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Monday, December 5, 2016

Eurozone Follies: Confusing Callousness For Courage

European elites pushing austerity are repeating the mistakes they made during World War I and the Great Depression. The question is whether they’ll realize it before it’s too late.

As Spain (momentarily?) reels again as rates rise over doubts it can roll over its debt, it is time to step back and note that the eurozone can almost surely solve its problems in the medium term if it truly wants to. Surprise? It shouldn’t be. But rarely has there been such poor management of economic affairs since the Great Depression. Readers should know this: there is a path to successful resolution. Yet one would be forgiven for thinking there is not after reading or watching the media.

The best piece of evidence that something could indeed work is the action beginning in December from the constructively crafty Mario Draghi, new head of the European Central Bank, the successor to the arrogant and stubborn Jean-Claude Trichet. Trichet, remember, raised interest rates in mid-2011 for fear that inflation was on its way back.

As is by now widely celebrated, Draghi was able to inject up to a trillion in euros to banks at low interest cost, which in turn they used to buy sovereign debt. Suddenly, the markets calmed, rates on debt for Spain and Italy fell, and there was breathing room. Perhaps as interest charges fell, they could pay off the debt coming due with room to spare. In such an environment, Europe even came to terms with Greece on a new bailout — albeit onerous ones for the Greeks.

This all could have been done earlier and more directly had the ECB been run by far-seeing people. But German bankers and politicians kept the ECB from being more aggressive back in early 2010, when it should have been doing what the U.S. Federal Reserve had done back in 2008. There should be more from Draghi going into the spring, but of course there are new fears he may cut back.

What should be clear is that the big reason why countries like Spain and Greece may not be able to pay their debt are those high rates, not public spending profligacy. Greece had even run a surplus. The average deficit compared to GDP in the eurozone was 0.5 percent in 2006. Then the recession devastated tax revenues and burst property bubbles. Even so, Italy, for example, has a rather tame deficit even today. But because it has a high debt to GDP ratio, much of it short term, a rise in rates spearheaded by speculative fears becomes very expensive in the near term. Indeed, if governments made an error, it was taking on too much short-term debt that needed constant rolling over, and the U.S. is no exception. Remember when the Clinton administration, with the encouragement of Alan Greenspan, eliminated its 30-year benchmark Treasury bond?

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