Since I last wrote about the euro crisis, events have taken a predictable turn for the worse. In my GoldMoney article dated September 17 I argued that eurozone governments should cut their own spending substantially, while the European Central Bank should restrict itself to working with national central banks to keep the banking system functioning, and that a sound euro is better for private sector recovery than a weak alternative. I also argued that there was a benefit in allowing Greece to default, pour encourager les autres.
Keynesians argue that the worst thing to do is to slash public spending. I would argue that the worst thing you can do is to not cut public spending, because public spending, which dominates most European economies, is a misallocation of economic resources, stifling their private sectors. A public sector is an economic burden, not a benefit, and the strangulation of private sectors in the eurozone is the fundamental economic problem.
Over the years the European Union and its members have become increasingly dominated by central planners and regulators, and the governmental solution to today’s crisis is for more of the same. Already no one in the EU can sell any product without conforming to myriad regulations, and employment laws and taxes on employment are strong disincentives for the expansion of small and medium-size businesses that make up the bulk of any domestic economy.
The deterioration in the underlying quality of private sector business, the result of central planning and needless regulation, has been concealed by the expansion of bank credit, which has fuelled both private and public sector debt. According to the International Monetary Fund, at the end of 2010 gross government debt-to-GDP for the Euro area was 87%, and household debt 72%, giving a total of 159%. Germany itself was running a combined total of 142%, which is often overlooked. On these figures alone, it is clear that the Keynesian solution of more government spending as the route to salvation is unaffordable, whatever the economic arguments.
It is difficult to know if anyone in the EU elite fully understands the problem. Noises emanating from them are extremely discouraging, from their resentment at being pressured at the recent G20/IMF meeting to deal with a rapidly deteriorating situation of which they seemed to be insufficiently aware, to the President of the European Commission’s analysis, which is that the problem can only be solved by closer political integration and new taxes. Their dilemma is not helped by their advisors, who are all highly qualified central planners who have no empathy with private sector business, beyond what they are told by monopolists. They are genuinely upset at and confused by the intrusions of market reality into their plans.
We will not change these people’s views, but their attempts to cross-subsidise their public sectors must be thwarted. This will not be done by the IMF, which is institutionally sympathetic to governments over free markets. The task must fall on the shoulders of the ECB, which is why it is so important that the ECB limits its activities to keeping the banking system solvent and not funding insolvent governments.
It must also resist calls for a weaker monetary stance, beyond what is necessary to keep the banking system functioning. Contrary to every bystander’s advice, you need certainty of monetary values to allow the regeneration of savings and business investment to develop, which is the precondition for economic progress. Let’s hope the ECB is strong enough to stand firm.