Finally, the tables are beginning to turn in Europe. The paradigm so far was that in order to fight the debt crisis and to lower the debt-to-GDP ratio, governments must make an effort to balance their budgets by cutting their spending.
This in turn led to a deterioration in the economic situation, meaning lower GDP. This in turn yielded less revenue from taxes, actually making the debt higher. Despite the counterproductive results of this policy, the reaction was more austerity, to further cut the budget to fight the new debt, which in turn led to another worsening of the situation. This is vicious economic cycle providing no hope. And it’s going on for too long.
The best example is Greece, but this policy isn’t really working in Portugal or Spain. Ireland is praised for its success in implementing austerity: the country experienced some growth and saw its bond yields dropping. The Irish success story isn’t such a success for its citizens: the unemployment rate remained on high ground: 14.7% as of February 2012.
Cozy Merkozy Went Too Far
And the citizens, not particularly in Ireland are fed up, as they see no light at the end of the tunnel. The “austerity only” approach was even signed on: German chancellor and French president Nicolas Sarkozy led 25 out of 27 EU members to sign the “fiscal compact” – an agreement that makes deficit and debt targets national laws, forcing automatic cuts in budgets if goals aren’t met.
The treaty hasn’t been ratified by all the countries yet, and it now seems that the agreement will never see the light of day, at least not in its current form. The failure of the austerity policy so far and stripping the national parliaments of their authority aren’t too popular.
The criticism towards the “austerity only” approach and the lack of any program for economic growth was discussed in Forex Crunch and other places over and over again. It has now become mainstream.
Growth is necessary in order to provide hope to the citizens, to enlarge tax revenue and to break the vicious cycle.
Austerity Backlash
The countries in the limelight are Greece and France which face elections and Spain, the epicenter of the current round of the crisis. Before we dive into the situation in these countries, the shift is seen in many other places.
The Netherlands, one of the countries that preached Greece about balancing its debt, saw its government fall over planned cuts. The government of Romania, and EU member outside the euro-zone, also fell due to heated debate about austerity. The Czech government hardly survived.
The talk about growth reached the heart of the establishment, with ECB president Mario Draghi also talking about a growth compact.
Also the code words “Marshall Plan” first mentioned in July 2011 and forgotten since, are now back on the agenda: The European Investment Bank might lead infrastructure projects worth 200 billion euros in the next few years, using both public and private funds. This is still a speculation, but the agenda has clearly changed.
A dramatic political shift awaits us, and this may rock the euro as well.
This article is part of the Forex Monthly Outlook for May. You can download it by joining the newsletter in the form below, which appears on any article on Forex Crunch.