Only Keynes Can Save Europe

Recently I have reported on the changing tone among Europe’s political leaders when it comes to austerity. The change came after the French government basically declared that it would not be able to unite around the same kind of job-destroying policies that the EU so viciously had forced upon France’s southern neighbors. But rather than admitting that their austerity policies have been a disaster for Europe, the Eurocrats simply shifted foot, declaring plainly that austerity had done its job.

Given the death of jobs and destruction of prosperity from the Aegean Sea to the Iberian peninsula, this is more than a little arrogant. It is political elitism coupled with a disdain for the lives of regular citizens.

It is, in one word, Eurotarianism.

If the EU Commission really cared about the citizens whose taxes are paying for their lavish lifestyle, they would pay a lot more attention to mundane things like, oh, the GDP growth rate of the euro zone. As technical and yawn-inspiring as that figure might be, it is still one of the best indicators of whether or not austerity is working. (Let’s not forget that Greece, Italy, Spain and Portugal are still enforcing austerity policies, despite the new words hot-airing out of the mouth of some Eurocrats.)

A good place for them to start learning about reality would be a recent article in Euractiv about the sluggish – to say the least – European economy:

The eurozone economy shows little sign of recovering before the year-end despite an easing of financial market conditions, European Central Bank Mario Draghi said … after interest rates were left at a record low. The ECB held its main rate at 0.75%, deferring any cut in borrowing costs … .

The common belief among parishioners of the Austrian school of economics is that so long as a government balances its budget a so called natural interest rate will emerge that will encourage entrepreneurs to invest and expand their production capacity. Regardless of the budgets of EU’s member states, if it was true that a low interest rate encourages investments, then a rate of 0.75 percent should have entrepreneurs all over Europe flocking to the banks.

Do you see that happening?

Neither does Euractiv, which reports that the ECB is also ready to keep interest rates down through its bond buying program:

The central bank has said it is ready to buy bonds of debt-strained governments such as Spain and Italy once they sign up to a European bailout programme with strict conditions, under a programme dubbed Outright Monetary Transactions (OMTs). So far no request has been made, but the announcement alone has calmed markets.

And is thereby keeping interest rates down. How surprising. The ECB has explicitly said that “we will use our money printers to churn out whatever trillions of euros it takes to buy every single treasury bond from Spain, Italy, Greece and Whateveristan, from now until Sweden freezes over”. When owners of even the junkiest of euro-denominated treasury bonds know that they can always get their money back, no matter how bad things get, then of course they will rest easier.

The problem is of course that at some point they will have had to print so much euros that owners of bonds outside the euro zone will want to secure the exchange rate of the currency. That becomes increasingly difficult if the ECB is going to flood the world with euros just to save its member states from the financial junk yard.

No one can say for sure when that point will come. Doomsday preachers have cast a spell on the U.S. dollar for years, yet it still stands relatively strong. That does not mean the doomsdayers are wrong – all it means is that we simply do not have enough examples of collapsing currencies to predict where either the Federal Reserve or the ECB will have printed too much money for their own good.

But long before we find that out, we will find out that the low interest rates the come with excessive money supply are not going to get the wheels turning in the economy. There is a very simple reason for that, which we will get to in a second. First, back to Euractiv:

Gloomy data this week indicated the eurozone economy will shrink in the fourth quarter, which the ECB could eventually respond to by cutting rates. Recent survey evidence gave no sign of improvement towards the end of the year and the risks surrounding the euro area remain on the downside, Draghi said. He signalled the ECB would downgrade its GDP forecasts next month, describing “a picture of weaker economies”, and said inflation would remain above the ECB’s target for the rest of the year, before falling below two percent during in 2013.

It is interesting that inflation is above two percent in an economy – the euro zone – that is at a complete standstill when it comes to GDP. While we will have to wait for the micro data behind the inflation number to know exactly where it comes from, my bet is that it is caused by tax increases and terminated government subsidies in austerity-ridden countries. The private sector is always quick to pass on such explicit and implicit tax hikes, even in tough economic times.

Pricing in modern economies is typically done on a mark-up basis where producers and seller review prices about two times per year. (If your microeconomics professor told you anything else, then I’m sorry for the rude awakening…) This means that if we have austerity measures being put into place this spring with a direct effect on consumer prices, we will see repercussions in inflation data for the rest of the year.

