Home > financial crisis, Recession, The Economy, unemployment > U.S. and Europe: slow strangulation is much more likely than financial catastrophe

U.S. and Europe: slow strangulation is much more likely than financial catastrophe

from Mark Weisbrot

The prevailing understanding of economic troubles in the U.S. and Europe, the world’s two largest economies, is misunderstood in a number of ways.  First: Imagine that you are driving a car down a road packed with snow and ice and you are worried about an accident. At the same time you are ignoring the fact that you are about to run out of gasoline, leaving you stranded and freezing in the middle of nowhere.

Such have been the main reactions to last week’s extreme volatility in financial markets: There has been much more fear of financial crisis than the slow strangulation that poses the greater risk. Investors’ panic attack subsided noticeably after the European Central Bank’s (ECB’s) decision to reverse its prior stance and purchase some 22 billion euros of Italian and Spanish bonds, which was successful.  It drove down interest rates on these bonds by more than a full percentage point, to 5 percent, and eliminated – for now at least – the most immediate threat of an acute financial crisis: the one that emanated from the fear that markets would drive up interest rates on these bonds to a dangerous level.

The European authorities also took some action to stem the immediate crisis of the European banks, which is of course related to the sovereign debt problems: France, Belgium, Italy, and Spain banned short-selling of the stocks of financial institutions. According to some press reports, speculators were shorting these stocks partly because the ECB was committed to keeping a floor under the euro, leaving the bank stocks as a “soft target.” The ban on short selling seems also to have helped, at least temporarily.

But there is still a lot of fear that we are close to a repeat of 2008-2009, when the U.S. fell into a deep recession and much of the world economy was dragged down with it.  For the U.S., this is not all that likely: The Great Recession was caused by the bursting of an $8 trillion housing bubble, and there is no such bubble now available to burst. The recession before that (2001) was also caused by the bursting of a big asset bubble – in the stock market, which is not currently overvalued.  The three recessions before were brought on by the Federal Reserve deliberately raising interest rates in order to slow the economy; but the Fed last week committed itself to keeping interest rates “very low” for two more years.

Of course, if unemployment remains at 9.1 percent or worsens, it will feel like a recession to most Americans even if we don’t have negative growth.  But the probability of an actual recession has been exaggerated, and the chance of a recession like the last one is very remote.

In Europe, where macroeconomic policy has been more right wing, recession is more likely. Portugal and Greece are already in recession, and others are not far away. In return for the ECB’s buying up Italian bonds, the European authorities extracted a promise from the Berlusconi government to close a 3.9 percent of GDP budget gap by 2013. This could easily push Italy’s $2 trillion economy into recession.  The latest GDP numbers for Europe’s second quarter arrived this week, and they look dismal: just 0.2 percent growth in the second quarter in the eurozone, the worst for two years. Germany, Europe’s largest economy, was practically stalled at 0.1 percent, and France, the second largest, came in at zero.

The most dangerous myth, and one repeated daily in much of the major media, is that these troubles on both sides of the Atlantic are a result of a “debt crisis,” and can only be resolved through fiscal tightening. The United States is not facing any public debt crisis at all, with interest payments on the debt at just 1.4 percent of GDP.  Some eurozone countries do have a “debt crisis” – for example Greece.  But this is only because the European authorities have failed to take the necessary steps to resolve it, and have instead made it worse by shrinking the economy.  In other words, there is no legitimate economic reason for a sovereign debt burden – even an unsustainable one – to result in years of economic stagnation and high unemployment. If the debt needs to be restructured because it is not payable, as in Greece, then that should be done as quickly as possible and with enough debt cancellation to make the resulting debt burden sustainable – as Argentina did with its successful default in 2001.

The eurozone is of course handicapped by the lack of a unitary fiscal authority, and many were disappointed that this week’s meeting of French President Nicolas Sarkozy and German Chancellor Angela Merkel did not move toward the use of eurobonds.  Much worse was their pledge to push for a Europe-wide balanced-budget amendment, starting in their own countries. This is ridiculous and – to the extent that it is not mere posturing – would only be another indicator of how far Europe’s leaders are from reality-based economic policy.

