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Posts Tagged ‘Euro’

Libertarians and other supporters of limited government historically have mixed feelings about the European Union (and its various governmental manifestations).

On the plus side, there are no trade barriers between nations that belong to the EU, and membership also makes it difficult for countries to impose regulatory burdens that hinder trade. The EU also has helped to improve the rule of law in some nations, particularly for newer members from the former Soviet Bloc.

On the minus side, the EU imposes trade barriers against the rest of the world. There is also continuous pressure for tax harmonization policies and regulatory harmonization policies that increase the burden of government – compounded by efforts to export those bad polices to non-member nations.

Given these good and bad features, it’s understandable that proponents of economic liberty don’t have a consensus position on the European Union.

But views may become more universally hostile since some European politicians now want to use the coronavirus crisis as an excuse to expand redistribution and enable bailouts by changing existing EU rules.

Currently, there is very limited scope for bad European-wide fiscal policy because Article 125 of the Treaty on the Functioning of the European Union ostensibly prohibits cross-country redistribution or bailouts.

For what it’s worth, there is another provision for nations that use the euro currency. Article 136 of the Treaty allows for a “stability mechanism” to “safeguard the stability of the euro,” but also states that “the mechanism will be made subject to strict conditionality.”

Now let’s apply this background knowledge to the current situation.

As I wrote last month, the coronavirus-triggered economic mess is wreaking havoc with the finances of EU nations, especially for “Club Med” nations.

For example, Desmond Lachman of the American Enterprise Institute writes for the Hill about the potential consequences for Italy.

The Eurozone’s moment of truth has arrived with the coronavirus pandemic. …a supply side-shock of unprecedented size to Europe in general and to a highly indebted Italy in particular. Indeed, Italy, the Eurozone’s third-largest member country, is now at the epicenter of the pandemic and is being subject to an economic shock of biblical proportions. …That is all too likely to cause the country’s public debt to skyrocket to over 160 percent of GDP by year-end. It is also likely to put enormous strain on the country’s rickety banking system…it would seem to be only a matter of time before markets…became increasingly reluctant to buy Italian government bonds for fear of an eventual default. They would also…chose to move their deposits out of the Italian banks to safer havens abroad. …we should brace ourselves for an Italian exit from the euro that would almost certainly roil the world’s financial markets.

None of this should be a surprise. Italy is a fiscal mess and I’ve been making that point with tiresome regularity.

The coronavirus and the concomitant economic shutdown are merely a final (and very big) straw on the camel’s back.

So is Italy going to default? And maybe crash out of the euro? Or, alternatively, actually impose some long-overdue spending restraint?

Well, why make any tough decision if there’s a potential new source of money – i.e., cash from taxpayers in Germany, Finland, Austria, the Netherlands, Sweden, and other EU nations in Northern Europe.

Needless to say, that’s a very controversial concept. British newspapers have been writing about this issue.

Here are some passages from a report in the left-leaning Guardian.

The European Union has weathered the storms of eurozone bailouts, the migration crisis and Brexit, but some fear coronavirus could be even more destructive. …Jacques Delors, the former European commission president who helped build the modern EU, broke his silence last weekend to warn that lack of solidarity posed “a mortal danger to the European Union”. …The pandemic has reopened the wounds of the eurozone crisis, resurrecting stereotypes about “profligate” southern Europeans and “hard-hearted” northerners. …The Dutch finance minister, Wopke Hoekstra,…infuriat[ed] his neighbours by asking why other governments didn’t have fiscal buffers to deal with the financial shock of the coronavirus. His comments were described as “repugnant”, “small-minded” and “a threat to the EU’s future” by Portugal’s prime minister, António Costa.

Here are excerpts from a piece in the right-leaning Telegraph.

Italian politicians took out a full-page advertisement in one of Germany’s most prestigious newspapers…, urging parsimonious northern Europe to do more to help the south… They urged Berlin to drop its opposition to a proposed EU scheme to issue so-called “coronabonds” to raise funds to fight the crisis. And they accused the Netherlands, which has led opposition to the scheme, of operating as a tax haven and diverting revenue from other member states. …Several EU members – led by France, Italy, Spain and Belgium – have called for EU-wide “coronabonds” to help poorer member states borrow as they struggle with the economic impact of the crisis. But a rival faction of northern members, led by the Netherlands, Finland, Austria and Germany, has opposed what it sees as an attempt to saddle the countries with the debts of their more feckless neighbours.

An article in the Express highlighted divisions between Portugal and the Netherlands.

Portugal’s Prime Minister Antonio Costa has stunned fellow EU leaders after raising the idea…that the Netherlands could be kicked out of the European Union… The Netherlands held up the talks after blocking demands from Italy, Spain and France for so-called ‘corona-bonds’ where the EU would issue joint shared debt to help finance a recovery. …The Portuguese leader said: “If under these conditions it’s not possible for Europe to ensure a common response to this challenge, this is a sign of great concern for those who believe in Europe.” Mr Costa went on to question whether “there is anyone who wants to be left out” of the EU or eurozone. He added: “Naturally, I’m referring to the Netherlands. “There is at least one country in the euro zone that resists understanding that sharing a common currency implies sharing a common effort.”

The rest of this column is going to explain why it’s a very bad idea to have intra-EU redistribution and bailouts.

But I first want to debunk the claim from the Portuguese Prime Minister that a common currency requires a common fiscal policy.

Indeed, he’s not the only one to make this mistake. In a column for the U.K.-based Times, Iain Martin also asserts that a common currency somehow necessitates cross-country redistribution.

European finance ministers and leaders have spent the week arguing over desperate pleas from countries such as Italy…who want the European Central Bank and the EU to underpin common debt that will cover the epic bills being faced by national governments. …The fiscally conservative northern nations see no reason why they should take on the “pooled” debt of weaker southern European economies. …The core problem is what it has always been: the elementary design flaw of the euro. Currency blocs that work depend on that notion of common endeavour and “pooling” debt and risk, and ideally must function as one political organisation. …the euro needed an institutional structure that would operate roughly as the United States does. …This escalating economic emergency is a tragedy…a currency and monetary and fiscal construction that is not capable of swiftly transferring resources to the weak.

Both Costa and Martin are wrong.

Panama does very well using the dollar as its currency, yet there’s obviously no common fiscal policy with the United States. Other nations also have “dollarized” without any adverse impact.

Or consider the fiscal history of the United States. For much of American history, the federal government was trivially small. Most spending happened at the state and local level.

Needless to say, having a common currency in this decentralized system wasn’t a hindrance to U.S. economic development.

With this topic out of the way, let’s now deal with whether the coronavirus crisis should be used as an excuse to open the floodgates for intra-EU redistribution and bailouts.

Politicians from nations on the receiving end obviously approve.

But some Americans also like the idea.

Max Bergmann, a former Obama appointee at the State Department, likes the idea. He argues in the Washington Post for more centralization and more redistribution in the EU.

…this is in fact a fight over the future of Europe. The common European bond proposal hits at the core of what Europe’s union is for. It is an act of unity… A common E.U. bond would take the debt that individual European states accrue to fight this crisis and make it a collective European responsibility. …Moving ahead with it would entail a sweeping increase in the power of the federal union. …The move by…nine countries for a common E.U. bond was in fact a revolt against Europe’s status quo. It was at its core therefore a revolt against Merkel and the past decade of austerity in Europe. …Merkel is also the architect of a decade of devastating austerity that has caused economic devastation and deprivation… The crisis revealed that Europe’s new currency (the euro) had a design flaw. While the E.U. had a common monetary policy with its own central bank, it lacked a common fiscal policy. …Merkel could have pushed for that. …Merkel lectured southern European countries about profligacy. She turned what was a manageable crisis into a systemic shock to Europe’s economies. …As the coronavirus crisis hit, …Merkel has stuck to her guns.

The New York Times, unsurprisingly, has editorialized for centralization and redistribution.

…the European Union is…an alliance of sovereign countries, not a central government, and Brussels has control only over external trade and competition. For the rest, its executive branch, the European Commission, can only seek cooperation, not order it. The states that share the euro do not have true fiscal union, under which wealthier parts of the bloc would prop up the poorer. …Europe could do better. Much better. …Italians or Spaniards confronted with death and economic catastrophe…aren’t in a bind due to profligate spending; they’re in the throes of a plague… The question to ask is what’s the point of any union if it cannot find unity when it is needed most…true leadership requires knowing that we’re all in this together and can only conquer it together.

