The economics news is currently dominated by the Greek election results and their implications, and, rightly so. Without assuming anything about how much Syriza will compromise (although I suspect too much), the voting has demonstrated that a large proportion of voters in Greece have rejected the basis of the European Commission strategy. The Greek voters know from personal experience, what armchair commentators like me know from theory, that fiscal austerity fails to achieve its aims. It is not rocket science – spending equals income and if you hack into it then the economy contracts. A private spending resurgence is not going to happen when sales are falling, unemployment is sky-rocketing, and incomes are being lost. The basis of Keynesian economics – that when the private economy is caught in a malaise the way out is for government deficits to kick-start economic activity, which, in turn, engenders confidence among private spenders and allows a sustainable recovery to occur – has been amply demonstrated by the GFC in all nations. Where that strategy has been employed the nations have been recovering (at a macroeconomic level). Where it has been defied, such as the Eurozone, the economies have stagnated. Thinking ahead (speculating) the election results have clearly shocked the cosy ECOFIN club, which has smugly swanned around Europe over the last 6 or so years dishing out misery to the disadvantaged citizens in the Member States. But I doubt that they will agree to a 50 per cent write-off in Greece’s debt because then the citizens of Spain, Italy and, even France, would line up for the same. Then it is game-over for the Eurozone. More likely, if Syriza sticks to its promises, then there will be an organised way to ease them out of the game. Greece will win either way.



One of the more revisionist commentaries on the Greek election outcome appeared in the UK Guardian (January 27, 2015) – Germany will relent on Greek debt – and Europe will suffer.

The author – Josef Joffe – is the “publisher-editor … of Die Zeit, a weekly German newspaper”. Die Ziet – represents the centre of German political opinion and provides a more in-depth approach to current affairs analysis.

The Guardian article opens with this:

… the “Club Med” countries plus the mainstream left – are quietly triumphant. The southern tier and Europe’s social democratic parties never liked the diktat of the Germans, who have been cracking the whip of fiscal discipline and market-oriented reforms since the great crash of 2008. For years they have all preached cheap money and unfettered deficit spending.

Not quite.

First, the low interest rates are a direct consequence of the structure of the monetary union, which was, in no small part, the product of German dominance of the economic debate in the 1980s. The ‘one-rate-fits-all’ approach led to low rates

The following graph shows one of the Eurozone’s key interest rates – the ECB Marginal lending facility rate – from January 1, 1999 to September 10, 2014.

The marginal lending rate is the “interest rate on the Eurosystem’s marginal lending facility which banks may use for overnight credit from a national central bank that is part of the Eurosystem”.

The marginal lending facility is a “standing facility of the Eurosystem which counterparties may use to receive overnight credit from a national central bank at a pre-specified interest rate against eligible assets”.

In other words, it is the rate that the ECB sets to provide overnight loans to commercial banks to allow them to manage short-term liquidity.

The cuts in the early years of the Eurozone were due to recession in Germany and France (to mention the two largest economies in strife during that period).

As a result of their membership of the Eurozone, nations such as Spain, Ireland, Greece and Portugal had to accept the lower interest rates.

That recession caused the first crisis in the Eurozone’s early history.

Given the poorly conceived nature of the SGP it was no surprise that it would fail its first test. What was surprising was the way the politicians and bureaucrats behaved in the face of what any reasonable assessment would consider to be extraordinary hypocrisy.

The history of the EMU to date has taught us that if Germany is unable to meet rules, then the rules will be altered. Otherwise, the rules will be used as a blunt weapon to devastate the employment base and living standards of weaker nations without the political clout of Germany.

In 2003, Germany was one of the first nations to transgress these rules. By early 2002, the German economy was slowing quickly and the European Commission gave Germany an ‘early warning’ under the Stability and Growth Pact (SGP) rules governing so-called excessive deficits (above 3 per cent of GDP).

The Commission demanded that Germany balance its fiscal position even though they knew it would cause a deterioration in the already high unemployment rate.

The neo-liberal mindset was thus firmly in place despite the obvious risk that Germany’s insipid growth would falter under the intensified fiscal austerity.

A similar narrative was applied to France. Its fiscal deficit was also outside of the SGP rules.

It was obvious the rules were ridiculous given the real conditions in both nations – high unemployment and declining output growth.

In October 2002, the European Commission’s president Italian Romano Prodi told the French daily newspaper Le Monde that:

… the SGP was stupid, like all decisions that are rigid and there was a need for a more intelligent tool with more flexibility”.

German growth had stalled completely by the end of 2002 as it tried to reign in its fiscal balance to meet the SGP rules. However, worse would come as the economy moved into recession in 2003. German unemployment, already high in 2001 at 7.9 per cent, rose to new heights over the next four years: 8.7 per cent in 2002, 9.8 per cent in 2003, 10.5 per cent in 2004, and finally peaking at 11.3 per cent in 2005.

