Eurozone 2020. Don’t mention the War!

I guess I cannot avoid commenting on the European Commission’s recently released (February 5, 2020) – Economic governance review – which, allegedly, “seeks to assess how effective the economic surveillance framework has been in achieving three key objectives: ensuring sustainable government finances and economic growth, as well as avoiding macroeconomic imbalances; … promoting convergence in Member States’ economic performance.” The short answer is that the framework has failed on all fronts. The Member State fiscal situations are always mostly teetering on the edge of insolvency and only the ECB has been bailing them out; macroeconomic imbalances that really matter, such as the on-going illegal German external surpluses persist, and divergence is the Eurozone norm. Why? Another simple answer: because the architecture of the currency union is deeply flawed and biases the economies to crisis and makes them vulnerable, in an existential sense, to fluctuations in global activity. Why would they have done that? Answer: the triumph of neoliberal ideology over reason.

In this age of PC, I imagine some out there will pass negative judgement on the following video.

But it establishes where the title of today’s blog post came from and provides a tangential clue to modern day problems in the Eurozone.

And, yes, when I watched it again after many years I still laughed.

Comedy is a bit like that – operating a little below the PC veneer.

The official line

As in all these EU spin exercises, we read that:

… the single currency … is one of Europe’s most significant and tangible achievements … [which] … provides a basis for our economies to become more integrated with a view to supporting greater stability and prosperity

Except it hasn’t done that at all.

Why is France in chaos, riven with social protests, if all is well?

Here is convergence in action.

It shows real GDP indexes (March 2008 = 100) for four Eurozone nations up to the September-quarter 2019 (latest data).

Germany and France are in a different world compared to Italy and Greece, the latter who are still operating with economies below the size they entered the GFC with.

Italy is 5 per cent smaller and Greece is 22.3 per cent smaller.

No convergence is likely.

Upon that score, the monetary union fails.

Further, the Eurozone inflation rate is nowhere near the ECB’S price stability target, despite the massive build up of government bonds on the ECB’s balance sheet, all in the name of trying to push the inflation up to that price stability target.

So the framework fails in that respect as well.

Please read my blog posts (among others):

1. ECB confirms monetary policy has run its course – Part 1 (September 17, 2019).

2. ECB confirms monetary policy has run its course – Part 2 (September 18, 2019).

The European Commission then claim that the “unique” design of the EMU reflected the need to prevent “free-riding behaviour leading to excessive government deficits and debt levels”, which just is another way of saying none of the original entrants trusted each other nor shared a deep commitment to the joint exercise.

The Germans, in particular, were really forced into allowing Italy into the union, because if they had have rejected them on the failure to meet the public debt thresholds during the so-called ‘convergence process’, they would also have had to reject entry to Belgium, which was impossible.

I covered that in detail in my 2015 book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale (published May 2015).

But the Commission goes the next step … too far:

This, in turn, would threaten price stability and might ultimately force the central bank to use monetary policy to finance budget deficits.

Which is where Basil Fawlty would have had a field day!

In my 2015 book, I clearly trace the way the ECB saved several Member States from insolvency in 2010, when it introduced the Securities Markets Program (SMB), which evolved into the current QE interventions.

The build up of public debt on the ECB’s balance sheet is, in, ‘look the other way’ language, claimed to reflect normal liquidity operations.

But the reality is that the ECB has been funding “budget deficits” throughout the Eurozone for years and breaking the spirit of the Treaty.

Yes, the purchases have been in the secondary bond markets, which then leads to the denialists claiming there is no ‘direct’ financing going on.

Tell that to the dealers in the primary markets who know they can offload debt at a handy capital gain to the ECB.

Smoke and mirrors is the expression!

Hence the title of the post ‘Don’t mention the War’!

So, now the Commission is seeking as part of “a new political cycle … to assess the effectiveness of the current framework for economic and fiscal surveillance …”

They recognise that the “economic context has materially evolved” since the Stability and Growth Pact was supplemented by the Fiscal Compact (the “six-pack and two-pack” changes which accentuated the austerity).

