Stratfor Agrees with Liberty Bullhorn

The European crisis is gaining more and more attention. Two days ago George Friedman, founder of the global intelligence research firm Stratfor, wrote an interesting article about the fragile state of affairs in Europe:

The global financial crisis of 2008 has slowly yielded to a global unemployment crisis. This unemployment crisis will, fairly quickly, give way to a political crisis. The crisis involves all three of the major pillars of the global system — Europe, China and the United States.

Just a quick note: the initial crisis was financial on the surface, but underneath it was the crisis of the welfare state, a system of entitlements and taxes that has been structurally unsustainable for a long time. For each recession since the oil crisis in 1979 the European welfare states have been nudged a little bit closer to the point where they become acutely fiscally unsustainable. With this recession came the point where Europe’s big entitlement systems finally overburdened their host organism, the private sector.

As the welfare state began falling apart, the EU-ECB-IMF troika set out to save it with harsh, depression-inducing austerity policies. The medicine made the patient worse, which is why there is an unforgiving unemployment crisis sweeping across Europe – with, yes, a political crisis on its tail.

Mr. Friedman does not see the welfare state’s role in this, but his analysis is nevertheless important. He points out that the exact nature of the crisis varies from country to country, but…

there is a common element, which is that unemployment is increasingly replacing finance as the central problem of the financial system. … Last week Italy held elections, and the party that won the most votes — with about a quarter of the total — was a brand-new group called the Five Star Movement that is led by a professional comedian. Two things are of interest about this movement. First, one of its central pillars is the call for defaulting on a part of Italy’s debt as the lesser of evils. The second is that Italy, with 11.2 percent unemployment, is far from the worst case of unemployment in the European Union. Nevertheless, Italy is breeding radical parties deeply opposed to the austerity policies currently in place.

This is exactly the point that I have been making for more than a year now. Glad to see others are paying attention.

The core debate in Europe has been how to solve the sovereign debt crisis and the resulting threat to Europe’s banks. The issue was who would bear the burden of stabilizing the system. The argument that won the day, particularly among Europe’s elites, was that what Europe needed was austerity, that government spending had to be dramatically restrained so that sovereign debt — however restructured it might be — would not default.

Then Mr. Friedman reveals that he has been glancing at this blog – how else would he reach the conclusion that austerity is bad for the economy…? No one else makes that point:

One of the consequences of austerity is recession. The economies of many European countries, especially those in the eurozone, are now contracting, since austerity obviously means that less money will be available to purchase goods and services. If the primary goal is to stabilize the financial system, it makes sense. But whether financial stability can remain the primary goal depends on a consensus involving broad sectors of society. When unemployment emerges, that consensus shifts and the focus shifts with it. When unemployment becomes intense, then the entire political system can shift.

It is unclear how austerity would save the financial system – the banks – even from the perspective of someone who truly thinks austerity is good for the economy. All that austerity does, according to its many supporters, is to reduce the budget deficit which raises the price of treasury bonds and reduces, perhaps even reverses, the upward pressure on interest rates.

The only link to the banking system is that they have invested heavily in treasury bonds and that austerity – if it worked according to its theory – would then improve their balance sheets. It appears to be the case that banks did indeed load up with treasury bonds prior to this recession, an aggravating circumstance that – given the destructive nature of austerity – could prolong or even accelerate the recession. Mr. Friedman does not clarify if he shares this view of where the banks fit in to the crisis picture.

He does, however, make the important observation that the Italian election is more of an accelerator than a brake pedal in the ongoing European crisis:

Only four countries in Europe are at or below 6 percent unemployment: the geographically contiguous countries of Germany, Austria, the Netherlands and Luxembourg. The immediate periphery has much higher unemployment; Denmark at 7.4 percent, the United Kingdom at 7.7 percent, France at 10.6 percent and Poland at 10.6 percent. In the far periphery, Italy is at 11.7 percent, Lithuania is at 13.3 percent, Ireland is at 14.7 percent, Portugal is at 17.6 percent, Spain is at 26.2 percent and Greece is at 27 percent. … more than half of Germany’s exports go to other European countries. Germany sees the European Union’s free trade zone as essential for its survival. Without free access to these markets, its exports would contract dramatically and unemployment would soar.

And with the escalating crisis in the EU, the German economy is in trouble. The latest forecast is that the German GDP will contract for this year, but let’s not forget that the situation gets worse with each forecast, as forecasters see that the real world is faring worse than they predicted.

In other words, Mr. Friedman is right on the euro here, and he reinforces his point by explaining how the structure of the euro zone might actually aggravate the current crisis:

The euro is a tool that Germany, with its outsized influence, uses to manage its trade relations — and this management puts other members of the eurozone at a disadvantage. Countries with relatively low wages ought to have a competitive advantage over German exports. However, many have negative balances of trade. Thus, when the financial crisis hit, their ability to manage was insufficient and led to sovereign debt crises, which in turn further undermined their position via austerity, especially as their membership in the eurozone doesn’t allow them to apply their own monetary policies.

