In the last week, several new data releases have shown that the Eurozone crisis is now consolidating in the core of Europe – France, Italy and … yes, Germany. The latter has forced nonsensical austerity on its trading partners in the monetary union. And, finally, the inevitable has happened. Germany’s factories are now in decline because the austerity-ravaged economies of Europe can no longer support the levels of imports from Germany that the latter relied on to maintain its growth and place it in a position to lecture and hector the other nations on wage and government spending cuts. The whole policy approach is a disaster and is exacerbating the flawed design of the euro monetary system. The leaders should find a way to dismantle the whole charade and allow nations to seek their own paths to prosperity with their own currencies. The German experiment has failed.
October opened with the release of the Manufacturing PMI data from Markit which summarises the state of orders to factories (October 1, 2014):
- Manufacturing PMI – Eurozone
- Manufacturing PMI – Germany
- Manufacturing PMI – France
- Manufacturing PMI – Greece
- Manufacturing PMI – Italy
The headlines for each of the Reports were:
1. Eurozone – “Eurozone manufacturing edges closer to stagnation – Output prices and input costs both fall”.
1. Germany – “German manufacturing stagnates in September as PMI drops to 15-month low – New orders fall for the first time since June 2013 – Production growth slows further – Companies reduce their selling prices amid sharper drop in input costs”.
2. Greece – “Production at manufacturers drops slightly in September – Output levels return to contraction as new orders fall – Factory employment remains in decline”.
3. France – “French manufacturing sector downturn eases in September – Business conditions deteriorate at slowest pace in four months – Rates of decline in output and new orders moderate – Pace of job shedding eases”.
4. Italy – “PMI ticks up, points to slight improvement in manufacturing business conditions – Modest increases in output and employment recorded… but new order growth slows to near stagnation – Output prices reduced as cost inflation hits four- month low”.
In all of that is a story of policy failure building on top of a monetary system that cannot deliver prosperity in its current form. Not only are there essential elements that are necessary for a monetary system to function effectively in all circumstances (for example, a lack of a federal fiscal capacity) but also the elites have placed this design failure in a straitjacket that only serves to magnify the failure (for example, the Stability and Growth Pact, Fiscal Compact, Two-Pack, and Six Pack).
If millions of people were not without work because of all this then we could nominate the political elites in Europe for the prize of best comedians of all time. It is almost unbelievable that these characters still strut the world stage and accept massive salaries and other perquisites when they have failed – systematically – for so long.
Human societies are very malleable it seems. Revolution is rare. But in the case of Europe – definitely warranted.
Further information about the failure of European policy came out yesterday when the Retail Sales PMI data was released (October 7, 2014):
The headlines for each of the Reports:
1. Eurozone – “Downturn in eurozone retail sector continues as sales drop for third straight month – Sharpest fall in eurozone retail sales for 17 months – Germany and France both record faster decreases in sales”.
2. Germany – “Retail sales fall at sharpest rate since April 2010”.
3. France – “French retail sales fall at sharpest rate in 18 months – Retail downturn intensifies in September – Survey-record annual decline in sales – Record drop in value of goods purchased”.
4. Italy – “Retail PMI at five-month high, points to slower drop in sales – Slower, but still solid, drop in sales in September – Employment falls only fractionally – Wholesale price inflation remains subdued”.
If you can define good as bad then good it was.
Where are all those Ricardian households and firms that were just poised to launch a spending boom as soon as the fiscal balances started to fall back towards zero signalling to these robust, perfectly foresighted economic agents that they wouldn’t have to pay any further debt rises back?
Note that the nonsense about a fiscal contraction expansion, which has been used to vilify government spending and deficits was introduced by the Monetarists initially in the 1980s.
As an alternative, they introduced the rather bizarre turnaround in logic that said that when there is unemployment the correct strategy for government is to cut its spending, that is, introduce what is now popularly known as ‘fiscal austerity’.
This policy view was based on an arcane theoretical notion that economic textbooks promote called ‘Ricardian Equivalence’.
It sounds scientific, but in simple terms it refers to the assertion that private spending is weak during a recession because households and firms form the view that the government will have to increase taxes in the future to pay back the debts it incurs due to the higher deficits.
As a consequence, the households and firms deliberately stop spending and save up to ensure they can pay the higher taxes. Once the government starts to cut the deficit, the theory claims that a signal is sent to the private sector that future taxes will be lower and so they start spending again. Problem solved.
Remember, Jean-Claude Trichet who is presumably in retirement with a very comfortable pension and plenty of financial security.
Trichet made many memorable interventions into the debate in his last years as ECB boss in the style of an evangelical minister.
At the Jackson Hole gathering of central bankers in August 2010, in his speech – Central banking in uncertain times: conviction and responsibility – he told the audience he didn’t believe the argument that cutting government spending would damage growth because:
… the strict Ricardian view may provide a more reasonable central estimate of the likely effects of consolidation. For a given expenditure, a shift from borrowing to taxation should have no real demand effects as it simply replaces future tax burden with current one.
Not to be outdone, the French Finance Minister and soon to be IMF boss, Christine Lagarde told the American ABC program ‘This Week’ on October 10, 2010 that:
… If we do not reduce the public deficit, it’s not going to be conducive to growth. Why is that? Because people worry about the public deficit. If they worry about it, they begin to save. If they save too much, they don’t consume. If they don’t consume, unemployment goes up and production goes down …
This was, of course, pure nonsense. To deduce the ‘Ricardian’ outcome, the proponents of the theory have to rely on several assumptions that never hold in the real world.
