German Chancellor Merkel wishes to stamp out any belief that there is a “magic bullet” to deal with the renewed euro zone crisis. Merkel’s response to the crisis, however, is the fundamental cause of the second-stage of the crisis and it is the product of magical (un)realism – a series of economic myths that she asserts as if they were facts.
Merkel’s rhetoric is intended to ridicule opponents of the Berlin Consensus – the austerity dogma that has thrown the euro zone back into recession and the periphery into depressions. Tens of millions of Europe’s citizens, however, hate the Berlin Consensus’ austerity dogma as recent elections have shown. My colleagues and I have explained many times why pro-cyclical policies (e.g., austerity in response to a Great Recession) make recessions more common and severe. Counter-cyclical fiscal policies are not “magic” – automatic fiscal stabilizers work, they make recessions less common and less severe for reasons that are understood. As we have also explained, it is proponents of austerity as a response to a Great Recession who rely on magic. Paul Krugman’s withering phrase is that austerity proponents are perpetually waiting for the arrival of “the confidence fairy.”
Even large segments of the German people are breaking from Merkel, as her party is routed in state elections in which she brands her political opponents as opponents of austerity. Merkel’s austerity arguments are premised on an initial myth that claims that the periphery is in trouble because they ran huge budget deficits that caused the Great Recession. “Growth on credit would throw us back to the start of the crisis and therefore we will not do that.” The reality is that the right was praising much of the periphery for its budgetary rectitude on the eve of the financial crisis that drove the Great Recession.
Merkel’s strategy is to keep on repeating the debt-origins and TINA (“there is no alternative”) myths more stridently.
“‘So much has been talked about Eurobonds or leveraging. All these measures have come and gone like magic weapons and then it is recognised that they are not sustainable solutions.
Only one thing is and remains sustainable: accepting that overcoming the crisis will be a long and difficult process that will only be achieved if we attack the origins of the crisis, which are the horrendous debts and a lack of competitiveness in some European countries,’ she said.”
Eurobonds would turn the euro into a true sovereign currency and dramatically reduce the extortion that the bond vigilantes can wield now because euro member nations’ sovereign debt is not denominated in their (no longer existent) national currencies. Eurobonds have not been shown to fail – they have not been used because they would succeed. The third myth is “lack of competitiveness” myth. It is code for what we call the “Road to Bangladesh” strategy. The Berlin Consensus’ central goal is a dramatic reduction in working class wages in the EU that is designed to “win” a race to the bottom of wages so that the EU nations can all become net exporters like Germany.
Merkel’s remarks also show that she is spreading two of the most basic and damaging myths an about sovereign financial systems.
“Around the same time, Mrs. Merkel was sticking to her guns on austerity; Europe’s “credibility”, she said, depended on reducing deficits and debt.
“We’re not saying that saving solves all problems,” she told a conference in Berlin. Still, “You can’t spend more than you take in. You can’t live your whole life this way. Everybody knows this.””
The first quoted sentence embraces the myth that governments in a Great Recession can control the size of their budget deficits and debt. As the events of the last year should make clear (and as economics has explained for over a half-century), the steps a nation takes to try to balance the budget during a recession or recovery phase – reducing public expenditures and raising taxes – will reduce public and private sector demand. Demand is already inadequate during a recession, so austerity increases unemployment which further reduces tax revenues and increases the need for public spending. The result is that trying to achieve a balanced budget through austerity can make the deficit, the debt, and unemployment increase instead of decrease.
The second quoted sentence propounds the myth that sovereign governments are just like households. Sovereign governments are not like households. Indeed, they are remarkably unlike households. Here’s one subtle hint about Merkel’s myth – “You can’t live your whole life this way.” That’s a reference to what is true of an individual with a finite life. Governments are not individuals and they do not have finite lives. Merkel’s view in the inerrancy of the myth she is propounding (“everybody know”) is betrayed by her inability to demonstrate that households and nation states are fiscal equivalents.
Nation states are also not like corporations, but it is striking that the proponents of austerity always claim that the household is the relevant analog for the federal government – while ignoring corporations. Corporations have no finite life. They can, perpetually, have debt ratios far greater than nation states. Banks, for example, often had debt-to-capital ratios of 30:1. Why aren’t the deficit hawks railing at corporations’ profligacy? Why aren’t they demanding that corporations end their use of debt? Why are the banks fighting for the right to continue to employ extreme leverage that would make Greece blush?
Nations with freely floating sovereign currencies and their debts denominated in their own currency are vastly less susceptible to attacks from the bond vigilantes. Japan and the U.S. are able to go to the markets (they need not do; they can and do create money via keystrokes) and borrow funds at an interest rate that is very close to zero. The financial markets treated the credit rating downgrade of the U.S. as what it was – an act of striking ignorance about modern monetary systems. The U.S. has throughout its history typically run budget deficits – while becoming the greatest store of wealth on the planet. The eight cases where the U.S. has significantly reduced its budget deficits and sovereign debt were followed by depressions and the Great Recession. That doesn’t prove causality, but the U.S. historical experience shows that running federal budget deficits is the norm – not the road to perdition.
Bill Black is the author of The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.
Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives.
Follow him on Twitter: @WilliamKBlack