Tom Sgouros: Bondholders Rule—Literally

Monday, November 21, 2011

Tom Sgouros, GoLocalProv MINDSETTER™

 

I wrote on Saturday how easily minor concerns like elections are swept aside when financial crisis threatens. The state has taken over from elected officials in Central Falls and East Providence now, and is there a peep of protest about the elected officials who have been so unceremoniously supplanted? But Central Falls and East Providence only contain a few tens of thousand people. Over in Europe, they're busy undermining democracy for tens of millions.

Last week the financial turmoil in Europe claimed another government, and the premier of Italy stepped aside to be replaced by the "technocrat" Mario Monti. Monti is a respected economist, with a career in the European bureaucracy. (He's a Goldman Sachs alum, having served on their board of "international advisers" since the 1990's.)

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This was only few days after the Greek government of George Papandreou fell, to be replaced by "technocrat" Lucas Papademos, another economist, who had been vice president of the European Central Bank before joining the Papandreou government last year. Unlike most prime ministers in most countries, Papademos has never been an elected official, a distinction he shares with Monti, who was appointed a "senator for life" by Italy's president two days before he became prime minister.

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Now I am sure that Papademos and Monti are intelligent people, and I'm equally sure they have what they see as the best interests of their nations at heart. However, is their interpretation of the best way to serve those interests widely shared? That is, both of them seem determined to continue the project of drastically reducing government expenses and debt in a desperate attempt to please the financial markets and remain part of the Euro. How popular will their efforts be?

Austerity only leads to more austerity

However they're regarded within their countries, at this point those efforts seem to be pushing uphill. The financial markets continue their run against Italian and Greek debt, and Portugal, Spain, and maybe even France, seem to be suffering some of the same symptoms. This makes it highly unlikely that the budget cuts and tax hikes those countries have already instituted will be adequate to stanch the bleeding. The logic of the situation demands more cuts and more taxes whenever the bond market twitches. These make the domestic economy worse off and will make it harder for the government to service the existing debt, and so why should a bond investor buy Italian bonds? There are plenty of other places to buy bonds. So the prices of Italian bonds drop more and the cycle begins again.

It's worth detouring here to point out that Italy's budget was quite close to balanced before the crisis hit, with a deficit of only about 1% of GDP. Their deficit is up to about 5% now. Estimates I've read say that they will have to increase their budget surplus to over 5% of GDP in order to stave off catastrophe. This amounts to a credible and immediate 15% cut in their annual budget, a virtual impossibility. Italy was doing what it was "supposed" to do according to the European rules, but they still got stuck.

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The lazy way to understand what is going on in Europe is to moan about the spendthrifts of the Mediterranean and talk of their comeuppance after years of complacency. There are plenty of people who do that, but the reality is quite different. By lowering trade barriers, the Euro allowed Germany to become the world's biggest exporter, a distinction it ceded to China only last year. Good for Germany, but the flip side of that coin is the devastation to non-German manufacturers in the Eurozone, like in Greece and Italy, for example. The decline in fortunes of manufacturers in those countries resulted in reduced tax receipts and increased expenses, and increasing pressures on their budgets.

Euro-rules rule

If Italy had its own currency, it would just devalue it, a move that would have protected both its own manufacturers and its budget. Without that option, Italy could only watch as factories closed and the expense of their debt rose. In other words, this crisis is far less a story about government spending than it is about the imbalance of economic strength within the Euro, the unwillingness of the Euro members to address those imbalances, and the impossibility of managing a national economy successfully without control of the currency.

Whatever the causes of the crisis, the circumstances bring home a new question: do we respect the ideals of democracy or not? The fact is that membership in the Euro is no longer a morally neutral question (if it ever was). For Greece, Italy, and any other nation caught up in the slow-mo bank runs that are the Euro crisis, membership in the Euro means sacrifice for millions of their citizens in exchange for propping up German banks.

These are not simply technical debates. These are fundamental issues of governance. Greece's prime minister was deposed over a call for a referendum on meeting further EU demands for still further budget cuts. The referendum will not happen, but the cuts will, administered by the new technocrat in charge. The technocrat in charge of Italy now has promised much more of the same, too.

Can a nation that makes a claim to democracy be ruled by people who think issues as important as these should never see a vote? In exactly what way does it remain a democracy then?

Tom Sgouros is the editor of the Rhode Island Policy Reporter, at whatcheer.net and the author of "Ten Things You Don't Know About Rhode Island." Contact him at [email protected].


 

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