There has never been any credible empirical evidence produced by anyone to show that private households and firms behave in this way when deficits rise.
The overwhelming evidence shows that firms will not invest while consumption spending is weak and households will not spend because they scared of becoming unemployed and try to minimise their outstanding debt obligations.
Ricardian agents only exist in the rarefied world of mainstream macroeconomic textbooks and have never been observed at large in the real world.
But with the ECB-IMF-German-French alliance firmly committed to fiscal austerity as the way forward back in 2009-10, the prospects for an early return to growth in Europe were effectively doomed.
And some 6 years into the crisis, and 4 years after these zealots told the world the Ricardian agents were poised to spend like crazy, the situation is deteriorating once again in Europe. The consumers and firms are acting as predicted – cautiously and pessimistically and they realise that the fiscal austerity is undermining their capacity to save and is stripping private wealth. There will not be a firm recovery under those circumstances.
On October 1, 2014, Joseph Stiglitz summarised the problem in his UK Guardian article – Austerity has been an utter disaster for the eurozone.
His by-line is worth repeating:
All of the suffering in Europe – inflicted in the service of a man-made artifice, the euro – is even more tragic for being unnecessary
It is more than that though. Lying behind that ‘man-made artifice’ are the political careers of the elites and the investment fortunes of the financial markets who can find a way to prosper even if the nations are in meltdown. They either do it in the financial markets casino using corrupt ratings and other means to flog nonsensical derivative products or when that fails they put their hands out and get bailed out by governments.
Joseph Stiglitz also introduces a theme that I have been pushing here for many years – that if the facts contradict the theory then the facts must be wrong. An old adage that a professor taught my graduate class when he was confronted by a quarrelsome student (me) who wanted to know why he held on to notions that had no chance of relating to reality and were continually making disastrous predictions.
Joseph Stiglitz says that:
… too often it is easier to keep the theory and change the facts – or so German chancellor Angela Merkel and other pro-austerity European leaders appear to believe. Though facts keep staring them in the face, they continue to deny reality.
He concludes that “Austerity has failed. But its defenders are willing to claim victory on the basis of the weakest possible evidence: the economy is no longer collapsing, so austerity must be working!”
We saw that a few weeks ago when the British Chancellor claimed that his austerity program was delivering results when in fact his austerity program had failed and the rising deficits were delivering the modest growth. Please read my blog – British economic growth shows that on-going deficits work – for more discussion on this point.
He also makes the essential point – that “every downturn comes to an end. Success should not be measured by the fact that recovery eventually occurs, but by how quickly it takes hold and how extensive the damage caused by the slump”.
At some rockbottom someone will take a risk or introduce a new product and growth resumes. But the austerity merchants can never claim that their strategy has been successful despite the inevitability that recovery will eventually come.
But, given the latest data, Europe is not even at that stage yet.
Joseph Stiglitz also correctly centres his criticism on Germany. He argued that:
Germany is forcing other countries to follow policies that are weakening their economies – and their democracies. When citizens repeatedly vote for a change of policy – and few policies matter more to citizens than those that affect their standard of living – but are told that these matters are determined elsewhere or that they have no choice, both democracy and faith in the European project suffer.
Germany is the major problem – its role in the flawed design of the euro system is clear. Its on-going phobia about inflation is particularly destructive. And its bullying of other nations to follow its path when it knows damn well that its growth strategy based on huge external trade surpluses requires the other nations to run trade deficits is particularly offensive.
The bullying has led to the big three euro nations stumbling and Italy being stuck in recession. Germany has been pushing Italy to reduce its deficits by a massive privatisation program.
But as Joseph Stiglitz notes “selling national assets at fire-sale prices makes little sense”.
The same theme was taken up last week by the UK Guardian writer Larry Elliot (October 2, 2014) – Germany’s malaise shows eurozone can’t cut its way to prosperity.
He notes that:
Europe has a problem and it is called Germany.
The latest data now suggests that the austerity bias is now bringing the core European economies down. Germany’s factories are now in decline. They can no longer hide behind their export boom and smugly tell the southernors to pull their belts in and take their medicine.
The absurdity is that the austerity they forced onto other eurozone nations is now coming back to bite them in the form of slower export growth.
Larry Elliot concludes that:
The experiment – German designed, German engineered and German exported – with austerity has failed. The eurozone is not cutting its way back to prosperity. It is cutting its way towards being the new Japan.
Yes and no!
Even in the worst of Japan’s crisis period after the property market collapsed in the early 1990s, the use of fiscal deficits and the willingness to allow the public debt ratio to rise allowed Japan to post only one quarter of negative GDP growth.
Japan’s unemployment hardly rose above 5 per cent and is around 3.5 per cent now (August).
The German experiment has produced many years of negative GDP growth and economies like Greece shrinking by more than 25 per cent. The overall Eurozone economy is around 15 per cent smaller than it was before the crisis in 2007.
The German experiment has failed but the nations are not in the same league as Japan – which has its own currency and is willing (mostly) to use those powers to maintain growth and keep unemployment down.
The German government has now posted a small fiscal surplus at a time when France’s deficit is still well above the SGP rules.
Germany’s trade balance is falling and its factories are seeing orders vanish.
A triple-dip recession for the Eurozone is now entirely possible, if not likely.
That is a failure by any measure.
That is enough for today!
(c) Copyright 2014 Bill Mitchell. All Rights Reserved.