This is indeed a very important analysis of the role that the euro plays in the crisis. Germany, says, Mr. Friedman, has by design or by intent rigged the euro zone so as to be to its own foreign-trade advantage. So long as the weaker economies were on board with the stability and growth pact this was a game Germany could not lose. But once the debt flood gates opened in Greece, and the EU rushed in with its austerity demands, it was only a matter of time before the crisis would hit Germany.

The euro zone’s artificial terms-of-trade relations work both ways, with menacing symmetry.

Mr. Friedman then moves on to a discussion about the geo-political consequences of the economic crisis:

Portugal, Spain and Greece are in a depression. Their unemployment rate is roughly that of the United States in the midst of the Great Depression. A rule I use is that for each person unemployed, three others are affected, whether spouses, children or whomever. That means that when you hit 25 percent unemployment virtually everyone is affected. At 11 percent unemployment about 44 percent are affected.  … in Greece, for example, pharmaceuticals are now in short supply since cash for importing goods has dried up. Spain’s local governments are about to lay off more employees. These countries have reached a tipping point from which it is difficult to imagine recovering. In the rest of Europe’s periphery, the unemployment crisis is intensifying. The precise numbers matter far less than the visible impact of societies that are tottering.

I would disagree about the role of the numbers. But be that as it may. Mr. Friedman is expressing great concern about what the future holds for the countries in Europe that are now effectively in a depression. I am entirely on board with his statement that it will be difficult for Greece and Spain to come back from this, though I also know that the day they decide to structurally eliminate their welfare states things will get a lot better.

That is, however, little more than a dream right now. In the way of such fundamental reforms lies, e.g., the stubborn and very destructive support among Europe’s political elites for a continuation of austerity.

Mr. Friedman sees a glimmer of hope on that front, though he does not quite define it that way:

The idea that the Germany-mandated austerity regime will be able to survive politically is difficult to imagine. In Italy, with “only” 11.7 percent unemployment, the success of the Five Star Movement represents an inevitable response to the crisis. Until recently, default was the primary fear of Europeans, at least of the financial, political and journalistic elite. They have come a long way toward solving the banking problem. But they have done it by generating a massive social crisis. That social crisis generates a political backlash that will prevent the German strategy from being carried out. For Southern Europe, where the social crisis is settling in for the long term, as well as for Eastern Europe, it is not clear how paying off their debt benefits them. They may be frozen out of the capital markets, but the cost of remaining in it is shared so unequally that the political base in favor of austerity is dissolving. This is compounded by deepening hostility to Germany. Germany sees itself as virtuous for its frugality. Others see it as rapacious in its aggressive exporting, with the most important export now being unemployment. Which one is right is immaterial. The fact that we are seeing growing differentiation between the German bloc and the rest of Europe is one of the most significant developments since the crisis began.

A good analysis indeed. Turning again to Italy, Mr. Friedman concludes:

The Five Star Movement’s argument in favor of default is not coming from a marginal party. The elite may hold the movement in contempt, but it won 25 percent of the vote. And recall that the hero of the Europhiles, Mario Monti, barely won 10 percent of the vote just a year after Europe celebrated him.

In other words, there may be enough political strength building against austerity. I pointed to this after the Greek election in June last year. And already in May last year I explained that the real winners in the welfare-state crisis are the fascists. I am glad to see that Mr. Friedman’s analysis is catching up with mine:

Fascism had its roots in Europe in massive economic failures in which the financial elites failed to recognize the political consequences of unemployment. They laughed at parties led by men who had been vagabonds selling post cards on the street and promising economic miracles if only those responsible for the misery of the country were purged. Men and women, plunged from the comfortable life of the petite bourgeoisie, did not laugh, but responded eagerly to that hope. The result was governments who enclosed their economies from the world and managed their performance through directive and manipulation.  … when we look at the unemployment rates today, the differentials between regions, the fact that there is no promise of improvement and that the middle class is being hurled into the ranks of the dispossessed, we can see the patterns forming. … Whether it is the Golden Dawn party in Greece or the Catalan independence movements, the growth of parties wanting to redefine the system that has tilted so far against the middle class is inevitable.

Indeed. The problem now is where Europe is heading next. If  Mr. Friedman is right in that the support for austerity is coming to an end in Europe, then there are only two ways forward: the freedom-pursuing way to a structural termination of the welfare state, or the authoritarian route led by parties like Golden Dawn. (There are others to factor in, such as the party duo governing Hungary; the Front National in France; the new nationalist coalition in Britain; and the nationalist parties in Scandinavia.)

I have warned of Europe’s authoritarian future for some time now. I wish I did not feel reinforced by Mr. Friedman’s analysis in that being my default forecast for Europe. Nevertheless, as time goes by, the crisis deepens and nothing is done to stop it, the authoritarian alternative gains momentum.

There is a dark cloud hanging over Europe. Let’s hope it won’t spread its darkness beyond the Old World.