The EU Austerity Policy and Why it Won't Work

By Roberto Marinucci

Italy is going through the second austerity package in 4 months- Greece has had countless of those, France has done some light versions, but ultimately the question is: will it work? Unfortunately, the answer is no. No matter how many austerity moves will be done, there is no way that any of these is going to take the EU out of the crisis. There will be more social unrest, recession and potentially depression in several countries and an acceleration of wealth moving out of EU. There is consensus that ,in fact, these tough measures will only have a positive impact if they are followed by growth stimulus. The conventional wisdom is that EU needs to fix the debt before it tackles growth. For example, Italy is going through a “tears and blood” budget, where the Government is trying to collect some €30bn to be able to use part to cut the public debt and part to fund growth. Unfortunately, the odds are that after some relief to the spread – behind the brief market celebration at the Italian plan—the spread will be back up and the money originally foreseen for the growth will be used to cover higher interest rates. So, a second budget correction will be necessary, and so it goes.

This situation reminds me of the “strategy” of many companies when they are in a bad financial situation: to soften the blow with Wall Street, they announce massive layoffs. For a week Wall Street rewards them with higher stock value, but ultimately the analysts realize that these measures are not sufficient in absence of a credible plan to grow sales profitably. No company has ever become rich only through cost savings, and no country has ever grown out of austerity packages.

The critical issue for EU countries, particularly those at the periphery, is how to create the conditions for growth. Here I just would like to offer a few considerations:

• We need to eliminate the conditions to speculate on EU interest rates. Currently, the swing in interest rates for countries like Italy is similar to the fluctuations of stocks. This cannot be right. A country needs to have stable access to credit, and to have a Central Bank which could use its ability to create liquidity as a way to balance the effect of different forces. So  far, the ECB can only be the defence against inflation. But it can’t intervene to buy countries’ debt, like all the other central banks, like in US, China, Britain etc. This leaves weaker countries totally unprotected from speculation. The first condition for growth is to give the power to the ECB to buy public debt at 1% rate.

• The above will also have the effect of easing liquidity. The lack of growth in peripheral countries is also driven by the credit crunch.

• Countries need to foresee a significant investment in infrastructures. This is a major opportunity to modernize Europe and to increase its competitiveness within the global market.

•  Last but not least, the EU needs to exercise a central drive and control on at least three major areas. The first is to use a central commission to control that the public funds are well spent. Unfortunately, we have witnessed in the past the bad use of money in several countries, and the EU needs to ensure that this won’t happen again. This is particularly important in countries with high level of corruption. The second is to create a pan-EU policy on liberalizations and common ground for competition law. The third is to have the same fiscal policy. The fiscal rules needs to be much simpler than today but need to apply for the whole of the EU.

Unfortunately, right now, Germany and France are trying to exercise their leadership only on the budget deficit, no matter how this is obtained, and are missing the much bigger picture. We are missing an opportunity to turn this crisis into what EU was meant to be:  the drive towards the United States of Europe. 

The Importance of Euro Devaluation (and Good Politics)

By Roberto Marinucci

Since the official start of the global economy in late 80’s, we have witnessed the rise and burst of several bubbles—in fact bubbles have been a component of globalisation. The new economy and the dot.coms, then the commodities, the real estate and finally the currency markets. Globalisation and the digital revolution have made available for banks and other investors huge amount of money to be moved quickly. So, banks (among others) stopped doing the traditional banking job and became speculators. The value of companies, commodities, etc. was not anymore linked to the normal process of demand and supply but to broker intervention. This had a dramatic impact on the (economic) life. Companies had to deal with this phenomenon and so did everybody else. Imagine oil moving in the space of a few years from $80 to $140 and back to $60 and then to $100, what impact might have had on company’s pricing policies, on inflation in general and on consumers.

The latest addition to the speculation chain was the currency bubble. And, the Euro was a relatively easy target. The European currency in its conception was meant to be pegged to the US Dollar, but after a slow start, it went well beyond the parity hovering above 1.20/1.30 with peaks at 1.5 before the 2008 crisis. The Euro was not created to be devalued: the role of the ECB, which had to only combat inflation with no possibility to print money, the German primacy in influencing the EU monetary policy (whose cultural aversion to inflation is deeply rooted), the lack of political integration among Member States, and the relatively high interests compared to USA and Japan made the Euro an attractive currency to create a bubble. Another indicator that the bubble was in development was that despite the Euro revaluation, the economy in the EU has been growing less than in the US and Asia.

Devaluation can be good. When you are in the midst of a bubble, it can help cool down markets and reach a better equilibrium. It can also help the economy by making your exports more competitive. This is what it has done in countries like China, Switzerland, and US. These are all very respectable States. Today, in the middle of the Euro crisis, we must devalue- it’s only a question of when. The discussion to give power to the ECB to print money to buy the member States’ debt at low interest rates is exactly that: devaluation, using a convoluted language. The austerity measures to reduce the debt are going to be useless, as long as the money will come from the market, because the market in one day can send interest rates soaring through the roof and  render all the sacrifices to no avail, swamped by the higher rates.

There are many arguments against devaluation, and in normal circumstances are valid. One is that it creates inflation. This is true. But there are a few considerations to be made in these crises circumstances. First, the alternative of gigantic austerity, high interest rates and collapse of the banking system are even less desirable circumstances . Said another way, the money that inflation is going to take from people will be generally less than  the combination of taxes, high rates to be paid to banks for mortgages and credit and lower levels of public services. Second, we could argue that the impact of the inflation will not be huge considering that EU is the largest trading area in the world, and that a large portion of EU commerce comes from within EU. Third, it will send the strongest possible signal to the markets that new bubbles will be faced, with injections of money at low interest rates—and that is probably most scary for them.

There is an ideology that says that Italy, Greece and Spain deserve all this because of their huge public debt. I believe that it’s only part of the truth. As an Italian, I believe that the problem for us is not just the debt-however big—as after all the US also has a huge debt (as do so many other countries). Our problem is that we squandered the money, as instead of building infrastructures, investing in education and in the health system we have created a mammoth bureaucracy that eats the country’s wealth with unproductive expenses. So, Italy deserves the bad things that are affecting it, but for different reasons, and can never fix the debt without growth allowing to redeploy people in the public service to other more productive sectors. This won’t happen with austerity packages alone. And that will require access to low cost borrowings, … and good politics (for once) in Italy.