Wall Street Journal Europe
October 4, 2010
by Irwin Stelzer
"Insanity: doing the same thing over and over again and expecting different results." So, it is alleged, spoke Albert Einstein. All over Europe officials are trying to prove him right.
Greece led the peripheral countries in piling up debts that it had little hope of ever repaying. Non-peripheral countries, most notably Britain and France, joined in the fun, the latter despite its commitment to its Euroland partners to keep its fiscal deficit within 3% of GDP—in the event, borrowing reached 8%.
Cometh the markets, cometh reality: payback time. National cupboards being bare, the Euroland authorities stepped in with a cunning plan to handle excessive debt: borrow more to repay the wild borrowings of the member countries. And the Irish government will drive its deficit to 32% of GDP by borrowing to bail out banks hit by the inability of property developers to repay excessive borrowings. If more borrowing to repay excessive borrowing doesn't fit the great physicist's definition of insanity, it is difficult to tell what does.
On to austerity. No responsible observer would deny that the welfare states of many Euroland countries should be trimmed. But austerity is not costless: it can cost jobs, profits and, therefore, tax revenues. Unless the central banks oblige with an offsetting loose monetary policy. Which the European Central Bank is disinclined to do.
Yves Mersch, a member of the ECB's governing council, believes the euro zone recovery is now self-sustaining and agrees with Jürgen Stark, a member of the Bank's executive board, that long-term liquidity support for the area's banks can be reined in. History suggests that austerity without loose monetary policy can be self-defeating. Never mind: Eurocrats will pay any price to avoid the humiliation of restructuring and unleashing inflation worries in Germany. So a combination of austerity and tighter credit is in store, to the applause of the rating agencies, those infallible appraisers of risk that endowed securitized subprime mortgages with triple-A credit ratings. Further proof of Einstein's genius.
In the end, this crisis is not about whether the piper will be paid, but who will do the paying. One set of candidates includes creditors and euro-zone citizens with fixed incomes. They can be forced to pay by having the central bank print lots of euros, produce inflation, and repay creditors with a debased currency. The ECB has said "no" to what is in effect a wiping out of creditors, with collateral damage inflicted on anyone without a cost-of-living escalator attached to his income source. And if the ECB weakens, there is always the loud "nein" from Berlin, representing a Germany ever fearful of the political consequences of inflation.
Another solution is to follow what is now the chosen path. Austerity, plus borrowing by Euroland as a whole. The borrowing in effect transfers the debts of the broke countries to Germany's balance sheet, while austerity concentrates the burden of repayment on the current recipients of government outlays—public-sector workers, benefits recipients, and private-sector contractors for whom the government is a major customer.
But this lets the creditors, who made the now-duff loans, off the hook. So consider the "D" word, or if default sounds harsh, call it restructuring. Frederico Sturzenegger and Jeromin Zettelmeyer, in their scholarly work on the subject of debt crises and defaults, note, "All lending booms so far have ended in busts in which some of the beneficiaries of the preceding debt inflows defaulted or rescheduled their debts." Their list of defaulters in the 19th and 20th centuries includes Turkey, Bulgaria, Italy, Japan, Mexico, Russia, China, Spain, Czechoslovakia, Portugal, and several Latin American countries—an incomplete list, but you get the idea.
Euroland politicians think they can (1) fight markets, (2) inflict infinite pain on voters in democratic countries, and (3) whip the profligate into line. They can do none of these. Markets set borrowing rates, voters turn out politicians who push them too far, and plans to land with hobnailed boots on profligate debtor nations founder on two facts. First, no action was taken when Germany and France pierced the 3% ceiling on deficits, and sauce for the big geese should be sauce for the smaller gander. Second, fining countries that are broke might not be sensible, even if feasible.
The reality is that Euroland now consists of a core and a periphery, or the best and the rest. The latter cannot meet their debt obligations without a combination that includes restructuring, a heavy dose of inflation, more than a touch of austerity, and a separate, depreciated, euro, what economists (before the full extent of Ireland's problems became obvious) call Eurosud.
That currency could be allowed to depreciate sufficiently to restore the competitiveness of the periphery countries while they work on structural reforms, as economists such as George Stiglitz and Martin Feldstein, who disagree on many other things, are suggesting.
Not easy, but more likely to succeed than Brussels bluster.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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