It all began in Horsham, Sussex on 14th March 2009 when finance ministers and central bankers of the G-20 countries met to prepare for the London summit that took place on April 2nd. At the pre-meeting meeting members agreed to restore growth as quickly as possible by coordinated and decisive actions to stimulate demand and employment.
Unfortunately for all the countries of the G-20, including the eurozone countries, this was just what the politicians wanted to hear:- spend more money, cut taxes and pursue a Keynesian demand management policy, which has been tested in theory, but has failed the reality test every time it has been used in the past. However a quick fix of this type is particularly useful just before elections, as for a short period of time it has beneficial effects while the damaging effects lie out of sight.
The only way that a single currency can survive, and it was not a bad idea at the time it was established, is for each member country to maintain a strict fiscal discipline. This was recognised at the start, which is why countries were asked to observe a “stability and growth pact” that required a yearly budget deficit not to exceed 3% of GDP and the accumulated debt not to exceed 60% of GDP.
By the end of 2009 Ireland had a budget deficit of 14.3% of GDP, Greece was 13.6%, Spain was 11.2% and Portugal was 9.4%. Combined with accumulated debt Greece was the biggest over-spender with a national debt of 115.1% of GDP, although Italy was even higher at 119.8%
It is not surprising that all the countries mentioned above are imposing most strain on the Eurozone. At this time Keynesians are saying do not worry and keep your nerve as successive fiscal stimuli will eventually create jobs, accelerate the growth rate, increase tax revenue and close the deficit gap at higher levels of employment and growth: at least that is the theory.
The reality is that for every job created in the public sector more than one job is lost in the private sector. Government spends money inefficiently and stops the private sector spending it more efficiently. The overall effect is negative for jobs and growth and, because the deficit does not close, another deficit will appear the following year and even if next years deficit is smaller it is still expansionary not the austerity which is claimed.
By 2012 budget deficits are still negative and national debts are growing: there are three options.
- Reverse the process by cutting government expenditure dramatically and watch growth stall and unemployment rise until the private sector picks up the slack. There is no political will to do this.
- Get a temporary fix by getting someone to bail you out. The biggest contributors to the bail out fund will not agree to do this indefinitely.
- Get the ECB to inflate away debt by monetary expansion and inflation of about 10% – 20% pa. The ECB will not do this.
So the eurozone will limp along and then suffer a disorderly collapse.
J B Hearn 20/6/12