Is this correct? Would it be a good idea to have “a sweeping increase in the power of the federal union”? Would that be “true leadership”?

Gideon Rachman warns in the Financial Times that such policies will cause political fallout.

…northern Europeans will…feel exploited by the south. …The longer-term fears of the northern Europeans are also legitimate. …The northerners are alert to any sign that they are being sucked into permanent, large transfers of cash to heavily indebted EU partners. They are justifiably concerned that the current anguish is being used to push forward ideas that they have already rejected, many times over. …if political leaders renege on longstanding promises…, they should not be particularly surprised if voters then turn to populist, anti-European parties. …Anti-EU parties have already made strong gains across northern Europe in recent years.

That’s very sensible political analysis.

But the bigger problem, at least from my perspective, is that a common fiscal policy would be very bad economics.

It means more redistribution, with all the unfortunate incentives that creates for both those paying and those receiving (as illustrated by this cartoon).

And it means more overall government spending. The “Club Med” countries obviously would spend any money they got (whether from so-called coronabonds, a common-EU budget, or any other mechanism), and there’s no reason to think the nations in Northern Europe would reduce spending as their taxpayers started to underwrite the budgets of other nations.

This is a problem since government already is far too large in every EU country. Here’s the most-recent data from the European Commission. If you focus on the left, you’ll see the average fiscal burden in the EU is about 45 percent of GDP (and slightly higher in the subset of eurozone countries).

The bottom line is that countries such as Italy, Spain, Greece, and Portugal are in trouble because their governments have been spending too much.

Sadly, I fear it is just a matter of time before Article 125 is somehow sidelined and the profligacy of those “Club Med” nations is rewarded.

And if/when that happens, what’s good about the EU (open trade and the remnants of mutual recognition) definitely will be dwarfed by bad policy (bailouts, transfers, and others form of redistribution).

P.S. One of the strongest arguments for Brexit was that the EU inevitably would morph into a transfer union – and thus accelerate the economic decline of Europe. Given what’s now happening, the British were very wise to escape.

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I wrote recently how government regulation and bureaucratic inefficiency are hindering an effective response to coronavirus in the United States.

And I also wrote yesterday about one foolish response from Washington to the crisis.

But what about developments in other nations? Are there lessons to be learned?

Henry Olsen, writing in the Washington Post, contemplates how Italy is very vulnerable because of stagnation, dependency, and debt.

Italy…has essentially shuttered its economy to fight its enormous health crisis. …Effectively, millions of Italians are out of work. These actions would shock any economy. But Italy’s economy is already weak, and has been for decades. Its gross domestic product has barely grown over the past 20 years. Its unemployment rate, at 9.8 percent, is one of the highest in Europe. Worse still, Italy is one of the most heavily indebted nations in the world. Government debt stood at 138 percent of GDP before this crisis hit… Italy’s economic crisis will ultimately put serious pressure on the euro. …If Italy’s economic hit weakens its banks sufficiently, the European Central Bank could be forced to step in with a large bailout. …Italians would likely face years of depression and stagnation… Italy’s economic lockdown is sending clear warning signs that a fiscal meltdown is coming.

Henry also speculates in the column that Italy’s current left-populist government will be replaced by a right-populist government. Furthermore, he thinks this could lead to the country abandoning the euro (the currency shared by many European nations) and going back to a national currency.

For what it’s worth, that would be a mistake.

A major problem in Italy is that populist politicians want people to believe the fairy tale that it’s possible to consume more than you produce.

That currently happens in Italy when politicians borrow money and spend it.

If the country gets rid of the euro and goes back to the lira, politicians will also be able to print money and spend it.

In other words, Italy’s populist politicians would have another way of undermining prosperity.

(I’m not a big fan of the European Central Bank’s easy-money policies, but it’s always possible to go from bad to worse.)

Meanwhile, Joseph Sternberg of the Wall Street Journal opines about lessons that can be learned from Europe about government-run healthcare.

Scientists around the world have worked overtime to get a handle on Covid-19, yet one great unknown remains. We still don’t know for sure whether this is only a medical crisis, or also a medical system crisis. …Doctors in Italy know what to do to treat severe cases, such as using ventilators in intensive-care units. But hospitals lack the beds and equipment for the influx of patients and Italy doesn’t have enough doctors even to make the attempt. Ill patients languish in hospital corridors for want of beds, recovering patients are rushed out the door as quickly as possible, and exhausted (and sometimes sick) doctors and nurses can’t even muster the energy to throw up their hands in despair. …U.K. policy makers understand what such analyses portend—because underinvestment in Britain’s creaking health-care system is even worse. …As a result, British authorities…are desperate to hold off on a mass outbreak until the socialized National Health Service has recovered from its chronic winter crisis. …the NHS…already falls to pieces every year with the normal ebb and flow of cold-weather ailments. Each winter crisis becomes a bit more acute, and this year was no exception. As of December, only 80% of emergency-room patients were treated within four hours of arrival, down from 84% in the depths of the previous two winters.

Interestingly, not all European nations are created equal.

…the U.K. and Italy are significantly more dependent on direct government financing of health-care than is France or Germany. Government accounted for 79% of total health-care spending in the U.K. in 2017, according to Eurostat, and 74% in Italy. Germany and France both rely on compulsory insurance schemes with varying degrees of subsidy and government meddling, but outright government expenditure amounts to only 6% of total health spending in Germany and 5% in France. …politicians already have made decisions that may seal a country’s coronavirus fate…the important choices may have already come in the guise of technocratic health spending and investment decisions made largely out of public view over many years. How lucky do Europeans feel?

The moral of the story is that coronavirus vulnerability may be worse in nations where government has the most control over healthcare.

Since the disease is a “black swan” (i.e., an unexpected big event), we should be cautious about drawing too many policy conclusions. After all, any nation with a severe coronavirus outbreak is going to face major problems.

That being said, it may be worth noting that Germany and France have an approach that’s more akin to Obamacare while the system in Italy and the United Kingdom is more akin to Medicare for All.

Either policy is greatly inferior to the free market, but it does raise the question of whether it’s a good idea to jump from a frying pan into a fire.

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I’ve warned many times that Italy is the next Greece.

Simply stated, there’s a perfect storm of bad news. Government is far too big, debt is too high, and the economy is too sclerotic.

I’ve always assumed that the country would suffer a full-blown fiscal crisis when the next recession occurs. At that point, tax receipts will fall because of the weak economy and investors will realize that the nation no longer is able to pay its bills.

But it may happen even sooner thanks to a spat between Italy’s left-populist government and the apparatchiks at the European Commission.

Here’s what you need to know. There are (poorly designed) European budget rules, known as the Maastricht Criteria, that supposedly require that nations limit deficits to 3 percent of GDP and debt to 60 percent of GDP.

With cumulative red ink totaling more than 130 percent of GDP, Italy obviously fails the latter requirement. And this means the bureaucrats at the European Commission can veto a budget that doesn’t strive to lower debt levels.

At least that’s the theory.

In reality, the European Commission doesn’t have much direct enforcement power. So if the Italian government tells the bureaucrats in Brussels to go jump in a lake, you wind up with a standoff. As the New York Times reports, that’s exactly what’s happened.

In what is becoming a dangerous game of chicken for the global economy, Italy’s populist government refused to budge on Tuesday after the European Union for the first time sent back a member state’s proposed budget because it violated the bloc’s fiscal laws and posed unacceptable risks. …the commission rejected the plan, saying that it included irresponsible deficit levels that would “suffocate” Italy, the third-largest economy in the eurozone. Investors fear that the collapse of the Italian economy under its enormous debt could sink the entire eurozone and hasten a global economic crisis unseen since 2008, or worse. But Italy’s populists are not scared. They have repeatedly compared their budget, fat with unemployment welfare, pension increases and other benefits, to the New Deal measures of Franklin D. Roosevelt.

Repeating the failures of the New Deal?!? That doesn’t sound like a smart plan.

That seems well understood, at least outside of Italy.

