All Quiet on the European Front?


In May and June, many mainstream media and “experts” were telling you that Europe was facing imminent disaster: A chain reaction of state bankruptcies in Southern Europe would blow apart the euro currency system and throw the euro zone, if not the whole continent into an economic depression. Merely two months later, the situation looks rather different.

By Michael Liebig

Hamilton Reloaded?

On May 8, in midst a massive speculative attack against the sovereign debt of Southern European countries and the euro currency, the European Union heads of government took a most extraordinary action. They decided to establish a 750 billion euro credit line to defend the sovereign debt of the euro zone member states together with the commitment to cut down budget deficits across all Europe. In addition, the European Central Bank was “authorized” to buy state bonds of EU countries having difficulties to refinance their state debt.

With hindsight, one may argue that EU leaders acted in the spirit of Alexander Hamilton, the first American Treasury Secretary. They did so, even though Italy’s Finance Minister Gulio Tremonti is probably the only public figure in Europe who has some understanding of Hamiltonian economics and its relevance for the EU. After the War of Independence was won in 1782, the 13 founding states were essentially bankrupt. Hamilton argued that the states‘ debt should be guaranteed by the (yet to constituted) federal government, and not be left to the states themselves. As a whole, the states would be able to service their debts more smoothly and clear them faster. Left to their own devices, the individual states would have remained dependent on the financial (and political) conditionalities of their (mostly foreign) creditors. Hamilton calculated that the “common market” of the 13 American states, combined with “dirigist” promotion of infrastructure and manufacturing, would generate the economic resources for rapidly consolidating the public debt. And he was proven right.

Obviously, the EU is no federal state. And the accumulated public debt is is not the result of war, but years of fiscal and economic sloppiness. Still, Hamilton’s basic approach does apply to the EU as well. Those in the EU, like the German Professors Hankel, Strabatty and Schachtschneider who have argued that Greece and other southern European states should declare bankruptcy and be excluded from the monetary union, essentially adopt a “Jeffersonian” position. Opposite to Hamilton, Jefferson advocated “states‘ rights” in a loose Union and wasn’t much concerned about the United States‘ economic and financial independence.

What About a “Haircut”

The EU action on May 8 broke the speculative attack driven by Anglo-American financial institutions. Some funds were released to Greece. Slovakia abstained saying that as a country which is poorer than Greece, it wouldn’t pay for Greek sloppiness; Slovakia however is participating in the EU protective fund. The ECB did buy some state bonds of Southern European countries. The total sum involved in these two measures was probably well below 100 billion euro in the May-June period and should correlated to the EU GDP of some 14 trillion euro. By late July, these support measures had fizzled out. The specter of the “Euro crisis” has gone.

However, defending the sovereign debt of EU member states should not mean that the creditors of the most indebted Southern European countries stay aloof from debt consolidation. Mostly German and French banks gave the credits – knowing they would not be invested productively – and cashed in hefty interest payments. Sooner than later a “haircut” on the Southern European public debt has to negotiated: The banks have to cancel a certain percentage of the outstanding debt; whether that’s 20% or 40% would be a matter of negotiations.

Such debt renegotiations are a standard procedure in banking – nothing spectacular and dramatic. The consolidation of a debtor country’s unsustainable financial condition is the precondition for his economic revival. The core problem in Greece, Spain, Portugal and Italy’s Mezzogiorno is the lack of technologically competitive manufacturing. Addressing that problem, is the decisive means to secure the intrinsic value of the public debt remaining after a “haircut”.

One can safely assume that the German and French banks will do what they can in order to avoid a “haircut” of their outstanding credits in Southern Europe. Even if an early, discreet and orderly write-off of some of their credits is in their own best interest. The banks should know that another 2008-style bailout by the state is no realistic proposition; the state simple doesn’t have the funds for another bailout. Either the banks become “reasonable” on their own, or they have to be forced to act reasonably – before the “markets” do that.

Austerity and Growth?

Talking to the Frankfurter Allgemeine Zeitung on Aug. 9, Italy’s Finance Minister Tremonti said that within the EU a consensus has been reached: “Stability and Austerity”. Why austerity, and not just in Greece or Spain, but in all of Europe? Tremonti’s argument can hardly be disproved:

“In a quasi-colonial world, Europe was able to sell its products at whatever prices it chose and to pile up debts as it liked. That’s not possible any longer, because Europe risks becoming colonialized itself. The crisis has demonstrated that Europe has lived beyond its means. No more living on the nod.”

