This article is co-authored with Belgian investment advisor Maarten Verheyen
A Word From Europe
A crisis - a depression in fact - as we know today, (Spain has more than 50% jobless youngsters in a fast shrinking economy), can only emerge from excessive debts. The buildup of those debts has given us the appearance of prosperity for years, but actually we have done nothing less than consuming our future income. This overconsumption of money that has yet to be earned is wiping out economic growth, although we keep denying it until it can no longer be done.
But one day soon the full awakening will come that these debts have become unbearably high. At that point it will be harder and harder to borrow money unless it is against unsustainable interest rates. This is what we see happening already in debt ridden countries as Greece, Spain, Portugal and Italy.
What needs to be done is find a new balance and work towards a period of decreasing the debts creating the problem. The overconsumption of the past needs to be replaced by underconsumption. Spending less money and saving money to bring down the burden. It is the economic shock from overconsumption to underconsumption that leads from a recession to a depression. Such a shock only occurs in countries with an excessive debt problem.
Excessive debts lie at the root of the evil. It is just that we do not seem to realize it yet. The stock markets are still in denial. We acknowledge the necessity for austerity measures and savings, but we're still hoping for economic growth and to avoid recessions. Against our better judgment. It can safely be called irrational exuberance.
In fact, austerity is an opposing force to economic growth. Just imagine your own household having excessive debts. At some point you need to bring those down, or you may lose your house and other assets. You can only bring it down by spending less and use the savings to pay off your debt. This means you need to cut back on luxury and buying power, thus contributing less to the economy. It works the same for governments.
The markets realized rather quickly that the bailout of Spanish banks is only a temporary delay of the problem. Other European countries are lending more money to Spain, just like they did to Greece. The core of the issue remains: Spain has a problem, Spain needs help. Help that may prevent a further downturn, but does nothing to improve Spain's ailing economy. That is something Spain needs to do on its own and according to its Prime Minister things will get worse before they get better. Hence, there was indeed no reason for the Spanish indexes rising 5%.
The tax paying citizens of stronger European countries are paying for this help by austerity measures, tax increases, welfare cuts and so on, weakening their buying power and economies. The money just goes from a strong pocket to a weak pocket, weakening the stronger pocket. It's somewhat like lending money to your bankrupt brother so that he can keep his million dollar home and his BMW on his driveway.
It's like the state of New York lending money to an ailing California. It's just moving funds from one member of the same economy to another, making the one richer, but the other poorer, in hopes to get the money back in spite of a negative track record.
The whole deal does nothing for the improvement of the overall economy. Probably less.
I never understood anyway why private banks have this superior status of preference over ordinary private companies. Why can they always count on being saved by governments, who then present the bill to their taxpaying citizens? Why do these governments never say what they say to other companies that have made a mess of their business: Just fail!
It would be good enough and a lot cheaper to guarantee the savings and pensions of the customers and pour them into another bank instead of keeping the whole bank alive, including its bad management.
If you believe some economists, the source of the problem lies elsewhere. I hear, for example, Krugman say that governments should not worry about increasing debts, but actually step up their spending behavior. That is supposedly the solution for confidence to return and should eventually induce the consumer to start spending again. In other words, Krugman wants to solve the debt problem with more debts.
Well, this was also the solution for Greece. When the country's problems arose in 2010, it was said that a loan of 30 billion euro would be enough to take Greece over the hill. This 30 billion first became 110 billion euro, and two years later an additional 135 billion euro was needed. Then we are still not talking about the billions that the ECB needed to provide to Greek banks. The Greek problem was handled with an avalanche of new debts, but the Greek economy is still sinking deeper into the abyss.
I do not understand why others do not see this. A surplus of debts will eventually strangle every economy.
Kenneth Rogoff described it in his book "This Time Is Different": Once the debt of a country becomes more than 90% of its economy, it becomes impossible to create economic growth.
Actually, I have never understood why governments need to make debts. What is wrong with spending only what you have? What is the difference with every normal household? If you spend more than you earn, sooner or later you will have a problem. Almost every American can testify to that these days.
Speaking of Americans, the markets don't seem to grasp that their debt problem is in fact bigger than Europe's. Since the financial crisis of 2008/2009 the already gigantic national debt has been quadrupled, resulting in a national debt percentage of GDP (over 100%) higher than most European countries.
This was simply done by the Federal Reserve printing money. Quantitive Easing was a more academic word. This policy gave America renewed, though meager, growth on borrowed time and money and can of course not be sustained as sooner or later those debts need to be paid back, which can never be done by raising the debt ceiling until kingdom comes. In short, this story is going to have an ugly ending also, either with shocking defaults, preceded by more downgrades, hyper-inflation or a combination of both.
If you have an annual deficit for social welfare, it is not a solution to finance it with more debt. You can only redistribute what you have. This is also the reason why job reports will keep disappointing for the time being. With twice as many Americans working for government than in manufacturing and construction, you can't expect job creation from a government that needs to cut back on spending in order to relieve its excessive debt.
Without excessive debts you will see confined recessions that will have been forgotten after a year or so. The normal tides of the economy.
However, in a world that drowns in unmanageable debts, such a recession becomes a beast that will turn society upside down and cause years of misery among its population. What we need is not more government, but less. A smaller, more efficient government that puts a brake on debt creation.
In France we see prime minister Hollande who wants to lower the retirement age (yes, you read correctly: lower). He wants to "solve" unemployment by making it so expensive to fire employees that it will be cheaper to keep them.
Let me ask you: How can you have confidence in these circumstances that everything will turn out all right?