In Europe, it’s debt vs jobs

As the signs of social unrest continue to grow in the southern peripheries of Europe, highlighted again by the over night action in Spain, I thought it was timely to take a step back from the day-to-day and re-assess exactly what we are witnessing in the Eurozone from the longer macro-view.

If you’ve been reading my near-daily pontifications about Europe for any length of time you should be aware that I consider the policy approach being taken in the Eurozone to be the makings of a real disaster. I have been accused by some of being anti-austerity but that isn’t my real issue with the policy at all. My major concerns has been that policy targets of internal devaluation and export driven recovery in the absence of debt forgiveness on a near-contintent wide scale will fail because:

a ) the initial outcome will be a rapid decline in industrial production and national incomes which mean existing debts will become unserviceable

b ) external surpluses require a counter-party external deficit

c ) structural adjustments require investment

So basically, the three targeted outcomes for the existing policy a) service existing debts, b) lower government deficits c) become export competitive are incompatible because the expectation that falling internal demand will quickly be replaced export driven production is a form of utopian economic fantasy.

Over the last two years Greece has been held up as a ‘outlier’ for what should occur but the reality is, as Spain and Portugal are now demonstrating, that this outcome is the most likely and,  as I have been discussing , completely predictable.

As I mentioned a few weeks ago, Portugal, the poster child of austerity, is failing to meet its targets even though it appeared to be on target over the previous 18 months. What we see in Portugal is a country bouncing off the limits of the current policy.

The basic premise of European policy is to tighten government budgets in an effort to drive down deficits. In the absence of a current account surplus in order to maintain a level of national income  this requires an expansion of private sector balance sheets. If this does not occur then the most likely outcome is a slowing of internal demand and therefore a slowing of imports. This in turn should drive the balance of trade towards positive territory, but at the same time lower overall GDP.

Falling GDP leads to falling national income, which in the absence of real across the board wage deflation means more unemployment and therefore slowing government revenues which, as I’ve said previously, leads to a self-defeating process of re-newed cuts to government budgets.

So in essence this whole process becomes a struggle between the balance of the external sector, real wages  and unemployment and this is the dynamic we have been witnessing in much of the periphery over the last 18 months. What I have noticed recently is that the adjustments in periphery nations balance of trade has been seen by some as a sign of recovery, which in part it is, but ultimately what is required is a sustained current account surplus.

The counter-weight to these external sector adjustments is on-going social retrenchment that occurs as unemployment rises. This is why the existing debt  and lack of currency devaluation are such barriers because without them it is likely to be impossible for struggling nations to reach a current account surplus, especially as they are all trying to enact the same policies all at once.

In short, much of the economic framework that allowed the periphery to get into this situation in the first place is now making it far more difficult for them to get out and it would now appear we are reaching the limits of the social and political systems within these nations to deal with the stresses. Obviously it’s not to much of a stretch to realise this situation could escalate quickly, and I have warned previously that political capital was likely to be tested over the next 12 months as the continuing deterioration in the Eurozone economy frays the remaining goodwill. I see the back-track from the Portuguese government and the growing tension in both Madrid and Catalonia as recent examples of just this.

Below are some corresponding charts of the metrics I have discussed above.





Latest posts by __ADAM__ (see all)


  1. I just don’t understand why the peripherals weren’t / aren’t kicked out of the Euro and their debts paid in local currency.
    The peripheral currencies would devalue massively. The lenders would take a bath. The peripherals would be more competitive via a reduced currency (iemore holidays in Greece, Portugal and Spain).
    The other alternative of Further integration, if achievable, will take too long.

      • Diogenes the CynicMEMBER

        Yeah you are forgetting all those Euro banks who engorged themselves on PIGS government debt to earn the extra yield carry. If they wrote off those debts as per your scenario then quite a few (many/most/all) of those Euro banks would be bust. Hence the continual stop-go of these Euro bailouts.

        • Renaging by PIGS on debt would bankrupt most banks in the EU core and the UK with devestating effects on those economies and people.
          Proping up the system as they are doing now might not work but the alternative would cause world wide economic chaos.
          Either way the EU is facing massive problems with a possible flow on to the world economic system. So the powers that be are trying a way of least difficulty for the EU, keeping the show on the road,and hoping to hades that somehow it works.

          • Yes, but all they are doing is creating a bigger problem that is going to bust harder and longer when it does.

  2. DE this is the crunch

    ” I have warned previously that political capital was likely to be tested over the next 12 months as the continuing deterioration in the Eurozone economy frays the remaining goodwill.”

    However,the way Barroso was talking a few day ago the people won’t get a choice.

  3. All true DE and maybe we are fast approaching the only real and lasting solution which is a formal North South split into at least two currencies.See Martin Wolf in todays FT making the case for a German exit.Maybe the Catalans will be the catalyst?

  4. Here is another stat on Portugal that could point to how this mess came about;

    “Government spending has increased to a level equivalent to 49.8 percent of GDP. The budget balance has recorded large deficits, with public debt reaching over 90 percent of total domestic output.”

    So, 50% of GDP is Govt. Big fat Govt intervention in the economy. Who then borrow externally to fund their deficits.

    Hmmmm, sound like a familiar situation?

    Yes indeed, Portugal certainly has gotten itself into a pickle.