They admit that the EMU is stuck in a weak growth state with low interest rates, but, refuse to acknowledge that it was the SGP and the subsequent changes that have made it virtually impossible for the union to perform in any other way.

They further acknowledge that a climate response “will require significant additional private and public investment over a sustained period of time.”

But then the logic fails.

1. Debt sustainability remains a focus because the Member States all face credit risk because they don’t use their own currency.

2. The risk is acute in the EMU because “governments with very different debt levels share the same currency and the central bank cannot act as a lender of last resort to governments”.

3. But monetary policy is now ineffective so expansionary fiscal policy has to be considered.

4. But because the Member States use a foreign currency the bond markets become involved and we are back to debt sustainability concerns.

5. And climate risks need big funding.

That is my 5-point impossibility structure – that is the Eurozone.

As long as they restrict national government deficits to austerity levels, the mess will continue and they will not be able to respond properly to the climate challenge.

In terms of the debt sustainability discussion, the Commission tries to make virtue that debt-to-GDP levels in most Eurozone nations are “far below that of the US or Japan”.

And they presumably write that sort of stuff with a straight face!

The monetary systems of Japan and the US are not comparable to the EMU, where no national government has currency sovereignty.

It is just a vacuous comparison.

And there is no acknowledgement that the “fiscal consolidation” that they revere has been directly responsible for the stagnating growth and zero interest rates (not to mention the negative long-term bond yields in some nations) that they document.

No connection is drawn.

Don’t mention the war!

Further, they acknowledge that despite earlier claiming the euro was about convergence, the reality is that public debt levels “remain around or (well) above 100% of GDP in some others, accounting for a large share of euro area GDP” and only “around half of the Member States” are below the 60 per cent threshold specified by the SGP.

And debt ratios “continued to rise”, which has “increased divergences between debt levels in the EU”.

Growth rates have diverged.

Debt levels have diverged.

Deficit outcomes have diverged “despite favourable economic outcomes”.

Unemployment rates have diverged.

And so on.

But then the analysis shows how much the whole governence, surveillance and enforcement structure surrounding the fiscal rules has failed:

Nonetheless, Member States’ fiscal policies have remained largely pro-cyclical … remained largely pro-cyclical during the crisis as consolidation took place in a context of heightened market pressure at a moment of very low growth or even contraction in economic activity …

This contributed to the weak economic and employment performance in that period, even if it aimed at bringing public finances on a sustainable path and at regaining market confidence.

Which means that fiscal policy was forced by dint of the reliance on private bond markets (due to the surrender of currency sovereignty) to make the consequences of the private spending collapse worse than would have been the case if the Member States had not have surrendered their currency.

This fact is a basis denouncement of the whole architecture and surrounding rules enforcement of the Eurozone.

It is why I have always believed the system would fail to deliver prosperity.

It is why there is an in-built bias to austerity and stagnation.

It is why it should be dissolved.

It is a system that prioritises the rule outcomes over attainment of human potential.

It requires human suffering to appease bond markets.

In nations which issue their own currency, the bond markets have to work within the terms set by the government.

In the Eurozone, the bond markets drive governments.

The European Commission is also forced to admit that:

… the current fiscal framework did not prevent a decline in the level of public investment during periods of fiscal consolidation, nor did it make public finances more growth-friendly.

And the UN Special Rapporteur (2014-2020) on Extreme Poverty and Human Rights, Philip Alston has just released his evaluation of – Spain – (February 7, 2019), which was compiled during a visit between January 27, 2020 and February 7, 2020.

I will consider that in detail another day but the summary results are terrible and an absolute condemnation of the Eurozone system:

1. “Spain is utterly failing people in poverty, whose situation now ranks among the worst in the EU”.

2. “The post-recession recovery has left many behind, with economic policies benefiting corporations and the wealthy, while less privileged groups suffer fragmented public services that were severely curtailed after 2008 and never restored.”

3. “26.1 percent of people in Spain, and 29.5 percent of children, were at risk of poverty or social exclusion in 2018.”

