European Debt Crisis: This Is How You Should Think About It1 November, 2011, 19:46. Posted by Zarathustra
Tags: Debt Crisis, Economy, Euro Crisis, Europe, Eurozone
Yes, I keep saying that European debt crisis is not solved if, summit after summit, the solution of it is to increase debt, more bizarre financial engineering and impose more austerity.
The way I see the European debt crisis is simple. Euro is like a gold standard, which forces one single monetary policy into 17 countries without having unified fiscal policy. Worse still, these countries’ economies are probably not exactly in-sync, giving some countries inappropriate monetary policy for extended period of time.
As some of these countries’ debts increases, there is no easy option for them to print money because the power of that is now in the hands of the European Central Bank, whose mandate is to maintain price stability of the whole Eurozone. This is the key why heavily indebted countries like the peripheral European countries now have rising funding costs, while countries such as the United Kingdom and the United States look totally fine.
Now, as these peripheral countries can’t print money, they need austerity to get the debt under control in order to restore confidence. But the problem is that, first of all, it is likely going to destroy economic growth, which is then crucial for reducing debt burden relative to the economy, as tax receipts tend to fall in recession, and as the economy shrinks in size, the debt burden will look even worse. Second, austerity makes life even harder for people, not only in places like Greece where the public sector is large. Without independent money printing, these people will have to face the so-called “internal devaluation”, or deflation, and that makes people’s life harder. Not that it cannot be achieved: in fact, Ireland has been faring relatively well, but it is difficult.
So unsurprisingly, people do not like it, because these austerity measures are crushing their living standard. Worse still, it is not doing much as far as cutting debts is concerned. In fact, even imposing 50% haircut on Greece will only cut debt-to-GDP ratio to 120% by 2020, hardly an encouraging figure. So it is hardly surprising that if Greece were to hold referendum on the EU deal, the outcome would indicate that Greek people do not want any of these.
They can buy some more time by floating ideas of leveraging the EFSF every other day, or making up rumours that China is going to rescue (and as I stressed, China’s rescue should be the last thing Europe wants). They can make as many conference calls and have as many meetings as they wish, if the “solution” is to have more debt, more financial engineering and more austerity, it is not going to work.
And unfortunately, there is just no easy solution.