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Marshall Auerback

Marshall Auerback

Posted: May 17, 2010 02:38 PM

Fiscal Austerity Fever Goes Global

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Virtually the entire world's press is now focusing on the travails of the euro zone, but continues to draw the wrong lessons from what now afflicts the region. But Americans might be pleased to know that this collective economic insanity is not restricted to the pages of the right wing press or the rantings of Fox News commentators such as Glenn Beck. No America, you can rejoice! This has become a fully fledged global disease. You are not alone.

As I have pointed out before, no euro zone government issues its own currency. Consequently, they have to "finance" every euro they spend. And, as Bill Mitchell notes, if tax revenues do not cover pre-existing spending desires, then all of these countries (including Germany) have to issue debt. The current crisis is manifested by the bond markets' unwillingness to lend to the PIIGS governments any longer because they are beginning to query the PIIGS' national solvency.

These funding constraints do not apply to the US government, which is sovereign in the US dollar and can never be revenue constrained.

The same applies to the UK government, although to judge from the comments of the new coalition Conservative-Liberal Democratic Government Cabinet, one would be hard-pressed to discover that fact. Will someone please remind the UK's new Chancellor of the Exchequer, George Osborne, that the UK is not Greece? Osborne attended Eton, one of Britain's elite private educational institutions, but they clearly didn't do a good job of teaching him economics out there, if one is to judge by his recent statements: "If anyone doubts the dangers that face our country if we do not, they should look at what is happening today in Greece and in Portugal."

The UK is a sovereign nation that issues its own currency and freely floats it on foreign exchange markets. Perhaps the keyboard operators have gone on strike (like British Airways), or the country has a paper shortage and can no longer write checks, but given the plethora of comments emanating from virtually all members of the UK commentariat, one has to assume plain ignorance. Just today, the incoming Chief Treasury secretary, David Laws, warned the British electorate that the UK has well and truly "run out of money." Hold on to those pounds, or you're doomed.

In defense of the current Greek, Spanish and Portuguese governments, they find themselves in a fiscal straitjacket not of their own making. It is a by-product of the Maastricht Treaty and the Stability and Growth Pact. The UK, by contrast, is willingly choosing to commit economic suicide. If the government had some understanding of the characteristics of its monetary system and the position of the currency in that system, they would stop worrying about debt ratios and deficit ratios and focus more on reversing the job loss and doing nothing to undermine the economy's capacity to recover. The Labour Party opposition ought to be secretly screaming with delight, although the Brown Administration clearly didn't know any better and therefore fully deserved to lose the last election.

The new UK coalition government has a choice. So do the Baltic nations, where a much more severe, more devastating and downright deadly crisis in the post-Soviet economies is taking place. Somehow the travails of countries such as Latvia and Estonia have escaped widespread press notice. The US and UK would do well to take note, because the Baltic Republics have well and truly imbibed the neo-liberal Kool-Aid peddled by the likes of the IMF.

On June 2009, the newly-appointed Latvian Prime Minister, Valdis Dombrovskis, made a national public radio address and said that his country had to accept major cuts in the budget because they would allow the country to receive the next installment of its IMF/European Union bail-out loans. He said the country was faced with looming "national bankruptcy" and then proceeded to ensure the validity of that claim by implementing the economic equivalent of carpet bombing. In effect, he turned the Baltic republic into an industrial wasteland via the most virulent form of neo-liberal economics.

Having broken free from the chains of the former Soviet Empire, Latvia promptly surrendered its currency sovereignty by pegging its currency against the Euro. This means it has to use monetary policy to manage this peg. The domestic economy also has to shrink if there are downward pressures on the local currency emerging in the foreign exchange rates. So instead of allowing the currency to make the adjustments necessary, the Latvian government handled the "implied depreciation" by devastating the domestic economy. (Public sector pay has been cut by 40 percent over the last year, while the economy has contracted by almost a third.)

But now, cries the government, there is light at the end of the tunnel! In the first quarter, GDP declined by a mere 6%! Well, when a country experiences a cumulative decline greater than anything sustained by the US during the Great Depression, I suppose a mere 6 per cent contraction seems like positive boom times again. And sure enough, Prime Minister Dombrovski has proclaimed this as "confirmation of the economy's flexibility" - what is left of it - and "yield from reforms and the fiscal consolidation program, the so-called internal devaluation," according to The Baltic Course. "Infernal devaluation" is a more appropriate description.

The currency peg is nonsensical, even though devaluation would be severely disruptive given the current nominal contracts held by the Latvian private sector. Around 80 percent of all private borrowing in Latvia is in euros, with the Swedish banks being the most exposed in Latvia. And, of course, the devaluation would undermine Latvia's ambitions to join the EMU (hardly an exclusive club worth joining these days, as any Greek, Spaniard or Italian would likely tell the Latvians). The debate in Latvia about the EMU is that it will provide financial stability for the country. The fact that membership destroys their fiscal sovereignty is never raised in the public debate, narrowing the range of policy options that the political classes are prepared to discuss, and thereby legitimizing nonsensical ideas that a contraction of a "mere" 6% is something worth celebrating.

All of this pain for an exclusive club -- the euro zone - which today looks on the verge of imploding.

And Latvia is not alone. By virtue of its low public debt, and low inflation rate, Estonia has become the new poster boy for the IMF. Its budget deficit was 1.7 percent of gross domestic product in 2009, well within the 3 percent Maastricht limit, while its government sector debt was the lowest in the EU at 7.2 percent, according to the Statistics Estonia. Estonia could pay off all its public debts and still have reserves left over, which is why the country has been provisionally admitted to join the European Monetary Union in 2011.

So, should Greece, with public deficit of 13% and public debt of 113% (both as percentage of GDP), follow Estonia, bite the bullet and get down to slashing budget and wages? Or Spain? Like all of the euro zone nations, Estonia has no exchange rate policy option because the Kroon is pegged to the euro, so its fiscal policy is similarly externally constrained. The euphoria around Estonia should die rather quickly when one looks at the GDP performance in 2009. It fell nearly 15%; Greece's GDP contracted just 2%. More recently, according to the Baltic Post, the number of jobs in Estonia is the lowest in almost 25 years. The release of Estonia's first quarter labor statistics show that the unemployment rate grew by nearly four percentage points in comparison to the end of 2009 and reached nearly 20%. God help the rest of the world if it manages to emulate this "success story." While their governments seems to think that by joining the EMU they will be "shock-proofed," they should just get rid of the "proofed" part and realize that they will shock their citizens into a new kind of indentured servitude.