That said, inflation above two percent and interest rates at rock-bottom levels is actually – according to standard economic theory – a good recipe for investments. You see consumer prices on a slow upbound trajectory, which tells you that if you lock in your costs today you have good reasons to expect profit margins in the future. At the same time, with very low interest rates you have good reasons to believe that you will lock in those low costs.

So why aren’t they investing?? Patience, my young padawan. Uncle Keynes will give you the answer in just a moment.

Euractiv again:

Before making any decision to cut rates further, the ECB will focus on making sure that its looser policy reaches companies and households across the eurozone, a mechanism that has been broken by the bloc’s debt crisis. The new bond purchase plan is the ECB’s designated tool but it can only be activated once a eurozone government requests help from the bloc’s rescue fund and accepts policy conditions and strict international supervision.

Which is technospeak for “more austerity”. Despite the hot air from Barroso, nothing has changed in the conditions that the ECB attaches to its bail-out program for debt-mired member states. Governments in already-suffering countries know that if they try to push more tax hikes and spending cuts on their citizens they will have an armed revolution on their hands – or be booted out of office in the next election and replaced by Nazis or “Bolivarian” communists. They obviously don’t want this to happen.

The problem for the ECB is that their bond-buying pledge has now calmed the markets, but the member states have not accepted the terms of the program. This means that in effect, the program is worthless. In order to avoid losing credibility the ECB is going to have to relax the conditions attached to the program, not now but in a year or two. The reason is that the countries in Europe’s dungeon of debt will not recover from their current crisis.

Why won’t they recover? Because their fiscal policies are still geared entirely toward balancing the budget in the midst of zero or negative growth and very high unemployment. With too few taxpayers and too many entitlement consumers indebted governments continue to run deficits – and therefore continue to try to close those gaps with the same policies that brought about the depression in the first place.

In order for those economies to start growing again the hopelessly indebted governments must give the private sector room to spend money. So long as consumers are pushed to the end of their finances by high taxes and unemployment they won’t spend. If they don’t spend there won’t be any demand for consumer products, services, houses, cars, food, clothes, haircuts, vacation travel services, books, plumbers, painters, carpenters, restaurants, recreational services like spas and gyms…

Which brings us back to why entrepreneurs are not taking advantage of virtually free money. They have no reason to believe that they will get their money back in the form of sales revenue.

People have cut their spending today, which according to the pastors of the Church of Mises and Menger means that they will increase spending by the exact same amount at 1:20PM on Monday. Keynes, however, had a more sober analysis. Here is how he opened Chapter 16 of his General Theory of Employment, Interest and Money:

An act of individual saving means — so to speak — a decision not to have dinner to-day. But it does not necessitate a decision to have dinner or to buy a pair of boots a week hence or a year hence or to consume any specified thing at any specified date. Thus it depresses the business of preparing to-day’s dinner without stimulating the business of making ready for some future act of consumption. It is not a substitution of future consumption-demand for present consumption-demand,— it is a net diminution of such demand. Moreover, the expectation of future consumption is so largely based on current experience of present consumption that a reduction in the latter is likely to depress the former, with the result that the act of saving will not merely depress the price of consumption-goods and leave the marginal efficiency of existing capital unaffected, but may actually tend to depress the latter also. In this event it may reduce present investment-demand as well as present consumption-demand.

Only Keynes can save Europe. It would take an enormous load of work, though, to allow his theory of effective demand to actually go to work in the European economy. While economically possible, I seriously doubt that there is enough political will power to allow that to happen. It would mean that those who have gained enormous political power both in the Eurocracy in general and among the austerity merchants, will have to take more than a few steps back.

I frankly don’t think this is politically possible. I am fairly certain that Europe has gone so far down the path of austerity and big government that it won’t ever come back again. But this message from Uncle Keynes could serve as an excellent reminder for American lawmakers to get their own house in order – the right way.

The Keynesian way.


  1. PorterSweden

    Keynes Inflation Policy is *** STEALING *** from the ignorant and savers.
    It transfers money from the poor, while enriching the wealthy. Grossly immoral to say the least.
    It may be the last prescription, before we all end up in economic misery and tyranny.