See article on original website

  1. David Stephens
    August 18, 2011 at 8:33 am

    As a non-economist but an amateur debt watcher, I was interested in the definition of “debt crisis” in terms of interest payments on debt as % of GDP rather than (as I took the concept to be) gross debt as % of GDP. Interested to hear real economists’, including real-world economists’, views pro and con various definitions and relative implications of the different measures going south. Is Steve Keen out there, for example?

  2. August 18, 2011 at 9:49 pm

    “The recession before that (2001) was also caused by the bursting of a big asset bubble – in the stock market, which is not currently overvalued.” Well, that is certainly debatable!

    • Alice
      August 19, 2011 at 10:57 am

      I agree mcbockalds – Ive thought the share market overvalued by at least 20% and maybe more since it rebounded after GFC v 1.

  3. August 18, 2011 at 10:47 pm

    Strict financial analysis of national debts leads to the dismissal of a Europe-wide balanced as ridiculous. This limited view ignores the broader economic aspects which are much more, if I may, reality based. Modern economic thought frames sustainability of human culture within a three tier definition of justice, there will be a general collapse without justice, equity, dignity and liberty for all who are presently alive, justice inconsideration for as yet unborn, the future, and justice with nature, also referred to as Mother Earth.

    A fully functioning modern democracy which includes the environmental effects of economic activity is the organic method of focusing human intelligence on the problems we face, selecting among proposed solutions, and choosing the course of action most likely to accomplish the selected solution. While it is true that deficit spending may not represent an overly large percentage of the financial measure of a given economy, it is also true that a small group of imperfect democracy representatives can avoid imperfect democratic controls by spending the future’s money and avoiding the discomfort of taxation that living but propaganda lulled citizens would have to acknowledge if the budget was balanced and tax burdens measured exactly the expenditures.

    On may examine the United States for proof of this democracy destruction by deficit spending. Look at the gross and bloody eternal war waged all over the world by smiling US politicians spending deficit dollars to kill and maim innocent families and entire villages, promote nuclear power and weapons, and bailout obsolete and criminal industries.

  4. Merijn Knibbe
    August 19, 2011 at 9:07 am

    Mark, you are optimistic. There is no reason why european unemployment (about 9,7% by now) will not cross the 10% and 11% and 12% thresholds in the months to come,


    * Construction is down
    * Industrial production, which recovered somewhat from its deep and steep post Lehmann fall, stagnates
    * the same for retail sales
    * unemployment hardly fell during the last 18 months and stagnates at the moment
    * Consumer confidence is down sharply
    * producer confidence is down, sharply
    * there is little room left for a new round of ´Kurzarbeit´ or ´Schottpremies´
    * real money groth is, deliberately, negative and has been negative for about two years now (what where these lessons from the thirties again)
    * ,differences in unemployment rates have increased
    * with the notably exception of Greece, differences in trade balances and current account deficits have increased (and austerity does not work: even in Ireland imports are growing faster than exports)
    * nominal interest rates are increasing, as inflation is going down quite a bit real interest rates are increasing even faster

    Governments won´t increase spending, companies have little reason to invest as there still is a large output gap and consumers are squeezed and even doubling exports to China won´t make much of a difference

    A ´positive´note: thanks to demographic developments, the labor force does not grow that fast any more. But 40 million jobs are still needed..

  5. August 20, 2011 at 4:57 am

    I prefer the financial catastrophe scenario. We have enormous private debt piled on top of a house of cards financial system which must be maintained for the benefit of a privileged elite which acts like a hysterical matron whenever it is asked to share the sacrifice. Slow strangulation is what it feels like to the non-elite, but that is going to produce desperation, and certainly an unwillingness to extend mercy should there be (the inevitable) financial sector problems.

  6. Bruce E. Woych
    August 20, 2011 at 10:03 pm

    Elizabeth Warren should be running for President. PASS IT ALONG!

    Enough deception from the con-artists in power. We know where Elizabeth Warren stands and we definitely know she will act appropriately with the people behind her.


    LET”S DO IT !

    • Alice
      August 21, 2011 at 8:57 am

      Elizabeth Warren look just fine to me.

  7. Jon
    September 8, 2011 at 6:09 pm

    USA will die slowly and will become a THIRD WORLD country, just like it wished upon others for past decades. The 9/11 INSIDE JOB has killed USA. The scum will be leaving the sinking ship. Get ready to kill the rats.

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