When Tremonti refers to the danger that Europe might become “colonialized”, he obviously means that Europe becomes a structural capital importer – like the United States, which depends on China’s good will buying (and keeping) $850 billion in U.S. Treasury Bills.

The same Anglo-American financial media which for many years have denounced European social “welfare” states, now argue that budget cuts and austerity measures would drive Europe into deflation and recession. Domestic consumption would contract and unemployment would rise – ending in a depression with global implications. That’s what Paul Krugman has been proclaiming for months.

But again, the Anglo-American forecasts of Europe’s looming disaster went wrong. The key economic indicators in Europe are pointing to accelerating growth. The upswing correlates to the export strength of national economies in Europe – meaning that Greece, Spain and Britain are the notable exceptions. Compared to June 2009, German exports rose 28.5% in June 2010. After a decline of 17.5% in 2009 (compared to 2008), German exports will likely rise 11% in 2010. In 2011, German exports are expected to be back to the 2008 (all-time record ) level of almost one trillion euro. This estimate is based on incoming orders, which for high-technology capital goods (a large part of German exports) have a lead time of 1-2 years. German machine-tool and engineering firms are again working at near capacity.

Europe & the Rising Powers

The current economic upswing across most of the EU is export-driven. Whenever you glance over the business pages of an European newspaper, you can read reports about record-breaking exports to China, India, Brazil or the Gulf states – in almost all manufacturing sectors.

During last May, there was an eerie debate about “trade imbalances”. Of course, Paul Krugman was at the forefront of this debate, but also the IMF and some in France argued that Germany “should export less” and spend more on domestic consumption, which would of course imply forsaking budget cuts and austerity.

It seems, the proponents of this position think that “exporting” is a practice for its own sake, a kind of national obsession. But exports are based on the demand for goods and services on the world market. Such demand is based either on cheap prices or high quality of products. Products are mostly cheap, because the labor force producing them is paid low or miserable wages. German labor costs are high in the manufacturing sector (opposite to the low-skill service sector). But the high labour costs in manufacturing constitute only 10% of the total costs. The bulk of production costs derive from sophisticated and expensive technical equipment and R&D for innovations.

Higher wages and domestic consumption, and forgoing austerity would have no or only marginal effects on German exports, because German exports are based on technological competitiveness, not on competitiveness based on labor costs. For Germany to “export less,” would mean scaling down the standards of technological quality. Evidently, an absurd proposition.

So we have in Europe a paradoxical situation: Fiscal consolidation and austerity and export-driven economic growth. Some may argue that this is merely momentary coincidence; a straw fire that will be rapidly succeeded by another recession or worse. I don’t think so, because European high-technology exports are based on structural demand in the world economy.

When the financial crisis hit the United States and Europe during 2007-08, many intelligent people thought that a world depression was inevitable. Why? They believed in the Anglo-American conception of “globalization” – even if they simultaneously opposed it. They sincerely believed the “West” merely exploited the emerging countries and that a crisis in the USA and Europe would inevitably ruin the emerging economies. They didn’t realize the “quasi-colonial” era was fizzling out precisely while “neo-colonial” globalization seemed irresistible.

Some may concede now that the rise China, India, Brazil and other countries was the “unintended consequence” of globalization – in the sense of Hegel’s philosophy of history. I would think that this is an “eurocentric”, ideological misconception. In reality, the rise of the emerging powers is based on their very own determination to develop and gain genuine economic and political independence. China, for example, used vast capital imports (for productive investments) and vast exports of cheap goods as transitional means for the overall process of its economic development. History does not “happen”, history is being made.

The development of the rising powers‘ economic potential necessitates the import of high-technology products, particularly capital goods, which cannot be copied and plagiarized easily. No matter what conjunctural ups and downs will occur in the world economy, there is a structural demand for high-technology capital goods in Asia, Latin America and Africa for the foreseeable future – at least the next 20 years.

Those economies in the “West” which can meet the demand for high-technology capital goods on emerging markets need not to worry. However, where such capabilities are missing, serious economic and financial problems are preprogrammed. Printing money and massive borrowing are no substitute for high-technology manufacturing and a correspondingly qualified labor force. Therefore, the Federal Reserve’s decision on August 11 to re-start “monetary easing” – buying up Treasury Bills – seems to me a lot more worrisome than fiscal consolidation in Europe. However, European leaders ought to familiarize themselves a bit better with Hamiltonian economics. Hamilton combined fiscal consolidation with developing the real economy, notably manufacturing.

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