In one of his “Thoughts from the Front Line”, John Mauldin, in speaking of the problem of sovereign debt in the eurozone, reiterates the point he has made many times before, namely that growth is the only solution to Europe’s problems. Moreover, he emphasises that growth can only come when the burden of debt has been shrunk to the level where interest payments on the debt do not cripple the economies concerned.
The point is worth emphasising in the light of the mini bull run that markets have been experiencing through the first two months of 2012. Either Mauldin is right, and the markets have got way ahead of themselves, or he is wrong and somehow gigantic debt doesn’t matter any more.
Mauldin argues that Europe has to address the ongoing trade imbalances between the peripheral nations and the core and that so far it is conspicuously failing to do this. The current Greek bailout and austerity plans do little to address the underlying issue of the productivity differences and disparities in the capital equipment bases of Greece and Germany, for instance. In a few years it may be that austerity impoverish Greeks so much that Greek wages will fall to the point where it becomes attractive for core eurozone nations to set up factories in Greece. That remains to be seen. But it is a hellish road to lay before a people, that much is certain.
Without some way of addressing the trade imbalances, Mauldin points out, the peripheral countries will continue to run up trade deficits with core countries. And since they cannot depreciate their currencies, this will, as he puts it, “render any debt solution moot,” since the trade imbalances will simply drive debt back up again:
“… a country cannot balance its budget while it runs a trade deficit and its citizens and businesses also deleverage…. There must be balance or there must be a mechanism to achieve balance. One cannot solve one problem without solving all three. Either they all get done or none truly get done. You can kick the can down the road by solving problems 1 and 2, but problem 3 will put you shortly back to square one.”
Europe’s current passion for austerity, particularly for Greeks, looks like a solution, but in reality it is simply pushing up deficits by diminishing tax revenues. The Draconian cuts Spain made in January already mean that the 6% deficit target it had set itself for 2012, now looks like being 8.5%. Moreover, even with the majority of PSI players agreeing to a very substantial “haircut” on their debt with Greece, that will still leave Greece grappling with a 120% debt to GDP ratio by 2020. This level of debt is precisely where Italy is now and the Italians are finding that it is a level of debt that is very difficult to cope with. Moreover, they have a real, functioning economy to work with, which the Greeks certainly don’t.
As an aside here, it is worth noting that according to reports in Italian papers, the stresses in the Italian economy are enabling the Mafia to spread its tentacles into businesses at all levels. That is a poison that could yet prove more destructive to the Italian economy than debt. The Russian economy is further down the line of being shot through with corruption and the legacy of that is already poisoning business growth in Russia. One person might be able to steal their way to what looks like sustainable profit, but that is not a road that can support a crowd and it sure as hell can’t support a national economy in the medium term.
These basic and inescapable truths need to be borne in mind when evaluating all the hoopla about Greek deals. It is far better that we have agreement than that we do not have agreement, but the agreements reached so far, such as they are, do not take us anywhere near where Greece needs to go to solve its problems. They’re just “baby steps” along the way, with pitfalls on every hand...
Further reading on sovereign debt
- The Challenges to Slow Growth in the Advanced Economies Just Keep Coming, by Stuart Thomson
- The Unintended Consequences of Globalization, by Paul Wharton
- Goldman Sachs, the Symbol and Essence of What Went Wrong with Western Capitalism, by James Anderson
Tags: austerity budget , bailout , budget deficit , European debt , european sovereign debt , eurozone debt , Greece's Odious Debt , Greek bailout , Greek deal , Greek debt , Italy , John Mauldin , kleptocracy , Mafia , PSI , Russian mafia , sovereign debt , trade deficit