I feel like I’m missing something. The media is obsessing over the latest eurozone summit, but as far as I can tell Sarkozy and Merkel have proposed nothing that would make the slightest difference to the eurozone’s immediate problems. As Detlev Schlichter puts it:
[The] Fact is this: Around the world government spending, budget deficits and accumulated debt loads are unsustainable in light of real underlying economic strength and the true available pool of private savings. But the modern welfare state cannot shrink. Nobody in the political machinery has any idea how it should be done. The fiat money economy is not built for deleveraging and the welfare democracy not for downsizing.
The Sarkozy-Merkel plan is, I think, a confidence trick (albeit with a few growth-destroying tax measures thrown in for good measure). It is nothing more than a grand political gesture designed to fool people into thinking that eurozone governments are really serious about running balanced budgets in the future, and therefore ought to be lent money now at low rates.
But how long would it be before it became clear that governments weren’t actually going to reduce spending? Or that higher taxes wouldn’t necessarily deliver more revenue? Or that these economies were so weighed down by debt, so distorted by unsustainably cheap credit, and so tied up in red tape that there was no growth coming any time soon? Call me a pessimist, but I don’t think it would take long.
And then you’re back where you started: with debt you can’t afford to refinance, spending commitments you can’t fund cheaply or get out of, and a financial sector that will go to the wall if you eventually hold your hands up and accept the fact that you’re bust. Perhaps a fully-fledged fiscal union in Europe, with large scale redistribution from some regions to others, would put off that day of reckoning for a while – but only at the cost of locking the healthier economies into the same fatal spiral as the PIGS.
It’s not going to happen anyway. More likely is the option favoured by mainstream economists and commentators: have the central bank monetize the debt by buying up government bonds. Once again, Detlev Schlichter’s on hand to explain the big problem:
The overall size of the operation would soon be such that concerns about inflation must rise, and once real interest rates begin to go up deficits will expand even faster, forcing the ECB to buy ever more bonds. A spiral of ever higher real rates, more central bank bond buying, and in turn rising inflation expectations and even higher real interest rates is the classic fiat money endgame.
Ultimately, there is no easy way out, and no crisis summit is ever going to discover one. Who knows? We might muddle through somehow and get away with a decade of stagflation. But I wouldn’t count on it.