The Guardian Unlimited, August 5, 2011
All money managers’ eyes were on the U.S. jobs report this morning after the U.S. stock market yesterday suffered its biggest drop since 2009 and panic surged through financial markets worldwide. The headline numbers were not as bad as many had feared: the U.S. economy added 117,000 jobs in July and the unemployment rate edged down from 9.2 to 9.1 percent. But the decline in the unemployment rate was due to people leaving the labor force, not finding jobs; and the overall picture of the job market in the U.S. is still terrible. Just 58.1 percent of the U.S. labor force is employed, as bad as it has been since the recession. As my colleague Dean Baker noted, "with the government shedding 30,000 jobs a month, we will be fortunate if the unemployment rate doesn’t rise over the rest of the year."
The weakness of the U.S. economy was part of what sent markets into a frenzy yesterday, but it was not the main part. The eye of the storm this time is in Europe, and the European Central Bank gets the credit for triggering yesterday’s events. The ECB announced that it was reviving its program to buy the bonds of distressed governments after a four-month hiatus, but then said that this would not include Italy or Spain.
This set off fears of a financial crisis, for two reasons: first, because of the fear that the financial markets would continue to speculate against Italian bonds, driving interest rates up to the point where Italy would not be able to borrow on the markets and would have to seek loans from the European authorities – as Greece, Ireland, and Portugal have already done.
Italy’s public debt is $2.6 trillion, which is more than triple the entire economies of the other three countries combined. The European authorities – sometimes referred to as "the troika" of the European Commission, European Union, and the IMF – are not yet prepared for a "bailout" for this level of debt.
The other source of fear concerns the European banks, who have hundreds of billions of dollars lent to Italy and Spain. As the interest rates on these bonds rises and their value shrinks, these banks face problems of liquidity and potential losses. The European banks' problems also contributed to fears of a financial collapse.
So why did the ECB send such a frightening message to the markets yesterday? The simple answer is they are trying to force the Italian government to do more budget tightening. It’s another dangerous game of chicken, which we have seen repeatedly in the eurozone.
My own view is that cooler heads will prevail and that the European authorities will sooner or later do what they have to do to avoid a financial meltdown. They are also reportedly under pressure from the U.S. government to act more aggressively to contain the crisis. And the threat of explosive debt problems in Italy and Spain has been exaggerated.
But unfortunately, getting past the current problems in financial markets won't solve the problem for the vast majority of people in Europe and the United States – economies that also have a large impact on most of the world, since the high-income countries are still around half of the world economy.
The basic problem is that governments in both of these economies have got their macroeconomic policies wrong. In this regard Europe is considerably worse than the United States – at least our Federal Reserve has taken some positive steps in monetary policy, keeping short-term interest rates near zero since December of 2008 and creating more than $2 trillion in money through quantitative easing. The ECB is much more right wing, as was on full display yesterday; they also have short-term interest rates at 1.5 percent (having actually raised interest rates twice this year) and have been much more conservative than the Fed on monetary policy overall.
On fiscal policy, the European authorities are trying to squeeze the weaker eurozone governments to cut budget deficits even as they are in recession or barely growing, with more than 20 percent unemployment in Spain and 16 percent in Greece. It’s not working, and it’s not likely to ever work.
Now we have the sad spectacle of the United States heading down the eurozone road to stagnation, after our Congress, president, and most of the major media have reached agreement that reducing our public debt is the top national priority. This despite having more than 25 million unemployed, involuntarily working part time, or who have dropped out of the labor force. This is absurd, of course: The deficit at present is overwhelmingly a result of the recession and weak recovery. As most Americans now know, the whole "crisis" over the debt ceiling was completely manufactured. In fact, the U.S. doesn’t really have a debt crisis at all; we are currently paying just 1.4 percent of GDP in interest payments, a low number by any historical or international comparison. Our main problem, as is Europe’s, is employment.
Even economists from relatively conservative sources like the IMF and the head of PIMCO, the bond fund, noted after the debt ceiling bill passed Congress that it would likely worsen the economy. The U.S. economy has not even caught up with its pre-recession level of output, and Europe is similar; meanwhile China has grown about 40 percent during the same period of three and a half years. They got their basic macroeconomic policies right.
That is the tragic irony of what is unfolding in the United States and Europe: a lost decade in the making, and it is all self-inflicted, unnecessary, and stupid.