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August 2, 2013


We saw in part I of this essay that Merkel has correctly defined Greece’s ailment even while prescribing the wrong medicine (austerity) for its recovery (if it can recover from its death spiral). She and the European Central Bank had another option when the Greek problem became too big to ignore, i.e., “loans” conditioned on Keynesian expansionism rather than depression-inducing austerity. Disastrously, they chose the latter, and predictably, it has been all downhill from there. Band-Aid loans, broken promises, threats, civil commotion – when are any of the actors in this economic drama going to understand that, contrary to right wing and bondholder propaganda, you (as one classical physicist noted) cannot get a quart of water out of a pint jar. You cannot get more from less, and running it through the formal auspices of government with all the attendant pomp and circumstance that entails does not and cannot alter this fundamental law of both social and physical science.

Ah, but one could argue, as Kuttner in his nearly year-old essay does: “Greece can perhaps be dismissed as a special case. It was risky to admit Greece to the Eurozone in the first place. In its corruption and incompetence, Greece resembles a Third World failed state. With only a few industries, even the most stringent wage cutting, commended by the Germans as a substitute for devaluation, is unlikely to increase its exports much. What’s shocking, however, is that Merkel has applied THE SAME RECIPE to other countries.”

Greece is not Portugal and Spain is not Italy. Each has a different economic history and has traveled a different route to its present financial predicament. A policy of austerity, of course, will not work in any of these economies, and to make things worse, an even application of a wrong policy which ignores individual differences compounds their respective problems. As Joseph Stiglitz, Nobel Prize-winning economist repeatedly states: “Austerity has never worked in large economies.” Is anybody listening?

What we have here is a wrong policy wrongly applied in uniform fashion. Are there any early results out there which prove both such policy and its application wrong? Yes.

As Kuttner notes, Greece under PASOK was the bad boy of fiscal policy, regularly lambasted for missing its belt-tightening targets. Portugal with a conservative government was the poster child. “We did everything they asked of us, and we even went beyond their demands,” said a former Portuguese cabinet minister and now a senior member of the European Parliament.

So what did Portugal do to conform its policy positions to the demands of Merkel? It privatized government assets, raised taxes, cut spending, slashed pensions. Indeed its reduction of the public deficit for 2012 EXCEEDED the targets. All lenders, including Merkel, showered Portugal with praise.

So how did things work out for the poster boy who not only acceded to but went beyond the demands of its European lenders, i.e., how did austerity work out in Portugal?

In a classic in-your-face example of how austerity (per Stiglitz) will not work in large economies, here is how it worked out. Unemployment has risen to 15 percent. The Portuguese economy will shrink by 3.3 percent this year, one of the worst downward spirals in Europe. Reduced wages and idled workers, not surprisingly, reduce revenue projections. The debt ratio (to GDP) is still rising. Portugal still cannot access money markets to roll over its bonds. Such a success story! Three cheers for austerity policies, policies that illuminate the road to failed state and Third World status!

Early in 2012, when the Spanish banks were reeling from a collapsed housing bubble, bond traders turned against Spanish debt. Spain’s new conservative prime minister decided to play a game of chicken with Merkel and Brussels by (rightly) refusing to give up Spanish sovereignty to prospective lenders on the same terms and conditions such as those that had been inflicted on Greece and Portugal. There was jubilance in the Spanish fiscal camp when Merkel and Brussels blinked as they advanced a line of credit of 100 billion euros to the Spanish state to support its banks, with NO AUSTERITY required in return. The rejoicing in Madrid was short-lived.

It was short-lived because, contrary to appearances, the results of such a line of credit imposed on Spain was actually a repeat of the self-defeating recipe imposed on Greece and Portugal. One size fits all, per Merkel, even when the feet may appear to be of different sizes. The Spanish state was as a result much deeper in debt, and with its own solvency in doubt, the rating agencies downgraded government bonds. Moody’s cut the ratings on 28 leading Spanish banks (noting that the country’s worsening economic picture would harm both the banks and the capacity of the state to support them).

The foregoing is another classic example of unintended result. The 100 billion-euro line of credit extended by Brussels-Merkel to Spain to reassure markets did exactly the opposite. Interest rates rose to record levels. By July 2012, Spain was paying nearly 7 percent for its short term (2 year) bonds. Speculation spilled over into Italy, where Italian short term bonds sold for slightly less than 7 percent interest. (To contrast, U.S. treasury bonds sell for some 4 to 5 percent less.)

So how did Merkel’s PR survive the failed Spanish experiment? She lost on the headline story of (ostensibly) lending money to Spain without austerity requirements, but pulled it off by lending to the government of Spain instead of directly lending to Spanish banks. What seemed like a concession was not a concession. It was more of the same as that inflicted on Greece and Portugal, inflicted in indirect fashion. The Spanish crisis continued to deepen. It was another “one size fits all,” and it didn’t fit.

Merkel is up for re-election no later than September of 2013. That campaign and its result may be instructive to Obama, who is increasingly buying into austerity policies approved by the tea party and Wall Street here. I think it is past time for him to ignore his Rubin-Summers-Greenspan (all Wall Streeters at one time or another) and tea party austerity policies that demonstrably do not work and adopt instead the Keynesian and New Deal policies of FDR, which worked then and will work now.

To repeat – the time for the contraction resulting from austerity policies is not when our economy is already in a state of contraction. It is plain as can be that when our economy is in a state of contraction, as now, policies of expansion are called for. Such positive policies as translated into action will not only resolve our fiscal problems; we will also be enabled to put our people to work and invest in fixing our road and bridges and educating our people in the process, among other such desirable outcomes in the interest of America and its people. Why are we treading water when we could be swimming? Let’s ignore tea party and Wall Street propaganda and get on with it.  GERALD  E


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