The question for Italy, and all of Europe, is how far Italy’s government is willing to go. Will it be forced into submission by the gravity of economic reality? Or will Italian leaders convince their voters that the country’s financial health is worth risking in order to blow up a political and economic establishment that they say is stripping Italians of their sovereignty? And Brussels must decide how strict it will be. …the major pressure on Italy’s budget has come from outside Italy. Fitch Ratings issued a negative evaluation of the budget, and Moody’s dropped its rating for Italian bonds to one level above “junk” last week.

So now that Brussels has rejected the Italian budget plan, where do things go from here?

According to CNBC, the European Commission will launch an “Excessive Deficit Procedure” against Italy.

…a three-week negotiation period follows in which a potential agreement could be found on how to lower the deficit (essentially, Italy would have to re-submit an amended draft budget). If that’s not reached, punitive action could be taken against Italy. Lorenzo Codogno, founder and chief economist at LC Macro Advisors, told CNBC…“it’s very likely that the Commission will, without making a big fuss, will move towards making an ‘Excessive Deficit Procedure’…to put additional pressure on Italy…” Although it has the power to sanction governments whose budgets don’t comply with the EU’s fiscal rules (and has threatened to do so in the past), it has stopped short of issuing fines to other member states before. …launching one could increase the already significant antipathy between Brussels and a vociferously euroskeptic government in Italy. Against a backdrop of Brexit and rising populism, the Commission could be wary of antagonizing Italy, the third largest euro zone economy. It could also be wary of financial market nerves surrounding Italy from spreading to its neighbors… Financial markets continue to be rattled over Italy’s political plans. …This essentially means that investors grew more cautious over lending money to the Italian government.

For those who read carefully, you probably noticed that the European Commission doesn’t have any real power. As such, there’s no reason to think this standoff will end.

The populists in Rome almost certainly will move forward with their profligate budget. Bureaucrats in Brussels will complain, but to no avail.

Since I’m a nice guy, I’m going to give the bureaucrats in Brussels a much better approach. Here’s the three-sentence announcement they should make.

  1. The European Commission recognizes that it was a mistake to centralize power in Brussels and henceforth will play no role is overseeing fiscal policy in member nations.
  2. The European Commission (and, more importantly, the European Central Bank) henceforth will have a no-bailout policy for national governments, or for those who lend to national governments.
  3. The European Commission henceforth advises investors to be appropriately prudent when deciding whether to lend money to any government, including the Italian government.

From an economic perspective, this is a far superior approach, mostly because it begins to unwind the “moral hazard“that undermines sound financial decision making in Europe.

To elaborate, investors can be tempted to make unwise choices if they think potential losses can be shifted to taxpayers. They see what happened with the various bailouts in Greece and that tells them it’s probably okay to continue lending money to Italy. To be sure, investors aren’t totally blind. They know there’s some risk, so the Italian government has to promise higher interest payments

But it’s highly likely that the Italian government would have to pay even higher rates if investors were convinced there would be no bailouts. Incidentally that would be a very good outcome since it would make it more costly for Italy’s politicians to continue over-spending.

In other words, a win-win situation, with less debt and more prudence (and maybe even a smaller burden of government!).

My advice seems so sensible that you’re probably wondering if there’s a catch.

There is, sort of.

When I talk to policy makers, they generally agree with everything I say, but then say my advice is impractical because Italy’s debt is so massive. They fret that a default would wipe out Italy’s banks (which imprudently have bought lots of government debt), and might even cause massive problems for banks in other nations (which, as was the case with Greece, also have foolishly purchased lots of Italian government debt).

And if banks are collapsing, that could produce major macroeconomic damage and even lead/force some nations to abandon the euro and go back to their old national currencies.

For all intents and purposes, the Greek bailout was a bank bailout. And the same would be true for an Italian bailout.

In any event, Europeans fear that bursting the “debt bubble” would be potentially catastrophic. Better to somehow browbeat the Italian government in hopes that somehow the air can slowly be released from the bubble.

With this in mind, it’s easy to understand why the bureaucrats in Brussels are pursuing their current approach.

So where do we stand?

  • In an ideal world, the problem will be solved because the Italian government decides to abandon its big-spending agenda and instead caps the growth of spending (as I recommended when speaking in Milan way back in 2011).
  • In an imperfect world, the problem is mitigated (or at least postponed) because the European Commission successfully pressures the Italian government to curtail its profligacy.
  • In the real world, though, I have zero faith in the first option and very little hope for the second option. Consider, for instance, the mess in Greece. For all intents and purposes, the European Commission took control of that nation’s fiscal policy almost 10 years ago. The results have not been pretty.

So this brings me back to my three-sentence prescription. Yes, it almost certainly would be messy. But it’s better to let the air out of bubbles sooner rather than later.

P.S. The so-called Basel Rules contribute to the mess in Europe by directing banks to invest in supposedly safe government debt.

P.P.S. If the European Union is going to impose fiscal rules on member nations, the Maastricht criteria should be jettisoned and replaced with a Swiss-style spending cap.

P.P.P.S. Some of the people in Sardinia have the right approach. They want to secede from Italy and become part of Switzerland. The Sicilians, by contrast, have the wrong mentality.

P.P.P.P.S. Italy is very, very, very well represented in the Bureaucrat Hall of Fame.

P.P.P.P.P.S. You’ll think I’m joking, but a columnist for the New York Times actually argued the United States should be more like Italy.

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As a general rule, we worry too much about deficits and debt. Yes, red ink matters, but we should pay more attention to variables such as the overall burden of government spending and the structure of the tax system.

That being said, Greece shows that a nation can experience a crisis if investors no longer trust that a government is capable of “servicing” its debt (i.e., paying interest and principal to people and institutions that hold government bonds).

This doesn’t change the fact that Greece’s main fiscal problem is too much spending. It simply shows that it’s also important to recognize the side-effects of too much spending (if you have a brain tumor, that’s your main problem, even if crippling headaches are a side-effect of the tumor).

Anyhow, it’s quite likely that Italy will be the next nation to travel down this path.

This in in part because the Italian economy is moribund, as noted by the Wall Street Journal.

Italy’s national elections…featured populist promises of largess but neglected what economists have long said is the real Italian disease: The country has forgotten how to grow. …The Italian economy contracted deeply in Europe’s debt crisis earlier this decade. A belated recovery now under way yielded 1.5% growth in 2017—a full percentage point less than the eurozone as a whole and not enough to dispel Italians’ pervasive sense of national decline. Many European policy makers view Italy’s stasis as the likeliest cause of a future eurozone crisis.

Why would Italy be the cause of a future crisis?

For the simple reason that it is only the 4th-largest economy in Europe, but this chart from the Financial Times shows it has the most nominal debt.

So what’s the solution?

The obvious answer is to dramatically reduce the burden of government.

Interestingly, even the International Monetary Fund put forth a half-decent proposal based on revenue-neutral tax reform and modest spending restraint.

The scenario modeled assumes a permanent fiscal consolidation of about 2 percent of GDP (in the structural primary balance) over four years…, supported by a pro-growth mix of revenue and expenditure reforms… Two types of growth-friendly revenue and spending measures are considered along the envisaged fiscal consolidation path: shifting taxation from direct to indirect taxes, and lowering expenditure and shifting its composition from transfers to investment. On the revenue side, a lower labor tax wedge (1.5 percent of GDP) is offset by higher VAT collections (1 percent of GDP) and introducing a modern property tax (0.5 percent of GDP). On the expenditure side, spending on public consumption is lowered by 1.25 percent of GDP, while productive public investment spending is increased by 0.5 percent of GDP. The remaining portion of the fiscal consolidation, 1.25 percent of GDP, is implemented via reduced social transfers.

Not overly bold, to be sure, but I suppose I should be delighted that the IMF didn’t follow its usual approach and recommend big tax increases.

So are Italians ready to take my good advice, or even the so-so advice of the IMF?

Nope. They just had an election and the result is a government that wants more red ink.

The Wall Street Journal‘s editorial page is not impressed by the economic agenda of Italy’s putative new government.

Five-Star wants expansive welfare payments for poor Italians, revenues to pay for it not included. Italy’s public debt to GDP, at 132%, is already second-highest in the eurozone behind Greece. Poor Italians need more economic growth to generate job opportunities, not public handouts that discourage work. The League’s promise of a pro-growth 15% flat tax is a far better idea, especially in a country where tax avoidance is rife. The two parties would also reverse the 2011 Monti government pension reforms, which raised the retirement age and moved Italy toward a contribution-based benefit system. …Recent labor-market reforms may also be on the block.

