Wednesday, 3 July 2013

The politics of Austerity – north south divide

There are two threats to recovery in the Eurozone, one is rising interest rates an inevitable consequence of Europe being two years behind the US in the recovery cycle and the second is politics.  It could prove to be a long hot summer in the PIIGS economies and in the dusty hallways of the European Central bank (ECB).  The good people of Italy, Spain, Ireland, Greece and specifically Portugal are being asked to endure years (potentially a decade) of austerity.  This Lutheran penance is being applied on these warm blooded catholic nations by the iron will and ice cold determination of German and Dutch bankers supported by the EU and the IMF.  The cheer leader for this chilling approach is Jeroen Dijsselbloem, Dutch finance minister and president of the Eurogroup, the Eurozone’s finance ministers.  His determination that these indebted economies on the fringe of the Eurozone should bail themselves out at breakneck speed is at the heart of the politics.

It may seem fair that these countries who are now on the brink of endless austerity should resolve the problems that were ‘self-inflicted’.  But the question at the back of most people’s mind is to what extent were these nations duped by Germany and the other northern European countries?  The answer is pretty clear!  From the launch of the Euro in 1999 until 2007, the period of the credit boom, the ECB held interest rates at an artificially low level and allowed a massive expansion of credit and government indebtedness.  This great easing of monetary policy was in support of the German’s need to kick start their economy after a decade of no or low growth – a kind of Abenomics to resolve the issues of reunification.  The problem was that this easing for Germany affected the whole Eurozone (the downside of a single currency) to create the credit bubble and eventually the crash, which was triggered by Lehman’s default but systemic in the West.  As the Chart below shows that the German economy, since reunification, has been growing a very slow rates as compared to the trend rate of 2% growth from 1973-1990 – this rate has only been achieved once in the period from 1993-2012.  It was this desire to reflate the German economy that triggered the policies of monetary easing in the Eurozone and now the consequences of this are plain for all to see.

Dismal German growth between 1990 - 2005 is the underlining cause of austerity
The impact of these policies applied in the period before the credit crunch has been enormous for countries like Portugal ( working its way through a €78bn bailout).  This week Pedro Passos Coelho, the prime minister, had two high-profile ministers resign in less than 24 hours. Even if the prime minister manages avoid fresh elections by forming a minority administration, the prospects of this enfeebled government pushing through the tough reforms required to keep the bailout programme on track is pretty remote.  The unrest in Portugal is a signal that the centre of gravity politically has shifted away from blithe adherence to austerity imposed from Brussels.  Until recently, the relationship between Lisbon and its international creditors – the “troika” of the EU, International Monetary Fund and European Central Bank – was genial but is now expected to “sour significantly”.  With public debt likely to peak at above 130 per cent of national output by 2015, the pain looks likely to go on for an indefinite period.  Mr Passos Coelho has pledged to stay in office and try to rebuild a stable government. “I will not resign and I will not abandon my country” he said in a televised address on Tuesday night, but nothing can disguise that fact the coalition is now holed below the waterline and a snap election is likely to bring in an anti-austerity coalition that would frighten the hell out of Brussels.  As a result of these shenanigans, today’s share prices in Portugal tumbled and bond yields soared to unsustainable levels.
Jeroen Dijsselbloem still has his head firmly in the sand and doesn’t believe that Portuguese crisis was in the offing. “I do not expect any problems with Portugal, first because I believe that the political situation will stabilise and secondly because the phasing and timing of Portugal’s programme is proceeding well.”   The people of Portugal may think rather differently.
It’s clear now that to avoid an outright crisis of a ‘Pexit’ there will need to be some rethinking in Brussels on the timescales and targets and more importantly on the approach to paying down the governments debts.  For my money the countries who benefited most from the monetary easing between 1999 and 2007 should put in place an emergency funding (in addition to the bail out) that achieves the following:
1. Soft loans to resolve the structural element of the deficit which was created by the appalling policies of the EU and the ECB, this amounts to 3% of GDP or about a €8bn annually
2. An unemployment fund that covers the ‘cyclical cost’ of austerity - probably a further €5bn annually
3. Investment in a new  industrial strategy to replace those industries that were destroyed by unfair competition from other parts of the EU
Significant measures such as these would go some way to repairing the damage the loose monetary policy at the start of the Euro and be small return for the support given to Germany in its hour of need.

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