Belmont Club

The rain in Spain

Fears that Southern Europe could not maintain fiscal discipline has caused the Euro to plummet and sparked market losses worldwide. News of a Portuguese defeat of a proposed austerity measure, added to reports that Greece is balking at measures which can plug a hole twice the size of the Lehman Brothers abyss and reluctance in Spain to cutting public spending have convinced some investors to conclude that the belt will never be tightened enough.

The VOA describes the situation: “Some analysts predict Greece could be pushed out of the bloc. Also unclear is whether the Greek government will have the political will to carry out the painful fiscal measures it promised — particularly if they spark protests. Spain also faces potential social unrest over its austerity measures. And in Portugal, the parliament on Friday voted down the government’s austerity plan.”  But the real worry was Spain. Neither the collapse of Greece nor Portugal could seriously threaten the Eurozone, but Spain’s much bigger economy could. The Wall Street Journal describes the scenario that has caused the market to fall:  a weak Europe stalls the global recovery and leads to a fall in commodities.  Like an airplane which has lost lift, someone, somewhere has got to get enough airflow over the wings to get the thing flying again. But how?

“The markets are betting on a situation that I don’t think will happen, which is a more extreme situation of default or an economy leaving the euro area,” said Carlos Almeida Andrade, chief economist of Banco Esprito Santo in Lisbon. … “The sovereign-credit concerns are just overwhelming people,” said Peter Boockvar, strategist at Miller Tabak. “It’s one big liquidation. People have been hoping there will be one event that will clear up the problems, but they’re having to realize, it’s going to be a process.” …

The breach triggered numerous sell stops, automatic orders to exit trading positions that many investors set up around major price milestones. Within minutes, oil prices had tumbled to $69.50 a barrel … oil’s free-fall acted as a cue for other commodities to follow suit. Copper sank to its lowest settlement since October… Gold, too, followed oil lower, … ICE March sugar was down 4.5% at 26.44 cents a pound.

“There’s a sense of uneasiness about … how robust the recovery’s going to be.”

The political reaction to the crisis has been to pull back hard on the stick as everyone moves to defend their entitlements. Spain’s Zapatero vows to defend the Euro have been met by hostility from his politial base. The unions have told him to take a hike. Trade union officials asked whether Zapatero wanted “social conflict”: in other words, whether he wanted a fight. There was even talk of a general strike with some saying that if the Spanish Prime Minister wanted to commit “hara-kiri” then it was his funeral. “Si Zapatero se quiere hacer el harakiri, si es su deseo, será su voluntad”.

Unfortunately the unions haven’t quite figured out that they might be commiting hara-kiri as well.  An even deeper crisis in southern Europe is not beyond the realm of possibility.

Events in Europe prefigure the possible negative consequences of President Obama’s pump priming public spending. Large increases in public spending are politically painful to wind down. The administration’s spending binge will lead to a dependence which will not be easy to kick. Rich Lowry describes the “inverse relationship” between public employment and the economic downturn at Real Clear Politics. As the economy falls the public sector rises.

The percentage of federal civil servants making more than $100,000 a year jumped from 14 percent to 19 percent during the first year and a half of the recession, according to USA Today. At the beginning of the downturn, the Transportation Department had one person making $170,000 or more a year; now it has 1,690 making that.

The New York Times reports that state and local governments have added a net 110,000 jobs since the beginning of the recession, while the private sector has lost 6.9 million. The gap between total compensation of public and private workers has only widened during the downturn, according to USA Today. In 2008, benefits for public employees grew at a rate three times that of private employees.

Public employees have developed an inverse relationship to the rest of the economy – as it shrinks, shedding jobs and cutting salaries, they draw on a never-ending taxpayer bounty.

What happens when the time comes to play the movie in reverse and downsize government? Jeffrey Sachs says why downsize it at all? The answer to the deficit is simple: raise taxes. In an article in Time, Sachs argues that America should be more like Europe and up the share the taxman takes. “Compared with those in other rich countries, taxes in the U.S. are low. Yet government spending is persistently higher than taxes: the budget deficit is at a record high for peacetime, and Washington is utterly paralyzed when it comes to addressing urgent needs.” Here’s a list of some of those urgent needs.

Shortfalls in education outlays are shortchanging young people, forcing many to leave college before they graduate because families are unable to cover college tuition. The conversion to clean energy is stymied by a lack of cash. Future NASA missions are being scrubbed. The list is long and perilous. …

The total tax take, federal plus state, amounts to 28% to 30% of GDP. That is more than 10 percentage points lower than the average total revenue collections in Europe. … We need a new political consensus. No doubt the Republicans are just waiting for Obama to reverse his campaign promise on taxes so that they can pounce, just as Democrats did when George H.W. Bush broke his “Read my lips,” no-new-taxes promise. Such is politics, where the first rule is to pander to antitax sentiment. But if we carry on down that road, we will end up with a much deeper fiscal crisis — the kind where the dollar collapses, foreigners stop buying Treasury bills and public services fall apart while inflation soars.

The answer, Sachs says, must be a mixture of tax increases and judicious spending cuts. The problem, apart from the fact that those countries Sachs longs to be like are no longer “rich” (Spain has an unemployment rate of 20%. Youth unemployment is near 40%),  is that the tax increase route may lead to precisely the trap that has imprisoned the Southern Europeans. With a proportionately reduced private sector the economy becomes uncompetitive, tax revenues drop and require even greater tax increases to maintain the beloved level of public “investment”. Demand falls and commodity prices drop. Where have we seen that before? Maybe in today’s news?


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