Simply stated, Italy elected free-lunch politicians who promised big tax cuts and big spending increases. I like the first part of that lunch, but the overall meal doesn’t add up in a nation that has a very high debt level.

And I don’t think the government has a very sensible plan to make the numbers work.

…problematic for the rest of Europe are the two parties’ demand for an exemption from the European Union’s 3% GDP cap on annual budget deficits. …the two parties want the European Central Bank to cancel some €250 billion in Italian debt.

Demond Lachman of the American Enterprise Institute suggests this will lead to a fiscal crisis because of two factors. First, the economy is weak.

Anyone who thought that the Eurozone debt crisis was resolved has not been paying attention to economic and political developments in Italy…the recent Italian parliamentary election…saw a surge in support for populist political parties not known for their commitment to economic orthodoxy or to real economic reform. …To say that the Italian economy is in a very poor state would be a gross understatement. Over the past decade, Italy has managed to experience a triple-dip economic recession that has left the level of its economy today 5 percent below its pre-2008 peak. Meanwhile, Italy’s current unemployment level is around double that of its northern neighbors, while its youth unemployment continues to exceed 25 percent. …the country’s public debt to GDP ratio continued to rise to 133 percent, making the country the most indebted country in the Eurozone after Greece. …its banking system remains clogged with non-performing loans that still amount to 15 percent of its balance sheet…

Second, existing debt is high.

…having the world’s third-largest government bond market after Japan and the United States, with $2.5 trillion in bonds outstanding, Italy is simply too large a country for even Germany to save. …global policymakers…, it would seem not too early for them to start making contingency plans for a full blown Italian economic crisis.

Since he writes on issues I care about, I always enjoy reading Lachman’s work. Though I don’t always agree with his analysis.

Why, for instance, does he think an Italian fiscal crisis threatens the European currency?

…the Italian economy is far too large an economy to fail if the Euro is to survive in anything like its present form.

Would the dollar be threatened if (when?) Illinois goes bankrupt?

But let’s not get sidetracked.3

To give you an idea of the fairy-tale thinking of Italian politicians, I’ll close with this chart from L’Osservatorio on the fiscal impact of the government’s agenda. It’s in Italian, but all you need to know is that the promised tax cuts and spending increases are on the left side and the compensating savings (what we would call “pay-fors”) are on the right side.

Wow, makes me wonder if Italy has passed the point of no return.

By the way, Italy may be the next domino, but it’s not the only European nation with fiscal problems.

P.S. No wonder some people want Sardinia to secede from Italy and become part of “sensible” Switzerland.

P.P.S. Some leftists genuinely think the United States should emulate Italy.

P.P.P.S. As a fan of spending caps, I can’t resist pointing out that anti-deficit rules in Europe have not stopped politicians from expanding government.

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The famous French diplomat Charles Maurice de Talleyrand supposedly said that a weakness of the Bourbon monarchs was that they learned nothing and forgot nothing.

If so, the genetic descendants of the Bourbons are now in charge of Europe.

But before explaining why, let’s first establish that Europe is in trouble. I’ve made that point (many times) that the continent is in trouble because of statism and demographic change.

What’s far more noteworthy, though, is that even the Europeans are waking up to the fact that the continent faces a very grim future.

For instance, the bureaucrats in Brussels are pessimistic, as reported by the EU Observer.

…the report warns of a longer term risk for the EU economy. “As expectations of low growth ahead affect investment today, there is potential for a vicious circle,” the commission’s director general for economic and financial affairs writes in the report’s foreword. “In short, the projected pace of GDP growth may not be sufficient to prevent the cyclical impact of the crisis from becoming permanent (hysteresis), ” Marco Buti writes.

The people of Europe share that grim assessment.

Pew has some very sobering data on angst across the continent.

Support for European economic integration – the 1957 raison d’etre for creating the European Economic Community, the European Union’s predecessor – is down over last year in five of the eight European Union countries surveyed by the Pew Research Center in 2013. Positive views of the European Union are at or near their low point in most EU nations, even among the young, the hope for the EU’s future. The favorability of the EU has fallen from a median of 60% in 2012 to 45% in 2013.

Here’s the relevant chart.

Establishment-oriented voices in the United States also agree that the outlook is rather dismal.

Writing in the Washington Post, Sebastian Mallaby offers a grim assessment of Europe’s future.

…since 2008…, the 28 countries in the European Union managed combined growth of just 4 percent. And in the subset consisting of the eurozone minus Germany, output actually fell. …most of the Mediterranean periphery has suffered a lost decade. …The unemployment rate in the euro area stands at 9.8 percent, more than double the U.S. rate. Unemployment among Europe’s youth is even more appalling: In Greece, Spain, France, Croatia, Italy, Cyprus and Portugal, more than 1 in 4 workers under 25 are jobless.

The bottom line is that there’s widespread consensus that Europe is a mess and that things will probably get worse unless there are big changes.

But the key question, as always, is whether the changes are positive or negative. And this is why I started with a reference to the Bourbon kings. European leaders today also are infamous for learning nothing and forgetting nothing.

Indeed, the proponents of bad policy want to double down on the mistakes of bigger government and more centralization.

The International Monetary Fund (aka, the “Dr. Kevorkian” or “dumpster fire” of the global economy), led by France’s Christine Lagarde, actually is urging a new form of redistribution in Europe.

The International Monetary Fund called on Thursday for the creation of a fund…in the euro zone… Managing Director Christine Lagarde said… “countries would be pooling budgetary resources in a common pot which could be used for projects and certain operations”

Lagarde says the new fund should have strings attached, so that nations could access the loot if they complied with the EU’s budget rules, and also if they use the money for structural reform.

That sounds prudent, but only until you look at the fine print.

The current budget rules are misguided and are more likely to encourage tax hikes rather than spending restraint. And while many European nations need good structural reform, that’s not what the IMF has in mind.

Lagarde told a news conference the new fund could pay for projects related to migration, refugees, security, energy and climate change.

Instead, it appears that this is just a scheme to transfer money from countries such as Germany and Estonia that have restrained spending in recent years.

Germany, Estonia and Luxembourg are the only EU countries that have posted budget surpluses since 2014. Lagarde said the pooling of budgetary resources could put these surpluses to good use.

Sigh.

But the problem goes way beyond an international bureaucracy led by someone from Europe. This is the mentality that is deeply embedded in most European policymakers.

Simply stated, the people who helped create the European mess by pushing for bigger government and more centralization agree that the time if right for…you guessed it…bigger government and more centralization. Here’s an excerpt from a report by the Delors Institute.

…a true economic and monetary union still needs to be built. It will have to be based on significant risk sharing and sovereignty sharing within a coherent and legitimate framework of supranational economic governance. This third building block includes turning the ESM into a fully-fledged European Monetary Fund.

The bureaucrats in Brussels predictably agree that they should get more power, as noted in a story from the EU Observer.

The EU should raise its own taxes and use Brexit as an opportunity to push for the idea, a report by a group of top officials says. …”The Union must mobilise common resources to find common solutions to common problems,” says the document, seen by EUobserver. …The paper also proposes a EU-level corporate income tax that would be combined with a common consolidated corporate tax base… Other proposals include a bank levy, a financial transaction tax, or a European VAT that would top national VATs. …The new budget EU commissioner Guenther Oettinger said that the report was “of great quality”.

And the senior politicians in Brussels are also beating the drum for added centralization.

…divergence creates fragility… Progress must happen…towards a genuine Economic Union…towards a Fiscal Union…need to shift from a system of rules and guidelines for national economic policy-making to a system of further sovereignty sharing within common institutions…some degree of public risk sharing…including a ‘social protection floor’…a shared sense of purpose among all Member States

Wow. I don’t know if I’ve ever read something so wildly wrong. As Nassim Nicholas Taleb has sagely observed, it is centralization and harmonization that creates systemic risk.

And all this talk about “common resources” and “public risk sharing” is simply the governmental version of co-signing a loan for the deadbeat family alcoholic.

Yet Europe’s ideologues can’t resist their lemming-like march in the wrong direction.

