Credit Writedowns

In a number of posts recently I have highlighted the impact of declining workforces on economic growth and the way the policies pursued to address the Euro debt crisis are having the impact of accelerating the movement of young people away from the periphery and towards the core thus accelerating the decline in their working populations and exacerbating their growth problem.

There is an experiment being conducted in Japan, but the experiment isn’t Abenomics (which I suspect won’t work, and could end very badly). No, the experiment is about learning to grow old with dignity, not as individuals, but as societies.

Japan is stuck in a shrinking population trap, and neither monetary nor fiscal policy will adequately solve the problem. Continuing to run fiscal deficits in a deflationary environment will only means that government debt is pushed onward and upwards leading to a variety of possible scenarios as to what the end game will finally be. Reining in the deficit, by raising consumption tax, for example, will probably only make deflation worse with a one year time lag, as happened in 1997, and will almost certainly force the economy into more economic shrinkage which in any event makes the debt issue worse.

The current crisis – which is arguably no longer a crisis but rather a way of life – has all now gotten so complex that the issues involved are almost certainly, and in principle, “beyond their ken.” Spain’s economy will continue to march boldly forward towards what now seems almost guaranteed to be long term decline, while from within the captain’s tower, far from an acceptance that what is happening really is happening, we will continue to hear yet one more crazy and implausible story after another telling us “if only this”, or “if only that” even as representatives of the Plataforma de afectados por las hipotecas (or equivalents) start to assemble outside the local version of the winter palace looking for their hides.

By Edward Hugh According to the Economist’s Buttonwood, “desperate times require desperate measures”. I am sure this is right, times in Spain are certainly getting desperate and many of the measures being implemented in Brussels, far from representing radical and innovative solutions look much more like continually closing the barn door after the horse has bolted. The issue Buttonwood draws [...]

According to Angela Merkel, speaking in the German city of Mainz in mid February, European countries struggling with the fallout of the euro-area debt crisis have much to learn from East Germany’s experience with economic overhaul following the fall of the Berlin Wall. In the main she was speaking about the need for reform, something on which we can all agree. “At the beginning of the 21st century”, she said, “Germany was the sick man of Europe and that we are where we are today also has to do with reforms we carried out in the past. That’s why we can say in Europe that change can lead to good.”

But there was one tiny little detail she forgot to mention. During the post unification period East Germany’s population went into melt-down mode.

The core of the issue is not whether the country could see one, or even two, quarters of positive performance, but whether any faltering recovery will be sustained out into the future, through 2014 and beyond. It is here that all the old doubts really emerge.

The rise and rise of Japanese debt is far from benign, and the dynamic, we are convinced, will at some point become unsustainable. Unfortunately by the time we reach that point it will be too late. Indeed, given that we agree with Krugman that the underlying cause of Japan’s malaise is demographic, after several decades of ultra-low fertility in all probability it already is too late.

Why is the global economy hamstrung by heavy debts and weak banks? Or put another way, why doesn’t deleveraging happen, and the weight of debt reduce, and why doesn’t the economy expand so the weak banks can once more become robust and healthy ones?

Short answer, it’s the demand side stupid! The longer version was offered by Paul Krugman when he asked the ironic question, “To which planet are we all going to export?”

Simply cutting the deficit back and cleaning up bank balance sheets won’t get the economy back to growth. Indeed this habit of continually getting behind the curve, and trying vainly now that the economy is spiralling almost out of control to introduce measures which should have been brought in a decade ago extends well beyond the issue of labour reform. Take reducing the generosity of unemployment benefits. This is also something that should have been done years ago, since the two year allotment really did encourage people to refrain from actively seeking work in times of relatively full employment. But cutting benefits now, as the Rajoy government has just done, when unemployment stands at 25% and rising seems insensitive and even cruel. A government’s job is to introduce policies to create employment, not to cut benefits going to those who cannot find work in an environment where total employment is falling and has been doing so for five years.

And going beyond April, the political arithmetic of a post Monti government looks complicated, making the kind of stability needed to advance what the population may well see as “harsh” reforms unlikely. In other words, as Monti says, when I go, watch out for the populists!

I guess we will never know whether or not Mariano Rajoy uttered the two magic words so effectively immortalized in song by Aretha Franklin that Saturday afternoon in late May as he cruised down the Chicago River in what Spanish media called a “Love Boat” ride, but one thing certainly is now clear, Angela Merkel has finally and definitively accepted Spain into the German embrace. Whether it will be a tender and loving one remains to be seen.