I am covering a few topics today, given that I used yesterday's post space to…
I am in Darwin today – right in the North of Australia. This is the frontier of Australia and merges our nation with Asia to the north. The dry season has just started and so the tropical weather today is glorious – warm and sunny and dry! It is a 6 hour flight from Newcastle and a remote part of our nation despite Darwin being one of our capital cities. But the world is not very far away from anywhere these days in terms of information access and so it is hard to avoid reading the latest data from around the world and analysing it. The news from Europe over the last 24 hours is shocking and the responses by leading politicians is worse. Just as the British Office of National Statistics was announcing that the UK has achieved a double-dip recession for the first time since the 1970s – an achievement that the Government will no doubt erroneously claim is the work of others – Bloomberg published a story (April 25, 2012) – Merkel Pushes Back Against Hollande Call to End Austerity Drive which tells you how far out of touch with reality the Euro leadership is. The UK government is working as hard as it can to undermine its own economy so it can catch up with the Eurozone economies in the race to the bottom of the slime. It beggars belief really. When will the citizens revolt?
The Bloomberg article reported comments made by the German Chancellor at a conference in Berlin on Tuesday (April 24, 2012). She apparently said:
… balanced budgets are the best answer to the debt crisis, rebuffing French Socialist presidential candidate Francois Hollande’s campaign pledge to reverse Europe’s austerity drive.
I wonder if we were to take Dr Merkel aside, away from the Bundesbank and Finance Ministry economist ideologues, and grilled her about what a balanced budget actually means with respect to the capacity of the private domestic sector to save overall, what level of understanding she would have. My guess is not much.
The Euro crisis is in two parts. First, it is a private debt crisis, exposed by the collapse of real estate markets around the world after a decade or more of non-government credit bingeing.
Second, the collapse in non-government spending that resulted created huge output gaps throughout Europe (and elsewhere). These output gaps drove increases in budget deficits (via the automatic stabilisers – collapse of tax revenue etc) and ordinarily, a government would allow that spending floor to remain in place and then augment it with discretionary expansionary fiscal policies.
The speed and size of those discretionary responses would then determine how long the output gap remained large and how robust the recovery phase would be. The rule for a responsible government is clear – maintain the expansionary stimulus for as long as private spending remains below the levels required to maintain zero output (spending) gaps given steady-state government net spending (and external balances – net exports).
The rule is clear and definite. Spending creates income and output growth. Output growth generates employment. Labour force growth adds to the number of people who desire to work at the current wage level while productivity growth reduces the number of people required to produce a given output.
Labour force growth (given productivity growth) thus defines the rate of growth of real output that will generate full employment. It is not magic at all. Just a comparison of the respective growth rates. If output growth is below this required rate then there will be excess capacity and demand-deficient unemployment.
The problem in the Eurozone is that they deliberately created a monetary system that precluded the member-state governments from responding to the collapse in private spending in the appropriate manner. They artificially imposed “fiscal rules” about the permitted size of deficits in member nations (the so-called Stability and Growth Pact) that were violated in many cases just by the cyclical response alone.
That is, the automatic stabilisers (collapse of tax revenue) in many cases pushed the deficits beyond the 3 per cent of GDP threshold so large were the output gaps that emerged in 2008.
Instead of allowing governments to meet this challenge in a responsible way, the Euro elites promoted the idea of fiscal austerity – as per Merkel’s false claim above – and buttressed it with lies taken from my disgraceful profession that private spending is weak because we are scared of the future tax implications of the rising budget deficits – so-called Ricardian Equivalence notions.
As I noted in yesterday’s blog – every time this notion is advanced to predict real world events, the formal Ricardian Equivalence models have got it exactly wrong. There has never been any predictive capacity in the theory.
The overwhelming evidence shows that firms will not invest while consumption is weak and households will not spend because they scared of becoming unemployed and are trying to reduce their bloated debt levels.
While the basic design of the Eurozone is flawed the situation could have been retrieved if the European Central Bank (ECB) had agreed to fully fund expansionary fiscal deficits in the member states where the output gaps demanded them.
Instead the ECB demanded austerity although behind the scenes via its Securities Management Program (SMP) it ensured that no nation would collapse completely. They have overseen a disgraceful default by the Greek government where investors have taken massive cuts which were entirely avoidable had the central bank acted appropriately to fund the Greek government deficits and allowed it to transition to growth.
The reason why the ECB is so central to the meltdown that is occurring in the EMU is because it is the only institution within the system that can issue the currency without revenue constraints. The flawed design, which forced member states to use a foreign currency and refused to establish a federal fiscal authority capable of meeting asymmetric aggregate demand shocks across the regional units (member states), means that the federal “fiscal” function has to be played by the ECB.
In the absence of that function, the system melts down. The SMP just means that the system bleeds to death a bit more slowly than it otherwise would as one nation collapses into recession. The economic imperative is growth – the political imperative is austerity. The twain shall not meet.
The point is that the problem of the Eurozone did not originate with fiscal settings but it has been made worse by adopting exactly the wrong fiscal response to the crisis – exemplified by the German Chancellor’s claims that balanced budgets are the appropriate response.
If we think about the Eurozone in particular it broadly runs an external balance as a complete monetary block. So a balanced budget in each nation would mean that overall the private domestic sector (aggregated across all member states) would be spending exactly what it earned.
But within the Eurozone itself, the overall external balance is comprised of significant external surpluses and corresponding and offsetting external deficits. The surplus nations would be experiencing private domestic surpluses while the deficit nations would be experiencing on-going private domestic deficits (that is, the private sector would be spending more than it was earning and accumulating debt).
