The Europe of Broken Dreams, Part 4: Depressing Repression9th February 2013

Our series on Europe continues, and the news continues to heat up. Ignore the apparently great news on the politically negotiated reduction in the EU budget. Even if it happens it is a tiny pinprick in the scheme of things, and is utterly irrelevant when compared to the scale of the Eurozone’s debt challenges.

Don’t get me wrong, we may ultimately need politics to solve the challenges, but politics is what created this mess, and there seems to be no understanding or desire to get a grip. Back in Spain, Prime Minister Rajoy is facing allegations of financial impropriety, which whether true or not, make a politician’s ability to fix things even less likely.

In previous articles in this series we established that banks create money, that banks are over-leveraged, that their governments are insolvent, that the merry-go-round of banks and governments symbiotically entwined, with each bailing the other out, all lubricated by the central banks creates a dizzying but unedifying spectacle. We reached the point where last year the ECB promised “unlimited firepower”, but with conditions. So if the conditions aren’t met, or are refused, then what?

Countries like Spain, as currency users not issuers, face a banking crisis, a sovereign crisis, and now are very close to a constitutional crisis. Already regions are calling for self-rule, and their country needs Euro cash to keep going. So what rabbits can be pulled out of the hat?

Choice 1:

Spain can meet the conditions and follow the Greek austerity route, which is painful indeed. Stabilising democratically elected government borrowings is hard enough, and requires real cuts in state spending, employment and welfare. This hits politicians where it hurts – their votes. Cut like that, and the reduction in demand throughout the economy hurts the private business sector and individuals, who are themselves highly leveraged with property mortgage and consumer debt.

Yes, private debt is actually much greater than state debt, and it is pretty pointless trying to cure one without sorting out the other. But I have heard very little on this subject, as states are apparently far too busy trying to sort themselves out. Rarely are their voters their top priority.

Choice 2:

The politicians fail, and are replaced by an unelected technocrat who introduces the austerity. This happened in Italy, but we are seeing limits to how long such a system can last, and, as we have seen, it hurts, and does nothing to sort out private sector debt.

In this world of quick fixes and failure to take responsibility, neither Choices 1 nor 2 are palatable. The pain in Spain and across other struggling Eurozone countries is real deflationary pain, with protests as incomes and asset values fall. It is true that past excesses need to be purged from the system. But talk of supporting countries undergoing austerity rarely mentions the problematic issue of the pledged funding to the ESM bailout fund – can bailouts funds really be committed over the next few years by states that are themselves the bankrupt beneficiaries of the fund?

Already painful enough, choices 1 & 2 also involve financial repression. If states can’t borrow or print their way out of trouble, they repress. In fact they repress anyway.

So what is financial repression? Whilst we pride ourselves in society’s respect for property ownership rights, we seem to forget that the state seems to be able to take at will through taxation – incomes, gains, imports, energy, spending, transactions, death and more. Inflation is another tax, reducing the value of government debt in real terms, but reducing the real purchasing power of incomes. The same happens with the manipulation of interest rates to their historically low levels, far below the inflation rate, so ordinary savers lose every day. Each is a type of repression.

As the Eurozone hots up, expect more repression. Cash transactions have already been capped in Spain and Italy. Regulations require certain investments made by banks and pension funds to be held in government bonds. Capital controls can prevent assets from leaving the country, and when things get really bad some countries – like Hungary and Argentina –  just grab entire private pension funds. These things are all done “in the public interest” to “prevent fraud”, or make people’s investments “safer”,  or some other spurious reason that initially sounds good in the media.

And don’t think that “financial repression” can’t happen in the UK. Look again at the above two paragraphs and you’ll see that most of it already is.

States have issued far more debt than they can ever repay. They can’t tax their populace much more because the populace is in trouble. So they repress it out of them anyway. It’s not an honest approach, and it reduces the ability of the private sector and individuals to improve their own lot, and the lot of their country.

Which leaves Choice 3:

Or the bankrupt nations can throw back the conditions in the face of the ECB, leave the Eurozone and default. Default can make many forms, creates many losers, and won’t end financial repression, but it provides an opportunity to wipe the slate clean and switch to supply-side economics. Lets see how that looks next week.