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Thursday, 9 February 2012

Why the European approach of forced austerity is wrong, but the American Keynesian approach is also flawed! My reaction to the article of Minyanville´s Jarad Vary.

This week Minyanville’s contributor Jarad Vary ( presented a thought-provoking article on the success of the American Keynesian approach versus the failure of the European forced austerity approach. The main conclusion of the article was: the American approach worked much better than the European one, as the US economy seems to be growing again.

I called the article thought-provoking; not because it’s absolutely right, as it isn´t in my opinion. But it forced me to think hard about why I found that both the European and US approach of the crisis are flawed. And ‘making you think’ is a characteristic of a great article. This is worth a compliment for this young and talented writer of Minyanville.

The current events in Greece show that the discussion of Keynes vs Austerity is a very important one. Therefore I want to quote here a large part of Score One for the Keynesians by Jarad Vary, accompanied by my comments. Not as to steal his lines for my own purpose, but because the article requires some extensive commenting:

First, in Athens, controversy erupted over the demand by EU, ECB and IMF representatives for renewed Greek austerity measures. Negotiations to save Greece from a disorderly default are now teetering on knife’s edge.

Meanwhile, here at home, the US Department of Labor reported surprisingly strong job growth for the month of January, with headline unemployment falling to 8.3%, the lowest of President Barack Obama’s presidency.

Today February 9, new austerity measures have been deployed in Greece. I will come to that in the remainder of this article. These measures are a disgrace in my opinion. As far as the Greeks are concerned, I totally agree with Jarad that the European approach doesn´t work at all. 

Instead of putting the country and the other PIIGS back on track for economic growth by making these economies more competitive, the additional austerity makes these countries only weaker. I have stated this many times during the last year and I will keep on stating this.

This week, the word in the Euro-zone was that the Greek problem is contained now and that the contagion risk from Greece to the other Euro-zone countries (i.e. the PIIGS) is mitigated. That in my opinion is a blatant lie: the current tranquility is deceptive, as only a little spark is necessary to reignite the Euro-crisis again. And that spark might be Portugal, Spain or any other country in the Euro-zone.

On the other hand, I have a problem with the official American unemployment figure of 8.3%. People that have a part-time job, but want a fulltime job are left out of this figure. People that don´t receive unemployment benefit anymore are left out too, as they don´t count in the statistics. Discouraged workers that want to work, but stopped looking for a job are also left out. But that doesn´t mean that these people are not unemployed anymore. The official unemployment rate by the BLS ( therefore looks a lot like windowdressing.

The figure that reflects the true American unemployment is the infamous U-6 figure from table A-15 Alternative Measures of Labor Underutilization. And that figure is still 15.1%, which is well above the vast majority of the European unemployment rates (see the following chart)

Data courtesy of
Click to enlarge
Except for the PIIGS and most East-European countries, the unemployment of all European countries is still beneath 10%.

In Athens, the Financial Times is the latest to report that Greece will default unless its leaders can negotiate a bailout deal with its creditors before March.  According to terms currently under discussion, private lenders would accept a roughly 75% haircut to the value of their Greek bonds, which would reduce Greece’s debt burden. The IMF and the EU would pitch in, loaning upwards of €130bn to the government. In exchange, Greek politicians would impose public sector job cuts and a substantial decrease in the minimum wage, among other hardships.

But Greek politicians are digging in their heels, the FT reports: “All three party leaders in Greece’s teetering national unity government have opposed new austerity measures demanded by international lenders, forcing eurozone finance ministers to postpone approval of a new €130bn bail-out and moving the country closer to a full-blown default.” (At this hour, Bloomberg is reporting that Greek officials have indeed come to an agreement on fiscal reforms, though the new deal will still require approval by the Greek parliament.)

Jacob Funk Kirkegaard, of the Peterson Institute, assures me that Greek leaders will eventually get with the program. Still, the recalcitrance of the politicians is hardly baseless. So far, economic growth under austerity has been much weaker than the EU, ECB and IMF initially predicted. To make up the gap, Greece has required a succession of patchwork bailouts. Poul Thomsen, chief IMF official in Greece, admitted Wednesday that fiscal consolidation has been harmful, and the IMF now predicts that Greek GDP will contract by another 3% in 2012.

Today a new agreement has been made between the troika (ECB, IMF and the EU) and Greece on a new package of emergency loans for Greece to the value of €130 bln. Combined with these new loans, a set of ruthless and draconic austerity measures has been forced on Greece ‘at gunpoint’. Take it or default! That was the deal.

What were these austerity measures to the tune of €3.3bln in total:
  • 15,000 civil servants lose their jobs at the end of 2012 
  • Government companies should be privatized at a much higher velocity 
  • The minimum wages in Greece will be reduced by 22% 
  • Pension payments will be reduced with €300 mln, although it is not yet clear how this reduction will happen 
  • Value added tax (VAT) and other taxes on consumer goods will be raised, making these goods effectively 30% more expensive 
Although most measures are defensible by itself, the integral effect on the Greek economy in 2012 will be devastating. The economy might contract by 5% in 2012, while the already high unemployment rate will again soar this year. I call this ‘choking the Greek economy in an economic coma’, while totally ignoring the solutions that really help (i.e. making the economies of the PIIGS more competitive). It is a total disgrace and it is something that the Euro-zone should be ashamed of.

The Greek three-party government said ‘yes’ as yes was their only option for staying in the Euro. And although this might sound strange in British and American ears, people should not forget that still 70% of the Greek population wants to stay in the Euro; at least, that is what Greek people said in November 2011. They know that abolishing the Euro would mean that Greece would become a kind of third world country in Europe.