What makes this especially odd is that there is so much evidence that Europe originally became rich for the opposite reason.

It was decentralization and jurisdictional competition that enabled prosperity.

Matt Ridley, writing for the UK-based Times, drives this point home.

…the leading theory among economic historians for why Europe after 1400 became the wealthiest and most innovative continent is political fragmentation. Precisely because it was not unified, Europe became a laboratory for different ways of governing, enabling the discovery of regimes that allowed free markets and invention to flourish, first in northern Italy and some parts of Germany, then the low countries, then Britain. By contrast, China’s unity under one ruler prevented such experimentation. …Baron Montesquieu…remarked, Europe’s “many medium-sized states” had incubated “a genius for liberty, which makes it very difficult to subjugate each part and to put it under a foreign force other than by laws and by what is useful to its commerce”. …David Hume…mused…Europe is the continent “most broken by seas, rivers, and mountains” and so “the divisions into small states are favourable to learning, by stopping the progress of authority as well as that of power”. …the idea has gained almost universal agreement among historians that a disunited Europe, while frequently wracked by war, was also prone to innovation and liberty — thanks to the ability of innovators and skilled craftsmen to cross borders in search of more congenial regimes.

But now Europe has swung completely in the other direction.

The European Commission’s obsession with harmonisation prevents the very pattern of experimentation that encourages innovation. Whereas the states system positively encouraged governments to be moderate in political, religious and fiscal terms or lose their talent, the commission detests jurisdictional competition, in taxes and regulations. The larger the empire, the less brake there is on governmental excess.

Ralph Raico echoes these insights in an article for the Foundation for Economic Education.

In seeking to answer the question why the industrial breakthrough occurred first in western Europe, …what was it that permitted private enterprise to flourish? …Europe’s radical decentralization… In contrast to other cultures — especially China, India, and the Islamic world — Europe comprised a system of divided and, hence, competing powers and jurisdictions. …Instead of experiencing the hegemony of a universal empire, Europe developed into a mosaic of kingdoms, principalities, city-states, ecclesiastical domains, and other political entities. Within this system, it was highly imprudent for any prince to attempt to infringe property rights in the manner customary elsewhere in the world. In constant rivalry with one another, princes found that outright expropriations, confiscatory taxation, and the blocking of trade did not go unpunished. The punishment was to be compelled to witness the relative economic progress of one’s rivals, often through the movement of capital, and capitalists, to neighboring realms. The possibility of “exit,” facilitated by geographical compactness and, especially, by cultural affinity, acted to transform the state into a “constrained predator”.

In other words, the “stationary bandit” couldn’t steal as much and that gave the private sector the breathing room that’s necessary for growth.

But today’s politicians in Europe want to strengthen the ability of governments to seize more money and power.

That strategy may work in the short run, but bailouts, redistribution, easy money, and statism are not a good long-run strategy.

So perhaps it’s appropriate that we conclude with a warning. As reported in a column for the UK-based Telegraph, one of the architects of the euro fears that bailouts are crippling the continent-wide currency.

The European Central Bank is becoming dangerously over-extended and the whole euro project is unworkable in its current form, the founding architect of the monetary union has warned. “One day, the house of cards will collapse,” said Professor Otmar Issing, the ECB’s first chief economist… Prof Issing lambasted the European Commission as a creature of political forces that has given up trying to enforce the rules in any meaningful way. “The moral hazard is overwhelming,” he said. The European Central Bank is on a “slippery slope” and has in his view fatally compromised the system by bailing out bankrupt states in palpable violation of the treaties. “…Market discipline is done away with by ECB interventions. …The no bailout clause is violated every day,” he said… Prof Issing slammed the first Greek rescue in 2010 as little more than a bailout for German and French banks, insisting that it would have been far better to eject Greece from the euro as a salutary lesson for all.

For what it’s worth, I fully agree that Greece should have been cut loose.

But European politicians and bureaucrats, driven by an ideological belief in centralization (and a desire to bail out their big banks), instead decided to undermine the euro by creating a bigger mess in Greece and sending a very bad signal about bailouts to other welfare states.

And keep in mind that the fuse is still burning on the European fiscal crisis.

As the old saying goes, this won’t end well.

P.S. While my prognosis for Europe is relatively bleak, there were some hopeful signs in the aforementioned Pew data.

First, Europeans at some level understand that government is simply too big. Indeed, they recognize that economic growth is far more likely to occur if fiscal burdens are reduced rather than increased.

Second, they also realize that the euro, while weakened and flawed, is a better option than restoring national currencies, which would give their governments the power to finance bigger government by printing money.

P.P.S. I can’t resist sharing one final bit of polling data from Pew. I’m amused that every nation sees itself as the most compassionate (though if you look at real data, all European nations lag the USA in real compassion). Meanwhile, the prize for self-doubt (or perhaps self-awareness?) goes to the Italians, who labeled themselves as least trustworthy. The schizophrenia prize goes to the Poles, who simultaneously view the Germans as the most trustworthy and least trustworthy.

Oh, and there’s probably some lesson to be learned from Germany dominating the data for being most trustworthy and least compassionate.

Maybe this poll should be added to my European humor collection.

P.P.P.S. Given the sorry state of Europe, now perhaps skeptics will understand why Brexit was the only good option for Brits.

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If you want to pinpoint the leading source of bad economic policy proposals, I would understand if someone suggested the Obama Administration.

But looking to Europe might be even more accurate.

For instance, I’d be hard pressed to identify a policy more misguided than continent-wide eurobonds, which I suggested would be akin to “co-signing a loan for your unemployed alcoholic cousin who has a gambling addiction.”

And now there’s another really foolish idea percolating on the other side of the Atlantic Ocean.

The U.K.-based Financial Times has a story about calls for greater European centralization from Italy.

Italy’s finance minister has called for deeper eurozone integration in the aftermath of the Greek crisis, saying a move “straight towards political union” is the only way to ensure the survival of the common currency. …Italy and France have traditionally been among the most forceful backers of deeper European integration but other countries are sceptical about supporting a greater degree of political convergence. …Italy is calling for a wide set of measures — including the swift completion of banking union, the establishment of a common eurozone budget and the launch of a common unemployment insurance scheme — to reinforce the common currency. He said an elected eurozone parliament alongside the existing European Parliament and a European finance minister should also be considered. “To have a full-fledged economic and monetary union, you need a fiscal union and you need a fiscal policy,” Mr Padoan said.

This is nonsense.

The United States has a monetary union and an economic union, yet our fiscal policy was very decentralized for much of our nation’s history.

And Switzerland has a monetary and economic union, and its fiscal policy is still very decentralized.

Heck, the evidence is very strong that decentralized fiscal systems lead to much better outcomes.

So why is Europe’s political elite so enamored with a fiscal union and so opposed to genuine federalism?

There’s an ideological reason and a practical reason for this bias.

The ideological reason is that statists strongly prefer one-size-fits-all systems because government has more power and there’s no jurisdictional competition (which they view as a “race to the bottom“).

The practical reason is that politicians from the weaker European nations see a fiscal union as a way of getting more transfers and redistribution from nations such as Germany, Finland, and the Netherlands.

In the case of Italy, both reasons probably apply. Government debt already is very high in Italy and growth is virtually nonexistent, so it’s presumably just a matter of time before the Italians will be looking for Greek-style bailouts.

But the Italian political elite also has a statist ideological perspective. And the best evidence for that is the fact that Signore Padoan used to be a senior bureaucrat at the Paris-based OECD.

The Italian finance minister…served as former chief economist of the OECD.

You won’t be surprised to learn that French politicians also have been urging a supranational government for the eurozone. And presumably for the same reasons of ideology and self-interest.

But here’s the man-bites-dog part of the story.

The German government also seems open to the idea, as reported by the U.K.-based Independent.

France and Germany have agreed a new plan for closer eurozone political unionThe new Franco-German agreement would see closer cooperation between the 19 countries.

Wow, don’t the politicians in Berlin know that a fiscal union is just a scheme to extract more money from German taxpayers?!?

As I wrote three years ago, this approach “would involve putting German taxpayers at risk for the reckless fiscal policies in nations such as Greece, Italy, and Spain.

But maybe the Germans aren’t completely insane. Writing for Bloomberg, Leonid Bershidsky explains that the current German position is to have a supranational authority with the power to reject national budgets.

