Europe! It's not too late to reverse austerity

Europe! It's not too late to reverse austerity 

The article is cross-posted on Fictional Reserve Barking.  We wish to thank the editor. Readers are invited to post comments on either blogs.

Months ago we outlined the challenges that presented themselves to Italy and Greece, and to Germany, France and the United Kingdom.  We opted against austerity, trusting that the technocratic appointments of Messrs Monti and Papademos could transform governments in Italy and Greece, and enable their respective legislatures to both recommend alternative and optimal public expenditure policies and to restrain policymakers from endorsing imposed fiscal restrictions while constraining budgets any further.

Unfortunately for the global economy and markets, Messrs Monti and Papademos initiatives did the contrary.  They aspired towards the heroic in adhering to a sub-optimal detriment and have now emerged as the scapegoats for political and investment désenchantées.

More ironic is that both men had very little to do with the original debacle.  They were recommended to their nation’s legislatures to clean up a mess.  Instead, as a result of attempting to implement austerity measures, they have generated more anxiety in world markets than expected.

Unfortunately, the recent economic deterioration and rising social tensions within their respective economies has become their responsibility, and the political disenchantment surfacing within the electorate is also their responsibility.  Worse still, the time for apologetics is long past and is now irrelevant.  At jeopardy is their leadership, the credibility they endorse for their visions of the future and the overall well-being of their citizenry.

Mr. Draghi and Mrs. Lagarde have voiced a redemptive message.  Both had professed that the worst was over.  For instance, in a speech on March 26 of this year, Mr. Draghi said the following:

“I would like to take this opportunity to provide you with my assessment of the current situation in the euro area and shed light on recent signs of improvements in the overall outlook.  I would particularly like to draw your attention to the effectiveness of the policy measures implemented by the Eurosystem, the EU institutions and national authorities.  And to remind you of the measures that we all must continue to pursue over the coming months and years with great diligence in order to continue on this path of stabilisation.”

As for Mme Lagarde, on March 18 of this year, the Managing Director of the IMF sought to reassure the audience of the 2012 China Development Forum with the following statement:

“There are signs that strong policy actions—especially in Europe—are making a difference. Financial markets have become a little calmer…”

Yet, Spanish yields are rising, as are those of Italy and Greece, and there is more and more talk of a potential third bailout for Greece although the IMF and the ECB have reassured the investment communities that changes in Greece are being introduced as promptly as possible and will be enacted effectively.

Any remnant stress in markets, according to the institutional duo is a result of the misperception by the interested communities that the consolidations proposed by the ailing economies cannot be achieved.

The emerging doubt on behalf of investment communities and investors in general should not be surprising.  After all, it’s their money and it’s their perception that underscores investment decisions.

One daresay that the investment community saw the collapse of the system much earlier than either the IMF or the ECB, although the leadership of the latter two has been proactive in attempting to stabilize investor sentiment and mitigate between some form of restraint and investment in growth and employment.  Notwithstanding, the reassessment that further bailouts will be necessary is now the swan song of European austerity politics.

Unfortunately, European policymaker perceptions of the bond markets are completely skewed as a result of their own biases.  What is difficult for them to appreciate is that there is no basis left for growth.  Unemployment is up, with Spain leading at 23.6% followed by Greece at 21.0%.  And in those Eurozone countries where unemployment rates are low, many of the employed are part-time workers and, as such, susceptible to labour volatility during these turbulent times.

Moreover, capacity utilization in the manufacturing sector over the last four quarters is dropping across the Eurozone at alarming rates.  Order books are not being filled as quickly as desirable, and their durations and size are shorter than required to support additional investments.  As a result, business investment is stalling as management constrains expenditures and saves its liquidity for dividends in lieu of growth to stabilize share values, foreboding that equity markets react adversely to this dilemma and possibly falter.

What most pundits expected from the emerging markets may not be realized: trusting that BRIC plug the slowdown in Europe, with China leading the way.  Unfortunately, there is no plug.  Most informed observers now mitigate between a slowdown and an ease in aggregate demand, with China’s future growth rates in question.  Projections for the region suggest that China’s growth potential could be in the midst of a major contraction with rates dropping to 7.5% from anticipated 8% and over.

Given the above, the most difficult challenge in domestic politics is for any Government to admit that it followed the wrong track.  There is no shame in being part of a bigger bloc of nations that propound fiscal consolidations even if austerity is showing itself as being the ineffective solution to the Eurozone’s financial crisis, a crisis which is now becoming an economic and political crisis.

It actually takes great courage in admitting that the austerity programs recommended may not work out.  The experiences of other nations in the matter, elicit danger signals that can’t be overlooked.  In such a case, the consolation is that if one’s admission is timely, the Government may come out of an unfortunate situation looking respectful and remarkably diligent.  There is still time for Europe to turn back its political agendas before turning the wrong corner.

Thanks, but Sorry, your way won't work, so let's...

The past two weeks have witnessed major changes in the political and financial landscape of the European Union and the Euro area.  Two of the European region's most economically and politically unstable members have endorsed visions for new governments. An Italian  lawmakers' consensus has accorded Mr. Mario Monti the opportunity to form a transitional government that will empower Mr. Monti to negotiate and manage Italy's financial portfolio through turbulent waters; a Greek lawmakers' consensus has accorded Mr. Lucas Papademos the opportunity to form a transitional government that will empower Mr. Papademos to negotiate and manage Greece's financial portfolio through even more turbulent waters.

