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The combination of ramped-up spending cuts and tapped-out consumers will make the Greek crisis come roaring back. Count on it. (John Kolesidis/Reuters/John Kolesidis/Reuters)
The combination of ramped-up spending cuts and tapped-out consumers will make the Greek crisis come roaring back. Count on it. (John Kolesidis/Reuters/John Kolesidis/Reuters)

Eric Reguly

The calm before Europe's next debt storm Add to ...

The euro zone’s sovereign debt meat grinder has stopped grinding, apparently. Greece has been bailed out and its debt load has been reduced by €100-billion ($130-billion) through a bond “haircut.” Italian bond yields, a measure of its government’s borrowing costs, have plunged. The European Central Bank, through a €1-trillion liquidity injection, has injected life into zombie banks. Markets have rallied, spring has sprung and the flood of crisis summits has slowed to a trickle.

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So happy times are here again? Forget it. Here are three reasons this is merely a lull before the next storm.

Austerity without growth is pointless

On Thursday, Fitch, the debt ratings agency, put Britain’s cherished triple-A rating on “negative” outlook, meaning there is a slightly greater than 50-per-cent chance of a downgrade within two years.

Britain’s response to the downgrade threat was, of course, to treat Fitch as a god to be worshipped and obeyed; there will be no let-up on the austerity measures. “This is a salutary reminder as to why Britain needs to deal with the enormous debts and deficits we inherited, why we have got to stick to those plans,” said the Treasury’s chief secretary, Danny Alexander.

The problem is that the British economy contracted in the fourth quarter. Vigorous austerity could easily push it into recession, which would, in turn, demand more austerity as rising unemployment and lower tax income make a mockery of budget deficit targets. Repeat in Italy, Spain, Portugal, Ireland and Greece, even France, where flat growth or contraction is being reinforced by aggressive austerity.

If governments are not spending, the slack has to be taken up by the private sector. But deleveraging means that the private sector in many countries isn’t spending either. Trying to unload your debt when your economy is in the tank can reinforce the financial and economic crisis, not eliminate it.

Note that the European Central Bank and the International Monetary Fund, in their new debt sustainability forecast for Greece, assume that Greece will emerge from deep recession next year, then grow at a rate of 2.5 per cent a year. This is sheer fantasy, all the more so since much of the austerity programs are back-end loaded – that is, they don’t even truly kick in until later this year and into next year. Meanwhile, consumer buying power is plummeting. The combination of ramped-up spending cuts and tapped-out consumers will make the Greek crisis come roaring back. Count on it.

Politicians acting like politicians

Surprise! Austerity-crazed politicians who fire civil servants by the arena load, slash spending on roads, schools, hospitals and pensions, cut wages – then raise taxes on property, income and fuel – tend to lose votes.

Indeed, governments have toppled throughout European Union since the debt crisis started 2½ years ago. So it is only natural that aspiring politicians will try to win votes by promising austerity-light programs.

The spring election in Greece is expected to produce a left-wing government deeply opposed to the deep, sovereignty-robbing austerity measures imposed by country’s handlers in Brussels, Berlin and Washington (home of the IMF). In France, opposition leader François Hollande, the man who could eliminate Nicolas Sarkozy in the spring presidential election, is promising to renegotiate the new EU fiscal discipline treaty championed by Germany. That treaty could be rejected by the minority government in the Netherlands, where the Labour party has serious reservations about its tough deficit rules, and in Ireland, where a referendum on the treaty is to be held.

Lesser austerity measures might actually help the economy (see first item). But any loosening of the screws would lure the ratings agencies and the bond vultures like starving lions to slabs of red meat. Note that the ruthless bond crowd is already going after Portugal, whose bond yields are soaring as talk of another bailout, or a Greek-style debt restructuring, intensifies. If that were to happen, the debt crisis would merely shift from the eastern to the western fringe of the Mediterranean.

Oil, the looming threat

The oil market does not care about the fresh EU recession or the weak recovery in the United States. The price just keeps powering ahead. Brent crude, the de facto global benchmark, is, at $125 (U.S.) a barrel, up 32 per cent so far this year on top of a 21-per-cent rise in 2011.

Europe is a huge net importer of oil, all the more so since the North Sea is rapidly running out of puff. Italy depends on imports for 85 per cent of its energy needs. Spain imports close to that level. Germany relies on imports for about 65 per cent of its energy requirements. When oil prices go up, money, and lots of it, makes a whooshing sound as it is sucked out of Europe and flies to the Middle East and North Africa.

Prices may go down, but they could also stay very high. Shale oil is overhyped. The world consumes about 32 billion barrels of oil a year. The Bakken discovery in the northern United States, the oil play that has the industry buzzing with excitement, has estimated recoverable reserves (using current technology) of no more than 4.3 billion barrels, according to a 2008 U.S. government geological report. Do the math. Globally speaking, it’s insignificant.

Now add in the Iran bombing threat and shrinking spare capacity in the global oil industry and you’ve got a recipe for continued high prices. For energy-sucking Europe trying to recover from recession, this is a nightmare. High oil prices act as new tax on consumers who have nothing left to give.

Follow on Twitter: @ereguly

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