Generalized austerity is a monetary dead end
A certain mood has been pervading the entire European economy for the last few months: people are getting tired of the crisis, and especially of austerity. Nobody now considers valid the budgetary rigidity that is overwhelming some countries with growth difficulties. Everyone wonders about the risks involved in the combination of a strong currency and budget austerity that increases inequalities and harms employment. In certain countries in southern Europe millions of young people find themselves swallowed up in a wave of poverty inherited from back in the 1930s. Political leaders are even moved: The President of the European Parliament talks of the "wretched" state of the European Union while the Italian Prime Minister refers to the 'death' of his country under austerity.
In reality, Europe is facing up to a dual crisis that requires a new political diagnosis.
First of all, there is the economic downturn, which reduces internal demand. Initially, the Commission thought it could deny the extent of this temporary pullback by imposing restrictive budget policies, i.e. forcing countries to return to balancing their public finances. This approach went against common sense. Of course it is necessary to reduce excessive public expenditure, make the labour market more flexible and adapt public finances to an ageing population, but it is also necessary to admit the end of the Welfare State, which has sunk under a mountain of public debt. However, a strong contraction of public expenditure in the middle of a depression goes against any reasonable financial theory. Although this approach has been supported by maintaining the homogeneity of the euro, we now see that it has been a failure. It was forecast, therefore foreseeable: one after another, the Eurozone countries are postponing a return to balanced budgets.
Then there is the Euro crisis, which has revealed a growing heterogeneity among the countries that adopted the single currency. Indeed, the Euro was intended to make harmony between countries smoother, but the result has been quite the opposite. The Euro now crystallises economic and social resentment. An illustrative example is the deteriorating relationship between France and Germany, the two countries at the heart of European monetary union. The differences that characterise them are starting to emerge strongly, and the currency that links them has become a factor of considerable political irritation.
During the first seven years of the single currency, Europe lived under the illusion of easy debt under German terms; the weaker countries took shelter under its rating. Later, when the crisis blew up, austerity was invoked to bring those same economies to their knees in the name of monetary cohesion. Nowadays, statements by European political leaders reveal a lack of direction, and the European monetary journey has become unclear as a result of so much hesitation. Do we need to redirect budget discipline as the majority of leaders demand, or should we increase interest rates as maintained by the German Chancellor? There is no consensus.
Previously, a country in difficulty could devalue its currency and stimulate its exports in exchange for imported inflation. Devaluation allowed it to juxtapose the currency with the weakness of the economy. This solution, as imperfect as it may seem, nevertheless imposed adjustments on an economy that would, in all probability, save it. Nowadays, however, countries cannot resort to devaluation like they did before: only internal devaluation is possible, i.e. a drop in internal consumption aimed at increasing the country's competitiveness abroad. In the short term, this policy leads to higher unemployment and inequalities that can be translated into social unrest.
Without wishing to be a catastrophist, I believe that the future of the single currency has been brought to its knees by the crisis and the lack of agreement among political leaders on an economic model. We also need to get back to the essence of monetary policy, in other words, the political management of currency. Indeed, without a political foothold and popular support, the currency symbol is not able to exert discipline on the ‘real’ economy.
This requirement for political management of currency is based on an irrefutable fact: austerity leads to a higher monetary risk because it strengthens the Euro, which in turn becomes unsuitable for the southern European countries. That is the level at which the dilemma exists: through austerity, Europe aims to reduce the level of public debt to avoid the European Central Bank (ECB) having to refinance it. However, this very austerity increases the level of debt and destabilises the currency in the process.
Obviously, the ECB cannot become the discounting house for all the public debts of countries in difficulty. Nevertheless, a joint budgetary and monetary policy should be considered, i.e. the ECB should be given a public orientation. Ideally, the bank should reflect the political representation in the European Parliament. At a time of deep crisis, it is, indeed, difficult to admit that the monetary issuing authority should enjoy absolute powers and restrict itself to subordinating the currency to an inflation target without taking economic growth into account. The ECB cannot, therefore, be a political counterweight because that would disqualify it, while fuelling social demands at the same time.
To save the Euro, it is necessary to increase the money supply or, to put it more simply, print money in a reasonable manner, at the risk of feeding certain asset bubbles. I remain convinced that inflation will ultimately alleviate the relative value of public debt. This is not yet apparent because the printing of money hardly transfers into the real economy because of the viscosity of banking channels. However, there is no doubt that, at a certain time, the printing of money will be translated into a reduction in public debt. Furthermore, the latest report by the ECB expresses concern at the lack of inflation.
In conclusion, two risks seem to have been underestimated. The first is of a monetary nature. The single currency was adopted without the Eurozone being ready to operate as an optimal monetary area, characterised by a lesser role played by the States, budgetary and fiscal harmonisation and the mobility of labour. In other words, the single currency was a political proposal rather than a monetary reality. So, we now need to know if, from now on, the currency as such will be sufficient to absorb its lack of economic foundations. If this is not the case, the dislocation of the Eurozone should be considered or, at best, an increase in the money supply from the ECB so that the economy can be kick-started by inflation.
The second risk is social, and therefore political. The Euro is no longer a unifying force; it is even the source of deep-seated resentment among the people of southern Europe. In the past this 'social risk' was attenuated by monetary nationalism and the discipline imposed by devaluation. These tools are no longer available to us. By adding rigidity to the currency one should, in effect, accept that other parameters become flexible. Therefore, it is theoretically possible that the Euro could become, through the lack of monetary adjustment options, a factor for social destabilisation. In other words, political nationalism could become a substitute for nationalism that was only monetary in the past. If this were to be confirmed, it would represent a serious failure, because the ways in which societies change are difficult to predict.
At a certain moment, therefore, budget and monetary restrictions should be relaxed before Europe disappears under the weight of austerity. Nobel Prize-winner Joseph Stiglitz also maintains that this option is tantamount to economic suicide. Is this the case? The future will tell us, but it is not out of the question. As I see it, those who advocate implacable budgetary rigour to get out of the recession are making a serious mistake; not just a historical mistake, they have got it fundamentally wrong.
From the moment when public debt reaches levels that economic growth cannot put right, an economy can only get back on a stable footing through the controlled loss of the value of a currency, i.e. inflation. The risk of the error of judgement of the advocates of stubborn budget inflexibility is that society might run out of patience and cross the line into social unrest and political discontinuity.
