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2 Europe's
crisis is about wealth, not
growth By Spengler
President Barack Obama will ask the Group
of 20 meeting in Mexico June 18 to present "a
unified message about the importance of growth",
according to Michael Froman, his deputy national
security adviser for international economics. What
the Obama administration means by "growth" is that
Germany continue to bail out its feckless southern
European neighbors. That has nothing to do with
growth. The issue, rather, is who takes the hit
when Europe's illusory wealth is written off.
Europe and America both entered the 2008
economic crisis with enormous asset bubbles.
America's was concentrated in the price of
residential real estate and mortgages issued
against residential real estate. Europe's is
concentrated in the debt of governments and banks.
America's asset bubble has already popped,
resulting in a US$6 trillion reduction in the
paper wealth of American
households, with a 40%
reduction in the net worth of the average American
family. But Europe's institutions continue to prop
up the continent's asset bubble.
The US
government misused government subsidies via
Freddie Mac and Fannie Mae to promote the housing
bubble, and looked the other way while financial
institutions and rating agencies created a
trillion-dollar house of cards in levered
mortgage-backed securities. The weaker members of
the eurozone used their enhanced borrowing powers
to pile up daunting levels of government and bank
debt.
Behind the financial manipulation in
both cases was an erosion in the foundation of
national wealth, as aging populations put
catastrophic pressures on national pension and
health systems. In the case of Europe, the number
of retirees is set to double during the next 40
years while the workforce will shrink by a third.
Exhibit 1: Europe's
working age population (15-59) shrinks by a third
while population over 65 doubles Source:
United Nations World Population Prospects
(Constant Fertility Scenario)
Exhibit 2: America's working population
grows but retired population grows faster
Source: United Nations World Population
Prospects (Constant Fertility Scenario)
In
a May 2009 essay for First Things, "Demographics
and Depression," I argued that reduced family
formation had shrunk America's demand for houses
and provoked the economic crisis:
America's population has risen from
200 million to 300 million since 1970, while the
total number of two-parent families with
children is the same today as it was when
Richard Nixon took office, at 25 million. In
1973, the United States had 36 million housing
units with three or more bedrooms, not many more
than the number of two-parent families with
children- which means that the supply of family
homes was roughly in line with the number of
families. By 2005, the number of housing units
with three or more bedrooms had doubled to 72
million, though America had the same number of
two-parent families with children.
The
housing bubble eventually had to pop, and the
result was a $6 trillion write-down in American
wealth. Europe's demographic problem is far worse.
Europe also requires a massive reduction in
private wealth, as Nobel Prize winner from
Columbia University, Edmund Phelps, explained in a
January 12 op-ed in the Financial Times:
What must be done? Italy, Portugal
and Greece must do without the deals that made
state borrowing so cheap for them - the
ill-deserved AAA ratings and the outrageous
exemption of banks from capital requirements on
sovereign debt holdings. Another must is a
wealth tax, so that net wealth bears some
resemblance to the true value of what Italians
can be expected to produce, net of expected
labor costs in the future. And next time an
economy is in the throes of exchange rate
over-valuation, it must jettison the urge to run
fiscal deficits.
Some European
countries, to be sure, can mitigate their
demographic dearth through immigration. After the
Thirty Years War of 1618-1648 wiped out most of
his people, the Elector of Brandenburg, Friedrich
Wilhelm I, invited French Huguenots, Poles, Jews,
and others to settle in what later became Prussia.
German was a minority language in Berlin during
the 18th century, and might be a minority language
again in the 21st century. The smartest Greeks and
Spaniards may decamp for jobs in Germany.
Europe's nominal wealth is embodied
disproportionately in national debt and in the
banking system, especially in the debt of the
banking system. To reduce the paper value of
wealth would be an overtly political act, rather
than a quasi-market phenomenon as in the United
States. All of Europe's politics now revolves
around the question of whose wealth gets taxed. If
Spanish pensioners are told that their pensions
will be reduced by a big margin because the
Spanish banks made too many bad loans to
construction companies while the government looked
on, they rightly will blame the government. This
may destroy the delicate fabric of Spanish
political life. That is unfortunate, and it may be
unavoidable.
There are many ways to write
off the nominal wealth to levels that correspond
to economic reality. The simplest and best would
be for Spain, Italy and so forth simply to impose
a wealth tax. But wealthy southern Europeans have
been hiding their wealth for generations precisely
in order to avert such an eventuality. Another way
to have a de facto wealth tax is to devalue the
currency, which makes everyone (but especially
people of modest means) much poorer, while
reducing the real liability of debtors (mainly the
government). And yet another way to tax wealth is
to wipe out the value of assets.
Americans
accepted the overall reduction in wealth because
the housing bubble was a people's Ponzi scheme, as
I wrote in this space (See The
people's Ponzi scheme, Asia Times Online,
August 16, 2011). Americans speculated on their
own houses, and lost. So did the Irish, who glumly
accepted the consequences.
Not so the
Spanish: the massive misdirection of credit to the
construction sector focused on corporate rather
than household lending. Financial institutions
issued debt in the astonishing volume of 109% of
GDP (about three times the level in the United
States). The construction sector ballooned to a
size large than manufacturing (vs a fifth of the
manufacturing sector in Germany and a quarter in
the United States).
The massive issuance
of financial institutions' securities constitutes
a large portion of the wealth of Spaniards; they
sit in pension funds and life insurance
portfolios. Wipe out their value, and Spaniards
will have to accept pension reductions. That is
precisely what should be done: the banks are
valueless, and their liabilities should be erased
so that an external buyer can recapitalize them.
The Spanish won't like it a bit. Nor will other
Europeans.
The alternative is to place a
de facto wealth tax on the frugal and industrious
northern Europeans, by extending Germany's (and
Holland's) balance sheet until the euro weakens
drastically, raising the cost of imported goods
for the Germans. It is unfair to tax German wealth
in order to maintain the wealth of the rest of
Europe, and the Germans won't like it.
In
neither of these scenarios is an uncontrolled
financial crisis a necessary outcome. That is a
bogeyman that economists use to frighten naive and
impressionable heads of state. It is entirely
possible to let the Spanish banks fail, wipe all
their equity and debt, and then bail out the
French banks who own a great deal of the senior
debt of Spanish banks. There will be no chain
reaction, because the European Central Bank can
simply put a circuit breaker wherever it wants.
Making a horrible example of Spain is the
best alternative, in our view. Spain probably will
devolve into political chaos, but the global
effects will be easily contained. And Spain's
misery will persuade the Italians that fundamental
reform is far preferable to repeating the Spanish
experience.
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