Page 2 of
2 Europe's
crisis is about wealth, not
growth By Spengler
As
the Chinese say, kill the chicken and let the
monkey watch. If Italy with its $2 trillion in
external debt were to fail, the situation would be
truly dire. But there is no need for that to
happen; although Italy's sovereign debt is above
100% of GDP, private debt is only 45% of GDP, the
Italian state has saleable assets worth perhaps
40% of GDP, and Italy has hundreds of first-rate
manufacturing companies that are market leaders in
their own fields (unlike Spain, which has very
little first-rate manufacturing).
The
political Gordion Knot must be cut somewhere, and
the easiest place to do it is in Spain. The
results will be frightful for the Spaniards but
salutary for everyone else. The alternative is to
reward bad behavior with bailouts and penalize
frugality and
industriousness. To call
this a "growth policy" is perverse. How can it
foster growth to arbitrarily shift rewards away
from market winners and assign them instead to
market losers?
Nobel Prize winner Robert
Mundell, the father of the euro, told Canada's
Financial Post (June 8),
"The euro is not the problem. The
problem within the European Union and the
European Monetary Union is government deficits
and the debts of a few countries, mostly in
Southern Europe. It is a failure of fiscal
discipline that has threatened the solvency of
the debt-ridden countries whose high deficits
are due in large part to the current recession
in Europe and more generally the slowdown of the
world economy. The debts would only become a
problem for the euro if these deficits led the
European Central Bank (ECB) to create
substantial inflation to try to bail out these
countries."
Central banks can't
expand their balance sheets forever. Or can they?
In the current issue of Foreign Affairs, the
journal of the Council on Foreign Relations, CFR
economist Sebastian Mallaby argues in all
seriousness that the central banks are "supermen"
who can print as much money as they want:
By December 2008, the Fed had
extended fully $1.5 trillion in emergency
financing to markets, dwarfing the $700 billion
bailout fund authorized by Congress through the
Troubled Asset Relief Program (TARP). Central
banks on the other side of the Atlantic have
acted with equal resolve. For much of 2011,
Europe's political leadership bickered about the
details of the European Financial Stability
Facility (EFSF), a TARP-like bailout fund with
an intended firepower of 440 billion euros.
Then, one day last December, the European
Central Bank provided 489 billion euros to the
continent's ailing banks, and in February 2012,
it repeated this stunt, effectively conjuring
the equivalent of two EFSFs out of thin air
through the magic of the printing press. Since
the start of 2007, the ECB has purchased
financial assets totaling 1.7 trillion euros,
expanding its portfolio from 13 percent to over
30 percent of the eurozone's GDP. That means
that the ECB has printed enough money to
increase its paper wealth by an amount exceeding
the value of eight years of Greek output.
This superman act has, at least as of
this writing, saved the euro system from
breaking up. Without the central bank's
extraordinary support, private banks across the
eurozone would have struggled to raise money and
would have collapsed ... For the foreseeable
future, therefore, the ECB can keep on printing
money to prop up banks.
Mallaby
ignores the enormous difference between the United
States and Europe. America undertook a $2 trillion
expansion of central bank assets while household
assets shrank by three times as much, that is, by
$6 trillion. The national balance sheet as a whole
shrank in the United States, but has yet to shrink
in Europe. McKinsey Consultants estimate that the
US has reduced overall debt by 15% since the
crisis, while Europe's debt has risen. Mallaby is
only looking at half of the balance sheet; his
article recalls the ethnic joke about the
accountant who ran off to Brazil with the accounts
payable.
Except for Greece, which has
already cut the value of its bonds by 50% to 70%,
Europe has written off little of its own asset
bubble. The $1.3 trillion debt of Spanish
financial institutions remains on the books of
Spanish pension funds and insurance companies (as
well as French and other European banks). The ECB
has lent 1.7 trillion euros (US$2.15 trillion) to
private banks to replace deposits removed by
depositors who expect them to go bankrupt
eventually. If the ECB keeps printing money, the
value of the euro will plummet and the cost of oil
and other imports will soar. Europe will lose
wealth through currency devaluation, and the
biggest losers will be the prosperous European
nations who have viable financial assets, namely
the Germans and Dutch.
Penalizing good
economic management and rewarding bad economic
management is not a "growth" policy, whatever the
Obama administration might think; it is a formula
for perpetual stagnation. It is sad that the
Spanish will have smaller pensions, just like
municipal workers in San Jose, California (which
also cut pensions due to a budget crisis). The
only way to get back to growth is to clear away
the phony valuations of paper attached to
insolvent institutions. Once the liabilities of
the Spanish banks are wiped clean, an outside
buyer - perhaps China or a sovereign wealth fund -
can buy in and reconstruct the system. That is
what happened in Thailand in 1997 after the
banking system collapsed during the great Asian
financial crisis.
A middle position argues
that insolvent European countries should get
bailouts if they cede power to Brussels. That is
the gist of all the plans now circulating to fix
Europe's financial problems. "Bailouts have to be
linked to some transfer of fiscal authority from
countries that have become insolvent to the
European Commission acting under the auspices, for
constitutional correctness, of the European
Council," Mundell told the Financial Post. That is
also the German position, although one suspects
that it is a polite way of postponing demands for
more German money.
Supposedly the
enlightened bureaucrats of the European Commission
(perhaps with the connivance of the International
Monetary Fund) will force reforms onto weak and
ineffective national governments. The big stick
from Brussels might actually help some countries,
under two conditions. The first is that reform is
what a country requires, and the second is that a
political party is in power that can use external
pressure to push through reforms it wants to adopt
in any case.
In small ways, this already
is occurring: Portugal's bailout by the European
Community and the International Monetary Fund has
empowered young reformers who are selling off
state assets, reforming labor laws, and breaking
up old monopolies.
Exhibit 3: Percentage of underground economy
activity vs labor force participation rate
Portugal has a high labor force
participation rate (which simply means that the
Portuguese work on the books and pay their taxes)
and a relatively low share of underground economic
activity. Greece has a much lower labor force
participation rate and a much higher share of
underground economic activity. Portugal's problems
are treatable; Greece might be too far gone.
Excepting Portugal, the Mediterranean
countries combine a pre-modern hostility towards
central government with a post-modern indifference
to the national future. At just 1.4 children per
female, Italy and Spain have some of the lowest
fertility rates in the world, which is to say that
its citizens are unlikely to sacrifice their
pleasures and prerogatives for a national future
to which they do not contribute by raising
children. Neither country's elite evinces a sense
of national obligation. To pay taxes is to play
the fool. Italy has a great deal of private wealth
and very low levels of private debt (which is only
45% of GDP, one of the lowest ratios in the
developed world). If Italians were
public-spirited, it would be a simple matter to
stabilize the country's public debt, which is
tantamount to saying that if we had some
meatballs, we could have spaghetti and meatballs,
if we had some spaghetti.
If Italians and
Spaniards treat their own national government as a
hostile entity to be frustrated and evaded at
every turn, how would they resound to a fiscal
boss from Brussels? The notion that supranational
controls can accomplish what national governments
have failed to accomplish is one of the stranger
ideas to achieve broad purchase in public policy.
Spengler is channeled by David P
Goldman, president of Macrostrategy LLC. His book
How Civilizations Die (and why Islam is Dying,
Too) was published by Regnery Press in
September 2011. A volume of his essays on culture,
religion and economics, It's Not the End of
the World - It's Just the End of You, also
appeared last autumn, from Van Praag Press.
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