The German perspective on a political and fiscal union is a little more cautious. Last year, German Finance Minister Wolfgang Schaeuble and a fellow high-ranking member of the CDU party, Karl Lamers, called for a euro zone parliament (not elected, but comprising European Parliament members from euro area countries) and a budget commissioner with the power to reject national budgets if they contravene a certain set of rules agreed by euro members.

And since the German approach is disliked by the Greeks, then it can’t be all bad.

Former Greek finance minister Yanis Varoufakis, Schaeuble’s most eloquent hater, pointed out in a recent article for Germany’s Die Zeit that, in the Schaeuble-Lamers plan, the budget commissioner is endowed only with “negative” powers, while a true federation — like Germany itself — elects a parliament and a government to formulate positive policies.

But “can’t be all bad” isn’t the same as good.

Simply stated, any sort of eurozone government almost surely will morph over time into a transfer union. And that means more handouts, more subsidies, more harmonization, more bailouts, more centralization, and more bureaucracy.

So you can see why Europe’s political elite may be even more foolish than their American counterparts.

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For understandable reasons, the fiscal mess in Greece has dominated the European economic headlines.

But there are other developments that deserve attention. Amazingly, some politicians think Europe’s stagnant economy can be improved with more harmonization, more bureaucratization, and more centralization.

The EU Observer has a story about a French scheme to transform the eurozone into a supranational government.

French president Francois Hollande has called for a stronger more harmonised eurozone… “What threatens us is not too much Europe, but too little Europe,” he said in a letter published in the Journal du Dimanche. He called for a vanguard of countries that would lead the eurozone, which should have its own government, a “specific budget” and its own parliament. …French prime minister Manuel Valls Sunday said…France would prepare “concrete proposals” in the coming weeks. “We must learn the lessons and go much further,” he added, referring to the Greek crisis.

I’m not sure what lessons Monsieur Valls wants people to learn. Greece got in trouble because of big government and excessive intervention.

So why is anyone supposed to believe that adding a new layer of government is going to make Europe more prosperous?

In all likelihood, the French are pursuing this agenda for two selfish reasons.

  1. A “harmonised eurozone” means that all affected nations would have to abide by the same rules, and that inevitably means taxes and regulations are set at the most onerous levels. The French think that’s a good idea because it’s a way of undermining the competitiveness of other eurozone nations.
  2. A eurozone government with a “specific budget” sets the stage for more intergovernmental transfers in Europe. The French think that’s a good idea since they presumably could prop up their decrepit welfare state with money from taxpayers in nations such as Germany, Finland, and the Netherlands.

By the way,not all French politicians are totally misguided.

At least one of them is expressing more sensible ideas, as reported by the U.K.-based Telegraph.

France is “the sick man of Europe”, François Fillon, the former centre-Right prime minister, has said in an open letter to French president Francois Hollande, calling for urgent economic reforms.“The Greek tragedy shows that the threat of bankruptcy is not abstract,” according to Mr Fillon… French commentators writing about the Greek crisis in recent days have pointed out that France’s own national debt of more than €2 trillion (£1.4 trillion), amounting to 97.5 per cent of GDP, places it in the same league as Spain and other southern European countries.

By the way, the commentators who are fretting about French debt are focused on the wrong variable. The French disease is big government. High levels of debt are simply a symptom of that disease.

Moreover, I’m not sure that Monsieur Fillon is a credible spokesman for smaller government and free markets since he served during the statist tenure of President Sarkozy.

In any event, if there are any serious reformers in France, they face an uphill battle. As I’ve previously noted, many successful people and aspiring entrepreneurs have left France.

Here’s a news report on the phenomenon.

And just in case you think this is merely anecdotal data, here’s a table showing the nations that lost the most millionaires since 2000.

In the case of China and India, rich people leave because they want to establish a domicile in a developed nation.

But successful people escape France in spite of its first-world attributes.

Let’s now cross the Pyrenees and see what’s happening in Spain.

Our Keynesian friends, as well as other big spenders, are always trumpeting the value of infrastructure projects because they ostensibly pump money into an economy.

I’ve made the point that such outlays should be judged using cost-benefit analysis. Well, it appears that Spain listened to the wrong people. It got a €10,000 return on an infrastructure “investment” of €1,100,000,000.

One of Spain’s “ghost airports”—expensive projects that were virtually unused—received just one bid in a bankruptcy auction after costing about €1.1 billion ($1.2 billion) to build. The buyer’s offer: €10,000. Ciudad Real’s Central airport, about 235 kilometers south of Madrid, became a symbol of the country’s wasteful spending.

Wow, and I thought Social Security was a bad deal.

But Spanish politicians should be known for more than just misguided boondoggles.

Some of them also are working hard to make sure citizens don’t work too hard. Here’s a story from an English-language news outlet in Spain (h/t: Commentator).

Between the hours of 2pm and 5pm you will struggle to find anyone in the Valencian town of Ador; the town’s inhabitants will have taken to their beds to catch their mandatory forty winks. The town’s summer siesta tradition is so deep-rooted the mayor has enshrined his citizen’s right to an afternoon snooze in law. …Ador could be the first town in Spain to actually make taking a siesta obligatory by law. …The new rules also stipulate that children should remain indoors:

One imagines the next step will be mandatory bed checks by new bureaucrats hired for just that purpose.

Though maybe they would need special permission to take their mandatory siestas from 11:00-2:00 so they would be free to harass the rest of the population between 2:00-5:00.

In any event, we can add mandatory siestas to our list of bizarre government-granted human rights.

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I’ve shared lots of analysis (both serious and satirical) about the mess in Greece and I feel obliged to comment on the latest agreement for another bailout.

But how many times can I write that the Greek government spends too much money and has a punitive tax system (and a crazy regulatory regime, a bloated bureaucracy, etc)?

So let’s try a different approach and tell a story about the new bailout by using some images.

Here’s an amusing perspective on what actually happened this weekend.

I explained a few days ago that the bailouts have simultaneously enabled the delay of much-needed spending reforms while also burdening Greece with an impossible pile of debt.

But the Greek bailouts, like the TARP bailout in the United States, were beneficial to powerful insiders.

Here’s a look at how banks in various European nations have been able to reduce their exposure to Greek debt.

Sure, the banks almost surely still lost money, but they also transferred a lot of the losses to taxpayers.

To get a sense of the magnitude of handouts, here’s a chart from a Washington Post story.

And now, assuming the deal gets finalized, that pile of foolish and unsustainable debt will be even bigger.

One of the main components of the new agreement is that Greece supposedly will raise revenue by selling $50 billion of state-owned assets.

Don’t believe that number. But not because there aren’t plenty of assets to sell, but rather because the track record on privatization proceeds suggests that there is a giant gap between what Greece promises and what Greece delivers.

To understand why assets aren’t being sold, just keep in mind that most of the assets are under the control of the government in order to provide unearned benefits to different interest groups.

If you’re an overpaid unionized worker at a government-owned port, for instance, the last thing you want is to have that port sold to a private investor who presumably would want to link pay to productivity.

Here’s the best bit of humor I’ve seen about the negotiations this past weekend. It purports to show a list of demands from Germany to Greece.

While this image is funny, it’s also wrong.

Germany isn’t imposing anything on Greece. The Germans are simply stating that Greek politicians need to make some changes if they want more handouts.

Moreover, it’s quite likely that Germany will wind up being a big loser when the dust settles. Here’s some of what Gideon Rachman wrote for the U.K.-based Financial Times.

If anybody has capitulated, it is Germany. The German government has just agreed, in principle, to another multibillion-euro bailout of Greece — the third so far. In return, it has received promises of economic reform from a Greek government that makes it clear that it profoundly disagrees with everything that it has just agreed to. The Syriza government will clearly do all it can to thwart the deal it has just signed. If that is a German victory, I would hate to see a defeat.

So true.

I fear this deal will simply saddle Greece with a bigger pile of debt and set the stage for a more costly default in the future.

The title of this column is about pictures. But let’s close with some good and bad analysis about the Greek mess.

Writing for Real Clear Markets, Louis Woodhill has some of the best insight, starting with the fact that the bailout does two things.

First, this new bailout is largely just a mechanism to prevent default on past bailouts. Sort of like making a new loan to your deadbeat brother-in-law to cover what he owes you on previous loans.

