Austerity, Europe, and the next financial crisis



This month, I have been reading Florian Schui’s 2014 book Austerity, The Great Failure. And I have recently noticed an important pattern emerging in the Eurozone which is a consequence of the implementation of public austerity policies in Europe. This pattern of economic behaviour in Europe will most likely lead to a global financial and economic crisis at the end of this decade at least as big as the one the world faced at the end of last decade. (See Wall St trembles but it’s not the Big One.)

Schui takes a historical view, looking back at arguments for austere behaviour and austere policies since the time of Aristotle. Most importantly, he notes that the arguments are moral, or quasi-religious, in nature; albeit dressed up in more recent times as scientific. Modern economics is a secular discipline, whose practitioners are for the most part people with deep-seated ethical beliefs, and whose ‘scientific’ work is infused with those beliefs; it’s a confused mixture of ‘is’ and ‘ought’.

The most significant combination of beliefs is a conflation of the Protestant (and Confucian?) ethic of thrift combined with an irrational fear of a relatively large government sector. (We need governments to buy collective goods.) In this subliminal moral outlook, virtue lies in thrift and privateness, whereas vice lies in debt and publicness. Hence the greatest vice of all is public debt.

What is austerity? To Aristotle it was to live in ways commensurate with one’s means. While it was un-austere (and wrong) for any individuals or segments of society to live above their means, it was taken for granted that it was equally inappropriate to live below one’s means.

Genuine austerity today is asceticism; the austerity of St Francis of Assisi and others who take vows of poverty. It is choosing to have substantially reduced means, and living commensurate with those reduced means. We saw such austerity in the ‘hippy’ communes of the 1970s. We continue to see it in Bhuddism, and more generally in both communities built on sustainable principles.

Neither of these represents what most economists, politicians and journalists today mean by austerity. For them, private austerity is living below one’s means, and public austerity means both governments living within their means and limiting their means. This ‘financial austerity’ combo of private saving and public non-borrowing is a logical nonsense. Saving means lending; and total lending must equal total borrowing. It’s a zero-sum game. Financial austerity as a social recipe makes as much sense as a mathematician (or a three-year-old) claiming that 1+0=0.

Indeed, by definition, the debt of one sector is the financial wealth of other sectors. (Your debt is someone else’s wealth; you pay interest, someone else receives it. The liabilities of one sector are the assets of other sectors.) Thus the debt of the public sector is the financial wealth of the private sector. A reduction in public sector debt, by definition, is also a reduction in private sector wealth. The realised financial austerity of some must be accommodated by the un-austerity of others.

TDB Recommends


European austerity

There are many who believe that governments have become too big in Europe, controlling too big a slice of the European economic cake; and that that is sufficient reason for public-sector austerity. More generally, the drive for austerity in Europe arises from a fundamental misunderstanding of the nature of the 2010-12 Euro crisis.

This crisis was widely framed as a ‘sovereign debt’ crisis when it was really a crisis of unbalanced trade; a result, not of wanton public largesse, but of the introduction of the Euro currency to the European Union in 1999.  Sure Greece had very high government debt, but so did many other countries in and out of the Eurozone. High system-wide government debt was simply the flip side of high system-wide private saving and debt repayment. While Government debt was a problem – a symptom of private austerity in the wake of the global financial crisis – it was not THE problem.

Most serious economists – unlike the journalists and politicians and businessmen and housefrau – understood to some extent the actual problem. Nevertheless those in policymaking circles advocated policies that conflated the actual trade debt problem with the presumed government debt problem.

While the global financial crisis accentuated a normal imbalance between private saving and government borrowing, the Euro had been creating, since the turn of the millennium, an imbalance (substantially private debt) between northern European savers and southern European borrowers. The northern countries were exporting to the southern countries, on indefinite deferred payment terms (otherwise known as ‘vendor financing’; Bernard Hickeyin Herald). Southern European debt was northern European wealth. This process necessarily ended in default and grotesque hardship.

The northern Europeans responded by requiring that all Eurozone governments reduce their deficits to less than three percent of GDP. But they did not require that private sector saving should also reduce to less than three percent of GDP. German and other northern policymakers largely achieved their targets, at a social cost similar to that incurred in the 1920s. Greece and Spain and Ireland were required to become more trade ‘competitive’ without Germany or Austria or Netherlands becoming less ‘competitive’. Through deflation and exploitation, they succeeded.