In the same European theatre during this year's summer and fall,  a new optic is also focusing the people and market's perspective on the political savoir-faire and competence of the region's traditional leadership.  According to many, Mrs. Merkel and Messrs Sarkozy and Cameron are demonstrating a lack of courage to make things happen. The situation is simply too overwhelming for that threesome.  To the boisterous three is the stage, but not History! History confirms that some leaders are made for good times and others, in the mold of Roosevelt and Churchill are made of a 'stuff' that captains the worst of storms.

Although premature and echoing the sound of fluttering feathers, we are nevertheless inspired by both Monti and Papademos, firstly because the respective country's lawmakers agreed to the appointment and secondly, because the national sentiment appears to be overall favorable. The fundamental criteria for success in bleak times is the support of the people-which, while it lasts tacitly transforms the leadership of a technocrat to leadership by charisma. The 'je ne sais quoi' that makes Monti and Papademos viable is exactly the opposite of 'je sais tres bien que' Mrs. Merkel and M. Sarkozy  are no longer comfortable to lead the EU nor the Eurozone out of this maelstrom. Mrs. Merkel whose economy is cruising through the turbulence seems confused about her directions and reads signals with great difficulty, she should possibly review her entourage for more capable resources. Mr Sarkozy should leave aside his political ambitions and rise to the European Region's challenge-it would probably guarantee him the undecided electorate. Finally, Mr. Cameron should abandon his economic platform and slowly steer towards fiscal accommodation before the country reaches the crevice.The economic indicators for the UK are in a sharp decline, and although inflation is for all intents and purposes non-problematic, unemployment is on the rise and capacity is in decline. The latter do not project good times.

In this maze of political ambiguity, Monti and Papademos, seconded by a  known entity Mr. Mario Draghi stand out quite remarkably. In fact, the rise of Monti may have been spurred by Mr. Draghi's reluctance to fully engage the ECB in support of the Italian auction sponsored under the last Berlusconi government. The politicization of the European Central Bank in this context is not acceptable-it mirrors the rise of a political elite beyond the legitimacy of elected representation. If the analysis of the ECB's undemocratic behavior is correct, then Mr. Draghi must explain the actions of his office towards the Italian electorate.

On the other hand, regardless of the origins of their rise, Messrs Monti and Papademos were well-trained to deal with the one concrete challenge of any political economy - to spur employment and extend economic growth. Mr. Monti, as a student of the keynesian Mr. James Tobin has the baggage and opportunity to challenge the austerity measures that are being imposed on the Italian economy. The discourse is not to settle on the terms for a refinancing but to convince markets that the conventional wisdom is not operative and will fail dramatically in the longer run. If markets do not want to be disrupted, then they must entertain the possibility that social unrest will certainly ensue a market's intransigence towards the plight of the unemployed. The matter does not involve a change in narratives, it requires a change in the essence of the discourse.

For Mr. Papademos, the measure of success lies in convincing the Greek electorate that unless there is some accommodation by the people, then there will be no accommodation by the markets. But this tradeoff is quite out-of-line with Mr. Papademos own dispositions. As a young economist, Mr. Papademos studied the accommodation of anti-inflation policy  in promoting employment.  If one considers that the whole segment of the public service is discontented about the market behavior towards Greece's dilemma, then Mr. Papademos must re-engage the early flirtations of his intellectual odyssey and abandon the ECB temple's aphorism of 'Price Stability'. One also hopes that he will challenge the skew towards privatization of public assets that seems to be permeating the ideological baggage of most European leaders in structuring refinancing.

Certainly, one of the critical errors of the ECB financial managers has been the concession to promote 'price stability' at the expense of employment. During two consecutive sessions in April and July, Mr. Trichet decided to boost interest rates when every economic indicator in Europe signaled that there was no inflationary threat imminent on the horizon. If anything, the rate increases intensified an already fragile economic landscape, tempering business investment, and disappointing any consumer initiative to spend. The initiatives certainly cast doubt on the sound judgement of European financial leadership.  One can forgive Mr. Papademos for the latter case in point,because obviously, Mr Papademos although a former member of ECB's executive directorship, and Vice-President to Mr. Trichet, had  left the ECB in 2010. What does that imply for Mr. Draghi who inherits the sequitor of that deepening crisis. On the one hand, Mr. Draghi has signaled his intentions to support any reasonable auctions in the market. If there is anything for Mr. Draghi to recall it is one of  his former teacher's Robert Solow's insight that persistent levels of unemployment adversely affect long term growth in productivity and a second caution that accelerating unemployment can have a disinflationary effect which, in our opinion, given the European context of the day translates into a tendency to affect adversely real wages more than prices, hence disposable income and consumer spending rather than corporate revenues.

Although both Messrs Monti and Papademos are highly capable and well-intentioned, the leap from technocracy to polity is not a matter of degrees. It involves a qualitative leap that resembles more a Kierkegaardian leap of faith that marks the end of innocence.  Although the scenario both men confront at the moment in their respective nations is reminiscent of  the High-Noon sheriff's duel with destiny, both men are certainly more equipped and better supported than the solitary Gary Cooper with his lone gun.

Nevertheless, we have faith that both men will succeed by cautiously pulling back from endorsing further austerity and inviting the markets to the table in order to embed the common sense of loosening up their exigencies. We also trust that Mr. Draghi will endorse a more accommodating stance towards national governments that confront onerous economic and financial challenges. There is no easy formula for success, but there are options that are more beneficial than tightening the coffers of an economy- put people back to work.