This was all down to the mindless fiscal austerity that Germany adopted within the recession-biases of the SGP.

Millions lost their jobs as a result, while others increasingly found their jobs becoming more precarious and their wage prospects suppressed under the so-called Hartz reforms (the creation of the ‘mini-jobs’). If there was ever a time for reflection on how damaging the EMU structure could be, then this period should have been it.

The Commission, however, pushed ahead with a Excessive Deficit Procedure (EDP) and Germany was now caught up in the trap it had set for Italy, Greece and other ‘suspect’ nations.

The German economy contracted in 2003 and the fiscal balance rose to 4.2 per cent of GDP up from 3.8 per cent in 2002.

On November 18, 2003, the Commission recommended to the Council that Germany be declared ‘non-compliant’ under the EDP, which would require much harsher cuts and fines. A parallel process had been going on with respect to France.

The French government was publicly hostile to the process but the Member States had all signed up to a discipline that they found impossible to maintain if they were to meet their responsibilities to maintain domestic growth and reduce unemployment.

The situation came to a head on November 18, 2003 when the Commission recommended to the European Council that the response of both the French and German governments to their earlier demands was inadequate under the terms of the Treaty and that further action under the EDP be triggered and a much tighter frame be required for resolution.

Five days later, the Finance Ministers met in Brussels to vote on these recommendations. Under the Treaty, it was Ecofin who oversaw the EDP process.

The outcome was a farce. Germany and France bullied other nations into voting down the Commission recommendation despite the majority of nations voting in favour of the recommendation.

The Council not only ignored the recommendation of the Commission, but also suspended any action under the EDP against France and Germany.

Where did that leave the whole enterprise? A report in the Financial Times (November 27, 2003) was representative of the media response:

France and Germany won: they usually do. But the European Union is assessing the damage of a joyless victory, secured in the small hours of Tuesday morning, that did much more than shred the EU’s fiscal rulebook … The message was clear. The European Union has rules, but not everyone has to obey them. France and Germany, long seen as the driving force behind European integration, looked more like a pair of playground bullies.

The Commission sought a ruling from the European Court of Justice (ECJ) on the grounds that the Council had not followed the rules and procedures as set out in the Treaty.

But despite the ECJ siding with the Commission, the real politics meant that the rules had to be renegotiated.

The ‘law breakers’ got away with it because the impasse led to a renegotiation of the SGP and no sanction against France or Germany was imposed.

German contribution to the imbalances

The Guardian article talks of “cheap money” as if it was a “Club Med” issue only.

First, the funds to underwrite the credit explosion came from the redistributed national income towards profits. This was caused by the neo-liberal obsession with restraining real wages growth below the rate of productivity growth. Germany led the way in the Eurozone bloc in this regard as a result of the pernicious Hartz reforms.

Second, the large German export surpluses also provided the funds to loan out to other nations. Germany didn’t experience the same credit explosion as other nations but German banks were prominent in the debt build-up elsewhere in Europe.

The suppression of real wages growth in Germany and the growth in the (very) low-wage ‘mini-jobs’ meant that Germany severely stifled domestic spending up to 2005. Schröder’s austerity policies forced harsh domestic restraint onto German workers, which meant that Germany could only grow through widening export surpluses.

The suppression of consumption in Germany and the reliance on exports to maintain growth was very damaging to the peripheral states.

The growth in employment in Germany in the lead up to the crisis was not due to a well-functioning monetary union.

Rather, it reflected its malfunctioning because it depended on widening trade imbalances – huge surpluses in Germany and some of its neighbours against widening deficits in the periphery, covered by unsustainable capital flows from the former to the latter.

That sort of unilateralism is not sensible in a monetary union, especially one that deliberately eschewed a federal fiscal transfer system.

It not only undermined the welfare of Germany’s EMU partners, but also meant that the living standards of German workers were reduced.

To some extent the German government understood the logic of the flawed design of the EMU more fully than the other nations.

They knew the monetary system encouraged a race to the bottom and exploited the ‘solidarity’ of its workers to game the other nations.

The huge current account surpluses resulted in German banks accelerating their lending to other nations, in particular Spain and Italy, and less so Ireland.

The common monetary policy meant that interest rates fell in the peripheral nations because rates were essentially set to reflect conditions in Germany rather than elsewhere.

The lower interest rates encouraged this massive borrowing spree, which then in Spain and Ireland, among other nations, found its way into the construction and housing boom. Much of the debt was private.

The massive shift in the employment mix across Europe (towards construction and FIRE sectors) was caused by these imbalances in trade and financial flows.

German capital had to find profitable opportunities abroad, given that domestic conditions were suppressed by the imposed austerity.

In turn, the poorly regulated banking sector allowed the European banks to build up risky portfolios. That is another part of the neo-liberal story that needs to be understood.

The accusations that would emerge as the crisis hit that the PIIGS were ‘spending beyond their means’ and gorging on debt were rather thin when you realise that Germany’s growth strategy required the PIIGS to borrow heavily. For every dollar borrowed there had to be a lender.

