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Coping With Austerity

Posted by: Andy Reinhardt on November 23, 2011

On the same day that German Chancellor Angela Merkel again swatted down the idea of issuing joint euro bonds to help ease sovereign debt in peripheral euro zone nations, Germany’s own bond issuance, which fell short of objectives, caused market jitters that pulled down exchanges from Milan to New York.

Merkel spoke out against a proposal backed by European Commission President José Manuel Barroso and other commission members to issue common debt securities for the 17 members of the euro zone. The German chancellor argues that euro bonds aren’t authorized under current EU treaties and that issuing them would weaken pressure on the euro’s indebted members to cut their deficits.

Yet movements in the bond market suggested that even gold-plated German debt is no longer free of the euro zone taint: In a routine offering of up to €6 billion worth of 10-year notes, some 39 percent went unsold, spooking investors who worried what that said about prospects for weaker European countries. Though it’s normal in auctions for some bonds not to sell—that has been the case in six of the last eight German offerings—today’s was the highest “uncovered” proportion at a 10-year sale since 1995, according to Bloomberg data. “If investors do not wish to buy bunds, they do not wish to buy Europe,” said Neil Jones, head of European hedge-fund sales at Mizuho Corporate Bank in London, in the Bloomberg News story cited above.

Against this market-shaking backdrop, the day-to-day concerns of European citizens trying to cope with the effects of the euro zone crisis can get a little lost. This week’s issue of Bloomberg Businessweek has a terrific piece by Bloomberg’s Finnbar Flynn called “The Irish Suffer Austerity in Silence,” that puts it in perspective.

Unlike the Greeks, who continue to protest against the harsh economic medicine being doled out by their government (unions there this week announced plans for more strikes in December) the Irish have been relatively sanguine about their sacrifice. Protests have been relatively few and small and the rhetoric has been restrained. One explanation offered in the story:

Many Irish realize they fueled the boom and bust by pushing up property prices and seeking pay hikes that led to a loss of competitiveness. “There is a sense that everyone was at a party that went a little too wild,” says Austin Hughes, chief economist at KBC Bank Ireland.

Many Greek citizens apparently don’t share the same sense. Even as officials from Europe and Greece ratchet up the pressure for further austerity commitments—in its interim monetary policy report today the Bank of Greece cautioned that this moment is Greece’s last chance to stay in the euro—normal Greeks resent, sometimes violently, their bitter pill. As Ezra Klein’s Washington Post Wonkblog says, “Greece’s new, technocratic government is walking a challenging tightrope on austerity, caught between the demands of the European Union and its own citizens.”

Adding an almost humorous note to the government’s economic reform efforts, Greece today announced that numerous jobs previously categorized as “heavy and arduous” and whose holders were thus eligible for early pensions were being dropped from the list. Among them: Confectioners, hairdressers, transit ticket-takers, and supermarket cashiers.

Even in countries with less sense of worker entitlement, austerity is a tough sell. Britain, outside the euro zone but facing bond-market pressure of its own, is feeling the economic pinch of reduced spending and higher taxes. This week, Prime Minister David Cameron admitted that tackling Britain’s debts was “proving harder than anyone envisaged.” The coalition government he heads with Liberal Democrat leader Nick Clegg may not be able to close the deficit by 2014-2015, as originally planned.

Public reaction isn’t as docile as Ireland’s or as violent as Greece’s, but Britain potentially faces years in the doldrums. Right-leaning London think tank Reform issued a report this week urging the government not to lose its nerve or seek quick fixes in the face of resistance. Austerity, it seems isn’t a sprint but a marathon.

Photographer: Niall Carson/PA/AP

Reader Comments

Armen V. Papazian

November 25, 2011 4:17 PM

The most daunting policy paradox today is the simultaneous and parallel implementation of quantitative easing and austerity measures. The former is a pure invention and creation of money, the latter is a contraction in spending based on the premise that money is not as available as it was previously. The parallel adoption of these policies explains public discontent. An informed public is observing how banks are being bailed out and provided with fresh reserves, while hard working people are being penalized by the same banks for defaulting on their loans or mortgages. Austerity measures are adding oil to the fire.