…the €53.5 billion in new loans…would just be recycled to Greece’s creditors (the IMF, the EU, and the ECB) to pay the interest and principal on existing debts.

Second, it prevents the full meltdown of Greek banks.

The key point is that a bailout agreement would restore European Central Bank (ECB) “Emergency Liquidity Assistance” (ELA) to the Greek banking system. This would allow Greeks that still have deposits in Greek banks (€136.5 billion as of the end of May) to get their money out of those banks.

That’s good news if you’re a Greek depositor, but that’s about it.

In other words, those two “achievements” don’t solve the real problem of Greece trying to consume more than it produces.

Indeed, Woodhill correctly identifies a big reason to be very pessimist about the outcome of this latest agreement. Simply stated, Greek politicians (aided and abetted by the Troika) are pursuing the wrong kind of austerity.

…what is killing Greece is a lack of economic growth, and the meat of Tsipras’ bailout proposal consists of growth-killing tax hikes. The media and the economics profession have been framing the alternatives for Greece in terms of a choice between “austerity” and “stimulus.” Unfortunately for Greece, austerity has come to mean tax increases, and stimulus has come to mean using “other people’s money” (mainly that of German taxpayers) to support Greek welfare state outlays. So, if “other people” aren’t willing to fund more Greek government spending, then the only option the “experts” can imagine is to raise taxes on an economy that is already being crushed by excessive taxation.

Let’s close with the most ridiculous bit of analysis about the Greek situation. It’s from Joe Stiglitz,

Joseph Stiglitz accused Germany on Sunday of displaying a “lack of solidarity” with debt-laden Greece that has badly undermined the vision of Europe. …”Asking even more from Greece would be unconscionable. If the ECB allows Greek banks to open up and they renegotiate whatever agreement, then wounds can heal. But if they succeed in using this as a trick to get Greece out, I think the damage is going to be very very deep.”

Needless to say, I’m not sure why it’s “solidarity” for one nation to mooch in perpetuity from another nation. I suspect Stiglitz is mostly motivated by an ideological desire to redistribute from the richer Germans to the poorer Greeks,

But I’m more interested in why he isn’t showing “solidarity” to me. I’m sure both his income and his wealth are greater than mine. So if equality of outcomes is desirable, why doesn’t he put his money where his mouth is by sending me a big check?

Needless to say, I won’t be holding my breath waiting for the money. Like most leftists, Stiglitz likes to atone for his feelings of guilt by redistributing other people’s money.

And I also won’t be holding my breath waiting for a good outcome in Greece. As I wrote five-plus years ago, Greece needs the tough-love approach of no bailouts, which would mean a default but also an immediate requirement for a balanced budget.

Last but not least, I’m going to confess a possible mistake. I always thought that Margaret Thatcher was right when she warned that the problem with socialism is that you eventually run out of other people’s money. But this latest bailout of Greece shows that maybe politicians from other nations are foolish enough to provide an endless supply of other people’s money.

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The European Commission’s data-gathering bureaucracy, Eurostat, has just published a new report on government finances for the region.

And with Greece’s ongoing fiscal turmoil getting headlines, this Eurostat publication is worthwhile because it debunks the notion, peddled by folks like Paul Krugman, that Europe has been harmed by “savage” and “harsh” spending cuts.

Here’s some of what’s in the report.

In 2014, total general government expenditure amounted to €6 701 bn in the European Union (EU). This represented almost half (48.1%) of EU GDP in 2014… Among EU Member States, general government expenditure varied in 2014 from less than 35% of GDP in Lithuania and Romania to more than 57% in Finland, France and Denmark.

Not only is government spending consuming almost half of economic output, redistribution outlays are the biggest line item in the budgets of European nations.

…the function ‘social protection’ was by far the most important, accounting for 40.2% of total general government expenditure. The next most important areas in terms of general government expenditure were ‘health’ (14.8%)… Its weight varied across EU Member States from 28.6% of total general government expenditure in Cyprus to 44.4% in Luxembourg. Eight EU Member States devoted more than 40% of their expenditure to social protection.

At this point, some readers may be thinking that the report shows European nations have very big governments with very large welfare states, but that doesn’t prove one way or the other whether there’s been austerity.

After all, austerity supposedly measures the degree to which there have been big spending cuts, not whether government consumes a large or small share of economic output.

So let’s now look at some of the underlying annual spending data from Eurostat.

Here’s their chart showing annual levels of government spending, both for the entire European Union (EU-28) and for the nations using the euro currency (EA-19). As you can see, there haven’t been any “harsh” or “savage” cuts.

Heck, there haven’t even been “timid” and “meek” cuts. The burden of government spending keeps climbing.

None of this should come as a surprise.

I’ve shared analysis making this point from experts on European fiscal policy such as Steve Hanke, Brian Wesbury, Constantin Gurdgiev, Fredrik Erixon, and Leonid Bershidsky.

So why is there a mythology about supposed spending cuts in Europe?

There are three answers.

  • First, there are lots of ignorant of mendacious people who don’t understand the numbers or don’t care about the truth. You can take a wild guess about the identity of some of these people.
  • Second, while overall government spending has continuously risen in Europe, a few nations (generally the ones that were most profligate last decade) have been forced to make some non-trivial spending cuts.
  • Third, some people cherry pick data on the burden of government spending relative to economic output and assert that austerity exists if government grows slower than GDP.

The people in the first category should be dismissed as cranks and ideologues.

Regarding the second category, if you look at Eurostat’s annual fiscal data, you’ll find that most EU nations since 2008 have had at least one year in which government spending declined. Indeed, the only exceptions are Belgium, France, Luxembourg, Austria, Poland, Slovakia, Finland, and Sweden.

But we’ve also had a few years of spending reductions in the United States since 2008, yet it would be silly to argue we’ve had “savage” and “harsh” cuts. The real question is whether any governments have been forced to make non-trivial reductions in the burden of spending. And if that’s defined as spending less today than they did in 2008, the only nations on that list are Greece, Latvia, and Ireland. But they’re also high on the list of countries that were most profligate in the years before 2008, so is it “austerity” if you give up drinking for a week or two after spending a week or two in an alcoholic haze? Perhaps the answer is yes, but the real problem was having a spending binge in the first place.

The third category is also worth exploring because the best way to determine if a country has responsible policy is to see whether government spending is falling as a share of economic output (i.e., are they following Mitchell’s Golden Rule). But you can’t cherry pick the data. For instance, look at this chart from Eurostat. If 2009 is used as the base year, it appears that EU nations have been frugal. But 2009 also was the year with the biggest bailouts and faux stimulus packages. So while government spending has receded a bit from the 2009 peak, the overall burden of spending today is significantly higher than it was before the 2008 crisis. Not exactly a very rigorous definition of austerity.

The bottom line is that there hasn’t been serious austerity in Europe, at least if austerity is defined as non-trivial spending cuts.

To be sure, there have been big fiscal changes in Europe. The bad news is that those changes have been big increases in income tax rates and big increases in value-added tax rates.

So if folks are looking for a good explanation of why Europe is suffering from anemic growth, that might be a place to start.

P.S. Unlike other European countries, the Baltic nations focused on genuine spending cuts rather than tax hike and their economies are doing comparatively well.

P.P.S. Even though Switzerland isn’t a member of the EU, Eurostat does include annual spending data for that nation. And it’s worth noting that spending has only grown by 2.07 percent per year since the implementation of the debt brake (which is really a spending cap). So that’s actually the best role model in Europe, as explained here by a representative from the Swiss Embassy.

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There’s a big fiscal battle happening in Europe. The relatively new Greek government is demanding continued handouts from the rest of Europe, but it wants to renege on at least some of the country’s prior commitments to improve economic performance by reducing the preposterous burden of spending, regulation, and intervention.

That seems like a rather strange negotiating position. Sort of like a bank robber holding a gun to his own head and saying he’ll shoot himself if the teller doesn’t hand over money.

At first glance, it seems the Greeks are bluffing. Or being suicidally self-destructive.

And maybe they are posturing and/or being deluded, but there are two reasons why the Greeks are not totally insane.