It is amazing that commentators in 2015 are still denying the central role of Germany in all of this. Joffe’s interpretation of history is very poor.

Fiscal deficits

The UK Guardian article also claims that the Club Med nations had preached “unfettered deficit spending” – where preaching implies some religious obsession.

Why the Guardian editors allow that sort of rubbish to appear in their newspaper is beyond me. It certainly reflects badly on the quality of the work.

The facts are quite different as the following graphs show. The graphs depict the fiscal deficit as a percent of GDP from the first-quarter 1999 to the March-quarter 2014 (latest quarterly data available from Eurostat – table gov_q_ggnfa). The data is not seasonally-adjusted which is why is moves around a lot. The black lines are 6-quarter moving-averages of the underlying deficit series, which allows you to see the trend around the seasonal variations.

First, the Club Med nations had quite different fiscal histories over the course of the Eurozone. Spain and Ireland were exemplars of the neo-liberal fiscal myths – they were running fiscal surpluses prior to the crisis – hardly unfettered deficits.

Second, Greece, Italy and Portugal had relatively stable fiscal deficits, which reflected the reality they were facing in terms of external sector deficits and the private domestic saving desires. Their inflation rates were falling from 2002 (2003 in the case of Italy) and were not very much higher than the Eurozone average.

So the fiscal deficits can hardly be said to be excessive in any way and were certainly not “unfettered” – a term implying out of control.

Third, fiscal deficits were recorded by France, Germany and the Netherlands in the early years of the Eurozone (as discussed above). These deficits were largely cyclically-driven (recession causing tax revenue to fall).

Fourth, all nations went into deficits of various sizes with the onset of the GFC as a result of the collapse in private spending and the resulting loss of national income (and tax revenue). Even Finland, which was running constant fiscal surpluses in the period leading up to the crisis went into deficit and remained in that stage into 2014.

The swings in fiscal balances were more severe where the loss of real output and income was greater. Those swings had nothing to do with “unfettered” public spending.

What about France and Italy?

Where the Guardian articles moves closer to reality is that it recognises that it is not so much the Syriza victory in Greece that matters for the Eurozone but rather what is likely to happen in France, Italy and Spain.

But while Josef Joffe thinks Germany will concede to the threat posed by France and Italy, I suspect the threat will harden Germany’s position – and Greece will be the winners.

Both France and Italy are up against it – low or negative growth, fiscal deficits that violate the SGP rules and rising unemployment.

Spain is still not looking very good.

These nations have a limited tolerance for so-called ‘internal devaluation’ – code for cuts to pensions, wages and working conditions – which is the only way that the nations can become more internationally competitive given their exchange rate is fixed.

The UK Guardian writer thinks that Syriza would probably tone down their opposition to fiscal austerity and walk a moderate line if they had not gone into coalition with the right-wing Independent Greeks.

He says:

Tsipras has decided to get into bed with the rightwing Independent Greeks, a party that shares none of Syriza’s ideological convictions, save two: contempt for fiscal probity, and resentment of Europe. With the far-right breathing down his neck, how will Tspiras change his colours, especially since the coalition represents not only the anti-reformist consensus of the country, but also a slew of deeply entrenched special interests such as public unions and sheltered industries? Let him move against Greece’s vast state sector, its patronage networks and its anti-competitive regulations, and he’ll court a coalition break-up from day one. So on the road to Brussels, don’t count on Saul turning into Paul, let alone on the government’s longevity.

As a result, he thinks Germany “will relent” and that “the Greek debt will be rescheduled and a chunk of it forgiven, together with a fourth rescue package for Athens”.

But then France and Italy will line up for relief.

Josef Joffe think that such a scenario will then leave Europe struggling “on a diet of cheap money, deficit spending and devaluation … [and] … the absence of painful pro-competitive reforms.”

Conclusion

If Germany does give up on its austerity mania and fiscal deficits expand then all of the Eurozone will return to growth.

Greece could resume growth tomorrow if the new government announces a large-scale public employment program.

It is a lack of spending that is causing stagnation. The obsession with structural reforms is a side-issue. The recession was due to a collapse in spending not any shift in competitiveness.

It will be amazing if Germany agrees to write off half of Greek debt. We will see whether that happens.

Soccer in Newcastle via Indian TV to Colombo

As an aside, I was working in my hotel room in Colombo this afternoon and in the background is the live TV coverage (via the Indian sport’s channel Star 4) of the soccer game between Australia and U.A.E, which is being played in Newcastle, NSW – the stadium being a few kms away from my home!

Australia scored early and went on to win.

I am not a soccer fan but am happy the game is getting some coverage. The TV coverage also told me that my vegetable garden was getting a solid watering – given the storms.

That is enough for today!

(c) Copyright 2015 Bill Mitchell. All Rights Reserved.