Europe: Keynes buried due to fiscal adjustment and austerity

After the first two months of 2012, it becomes relevant to reflect upon the performance of the global economy and to present some forecasts for the current year. In USA, 2011’s fourth trimester Gross Domestic Product’s trailed upwards: 3% and the unemployment rate stalled. There are some elements that refer to the housing market, manufacturing and consumer confidence index that confirm a slight recovery is in process. The service sector, which represents more than three quarters of US economy has grown in February and accumulates a consecutive 26 months expansion. I believe that as the possibility for Obama to be reelected increases, the recovery will accelerate in the second semester, if the European crisis and warmongering conflict with Iran remain constrained. China has just formalized its GDP growth rate for 2012 will be 7.5%. The day after this announcement markets all over the world collapsed, which confirms the ‘engine’ role China plays for the global economy in crisis. In Europe, the analysis acquires a different nature. In these 60 days, Europe has been the center of attention worldwide and changes have occurred vertiginously. What will happen there is determining for the outcome of global economy, at least in the present year. The fear of a Euro collapse and the disintegration of the European Union has dominated the behavior of investors, analysts and political leaders. If it were to happen, the level of contagion would have the strength of a great tsunami whose wave would reach all shores in the planet. At the beginning of the year, this scenario had a great chance of happening: the debt crisis in most countries of the EU showed in a growing risk premium for some countries and the placements of sovereign bonds Italy and Spain issued came close to the dangerous threshold of 7% a year. Panic ruled the capital market and it spread to stocks and currency. As a result, ‘the horror’ started exerting its effects upon European political leaders, particularly on German and French leadership, countries to which most banks that are flooded with sovereign Italian, Spanish, Portuguese, Greek and Irish, among others’, bonds belong to.

Consequently, as of the second half of January, a series of events that have framed a certain scenario were unleashed, a scenario in which, although the risks of collapse have decreased, the hypothesis of severe recession during 2012 for the EU and the Euro Zone has been established. This change of scenario has been the outcome of a whirlwind of meetings of communitarian authorities and presidential summits, all of them with the purpose of reformulating the EU’s institutional architecture, giving the EU and the Euro Zone greater governance, redefining the European Central Bank’s role and generating new treaties in order to maintain the Euro Zone unified and the fate of its single currency.

All this utterly intense activity has had a dominant ideological perspective at its core: ‘Merkozy’s theory of fiscal balance as a precondition for growth’. In addition to a structural obsession, the crisis made it evident that countries that share the Euro must not only give up their monetary policy, but also their fiscal policy.

The corollary is that in the summit of Thursday March 1st, the Merkozy theory accomplished its formalization in a treaty that consecrates fiscal austerity and imposes the constitutional obligation of maintaining fiscal balance upon signatory countries. A total of 25 countries, of 27 integrating the EU, signed the treaty that will become effective in the Euro Zone with the ratification of 12 countries at least. Resorting to the purest of liberal theories, Merkel justified the treaty stating that ‘the first thing that must be done is to sign the treaty as to eradicate fiscal imbalance, the second is how to generate growth’. Exactly opposite to what Keynes would say, and even post Keynesian structuralists such as Paul Krugman, which transforms the European crisis into a subject of economic theory dispute: Keynesianism versus neoliberal classicism. Either Europe falls into a vicious circle of more adjustment, more contraction, more deficit, or into a virtuous circle like Mercozy asumes: lower fiscal deficit, greater investors and consumers trust and therefore, greater growth. Merkel sustains her position in those analysts that claim that Europe is not going through a debt crisis, but a trust crisis, and so what needs to be reinstated is investors and consumers’ trust through solid treasuries and balanced budgets. Obviously, none of this, not even in Merkel’s opinion, will happen in 2012. Trust, if this were the right thesis, is something one regains after many years. Latin-Americans know the length of these cycles. Consequently, the contraction of activity and this year’s Product will come as no shock, even for Germany, and especially for the countries that have implemented greater budgetary cuts: Greece, Portugal, Spain and Italy. Already 2011’s last trimester had an 0.3% negative growth and it is expected, in the most optimistic view, that this figure will repeat itself at similar levels in 2012. Let us bear in mind that today five economies -Greece, Portugal, Italy, Netherlands and Belgium- are under technical recession (two trimesters of negative growth).

In the March 1st summit, there was a second transcendent fact in the persistent attempt to boost the Euro. It was constituted by the decision to advance half the 130.000 million Euro loan to Greece as to back the bonds exchange and recapitalize banks; nothing to relieve battered Greece’s budget crisis. The exchange is due on the second week of March; Minister Venizelos claimed he is optimistic and that participation will surpass 90%. But the EU keeps being precautious and postponed paying the other half for a few days.

Anyhow, this partial funds release to Greece, same as the launch of the greatest exchange in history- a 53.3% remission of bonds in the hands of private holders to erase 107 billion of their 350 billion debt- generated a very positive effect (if the exchange were successful) for the European crisis’ management. Greece is no longer the center of the political and economical agenda, which increased investors’ trust, mortified for over two years by the uncertainty the Hellenic tragedy generated.