This meant that the Eurozone itself shifted from a state of financial balance with the rest of the world (ie all trade imbalances up to 2011 were internal) to a ‘mercantilist’ state of financial imbalance with the rest of the world. In other words, Europe’s strategy has been to adopt the Swedish solution (see my Global Savings GlutEconomist article on deflation and export prioritisation) to solve an internal crisis through vendor finance to the rest of the world. Some other parts of the world are being required to play the accommodating role that Greece and Spain and Ireland had previously played.

Last year the Eurozone ran a current account surplus (essentially a trade surplus) equal to three percent of its GDP, and trending to be significantly higher in the next few years. It has 11.5% unemployment and inflation rates fractionally above zero. Deflation – already the reality for Greece and Spain – beckons for the Eurozone as a whole. By exporting the Southern Europe problem to parts of the world outside of Europe, the austerity policies look, to many, like they have been successful.

It was the accommodating stance of the BRICS – Brazil, Russia, India, China, South Africa [add Turkey, Mexico, Indonesia and Kazakhstan] – that gave us a ‘get out of jail free’ card in 2010-12. New Zealand has been an accommodating country, for the most part, since the mid-1980s. Our internationally accommodating monetary policies ensure that we are happy to dispose of more than our share of Europe’s savings, mainly in dairy farming, house-building, and asset speculation.

But there are limits to the extent that New Zealand’s private sector can become debtor and importer of last resort to the financially austere savers and exporters of Europe. Our debt is their financial wealth. But it’s a form of wealth that makes a house built on sand appear to be a very secure investment. We will see similar limits – similar resistance to borrowing and importing – in the other traditional debtor nations, such as the USA, UK and Australia.

Soon enough, smaller countries playing the accommodating role that Spain played within Europe a decade ago stand to find themselves experiencing the same kind of fate. (Argentina is already becoming the global Greece; its government is in default to Wall St.) If too many such countries resist the accommodator role, without others relieving them, then their abrupt curtailment of spending will trigger a global economic crisis this decade. The Great Depression of the 1930s was sparked in the main by abrupt cessations of spending in the USA in 1929, Germany in 1930, and United Kingdom in 1931. The collapse of imports then became, by definition, a collapse of exports. This is the global logic tomorrow of European austerity today.


  1. The creation of new debt in excess of GDP growth is effectively the same as counterfeiting the currency. Any new debt that is issued is ALWAYS immediately spent in the economy. Because we now have new money chasing the same amount of goods and services, prices must by definition rise by a commensurate amount (inflation). Whenever debt levels rise faster than GDP the vast majority of the population get poorer due to their spending power being negatively impacted. This is obviously most acutely felt by the poorest members of society, and is imo one of the main reasons for the increases we are seeing in inequality. It should be noted that government debt in most Western economies (the US and Europe are especially bad) is almost never paid back i.e. unwound. Many corporations also never retire their debt, electing rather to “roll it over” by issuing new bonds (debt). The only reason we have gotten away with this literal Ponzi scheme for as long as we have is that interest rates over the last 30 years in the economies that matter have been trending down (now approaching zero), i.e. the cost of servicing outstanding debt remains the same despite the issuance of additional debt.

  2. Great article Keith again, nice to have a distraction from NZ politics.

    I think the creation of the Eurozone and the Euro was a catastrophic mistake, but it looks like its going to be a while before the full effects are felt. While most of the world is (very) slowly but steadily pulling itself out of the GFC, I expect the EU will continue to stagnate for years to come.

  3. Although the article is detailed and well reasoned within its chosen assumptions, those assumptions are wrong and lead to false conclusions. The main false assumption is that saving and lending are equivalent. This implicitly claims that commercial banks are simply intermediaries who borrow money at low interest and lend on at a profit. This myth has been exploded recently by the Bank of England (which ought to know) in its 2014 Spring Bulletin, which makes it clear that commercial banks are not intermediaries at all.
    Every new loan that the banks make creates an equal amount of new money. Our entire electronic money supply is created from nothing and then loaned out with added interest. So long as the banks collectively lend at about the same rate, the only limit on new money supply is the demand of its customers.
    This means that all the problems that the article addresses are simply the wrong problems. The solutions are both obvious and easy. If you doubt that look up and its NZ equivalent.