4. “Deep widespread poverty and high unemployment, a housing crisis of stunning proportions, a completely inadequate social protection system that leaves large numbers of people in poverty by design, a segregated and increasingly anachronistic education system, a fiscal system that provides far more benefits to the wealthy than the poor, and an entrenched bureaucratic mentality in many parts of the government that values formalistic procedures over the well-being of people.”

5. “companies are paying half as much in taxes as they did before the crisis despite strong profits.”

6. “Neighborhoods of concentrated poverty where families raise children with a dearth of state services, health clinics, employment centers, security, paved roads or even legal electricity.”

7. “Poverty is ultimately a political choice, and governments can, if they wish, opt to overcome it.”

Convergence!

Stability!

Have the EU boffins been down to some of the Spanish villages where the UN visit found “far worse conditions than a refugee camp”.

I doubt it. Brussels is too comfy for that lot.

All they can say is that:

… the six-pack and two-pack reform … have strengthened the framework for economic surveillance in the EU and euro area and guided Member States in achieving their economic and fiscal policy objectives … The strengthened surveillance framework has also fostered convergence in the economic performance of Member States …

Anyone who does not condemn this charade should question their own values.

The progressive response – disappointing to say the least

The best the “Socialists and Democrats in the European Parliament” can come up with is that the review provides “a much-needed opportunity for improving the EU’s fiscal rules by introducing a Golden Rule for sustainable investments.” (Source).

One European Parliamentarian said that:

The European Green Deal has the potential to transform Europe into a sustainable and inclusive society. To make our Green Deal ambitions a reality, we must now put significant money behind it. According to Commission estimates, an additional 260 billion Euros is needed every year to meet our Paris Climate goals. It is high time we up-date our budget rules to enable member states to invest in a good future for all.

I do not disagree with the sentiment or the focus on environmental sustainability.

The problem is that while the intention is sound, the reasoning remains flawed as long as the Member States use a foreign currency.

Further, it is disappointing that the so-called progressive forces in European politics are content to operate within the flawed monetary architecture of the EMU and adopt a position that the only change required is to introduce a ‘golden rule’, without, seemingly, understanding its drawbacks.

The talk of ‘golden rules’ goes back years. It is hardly an innovative suggestion and just exemplifies the crippingly slow speed at which debates in the EU unfold.

Golden Rules are often proposed by economists who want to appear progressive, but, ultimately, still work within the so-called orthodox ‘government budget constraint framework’, which falsely asserts that spending by a currency-issuing government is financially constrained.

These economists, however, do argue that in some cases, it is more fruitful to concentrate on stimulating economic growth, than it is to cut government deficits.

In this regard, they argue that public borrowing should be use to ‘finance’ capital expenditures and deficits incurred as a result of such investment in public infrastructure and other public works, are tolerated as long as they ‘pay for themselves’ through rates of return on infrastructure, for example.

The latter point has then dove-tailed into the ‘user pays’ mentality, where essential public infrastructure is provided at escalating charges as part of the fiction that the government is like a business and has to receive a commercial return on what should be seen as delivering social returns.

The ‘Golden Rule’, typically specifies that the recurrent fiscal balance should be zero and the capital account (investment) can be in deficit and covered with borrowing.

Some proponents also restrict such investments to times when interest ratesa are low, further adding to the fiction by claiming this makes government investment cheaper.

Of course, the ‘cost’ of the investment is embodied in the real resources that are consumed in the process of the policy execution.

For a given project, that ‘cost’ is invariant to the yields that might be offered on public debt.

The ‘Golden Rule’ was already recognised by the classical economists in their discussions of public finance. So even within an orthodox public finance model, their is some flexibility for fiscal deficits as long as they reflect spending that will ‘pay for itself’ through rates of return on infrastructure, for example.

Without such a ‘rule’, the application of the European fiscal rules, biases public investment expenditure toward being pro-cyclical – cutting spending when non-government activity is declining – to meet pre-conceived fiscal balance targets.

This is because in political terms, it is much easier to cut capital expenditure than it is to cut current expenditure, the latter being more directly noticeable for voters on a daily basis (pensions etc).

