The euro mutiny begins

Thursday, June 17, 2010
By Paul Martin

By Ambrose Evans-Pritchard
June 16th, 2010

The rebellion against the 1930s fiscal and monetary policies of the Euro-complex is gathering pace.

Il Sole has published a letter by 100 Italian economists warning that the austerity strategy imposed by Brussels/Frankfurt risks tipping Europe into a self-feeding downward spiral. Far from holding the eurozone together, it will cause weaker countries to be catapulted out of EMU. Others will leave in order to restore sovereign control over their central banks and unemployment policies.

At worst it will blow the EU apart, leading to the very acrimony that the European Project was supposed to prevent.

For readers of Italian, it’s here.

While I don’t share the big-state Left-Keynesian perspective of these professors — nor their implicit hostility to the free market — I do agree with much of their overall analysis.

My rough translation:

“The grave economic global crisis, and its links to the eurozone crisis, will not be resolved by cutting salaries, pensions, the welfare state, education, research …….. More likely, the `politics of sacrifice’ in Italy and in Europe runs the risk of accentuating the crisis in the end, causing a faster rise in unemployment, of insolvencies and company failures, and could at a certain point compel some countries to leave monetary union.

“The fundamental point to understand is that the current instability of monetary union is not just the result of accounting fraud and over-spending. In reality, it stems from a profound interweaving of the global economic crisis and imbalances within the eurozone …..

It blames the crisis on the “deflationary economic policies” of the richer states. “Especially Germany, geared for a long time to holding down salaries in relation to productivity, and to the penetration of foreign markets, gaining European market share for German companies…

They say the policy has led to growing surpluses in Germany, offset by growing debts in Southern Europe. The adjustment mechanism has not only failed. Matters have got worse, and worse.

“This is the deeper reason why market traders are betting on a collapse of the eurozone. They can see that as the crisis drags on this will cause tax revenues to fall, making it ever harder to repay debts, whether public or private. Some countries will progressively be pushed out of the eurozone, others will decide to break away to free themselves from a deflationary spiral… It is the risk of widespread defaults and the reconversion of debts into national currencies that is really motivating bets by speculators.

The economists denounced the “obstinacy” with which the EU authorities and governments are pursuing “depressionary policies”, and called on the European Central Bank to abandon its policy of “sterilizing” purchases of Greek, Portuguese, and Spanish bonds, and move to fully-fledged quantitative easing to boost the money supply.

“We must have an immediate debate on the extremely grave errors in economic policies now being committed..

Si, Signori .. Bravissimi.

Just to be clear, I do not share their Krugmanite view that huge fiscal deficits are benign. In my view, it is imperative that the whole western world reduces debt in a orderly fashion over 10 to 15 years. Pacing is crucial. Too fast can be self-defeating. Too slow is not an option.

My objection with the EU’s mix of policies is that extreme fiscal austerity is being imposed on a string of countries without offsetting monetary stimulus. (Yes, I know, some will say that I am mixing apples and oranges).

Ireland, Spain, and Portugal have already tipped into outright deflation. Ireland’s nominal GDP has contracted 18.6pc since the peak. They are falling deeper into an Irving Fisher debt-deflation trap.

This is reactionary folly. The College of European Commission should be taken out and horse-whipped outside the Breydel Building for demanding yet further cuts from Spain — which is already cutting wages 5pc this year, in an economy where total public /private debt is 280pc of GDP or more. Can nobody think of a more coherent way out of this?

As for Germany, frankly it is hard to know what to say. It is astonishing that Chancellor Merkel should unveil an €80bn package of fiscal retrenchment without consulting with the rest of Europe. This has raised the bar for everybody else, forcing them into yet further contractionary policies to keep up. Mrs Merkel does not begin to understand the nature of commitment made by Germany when it launched monetary union.

EMU has become an infernal machine. This will not be the last letter by angry economists.

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