  4. This is a flawed post by Keith.

    There has only been some “austerity” in some economies in Europe, like Greece, Spain, Ireland, but otherwise they have tried to have the European Central Bank intervene, buy up debt, and also to a degree release funds to keep things ticking over.

    Some economies have stabilised and even grown.

    But yes, the whole system is still needing major adjustments, which need to go further than bringing in a few tighter restrictions re capital to be held by banks and so. But the problems are no way limited to Europe, we live in a global economy, no doubt about it.

    What we have now is a huge bubble in real estate and other “investments” in China, which is about to burst. While it will be controlled to a degree there, it will mean China will not be the giant market NZ governments and others dream of selling more to, it will slow and not offer much at all.

    A major refocus on economic goals is needed, and we also need to bring in the considerations for more sustainable economic management, based on limited resources and so forth.

    The endless growth mantra is over, and has no time in this world anymore, but sadly the stock brokers and others keep up the hype, and central banks keep feeding the frenzy with still rather “easy money”.

    I fear there will be massive shock soon, and it will hurt hundreds of millions, and bring the NZ economy to its knees also. New Zealand is structurally one of the most volatile and vulnerable economies on this planet.

    It just cannot go on as usual, the shit will hit the fan, and the whole societal order will collapse, leading to a new situation, which needs revolutionary rethinking, and a totally new start, at local and regional levels. Better prepare for it, build networks, as we will otherwise have massive disorder, crime and looting all over.

    It will not be nice what will come to happen in the coming decade.

    • I think you are absolutely right. WE have probably less than 20 years to find intelligent answers or civilisation as we know it will end abruptly.

  5. Financial austerity as a social recipe makes as much sense as a mathematician (or a three-year-old) claiming that 1+0=0.

    To hear the remaining economists and politicians that still believe in austerity tell it it’s more like 1+0=10.

  6. I dare to say, the “bold” and “firm” policy by Russia towards Ukraine, same as China’s “bolder” stance against some neighbours, re disputed territories, is all part of new strategies, to prepare for major wars.

    Wars are events that governments risk to engage in, or choose to engage in, when there appear to be no other solutions to deal with major issue or crisis, such as economic collapse.

    War will firm the local popular sentiment and support base, showing in nationalism, and Hitler used, it, so did many before and after him. I dare to say, even the US used war to distract from domestic problems, when keeping fighting in Vietnam, in Iraq and Afghanistan.

    So has Britain, has France and have others.

    We will see all this repeated in future, again, as war is a measure, that nobody will be able to escape, it forces people into an alert, danger mood, and puts them under immense pressure and distress. Under such conditions most will seek refuge in simple solutions, psychologically, and that is what demagogues have exploited throughout history.

    It is happening right now in Syria and Iraq, and happened sporadically in Israel and Gaza, just days ago.

    So I see a new global war coming, I am afraid, I see this as the goal of desperate governments, who know full well, it cannot go on as usual, and the collapse is looming. So they will wage major wars again, to keep their powers, and to keep us all suppressed, and fighting each other.

    Sorry, that is how I see it what is happening right now.

    • There are other just as likely causes of extinction:- 1) viruses for which we havde no cures (like ebola) because Viagra is more profitable than saving lives in the third world and 2) the problem no-one talks about – overpopulation.

  7. Another Rogoff ,Reinhart, fallacy of composition.N.Z. issues its own currency and cannot default on debt it issues in its own currency.The euro zone countries forfeited their sovereignty . These issues were worked out in the thirties.Austerity will led to war .Ask any German.

  8. Kia ora Keith, I will definitely check out Florian Schui.
    I am currently reviewing Wolfgang Streeck’s book Buying Time : The delayed crisis of democratic capitalism. It deals with similar themes but goes all the way back to the post-WWII boom, to analyse the dysfunctional couple of democracy and capitalism. The first part of my review is here, on the European Tribune, a progressive collective blog on European issues.

    Among other things, Streeck documents the progressive disenfranchising of actual electors, as each nation’s creditors gain the whip hand after the transformation of our “tax states” into “debt states”, and analyses the EU as a machine for imposing neo-liberal reform.

    I think that, in the fightback against neoliberalism, “Buying Time” is as important as, and convergent with, Thomas Piketty’s “Capital”. Streeck is a philosopher and sociologist, the leading figure of the “Frankfurt school”, and his take on economics is a refreshing re-injection of the social element that orthodox economics so rigorously excludes and ignores.

Comments are closed.