But the cuts to public capital expenditure not only undermine current economic activity and pushes up unemployment, but, also undermines the future growth potential by slowing the rate of capital accumulation.

It also reduces private investment opportunities, which typical leverage off well-built and maintained public infrastructure.

Responsible fiscal policy requires that stimulus/contraction cycles be counter-cyclical – to offset non-government spending fluctuations in either direction.

So within the neo-liberal fiscal conservatism, the introduction of a ‘Golden Rule’ might remove the bias against public investment.

Proponents of the Golden Rule also appeal to its equity advantages whereby the public expenditure is steadily financed over time as the debt is repaid, which means there is a better matching of who receives the benefits from the services flowing from the infrastructure and who pays for it.

Both arguments, within the flawed overall logic, are reasonable.

But, once we grasp the essentials of Modern Monetary Theory (MMT), then we know that this claimed matching of costs and benefits overtime is somewhat misleading.

The true ‘cost’ of providing public infrastructure is not the flow of financial outlays (including interest payments) over time but the real resources that are deployed to construct and maintain the infrastructure.

For most projects, the cost is mostly incurred upfront in the construction phase, which means the current or near generations still end up bearing most of the costs.

However, there are many problems with the concept of the ‘Golden Rule’.

When we get into demarcation issues as to what should be classified as net investment spending, the ‘Golden Rule’ essentially breaks down.

While the split between current and capital is normally defined as some time period in which the benefits of the spending are exhausted (less than or more than 12 months usually), it is more sensible to think of capital expenditure as that which improves the potential productive capacity of the economy.

A progressive approach should conceive of productivity much more broadly than the narrow concept that mainstream economists deploy.

Productivity is not just the contribution an input makes to the private profit bottom line.

In this context, one could make a strong case to include much of the recurrent spending on health, education, research and development along with spending on bridges, transport and other physical capital as capital items.

For example, the public investment in the education of its population delivers massive social and private returns over the person’s lifetime. These returns are not exhausted within 12 months.

If education and health expenditure on teachers and nurses and libraries and books, for example, are considered as current spending, then the ‘Golden Rule’ biases total public spending against it in favour of ‘building bridges’, which might be a poor use of the society’s real resources.

The bias towards physical infrastructure and financial assets is reflected in what governments put in their so-called financial statements – specifically their balance sheets or statements of financial position.

I explain that point in detail in this blog post – The non-austerity British Labour party and reality – Part 2 (September 29, 2015).

The point is that current definitions of capital items would bias the application of the ‘Golden Rule’ to be too restrictive in terms of advancing general well-being.

The other major problem with this idea in relation to the Eurozone Member States, is that they would remain dependent on private bond markets to fund the deficits arising from the investment in public infrastructure.

All 19 Member States carry credit risk as a result of using a foreign currency. In that sense, they are vulnerable to shifts in bond market sentiment, which could choke their capacity, relative to revenue, to continue servicing the debt obligations and provide first-class public services.

Imagine in a recession as taxation revenue declines, the recurrent fiscal position becomes stretched and austerity would be invoked to bring the two fiscal sides back into balance.

This would undermine grow th even further and increase the risk that the government would be unable to meet it debt obligations.

And then the crisis deepens.

Replay!

Conclusion

Nothing since the GFC has convinced me that the EMU can be reformed in any meaningful way to resolve the inherent flaws in its architecture, which reflect the neoliberal bias which set the system up in the first place.

The propaganda machine from Brussels continues to pump out these elaborate technical discussion documents that essentially mean more of the same.

And as the UN Special Rapporteur noted the Eurozone maintains a “fiscal system that provides far more benefits to the wealthy than the poor”.

That is why it was designed in this way and why the elites will not broach any serious reform.

Why should they? They are doing very well out of the disaster.

It should be dissolved. And nations such as Italy and Spain which are unable to provide for their own citizens in any reasonable way should unilaterally leave and restore their own currencies.

As soon as possible.

That is enough for today!

(c) Copyright 2020 William Mitchell. All Rights Reserved.