Mounting Evidence GOP Spending Cuts Are Recovery-Killers

As if any more evidence was needed to prove that drastic U.S. spending cuts is a recovery-killer, the euro zone debt crisis dragged the bloc into its second recession since 2009 in the third quarter despite modest growth in Germany and France, data showed on Thursday.

Two quarters of contraction put the euro zone’s 9.4 trillion euro ($12 trillion) economy back into recession, although Italy and Spain have been contracting for a year already and Greece and Spain are suffering outright depressions.

A rebound in Europe is still very far off. The debt crisis that began in Greece in late 2009 is still reverberating around the globe, especially the U.S.,  and holding back a lasting recovery.

Analysts said even the euro zone’s top two economies were likely to succumb in the final three months of the year.

A Reuters poll of more than 70 economists predicted the bloc’s new recession will extend until the end of the year and 2013 promises little better than stagnation, in line with what the Commission is forecasting..

The Real Causes of the Crisis

There was a big build-up of debts in Spain and Italy before 2008, but it had nothing to do with governments. Instead it was the private sector – companies and mortgage borrowers – who were taking out loans. Interest rates had fallen to unprecedented lows in southern European countries when they joined the euro. And that encouraged a debt-fueled boom.

All that debt helped finance more and more imports by Spain, Italy and even France. Meanwhile, Germany became an export power-house after the eurozone was set up in 1999, selling far more to the southern Europeans than it was buying as imports. That meant Germany was earning a lot of surplus cash on its exports to other bloc members. And guess what – most of that cash ended up being lent back to southern Europe. By “allowing” the southern euro zone countries to join the bloc by enticing them with German loans for German imports, Germany essentially got them hooked on the German goods, then raised the rates and prices for goods once the deal was done.

But debts are only fraction of the problem in Italy and Spain. During the boom years, wages rose and rose in the south (and in France). But German unions “agreed” to hold their wages steady. So Italian and Spanish workers now face a huge competitive price disadvantage. Indeed, this loss of competitiveness is the main reason why southern Europeans have been finding it so much harder to export than Germany.

So to recap, government borrowing – which has blown up since the 2008 global financial crisis – had very little to do with creating the current eurozone crisis in the first place, especially in Spain (Greece’s government is the big exception here). So even if governments don’t break the borrowing rules this time, that won’t automatically stop a similar crisis from happening all over again.

Spain and Italy are now facing wicked recessions, (Spain is in a full-blown Depression with unemployment over 25% and unemployment in the 18-35 yr old group over 50%) because no-one wants to spend. Companies and mortgage borrowers are focused on repaying their debts rather than spending to create demand. Exports are uncompetitive. And now governments – whose borrowing has exploded since the 2008 financial crisis savaged their economies – have agreed to drastically cut their spending back as well. This is exactly how the Great Depression occurred in the 1929.

The Dilemma

So now southern European countries have a wicked dilemma:

Cut spending :

  • And you are pretty sure to deepen the recession. That probably means even more unemployment (already over 25% in Spain), which may push wages down to more competitive levels – though history suggests this is very hard to do. Even so, lower wages will just make people’s debts even harder to repay, meaning they are likely to cut their own spending even more, or stop repaying their debts. And lower wages may not even lead to a quick rise in exports, if all of the European export markets are in recession too. In any case, they can probably expect more strikes and protests, and more nervousness in financial markets about whether they really will stay in the euro.

Don’t cut spending…

  • And you risk a financial collapse. The amount borrowed each year has exploded since 2008 due to economic stagnation and high unemployment. But the economy looks to be chronically uncompetitive within the euro. So markets are liable to lose confidence in them – markets may fear the euro zone economy is simply too weak to support their ballooning debt load. Meanwhile, other European governments may not have enough money to bail them out, and the European Central Bank says its mandate doesn’t allow it to do so.

And if they won’t lend to their own, why would anyone else?

Harvey Gold

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