A generous interpretation of Europe's economic salvation plan is that it is buying time.
The European Central Bank has knocked down interest rates to virtually nil. It has put so many fire-fighting measures and guarantees into place that sovereign bond yields have plummeted, allowing countries that were on the verge of bankruptcy to finance themselves at bargain rates. All the ECB asked for in return was economic reform in uncompetitive countries like France and Italy.
This week, ECB president Mario Draghi begged again for reforms that have gone AWOL. His message: I have done everything I can, short of outright (and possibly illegal) U.S.-style quantitative easing, so over to you. But his pleas never work. The grand unstated bargain – money for nothing in exchange for reform – has failed. Yet the charade remains. This week, France demanded two more years, to 2017, to bring its budget deficit down to the European Union threshold of 3 per cent. This is France's way of admitting that its austerity and reform efforts are proceeding as leisurely as a champagne dinner on the Cote d'Azur. Yet the ECB stands by, no doubt realizing that the cliché is true: No good deed goes unpunished.
Buying time is not always a moronic strategy. Good fortune can strike. Downward economic cycles can reverse themselves. Crowd consumer psychology can change for the better. But that strategy looks suicidal this time, because national debt burdens are soaring as Europe fiddles. The post-2008 disaster that triggered the bailouts of Greece, Ireland, Portugal and Cyprus, and a bank bailout in Spain, is commonly referred to as the "debt crisis." That was a misnomer. The real debt crisis is yet to come, which brings to mind Ernest Hemingway's quip about solvency: "How do you go bankrupt? Two ways. Gradually, then suddenly."
Excessive debt and bloated deficits did not fell Ireland, Portugal or Spain (though they did in Greece). Before the 2008 crisis, the deficits of most of the EU's biggest economies were below the 3-per-cent threshold. The debt-to-gross national product ratios of Ireland and Spain were actually lower than Germany's. So it wasn't really debt that sent the world over the cliff in 2008. The guiltier parties were the banking crisis, the enormous balance of payments problem and oil was charging towards $150 (U.S.) a barrel.
Today, debt is the proverbial elephant in the room that polite company tries to ignore. Debt is rising because the denominator in the debt-to-GDP ratio is flat or in some miserable cases, like Italy, back in decline.
It is rising because governments in countries saddled with double-digit unemployment are terrified of cutting spending even more than they have, for fear that the jobless tally would rise again. The mass protests and riots in austerity-whacked Greece in 2011 and 2012, which turned Athens into a war zone, haunt Europe's leaders.
It is rising because deflation is a clear and present danger. Saxo Bank chief investment officer Steen Jakobsen said "the current flirt with deflation will make servicing the growing debt even more expensive. The nightmare for the ECB and the world is deflation, as it's a tax on debtors and a boon to net savers. The new reality is that we currently stand face-to-face with the very deflation risk that just about every denied could ever happen when the [first quarter] outlooks were written."
The rise in debt loads since the start of the crisis inspires awe.
Portugal's precrisis debt was 70 per cent of GDP; today it's 130 per cent. Italy's was 106 per cent, a level then considered unsustainable; today it's 135 per cent and rising, making it all the more unsustainable. Spain's ratio has gone from 40 per cent to 94 per cent. Greece's is at 175 per cent. The phenomenon is not limited to Europe. The debt in the United States has almost doubled, to 80 per cent of GDP, in 10 years. Below-trend growth and productivity gains, and financing endless wars, will surely keep the trend intact. China's debt is soaring too and its slowing growth rate will only make the problem worse.
With sovereign bond yields so low, there is no sense of panic even as debt climbs relentlessly. Italy can now borrow 10-year money at 2.3 per cent and it's a recession-stricken, deindustrializing disaster with no realistic economic turnaround plan and a debt load that's the second highest in the world, after Japan. Britain, Europe's fastest growing economy and best job creator, actually pays slightly more than Italy to raise debt.
So much could go wrong. The nightmare scenario would come if debt costs rise or disinflation turns into outright deflation – neither is a fantasy.
A spike in oil prices could also inflict enormous damage. While rising energy costs might remove the immediate threat of deflation, they could also wreck Europe's feeble recovery. Oil has plunged to about $90 a barrel. The price could reverse once the short sellers clear out of the market, as they inevitably will do.
Debt has to be repaid eventually. Paying it off becomes harder as the debt load rises and the prospect for sustained growth goes in the opposite direction. The debt crisis that never was may be just around the corner and poor Mario Draghi won't have anything left in his arsenal to fight it.
Eric Reguly