Tuesday, May 22, 2012
Pessimism comes more naturally than optimism. It is now five years since we first heard the phrase "the sub-prime crisis", which rang the end of a golden era of debt-financed growth. Since then, we've had years of recurring crises, summits and resolutions that promised to solve the problems, but haven't.
Australia escaped the damage through a combination of luck, circumstances and good policy. Our banks did not go broke, because the Australian Prudential Regulation Authority did a great job as watchdog, our real estate boom gave banks ample opportunity for growth and, when the crisis hit, the government guaranteed their debts so they could keep borrowing.
The government did not go broke, either. Two decades of asset sales and bipartisan fiscal discipline have made it a net creditor, so it could deliver quick, decisive and well-targeted stimulus measures while maintaining a AAA credit rating. And even bigger stimulus in China saw demand for our exports keep growing in 2009 as the world's exports shrank.
In Europe it was different. To understand where it is now, it's worth taking a look at how it got there.
The euro was born in the '90s as part of the grand vision to create a European government and identity alongside those of the nation states. It promised economic gains: reducing transaction costs, giving business a bigger and more stable market, and creating a currency too big for the speculators to take on. And it has delivered those gains.
But it also brought new problems. Interest rates could no longer be set to fit each country's needs. Countries in trouble would no longer see their competitiveness restored by a falling currency and falling interest rates. And that meant fiscal policy government spending and tax cuts had to do all the work when things went wrong.
Europe's leaders saw that this would require tighter fiscal discipline. As a first step, they agreed to limit their deficits to 3 per cent of GDP, except in exceptional circumstances, and their gross debt to 60 per cent of GDP. Some governments took these goals seriously. Others, including Germany, Britain, France and Italy, did not.
In 1992, when that deal was agreed, the future eurozone had an average government debt of 56 per cent of GDP, and Australia 28 per cent. By 1993 the eurozone's debt crossed its self-imposed 60 per cent threshold, never to return. This year, even with all the austerity, its gross debt will average 90 per cent of GDP, and Australia (including the states) 24 per cent.
Lack of fiscal discipline was one cause of Europe's problems, although only Greece was seriously delinquent. Some countries also resisted reforms. That partly reflects the social conservatism of tribes with a long history low rates of workforce participation by women and older workers in Greece and Italy; shops closed at weekends; pensions at 60 but also shows a lack of political courage to tackle reforms. Even in per capita terms, Europe has grown more slowly than the US or Australia, and tolerated higher unemployment.
But this crisis was caused by Europe's banks. They were big, gullible investors in US sub-prime loans. In many countries, above all Spain and Ireland, they financed real estate bubbles so large they were bound to burst, with devastating fallout. Ireland's banks collapsed, and were bailed out at great expense by Irish taxpayers. In Spain, where one in four home owners now owes more than their property is worth, the banks kept refusing to admit their losses and have lost the trust of investors.
The problems are different in each country. In Greece, government debt is the problem. In Spain, it is the banks. In Ireland, it has become both. And all of them have massive unemployment: 5.5 million people in Spain, almost 3 million in France, 1 million in Greece, 300,000 even in little Ireland. And with their economies going backwards, voters are demanding not more austerity, but growth.
Under the EU's fiscal pact, however, austerity is what they're getting. The pact requires governments to cut their deficits below 3 per cent of GDP by next year. Last year 17 of its 27 members were above that threshold, many of them hugely so Ireland had a budget deficit of 13.1 per cent of GDP, Greece 9.1 per cent, Spain 8.5, Britain 8.3. But they also have very high unemployment and shrinking economies. More austerity will mean far more pain ahead.
The austerity push is driven by Europe's most successful economy, Germany, which is booming due to its state-of-the-art manufacturing industries, especially in machinery. Germany is prepared to add a "growth package" to the austerity pact, which would focus on infrastructure investment and be financed by the EU. There is debate over what more should be done to safeguard the banks. Should the European Central Bank, for example, became a lender of last resort if banks face a run by depositors? Should it invest in the banks when governments lack the capacity to do so and private investors lack the trust?
But on one key question, the EU has not budged. EU President Jose Manuel Barroso has drawn the line at renegotiating the fiscal pact itself, even though its economic (and political) consequences look increasingly dangerous. With all the austerity imposed in Greece, for example, it is running a bigger budget deficit now than when it started, because its economy has shrunk 20 per cent. It's like a dog chasing its tail. You can't generate growth through austerity.
Perhaps the real options will emerge after the Greek election on June 17. The EU and Germany want Greek voters to make it a referendum on whether or not they should stay in the eurozone. But if last week's market plunge continues, or the run on the banks in Greece and Spain gathers strength, time may not be on the EU's side. And it is hard to see where a real solution lies.