Now, despite a lousy third quarter of 2011, the US looks to have avoided the danger of a double dip recession, and has even experienced several consecutive months of respectable job growth. If this is a recovery, some of the credit goes to Obama’s Keynes-inspired economic policies, including the American Recovery and Reinvestment Act (the much-maligned stimulus), and the December 2010 payroll tax cut.

To be sure, the Obama administration shouldn’t start popping the champagne just yet—quarterly GDP growth remains weak, and as Matt Yglesias points out, at this rate the US economy is unlikely to reach full employment in this decade. But the champions of budget austerity have even less to celebrate. Euro nations including Spain, Portugal, Ireland, France, Germany and Italy have all aggressively pursued austerity. Now, the eurozone faces a year of negative growth and record-high unemployment. And then there is Greece, where unemployment reached 18.2% in October. There is little question whose economic policies are working better.

This seems like a correct statement by Jarad. The US with its Keynesian stimulus is on the way back into a growing economy, while the EU with its austerity measures is only dropping down further. But that´s too easy, in my opinion.

First, the process of debt destruction in the US has been very violent. The American housing market has in average lost at least 35% of its value since 2008, ten thousands of shops and companies had to close their doors for good and the unemployment rate has soared by almost 6% in the US between 2008 and 2010. The results of this relatively short, sharp shock were that the pain of the crisis was heavy, but relatively short-lived.

The credit crisis hit the PIIGS-countries hard, that goes without saying. But these countries, that all shared a troubled past until the seventies and eighties, had economies that were not very healthy already before the credit crisis started. Italy, Greece, Portugal, Ireland and Spain had their share of misfortunes during the beginning of this century; real estate bubbles (Spain, Ireland), a debt explosion (Greece, Ireland and Spain), an economy that crashed and burned (Ireland) or an economy that has been anemic for ten years (Italy).

For all other countries, the crisis in the Euro-zone has been relatively mild. The unemployment rate in the Euro-zone has only increased moderately by 3.4% in the period between 2008 and December 2011, in spite of the massive unemployment increases in the PIIGS countries.

The US versus Euro-zone unemployment from 2002 until December 2011
Data courtesy of and
Click to enlarge
This mild recession was the result of a mixture of very competitive economies, years of wage restraint in Germany and earlier in The Netherlands, making labor cheaper than it otherwise would have been and ´Keynesian´ stimulus (!). 
An example of the latter was the Part-time Unemployment Benefit in The Netherlands, where the government gave subsidies to companies to keep people in service, that otherwise would have been fired. 

The result of all these measures was that the typical exporting countries The Netherlands, Belgium and Germany resumed their exports in 2010. And their best clients? That were France and The PIIGS.

The situation for the non-PIIGS Euro-countries started to deteriorate again in 2011, when domestic demand started to drop as a consequence of changing mood among the citizens and exports to France and The PIIGS diminished. This mood change as well as the dropping exports were caused by the uncertainty of the financial markets concerning the Euro-zone and especially the PIIGS countries. As costs of credit soared, it was much harder for the PIIGS countries to keep their imports at the previous level.

This had a severe impact on the other Euro-zone countries that still had been in a situation of excess production capacity and where the excess production had been used for exports. When exports started to drop, it was clear that the production capacity had to drop too. 

So yes, Europe indeed had a double dip in 2011, but only because the first dip  in 2009 had been too mild.

The result of the different consequences of the crisis for the US and the Euro-zone is, that the EZ seems only to be at the beginning of the crisis, while the US already seems to be in the final stages of it (see chart). The US have been hit harder, but shorter. The Euro-zone (except for the PIIGS) has been hit less hard, but for presumably a longer period. So in my opinion it is not the Keynesian approached that saved the US, but rather the violence of the debt destruction process that originated from the crisis.

The position of the US and the most competitive countries
in the Euro-zone in the crisis lifecycle
Click to enlarge
And to emphasize the negative consequences of the Keynesian approach, I want to state first that the Part-time Unemployment Benefit stimulus in The Netherlands (and other stimulus as well) delayed the problem of excess capacity in The Netherlands, instead of doing something about it. 

To give you a few other examples of Keynesian government stimulus that didn't work the right way:

The Mortgage Interest Deduction (fiscal stimulus), in combination with the low interest rates (this could be considered monetary stimulus) of the last 15 years, caused that Dutch real estate (commercial as well as residential) has turned into a massive bubble, while the housing and office building market is totally locked up.

Central and local governments and semi-governmental organizations in The Netherlands have spurred a building frenzy by creating:
·    too many windmill parks that only survive due to heavily subsidized energy production;
·    too many subsidized industrial zones;
·    too many new houses that nobody asked for;
·    too many office buildings that are vacant permanently.

The result is that many building companies that had turned into´fat cat' organizations are now on the brink of defaulting, due to a widespread excess capacity, spurred by the aforementioned government investments.

Dutch Government investments in ICT, energy and transport infrastructure, although worth many billions in value and often executed with the best intensions, seldom delivered the desired results. And when I speak about The Netherlands, this is probably true for the whole of Europe. 

The top-down approach for large infrastructural investments in the form of government interference and stimulus has seldom the desired effect and causes in general massive debt at central and local government levels.

And it happened often in the past that government investments, in order to save ´important industrial companies´ that were on the brink of defaulting, led to enormous black holes that sucked up billions in subsidies and special benefits, only resulting in the companies failing after all.

And concerning the US and its Keynesian stimulus, I only have to refer to the US National Debt Clock on Times Square, that stood today at: $15,339,568,245,525 or a staggering $49,134.52 per US citizen. What a message to tell to a newborn that he/she is the proud owner of $50,000 in debt!

And that is what I have against Keynesian stimulus.

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