Let’s face it: everybody enjoys a bit of Germany bashing. And why not? Basically, from the moment it could (when it became a unified country in 1870) to the moment it couldn’t (when it was eclipsed by the superpowers of the USSR and the USA in 1945), Germany was the neighbourhood bully, launching aggressive wars against real or imagined enemies, external and internal. Combine this with a guttural language, a pretty deplorable cuisine, some notoriously aggressive pool-side furniture behaviour and a style of football (a.k.a., “soccer”) that is as boringly methodical as it is successful, and it is no surprise that Germany is a country that a lot of Europeans love to hate.
The latest form of Germany bashing relates to the ongoing Eurozone crisis. The storyline is that the German ogre is imposing an unfair and ultimately self-defeating austerity on the peripheral countries of Europe. If Germany would only do the necessary, then the crisis would end. Here is a good example of this type of thinking.
And what is the “necessary” that Germany is being invited to perform? Not surprisingly, almost all the proposals involve some form of the feckless peripherals reaching into the pockets of the stronger and more prudent members of the currency union, principally Germany, and walking off with a big wad of cash. A particularly flagrant example of this was the proposal for the creation of “Eurobonds”, championed by Francois Hollande and therefore automatically suspect, which would be the joint and several liability of the 17 Eurozone countries. This was a recipe for the likes of Italy and Greece to go on a shopping spree with Germany’s credit card.
This prospect is galling to the Germans for a variety of reasons. First, the German public has always feared that the Eurozone would be a siphon for their hard-earned cash and they insisted on guarantees from the beginning that this would not happen, guarantees that certain members of the Eurozone are now busily trying to circumvent. Second, the German economy has recently more or less recovered from the cost of re-unifying the country, a project that cost the federal state something like EUR 1.3 trillion and for which the Germans received absolutely no assistance from the same neighbours that are now clamouring for European solidarity. Third, the Germans know very well that, without the pressure of some external force, either the market (which has been neutered by the actions of the European Central Bank) or the governmental creditors, the habitually spineless and profligate governments of the southern fringe will never take the hard decisions necessary to improve their economic performance and fiscal position.
Moreover, and contrary to the views of the author of the Venn diagram cited above, it is far from obvious that the measure the anti-austerity camp proposes would be effective. This group believes that the solution for Europe is to follow the lead of the USA, using massive fiscal stimulus financed by printing money (also known as “quantity easing” or “QE” in Bernanke-speak). But a strong case can be made that this policy is not working particularly well in America, even though the conditions for its success are much more favorable here than in a multi-speed Europe. It is also producing some nasty side effects.
The policy of quantitative easing is born of the observation, which is doubtlessly true, that the Great Depression became “great” largely because of the implosion of the money supply following a string of bank failures in the USA and Europe. This is the message of the famous study by Milton Friedman and Anna Schwartz (A Monetary History of the United States, 1867-1960), which argued that central banks were negligent in failing to intervene strongly to offset this implosion. Hence the speech delivered by Bernanke in 2002 at the celebration of Friedman’s 90th birthday: “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right; we did it. We’re very sorry. But thanks to you, we won’t do it again.”
But it is one thing to realize that central banks should have intervened to offset a sharp reduction in the money supply and another thing to continue, as the Fed is currently doing, to lavish money on a largely stabilized system. A recent study by the San Francisco Federal Reserve Bank, under the stewardship of Bernanke’s probable successor (Janet Yellen), found that QE2 only added 0.13% of GDP growth per annum to the US economy. In return for this piddling result, what have been the other consequences of this policy?
First, there is a growing chorus that QE is promoting financial excesses and distortions similar to those that led to the Great Recession. No one active in the markets would dispute this. The most recent voices to be added to the chorus are William White, the former chief economist of the Bank for International Settlements, and Lord Turner, the expert charged by the British government with making proposals for banking reform. In other words, QE is yet another example of the Fed’s tendency, manifested repeatedly under Greenspan, to pursue a “hair of the dog that bit you” monetary policy: the solution to asset and credit bubbles is to create new ones.
Second, QE is a major factor behind the recent rise in income inequality. One of the things that QE is designed to do is to create a “wealth effect”, encouraging household consumption by inflating asset values. (Yes, you heard that right: QE is in part designed to persuade people to increase consumption on the basis of an unsustainable rise in asset values, as if we haven’t all seen that movie before.) The wealth effect has clearly worked, but unfortunately only for the small part of the population which actually owns net assets. This means that the bulk of the income that has been generated since the onset of QE has gone to people who were already well off, whereas the average worker has seen flat or negative real earnings growth. This will inevitably have very negative political and economic consequences.
Third, there is the dreaded problem of the unwind. The recent Fed flip-flops over “tapering” give a hint at the difficulties that this will cause. When the Fed finally had the temerity to hint that it will reduce its level of asset purchases – not stop or, God forbid, reverse them – the markets went into a tailspin and the Fed beat a hasty retreat. But this is nothing compared to the work that the Fed will eventually have to undertake. QE has greatly inflated the monetary base. This has not had a material impact on inflation because the “velocity of money”, the speed with which money circulates in the economy, has moved in a more or less equal and opposite direction. If the velocity of money returns to its historical levels, and there is no reason to believe that it won’t, then the Fed will either have to neutralize this expansion or watch prices skyrocket. It will be difficult to neutralize without creating highly contractionary and disruptive financial conditions, a small taste of which we have just received. To use a favoured metaphor of the economist Friedrich Hayek, the Fed has a “tiger by the tail” and it dares not let loose.
Finally, and returning more specifically to the case of Europe, the anti-austerity policy of borrowing and spending will inevitably increase the debt loads of countries that are already over-indebted. (This is of course happening in America also, but the increase in debt is being largely absorbed by the Fed through QE, which means that the government is borrowing from itself. Note that this statement is only true if reversing QE does not result in the Fed selling government bonds back into the market, at which point this circular borrowing will cease and the Fed will no longer be the creditor of the Treasury.) It is clear that this additional debt for the periphery would never be provided by the private sector, which means that it can only come from governmental lenders (such as the IMF) or, directly or indirectly, the European Central Bank. The IMF won’t play ball with anti-austerity measures, which leaves the ECB as the lender of last resort. Unlike the situation in America, however, the ECB is not merely an arm of the same government doing the borrowing; the periphery would, in fact, be adding to their external debt load by borrowing from the ECB. At which point, the question has to be asked how effective this fiscal stimulus would be.
There is a doctrine in economics called “Ricardian Equivalence”. This doctrine argues that fiscal policy is ineffective since rational tax payers know that eventually the debt will have to be repaid through higher taxation, and they therefore reduce their current consumption in anticipation of this additional tax burden. Now, there are all kinds of reasons to believe that Ricardian Equivalence doesn’t appear in a real world of moderate levels of debt. But the periphery is not in a real world of moderate debt. In fact, today’s austerity in the periphery is nothing but the thunderous noise of chickens coming home to roost from earlier fiscal excesses. I doubt that the tax payers in the periphery, if there are any left, have failed to learn this lesson. They will realize that today’s anti-austerity measures will quickly produce tomorrow’s increased tax bills.
The reality is that there is probably no way for the periphery to borrow their way out of their debt mess. So now we have come back full circle to a periphery dependent on German largesse. They are hoping that there is a little bit left of the German Kriegsschuld (“War Guilt”) that they can tap. I think that Sunday’s election results, where the German electorate strongly supported Merkel’s current policies, show that the Germans feel that they have done enough.
Roger Barris, London