by Elliott Morss, Morss Global Finance
In earlier articles, I have talked of the “weak sisters” (Greece, Italy, Portugal and Spain) together, arguing they will never be able to compete with Germany and other more “efficient” Eurozone countries. Of course, each weak sister is different. In this piece, I consider each separately and whether the German/IMF ongoing austerity pressures will lead to a major crisis.
For what follows, remember that without their own currencies, Eurozone countries can “run out of money” in two ways:
- If governments cannot borrow, they cannot run deficits. This means their expenditures will be limited to the taxes and fees they can collect. This is significant inasmuch as the government deficits of the “weak sisters” are averaging more than 5% of GDP.
- If countries pay out more for imports than they take in and nobody will lend them money, they will exhaust their international reserves and draw down their domestic money supplies (Euros will be paid out to make up the deficit). This reduction will cause domestic interest rates to rise and add to recessionary pressures. This is a problem for “weak sisters” inasmuch as their current account deficits are averaging about 4% of GDP.
By these standards, Greece is in a lot of trouble. Below, I consider the problems facing each “weak sister” and the likely effects IMF/European Commission/European Central Bank (IMF/EC/ECB) austerity policies.
Recent news: “Antonis Samaras, the Greek prime minister, approved a package of €11.5 billion ($14.8 billion) in budget cuts. The following day a general strike was held….”
Table 1 provides data on what is happening in Greece. Nobody wants to make loans the Greek government. The IMF/European Commission/ECB (IMF/EC/ECB) is lending the Greek government money contingent on it reducing its deficit and “labor market reforms”. Between 2010 and 2011, the government reduced its deficit by 1.3 percentage points. By the end of 2012, the government in theory (still a work in progress) will reduce it by another 2.3 percentage points. Together, that amounts to 3.6 percentage points. In an earlier piece, I estimated that such a reduction would cause an increase in Greek unemployment of 2.5 percentage points. In actual fact, the unemployment rate has increased by much more: from 12.5% in 2010 to a seasonally adjusted 25.1% (National Statistical Service of Greece) at the end of July.
Looking ahead, the IMF/EC/ECB are calling for further deficit reductions of 5.2 percentage points over the next two years. Using the same calculus as used above, that would cost a 3.5 percentage point increase in unemployment. So if the unemployment rate today is 24.4%, it will grow to 27.9% in 2014 as a result of the government deficit reduction. Keep in mind there other IMF/EC/ECB policies being pushed for “labor market reforms”. The effect of these policies will be to fire redundant workers and reduce salaries – more unemployment. Can Greek politicians allow this to happen? I doubt it. If they try, riots will become severe and they will be thrown out of office.
Then there is the large Greek current account deficit. While falling, it is still large. How long will the IMF/EC/ECB finance it?
The Greek situation remains untenable.
Recent news: “An anti-austerity rally outside the Spanish parliament building in Madrid turned violent, ahead of a budget presented by Mariano Rajoy, the prime minister.”
The Spanish situation is not as desperate as Greece. Its debt is still less than 100% of its GDP and its current account deficit is not as severe. But like Greece, the austerity squeeze is being applied. I quote from a recent IMF Staff Report:
“On July 10, the Council of the European Union issued a recommendation giving Spain another year (until 2014) to reduce its deficit below 3 percent of GDP and loosening the targets for 2012–14. The new path for the overall deficit is: 2012, 6.3 percent of GDP (previously 5.3); 2013, 4.5 percent of GDP (previously 3.0); and 2014, 2.8 percent of GDP (previously 2.2). To achieve this path, the Council called for an average annual improvement of the structural balance of almost 2½ percent of GDP over this period. The new path is in line with IMF staff recommendations.”
Okay. What will this mean?
Spain is like Greece in that it has a high unemployment rate. Haver Analytics estimated Spanish unemployment to be 25.1% last July. So what effect will reducing the government deficit from 6.3% to 2.8% of GDP have? The loss in aggregate demand resulting from the deficit reduction should cause the unemployment rate to increase by 2 percentage points.
As in the Greek case, this is probably not politically feasible.
Recent news: “The Portuguese government was criticized for caving in to pressure from unions and business groups when it reversed a decision to finance a cut in corporate taxes by increasing workers’ pension contributions. It is now to make up the shortfall by raising taxes and cutting wages. Portugal, too, braced itself for anti-austerity protests.”
The Portuguese government debt is high, and in 2012, the unemployment rate increased dramatically. In the next two years, the government is supposed to cut its deficit by 2.2 percentage points. That should increase unemployment by another two percentage points.
A major Euro crisis will probably not start in Portugal, but the country could certainly get caught up in one.
Recent news: “Mario Monti, Italy’s prime minister, declared that he “will not run for the election” next year….Meanwhile Silvio Berlusconi, Mr. Monti’s predecessor, accused him of being ‘too servile’ to Germany.”
As Table 4 indicates, Italy’s biggest problem is its government debt. In addition, its unemployment rate continues to grow. And Monti has agreed to cut its government deficit by another 1.2 percentage points over the next two years. That means the unemployment rate will continue to grow.
Berlusconi is waiting in the wings. Where will this all lead?
The IMF/EC/ECB is sleepwalking. It is acting as if all they have to do to “make things right” is to force “weak sisters”’ government deficits down and bail out the banks that made foolish loans to their governments.
There are two problems with this strategy:
- the deficit reductions they want would generate politically unacceptable unemployment and
- even if the deficits were eliminated, the current account deficits will continue to grow because the “weak sisters” cannot compete with the stronger Euro nations.
The Eurozone continues to be a ticking time bomb. Riots, political turmoil and general uncertainty will continue.
© 2012 Elliott R. Morss, Ph.D.