That sort of situation is unsustainable because the private domestic sectors in the external deficit nations will eventually face unsustainable balance sheets and spending will be curtailed. The balanced budgets would then be compromised and a spiral of stagnation would result.
In external deficit nations, the budget deficit has to rise to support the desire of the private domestic sector to save overall. If it doesn’t, then recession or stagnancy is the result. Fiscal rules that impose the same behaviour across all member states irrespective of their external capacities fail.
Further, a truly sovereign nation can adjust to external imbalance (surplus or deficit) via exchange rate movements. The Eurozone nations cannot enjoy that flexibility and so the imposition of balanced budget rules onto nations with external deficits means that domestic stagnation is almost guaranteed.
The German Chancellor also signalled to the Berlin conference that her understanding of macroeconomics doesn’t go beyond what students are taught in mainstream undergraduate programs. It is a crude and flawed understanding.
Invoking the erroneous household budget equals government budget analogy she said:
All users of a currency know that. But every issuer of a currency also knows that they can spend whenever there are goods and services available for sale in the currency they issue.
Every issuer of a currency also knows what a nonsensical statement it is to say that a government can “save” its own currency. That is a totally inapplicable concept.
Saving is when households forgo consumption that would be permitted given their disposable income in order to expand their future consumption possibilities beyond their projected financial resource access. All revenue-constrained spending units have to save to expand future consumption possibilities (in one way or another).
A currency-issuing government can consume whenever they want (subject to real constraints relating to availability) irrespective of what they did last period. That is the unique capacity of a sovereign government. It makes no sense to say that a government is “saving” its own currency once we understand that saving is an act of intertemporal (across time) consumption smoothing and risk management.
Amidst all that neo-liberal nonsense, came the real world reminder of what the ideological obsession with austerity is doing – on the ground rather than in the plush European meeting rooms where Merkel and Co hang out eating and drinking and making deranged decisions that impact badly on millions – the UK had returned to recession and this was the first time since the 1970s that it had double-dipped.
When a nation goes into recession, it is a sign that government policy has not reacted quickly enough to the decline in non-government spending (private domestic and/or external).
What the government does next determines how long the recession lasts and how robust the subsequent recovery is. The aftermath of a recession is typically an entrenched pool of long-term unemployed. The more quickly the government reacts with fiscal support for overall spending the smaller the overall income losses and the smaller is the pool of unemployed that has to be mopped up with faster than normal employment growth.
However, when a nation double-dips – that is goes back into recession soon after it began recovering from a previous recession then the fault lies unequivocally with government. A double-dip recession always means that the government has failed to provide sufficient fiscal support for a sufficient duration given non-government spending behaviour.
A double-dip recession condemns a government – and exposes it as an incompetent economic manager.
The other salient point is that the history of double dip recessions tends to occur after a government bows to conservative pressure and/or its own ideological biases against the use of budget deficits and begins to withdraw fiscal support for growth long before the private sector has re-organised itself, regained confidence and resumed more normal spending growth.
Think 1937 in the US, 1997 in Japan, 2012 in Britain – they are all related by this government-generated sabotage of their own economies.
Double-dip recessions are entirely avoidable if appropriate macroeconomic policies are followed.
The following graph shows the broad sectoral contributions to real GDP growth (quarterly) over the last five quarters.
The service sector has been keeping the economy growing over the last year but in the March quarter its relatively modest contribution to real GDP growth (0.1 percentage points) was swamped by zero (Agriculture) negative contributions (Manufacturing -0.1 pts; Construction -0.2 pts) from the remaining sectors.
The construction and manufacturing sectors are now performing poorly and the trend is to worsen.
Overall, growth in real construction fell a staggering 3 per cent – the largest fall since the height of the recession in the March quarter 2009. Industrial production fell by 0.4 per cent (Manufacturing 0.1 per cent).
The move into recession is being mainly driven by government spending cut backs and a rapidly deteriorating real wage situation which is not the combination that would lead to a private domestic sector spending recovery.
Nominal pay has grown by 1.1 per cent in the first quarter 2012 which is about 1/3 the inflation rate. That is a dramatic real wage decline.
Britain is also not being helped by the Eurozone collapse given that the Eurozone is its largest export market.
Please read my blog – Fiscal austerity – the newest fallacy of composition – which explains why export-led growth strategies, which are the darlings of the neo-liberal gang, fail when fiscal austerity is imposed across the board.
By killing domestic spending in the Eurozone, the fiscal austerity is also killing British export growth (and vice versa).
The next two graphs break the production and services sector (respectively) into their sub-aggregates and show the contribution to real quarterly growth at that level (in percentage points).
It is clear that the production side of the economy has in broad decline for the best part of 12 months. This indicates a lack of consumer spending and the unwillingness of firms to invest (given the consumption and export outlook). The lack of confidence reinforces itself and can only really be broken by a significant government boost, exactly the opposite to what is happening.
As noted in the broad sectors graph above, the service sector has been providing the growth engine for the UK economy through the third-quarter 2011, but that contribution is now receding and failing to offset the consistent decline in production industries.
It is worth noting that the government sector is still contributing to growth which means that the worst of the fiscal austerity is yet to come. Up until now, the worst impacts of the austerity appear to be to undermine the confidence of the private sector.
Once the government contribution turns negative then the pace of the overall real GDP contraction will become more rapid.
More evidence, more ridiculous political input.
It is interesting to watch nations chase each other down the rat hole into oblivion and observe the degree of tolerance in each of the societies to the malaise that is being imposed on them by their political leaders.
It is also a vast human tragedy and history will definitely not judge this era very kindly.
I have some meetings to attend now.
That is enough for today!