Across the world, and especially in the UK and Europe, the policy assumptions used to address the current crisis are based on a monetary architecture that is deeply flawed. Indeed, it is so seriously flawed that the shortcomings in our architecture evoke the limitations we used to impose on ourselves when we believed without evidence that the Earth was flat. Today, our belief in the debt-based monetary architecture is as limiting and as restrictive.

Money is backed by government debt. Central banks print the banknotes and balance the entry in their liabilities with assets that are mainly government bonds. Money is created by debt and then grows through credit. Credit, through the fractional banking system, creates new money. This is achieved by creating new deposits based on debt agreements and contracts that banks sign with their clients. Thus, at the creation level and at the expansion level, money is driven by debt and credit.

We must rethink money and add a channel of money creation and injection that does not require a commensurate debt increase in the system. If we shy away from this challenge, and continue the current policy course, we will end up with an unprecedented global upheaval accompanied with a recession. Austerity measures are reducing aggregate expenditure and thus income levels, while quantitative easing is only adding fresh reserves to the banks who can hardly lend it out given their own difficulties, higher regulatory requirements, and already overleveraged economies. We need to take policy actions that add income and reduce credit, not the other way around.

The results of austerity policies have already been demonstrated in Greece. Budget cuts had a negative impact on aggregate expenditure and income, reinforcing the recession and thus reducing tax revenues and failing the very purpose of the policy. Although tax evasion seems to be a key challenge in Greece, the decline in tax revenues in 2011 is indicative of how fruitless the policy trend is because expenditure declines lead to further declines in income and thus tax revenues, increasing recessionary pressures and making effective deficit reduction almost impossible.

The upcoming recapitalization of European Banks and the Greek haircut, if they actually happen as planned, shift the debt burden, they do not eliminate the issues. Increasing the firepower of the European Financial Stability Facility (EFSF) through some form of leverage, pending details and implementation, utilizes debt and credit again, and is a long way from creating more jobs. The same reasoning applies to the recent quantitative easing announced by the Bank of England, which provides fresh capital to the banks. The issue and key systemic bottleneck remains.

To resolve the crisis effectively and fundamentally, the debt-based monetary architecture must be complemented with a channel of money creation that does not add more debt to the system and creates income without depending on bank credit.

Governments must be able to inject fresh money without adding debt. Central Banks must be able to inject new money through instruments that are not debt-based instruments.

After all, the State is the creator of money and a 'sovereign debt crisis' is an absurdity of the highest order, a system chasing its own tale. The only true challenge that a transformed and healthier financial architecture faces is our ability and willingness to think and implement a better system.


November 26, 2011 6:31 PM

I look on with amazement at the perverse stance of the Greek Unions. Over the decades they pretty near forced the Government of Greece to capitulate to their demands of excess and ridiculously lavish benefits. As Prime Minister George Papendreau stated in August to the effect; the number one cause of Greed Debt is the Public Service and Public Service Unions. I say the Public Service Unions are protesting themselves, they are the cause of their own misfortune out of primarily greed, greed, and more greed. What do they expect the Government to do? As the old saying goes unfortunately, All is now lost. There will be a hard default probably and the future of Greece will be bleak to say the least. The entire world is in toilet because of Public Service Unions and Public Service greed and largess. I'd say People and nations better wake up, however I think it's way too late, the damage is done and the 2nd Great Depression is now on the way.

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Financial markets are on the edge as investors await a solution to the European debt crisis. This blog examines the banks that hold billions of euros worth of Greek, Italian, and other sovereign debt; the governments that must pay off or refinance that debt; and the implications for the worldwide financial system if they can't.

Analyses or commentary in this blog are the views of the author and or commentators, and do not necessarily reflect the views of Bloomberg News.

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