Having Greece been displaced from the center of the agenda (for now) and harmonizing monetary policy with fiscal policy in the Euro Zone, it more clearly reemerges the dimension of the financial crisis and its impact on credit availability for companies and families, and therefore on consumption and, ultimately, on the more and more distant ‘dream of growth’. And this is where the focus of discussion shifts to the ECB’s role. Should the ECB intervene in the direct purchase of sovereign bonds? Should it be more aggressive in the secondary market? Should it be more incisive in its ‘firewall’ role granting more liquidity to the banking system? Is it urgent to implement Eurobonds?

The urgency has already rushed the ECB to a liquidity injection in the banking system for a trillion euros. Reality has given its first response: the banks are capitalized but they have not transferred any of those first drops of liquidity into credit for companies or families. Double concern: banks are not reactivating their main business and therefore enhancing their financial fragility, and distrust, along with the level of risk uncertainty generates over the EU’s economy evolution, are keeping the ‘unfreezing’ of credit from jumpstarting growth. Budget cuts, activity decline, increasing unemployment (10.7% in the Euro Zone, with a maximum of 23.3% in Spain) and lack of credit, make out a discouraging picture. In response to this, Merkel insists that ‘the treaty of fiscal consolidation is an important step towards a stable union, it makes a political union possible’: again, the issue of growth is still going AWOL from her agenda, perhaps because as Christine Lagarde implies, ‘some countries have to move forward at full speed to drive growth’, ‘those with room for fiscal maneuver, must find a way to set in motion the growth of those countries restricted in their expansion by imbalance’. Although she did not mention any country in particular it was easy to assume she meant Germany, the engine of European growth. Cameron, more laconic, introduced the new dimension ‘Europe does not only face a debt crisis, it is also a growth crisis’.

The other event that throughout these first 60 days of the year has pushed Germany away from its orthodoxy and initial inflexibility, mainly because of the pressure put on Merkel by the G-20 and the IMF, was the acceptance adopted at the end of February by the EU of unifying the Financial Stability Fund (EFSF) with the new European Stability Mechanism (ESM), or bailout fund, raising its capacity to 750 billion euros, with the purpose of backing countries in which the economic crisis and unemployment worsen.

In short, the first two months of 2012 have feverishly revolved around the Europe that has chosen an economic course of privileging adjustment as to accomplish fiscal balance. The Euro’s collapse has been avoided, which would be very negative for the global economy, but dramatic for the European financial system and for Germany in particular, whose exports, the engine of its economy, are up to 50% destined to the European market itself.

Falling into the void has been avoided, but it is unquestionable that the exit adopted and imposed by Mercozy upon the rest of the countries of the Union has a serious sustainability problem. Political sustainability and economical sustainability. Hard to imagine that societies subject to tremendous sacrifices in their quality of life and elevated unemployment rates will not react or express themselves through their vote in different political alternatives than the ones today have agreed upon austerity and recession. The presidential election in France on May is the first challenge. What will happen if the socialist candidate (François Hollande) is chosen president? (he has already openly expressed his refusal to the text of the treaty approved in last Thursday’s summit).

Economic sustainability is also questionable. The question that several economists today ask themselves is highly relevant: the adjustment leads to a decline in activity, which in turn leads to greater fiscal deficit, and because of the fiscal balance treaties to further budget cuts and so on to more declines in activity and employment. In Merkozy’s vision there is no growth intention, the engine, the model is unidentified, it seems to be a ‘tapestry woven without design’, an escape from the ‘horror’ without a roadmap, without strategy.

The contagion in global economy is already beginning to show its first signs. As we said, China has just announced its growth in 2012 will be 7.5%. And, setting aside some domestic imbalances, it has linked the fall in its Product growth rate to the fall in exports to Europe. This phenomenon can gradually progress throughout the year. What matters for the global economy is that the European recession will not weaken the fragile recovery in USA, whose communicating vessel would be the financial sector rather than commerce. Demonstrations of the CBE’s fire power bring some hope in this regard. Latin American countries will suffer the double effect of having their exports to Europe decrease with a possible fall in the price of some agricultural products (mainly soy) due to the decrease of activity in China.

What is our conclusion? An economy cannot be ruled by adjustment, this is not an end (o GOAL) in itself. We have already been through it in Latin America and perhaps because of it we have learned and we are, in words of Izaguirre (World Bank), an example of macroeconomic and social policy. Europe has to go back to thinking long-term, to developing a vision for a decade down the road, and it is that vision that must unify the countries of the EU. Fiscal imbalance is and instrument and its application is reasonable in extreme cases, but what must prevail is politics and long-term vision, maybe in that vision Keynes will rise from his grave and have a role to play.

Leave a comment

Your email address will not be published. Required fields are marked *