It looks like the EU has finally figured out that austerity is anti-growth and that in the EU context this is leading to debt deflation. The word on the street is that the EU is prepared to temporarily relax the 3% Maastricht hurdle. This article explains why.
Before I get into why let me enumerate the country problems.
- Greece: in a deep depression after receiving a bondholder haircut and default. Fears of a second haircut and default are already circulating. meanwhile bank deposits are in freefall as the Greek banking system collapses. Elections are due later this year.
- Ireland: Already socialised bank losses onto the sovereign. Now the Irish government is looking to rescind some of these guarantees. Meanwhile talk of a new bailout has surfaced as Ireland has been confirmed to be in recession. The Irish are now balking at more cuts in public service pay because of the deflationary impact of austerity. Privatisations loom.
- Portugal: I see Portugal defaulting. Their government debt to GDP is over 100%. Portugal still has a large current account deficit. Not much new on the horizon here.
- Italy: Monti has already said growth and deficits will miss targets. Government debt to GDP is over 120% already. Nuff said.
- Spain: This is the country everyone is talking about. They missed their 2011 targets, unilaterally raised the 2012 targets and are now under pressure in the sovereign bond marketplace. Spain is in big trouble, especially due to its undercapitalised banking system.
- Czech: Not part of the euro zone but also engaged in austerity. Crowds of 100,000 people against government were largest protests since the fall of the soviets. Government now holding a confidence vote to survive.
- Netherlands: The government recently collapsed and it is now clear they will miss the 3% hurdle. The Netherlands is the reason for relaxing the target. While all Dutch parties want to cut, they have signalled that they don’t want to adhere to the 3% hurdle for 2012. That’s big new.
Bottom line: everywhere you look, Europe looks terrible. So the voices for pro-growth policy are now being heard everywhere including at the ECB where Draghi has called for a growth compact. Ambrose Evans-Pritchard gives an update on how this is going down:
Officials believe they have enough legal leeway to relax budget deficit targets for eurozone states without violating the Stability and Growth Pact, though the plans risk a serious showdown with Germany. "The Stability Pact is not stupid. There are elements of flexibility when growth is lower than expected," said a senior Commission strategist.
Current EU rules stipulate that every state must cut its deficit to 3pc of GDP by next year but this is not written in stone. "So long as a country is doing its homework and taking ‘effective action’, we can show some flexibility," the strategist said.
Marco Buti, director-general of economics at the Commission, said EU framework "leaves considerable scope for modulating the fiscal policy reaction" and "explicitly allows for the playing of automatic stabilisers" in response to shocks.
The shift in thinking predates the surge of votes for Marine Le Pen’s National Front in France’s elections and the collapse of the Dutch government over austerity cuts, but the political upheaval has added fresh urgency.
The policy shift by Brussels requires the assent of EU ministers. It takes a qualified majority vote to block such initiatives so Germany alone does not have veto power.
Now, Marc Chandler has said that he doesn’t expect the Germans to change stance 180% and that they will do this growth compact on their terms. But the political winds are clearly shifting. In my view it is the revolt and collapse in the Netherlands that has been the major reason. As this policy shift is evolving, we will need to watch it closely.
UPDATE: The Dutch Parliament is in late session today hammering out a deal to make austerity cuts. But this deal will only see the Dutch get to the three percent hurdle in 2013. It is now clear that the Dutch want to miss the target for 2012, the reason I expect the EU to give a green light on relaxing this constraint. I expect the deals for targets will be worked out on a case by case basis just as we saw in Spain. What this means for the Irish (or the Portuguese and Italians), I don’t know yet.