is the only way out of this mess and that will take some years at least.
I am heading to Melbourne today to be part of a panel at a workshop – Euro crisis – held by the Monash University EU Centre.
I will report back on the discussions tomorrow. And, yes, I am sorry – it means more air travel.
That is enough for today!