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European Analogies to the 1920s and '30s

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The slow motion train wreck that is the Eurozone continues to roil bond markets, banks and governments. The complex issues involved cannot be described, yet alone adequately explained, in this short piece but bear with me.

Economic activity is still contracting in much of Europe including the UK, Spain, Portugal, Greece, Iceland, Ireland and, quite possibly, France. To a greater or lesser degree all of these countries are pursuing policies of reduced spending, especially on health, education, welfare and retirement and government employment. In the UK and France this punishment is self-inflicted and relatively mild.

In the remaining countries the cutbacks have been more severe as a result of various bailout terms imposed by European authorities and the International Monetary Fund, or implicitly dictated by the bond market. Or, as the unflinchingly capitalist Financial Times put it in a recent editorial: "European leaders [do not] grasp that states and economies - not senior bondholders - must be kept safe from teetering banks... Instead they are strong-arming the periphery into bailing out savers in the core and the reckless banks they entrusted their savings to."

In these peripheral countries unemployment is already around twenty-percent of the labor force. National income is falling rapidly with the inevitable result that the ratio of government debt to total income is increasing. A falling economy means falling tax revenues and some increases in public welfare expenditures no matter how determined these governments may be to limit spending. In addition, interest rates on these countries' bonds continue to rise as the prospect of an eventual default (or restructuring, which is a polite and civilized default) rise by the day. Those higher interest rates, like every other consequence of the wrong-headed policies of a fractious European leadership, only intensify the problem they purportedly set out to solve.

The unavoidable outcome will be an eventual default or restructuring of these countries' debts as their commitment to continue cutting or their ability to obtain more outside assistance comes to an end. The sooner the debt is restructured, the sooner these countries will be able to resume economic growth, increase employment and re-establish their ability to borrow and repay. Here also there is a close and discomforting analogy with the 1920s and 1930s. At the close of World War I, Germany, the loser, was burdened with unsustainably large reparation payments to France and Great Britain at the same time that some of its most valuable economic assets and territory were taken away. John Maynard Keynes immediately and famously predicted that this was a policy guaranteed to yield a disaster. For the next dozen years there were repeated efforts to reduce the size of these burdens, and to make them more bearable mostly by America lending money to Germany with which to pay the British and the French, much like the current bailout funds being provided to Greece, Ireland and Iceland, and perhaps also Portugal by the time you read this.

From beginning to end Germany was unable to pay its obligations in full. This resulted first in the infamous hyper-inflation of the early 1920s coupled with an unemployment rate of 25%, as a desperate government printed money to pay its expenses and support its unemployed workers, while the supply of goods that could be bought with that money was small and shrinking. After the stock market crash of 1929, U.S. loans to Germany were recalled. Combined with a German government policy identical to current programs in Greece and Ireland, this led to a disastrous collapse of the economy.

In 1933, when Hitler's National Socialists came to power (and renounced the reparation debts), Germany's unemployment rate of 36% was the highest anywhere in Europe or North America. Four years later the Nazis had made Germany the first country to eliminate its unemployment problem through a vigorous program of central planning directed at building infrastructure, consumer goods factories and many new weapons plants along with a large increase in the size of the armed forces. All of these efforts increased employment and growth without inflation because of the surplus of workers and resources and the use of price controls. In 1937 spending by the Nazi government amounted to 34% of German GDP, compared to 20% in the US under the New Deal, where unemployment was still high and about to go higher.