Friday, 7 February 2014

Austerity Strikes Back

The tale of the hard-working North vs the lazy South has been cited again and again during the past couple of years, mostly from Northern politicians who saw the on-going crisis as an opportunity to promote their own agendas. At the core of this "argument" was the self-assuring conviction that "we do not need them (the South), they need us". Through an array of measures mostly aimed at austerity in order for state financials to regain their vigor, the North is surprised at the increasing debt-to-GDP ratio in the short-run and is accusing some of the South for not pushing through enough reforms.

As has been explained before, when GDP goes down, debt has to decrease by much more in order for the debt-to-GDP ratio to remain constant. Yet, this will obviously not be the case as the economy contracts much faster than the GDP can be reduced. In addition, when policies are based on austerity, results are usually much harsher for citizens than when they are not. Even though many have failed to see it at the time of implementation, austerity measures in the periphery also affect the North. The simple rationale behind this is that the North was (until now) basically exporting while the South was largely importing goods; the heavy reliance on each other was more than evident as in 2010, no country in the Eurozone had less than a 57% share of intra-EU exports.

Yet, many continued to think that a heavy reliance on exports was a sign of a "vibrant economy" which would lead to higher wages and higher domestic demand. The brief answer is a big fat no. You see, the issue here is that heavy reliance on exports means heavy reliance on the well-being of your neighbours; if your neighbours are poor it means that they buy much less from you than if they were rich. Simply put, reliance on exports means that if they go down, they take you down with them. 

The issue is not new. Some of us have already discussed this in detail, and warned that this situation cannot go on forever. We were (unfortunately for the citizens of the North which are not to blame for the mistakes of their governments) correct. The latest data show something quite startling: Retail trade in December 2013, the month which generally signals the peak in consumer spending, has decreased by 1.6%, compared to November.
In monthly terms, Portugal and Spain were the leaders in the drop, although this did not come as a surprise. The "surprise" is that Germany, Austria, Belgium and Finland have also seen a sharp drop in retail spending. What is even more astonishing is that on a year-to-year basis,  Germany, Belgium and Finland lead the race in the drop. As if this wasn't enough bad news, the bank de-leveraging procedure which has been going on in the periphery appears to have started in the North as well. Germany, Austria and France saw total bank loans to non-financial corporation reduced by 1%, 1.1% and 1.5% respectively, and even if this is not large compared to what happened in the periphery (and Slovenia with the extraordinary 23.8%) it is indicative of the worsening situation in the region.
As a result of de-leveraging and the decrease in spending, inflation in the Eurozone has dropped to 0.7% on an annual basis. Even though just 4 out of 28 countries experience deflation, the rest are barely above 1%; only Austria is close to the ECB mandate of 2%.

North's problem can be reduced to two simple words: no demand. You see, as others also note as well, while banks are not currently in a large need for de-leveraging and are more than willing to lend their excess funds, they cannot do it in their domestic markets as people, in contrast to what most monetary authorities would suggest, are not willing to borrow even at near-zero rates. Less borrowing means less spending, or in economic terms less demand. This results in deflation, which in its turn ends up being a self-perpetuating situation (unless this is stopped as Irving Fisher noted in 1933). As consumption comprises more than 2/3's of GDP, output falls when consumption is reduced.

The situation has begun evolving in Finland where output decreased by 1.1% in November 2013 compared to the previous year, with the same thing occurring in October 2013. The 0.4% contribution to GDP growth led by net exports in the country in 2012, is unlikely to be repeated until demand in the South picks up. With the main forces of the decrease in the 2013 GDP being domestic demand and inventories (both driven by consumption and demand) the path appears to be same as Germany where net exports are expected to take growth down with them in 2014. Even though the country's trade balance has also fallen in December, the effect of local demand, which fell by 1.6% has taken its toll in factory orders in the last month of 2013.

As the gains from trade are not translated into higher domestic demand (either by credit or directly), these have to be tunneled somewhere: housing prices in Germany have soared by at least 25% (in some cases more than 35%) since 2008. The Lehman story has taught us that housing bubbles are not a good thing; actually Deutsche should remember its experience better. With the rest of the Eurozone decreasing imports and domestic demand where does the North expect to ship that 20% of GDP in intra-Eurozone exports and how is it going to sustain the level of GDP currently obtained if domestic demand is also shrinking?

1 comment:

  1. I really enjoyed reading your article. I found this as an informative and interesting post, so i think it is very useful and knowledgeable. I would like to thank you for the effort you have made in writing this article.