    • Some other countries also rendered into apocalyptic wastelands by similar levels of Government spending (and their overall score of “Economic Freedom” and net):

      Denmark (55%) (76.2)
      Netherlands (51.4%) (73.3)
      Sweden (55.2%) (71.7)
      Norway (46.4%) (68.8)
      Austria (53.1%) (70.3)
      Finland (56.2%) (72.3)
      Germany (47.5%) (71)

      Clearly we’re in deep trouble:

      Australia (34.3%) (83.1)

      • More importantly you forgot to mention that the women in all of those debt wastelands rate very highly on the “Smokin’ scale. You can see that the lower you move down the Govt debt scale (to Australia in particular) the less attractive your women become. There is something in this, and Prof Keen continues to rebuke my emails suggesting he broaden his research on this front. Govt debt, private debt, pish posh. Which economic policies are creating the most attractive women. That’s where it’s at.

        • Two things.

          Spleenblatt, you are onto something there, but I dont think it is the government debt smokin nexus. It is actually the government spending as a part of GDP nexus. As convincing proofs I offer Russia and Ukraine. Frankly when I am there I couldnt give a toss about how much of the economy is controlled by the govt, because a lot of their public servants look mighty fine in a skirt and high heels..

          The other thing I would observe is that there is a strong positive link between average private debt levels and ugliness. Some of the slappers mounting kerbs in lycra leggings and brnaaishing a purse full of cards in Australia need to take a good hard look at themselves.

  5. Those same lenders are now soaking in a long, slow acid bath as a result of that initial reluctance to recognise the absurdity of the situation and realise a loss. None of this makes economic sense in the short-term, and the long political/ideological game being played clearly envisions a substantial payout in terms that are not purely economic. Bringing those lager swilling soccer hooligans (a.k.a voters) along for the ride is only going to get trickier as their sense of nationhood and independence is gradually eroded above and beyond those effects already wrought by globalisation. Resolving that non-insignificant problem of voter preference in purported democracies when the end game is potentially many decades away, I would imagine will only lead to more and more ‘soft’ repression of subversive movements via the usual cultural mechanisms of ‘mainstream’ media and the education system. But as those mechanisms of themselves become less and less effective, it requires scarier and more shrill rhetoric at a political level, which invites equally shrill opposition. In the absence of less freedoms being imposed upon its citizens, I don’t see how the utopia of an integrated EU involving those peripheral countries can achieve its aims in the long run. It can only ever exist as a ‘soft’ totalitarian state at best.

    • Good comment spleen!
      Suddenly we are looking realistcally at the scenario Marc Faber used get publicly ridiculed for just a couple of years ago!

      I forget what I was called on MB not so long ago…it was like ‘doom-monger’ or something. My point is how quickly this damned situation is spinning out of conhtrol.

      William Butler Yeats ‘Second Coming’ always comes to mind

      Turning and turning in the widening gyre
      The falcon cannot hear the falconer;
      Things fall apart; the centre cannot hold;
      Mere anarchy is loosed upon the world,
      The blood-dimmed tide is loosed, and everywhere
      The ceremony of innocence is drowned;
      The best lack all conviction, while the worst
      Are full of passionate intensity.

      Don’t mean to be melodramatic but this stuff really weighs on me!

  6. Great post DE tahnks.

    the expectation that falling internal demand will quickly be replaced export driven production is a form of utopian economic fantasy.

    About as utopian as thinking that the system of ever expanding debt accompanied by the wealth generating process of selling each other houses, and, as GSM comments, ever-increasing Got while importing anything we really need.

    And yes GSM it’s all very familiar somehow!

    • flawse,

      Sooner or later, after all the huffing and puffing, the windbaggery and pontificating, REALITY ( or another name- consequences) asserts itself.

    • Flawse, Nice observations here and above. Sober Look has had a couple of short posts lately illustrating your point that “the expectation that falling internal demand will quickly be replaced export driven production is a form of utopian economic fantasy.”

      …with links to others on France & UK. Alas I remain unconvinced that similar expectations held by some upon the fall of the AUD are equally misplaced.

  7. As it starts to get cooler in southern Europe and the only people with money, being tourists, leave, sh!t will get real, the months before last Xmas were interesting, the next 3 months could be a block buster

  8. Instead of giving trillion Euros to bad banks, they should have created new banks and given them the a trillion. The bad banks would go bust as the PIIGS inevitably default on their debt.

    This would be followed by short-term carnage on the markets as the whole Ponzi scheme collapses overnight.

    Left standing the next day would be the new banks, with a trillion Euros in assets and zero debt. Let them leverage it up 30 times and lend out 30 trillion Euros to fresh young entrepreneurs to take over the skeletons of the old banks and investment houses. The PIIGS could then immediately borrow more to keep their economies going, provided they promised to institute some austerity, but much slower over the next couple of decades. Ease the baby boomers into comfortable retirements, but lower wages and conditions for future generations of parasites (public sector workers). Slowly, so no-one really notices.

    Think it was a good idea, but obviously involved the destruction of vast amounts of rich people’s wealth. And we know that ain’t gonna happen.

    Rather than “too big to fail”, it really is “too rich to not sacrifice the middle class and future generations for”. Sad.

    • or instead of lending the old ones money, how about any rescue funds take equity. Then when the bank is profitable again sell the equity.