1. The rest of Europe does not want a Greek default.

There’s a famous saying, attributed to J. Paul Getty, that applies to the Greek fiscal fight. Simply stated, there are lots of people and institutions that own Greek government bonds and they are afraid that their investments will lose value if Greece decides to fully or partially renege on its debts (which is an implicit part of Greece’s negotiating position).

So while Greece would suffer if it defaulted, there would be collateral damage for the rest of Europe. In other words, the hypothetical bank robber has a grenade rather than a gun. And while the robber won’t fare well if he pulls the pin, lots of other people may get injured by shrapnel.

And to make matters more interesting, previous bailouts of Greece have created a rather novel situation in that taxpayers are now the indirect owners of a lot of Greek government debt. As you can see from the pie chart, European taxpayers have the most exposure, but American taxpayers also are on the hook because the IMF has participated in the bailouts.

The situation is Greece is akin to a bankruptcy negotiation. The folks holding Greek government debt are trying to figure out the best strategy for minimizing their losses, much as the creditors of a faltering business will calculate the best way of extracting their funds. If they press too hard, the business may go bust and they get very little (analogous to a Greek default). But if they are too gentle, they miss out on a chance of getting a greater share of the money they’re owed.

2. Centralization is the secular religion of the European elite and they want Greece in the euro.

The bureaucrats at the European Commission and the leaders of many European nations are emotionally and ideologically invested in the notion of “ever closer union” for Europe. Their ultimate goal is for the European Union to be a single nation, like the United States. In this analogy, the euro currency is akin to the American dollar.

There’s a general perception that a default would force the Greek government to pull out of the euro and re-create its own currency. And for the European elite who are committed to “ever closer union,” this would be perceived as a major setback. As such, they are willing to bend over backwards to accommodate Greece’s new government.

Given the somewhat blurry battle lines between Greece and its creditors, what’s the best outcome for advocates of limited government and individual liberty?

That’s a frustrating question to answer, particularly since the right approach would have been to reject any bailouts back when the crisis first started.

Without access to other people’s money, the Greek government would have been forced to rein in the nation’s bloated public sector. To be sure, the Greek government may also have defaulted, but that would have taught investors a valuable lesson about lending money to profligate governments.

And it would have been better if Greece defaulted five years ago, back when its debt was much smaller than it is today.

But there’s no point in crying about spilt milk. We can’t erase the mistakes of the past, so what’s the best approach today?

Actually, the right answer hasn’t changed.

And just as there are two reasons why the Greek government is being at least somewhat clever in playing hardball, there are two reasons why the rest of the world should tell them no more bailouts.

1. Don’t throw good money after bad.

To follow up on the wisdom of J. Paul Getty, let’s now share a statement commonly attributed to either Will Rogers or Warren Buffett. I don’t know which one (if either) deserves credit, but there’s a lot of wisdom in the advice to stop digging if you find yourself in a hole. And Greece, like many other nations, has spent its way into a deep fiscal hole.

There is a solution for the Greek mess. Politicians need to cut spending over a sustained period of time while also liberalizing the economy to create growth. And, to be fair, some of that has been happening over the past five years. But the pace has been too slow, particularly for pro-growth reforms.

But this also explains why bailouts are so misguided. Politicians generally don’t do the right thing until and unless they’ve exhausted all other options. So if the Greek government thinks it has additional access to money from other nations, that will give the politicians an excuse to postpone and/or weaken necessary reforms.

2. Saying “No” to Greece will send a powerful message to other failing European welfare states.

Now let’s get to the real issue. What happens to Greece will have a big impact on the behavior of other European governments that also are drifting toward bankruptcy.

Here’s a chart showing the European nations with debt burdens in excess of 100 percent of economic output based on OECD data. Because of bad demographics and poor decisions by their politicians, every one of these nations is likely to endure a Greek-style fiscal crisis in the near future.

And keep in mind that these figures understate the magnitude of the problem. If you include unfunded liabilities, the debt levels are far higher.

So the obvious concern is how do you convince the politicians and voters in these nations that they better reform to avoid future fiscal chaos? How do you help them understand, as Mark Steyn sagely observed way back in 2010, that “The 20th-century Bismarckian welfare state has run out of people to stick it to.

Well, if you give additional bailouts to Greece, you send precisely the wrong message to the Italians, French, etc. In effect, you’re telling them that there’s a new group of taxpayers from other nations who will pick up the tab.

That means more debt, bigger government, and a deeper crisis when the house of cards collapses.

P.S. Five years ago, I created a somewhat-tongue-in-cheek 10-step prediction for the Greek crisis and stated at the time that we were at Step 5. Well, it appears my satire is slowly becoming reality. We’re now at Step 7.

P.P.S. Four years ago, I put together a bunch of predictions about Greece. You can judge for yourself, but I think I was quite accurate.

P.P.P.S. A big problem in Greece is the erosion of social capital, as personified by Olga the Moocher. At some point, as I bluntly warned in an interview, the Greeks need to learn there’s no Santa Claus.

P.P.P.P.S. The regulatory burden in Greece is a nightmare, but some examples of red tape are almost beyond belief.

P.P.P.P.P.S. The fiscal burden in Greece is a nightmare, but some examples pf wasteful spending are almost beyond belief.

P.P.P.P.P.P.S. Since we once again have examined a very depressing topic, let’s continue with our tradition of ending with a bit of humor. Click here and here for some very funny (or sad) cartoons about Obama and Greece. And here’s another cartoon about Greece that’s worth sharing. If you like funny videos, click here and here. Last but not least, here’s some very un-PC humor about Greece and the rest of Europe.

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Four years ago, I put together some New Year’s Day Resolutions for the GOP.

Three years ago, I made some policy predictions for the new year.

But since I obviously don’t control Republicans and since I freely admit that economists are lousy forecasters, let’s do something more practical to start 2015.

Let’s simply look at three very important things that may happen this year and what they might mean.

1. Will the Republican Senate support genuine entitlement reform?

One of the best things to happen in recent years is that House Republicans embraced genuine entitlement reform. For the past four years, they have approved budget resolutions that assumed well-designed structural changes to both Medicare and Medicaid.

There were no real changes in policy, of course, because the Senate was controlled by Harry Reid. And I’m not expecting any meaningful reforms in 2015 or 2016 because Obama has a veto pen.

But if the Republican-controlled Senate later this year approves a budget resolution with the right kind of Medicare and Medicaid reform, that would send a very positive signal.

It would mean that they are willing to explicitly embrace the types of policies that are desperately needed to avert long-run fiscal crisis in America.

I don’t even care if the House and Senate have a conference committee and proceed with actual legislation. As I noted above, Obama would use his veto pen to block anything good from becoming law anyhow.

My bottom line is simple. If GOPers in both the House and Senate officially embrace the right kind of entitlement reform, then all that’s needed is a decent President after the 2016 elections (which, of course, presents an entirely different challenge).

2. Will there be another fiscal crisis in Greece (and perhaps elsewhere in Europe)?

The European fiscal crisis has not gone away. Yes, a few governments have actually been forced to cut spending, but they’ve also raised taxes and hindered the ability of the private sector to generate economic recovery.

And the spending cuts in most cases haven’t been sufficient to balance budgets, so debt continues to grow (in some cases, there have been dramatic increases in general government net liabilities).

Sounds like a recipe for further crisis, right? Yes and no.

Yes, there should be more crisis because debt levels today are higher than they were five years ago. But no, there hasn’t been more crisis because direct bailouts (by the IMF) and indirect bailouts (by the ECB) have propped up the fiscal regimes of various European nations.

At some point, though, won’t this house of cards collapse? Perhaps triggered by election victories for anti-establishment parties (such as Syriza in Greece or Podemos in Spain)?

While I’m leery of making predictions, at some point I assume there will be an implosion.

What happens after that will be very interesting. Will it trigger bad policies, such as centralized, European-wide fiscal decision-making? Or departures from the euro, which would enable nations to replace misguided debt-financed government spending with misguided monetary policy-financed government spending?

Or might turmoil lead to good policy, which both politicians and voters sobering up and realizing that there must be limits on the overall burden of government spending?

3. If the Supreme Court rules correctly in King v. Burwell, will federal and state lawmakers react correctly?

The Supreme Court has agreed to decide a very important case about whether Obamacare subsidies are available to people who get policies from a federal exchange.

Since the law explicitly states that subsidies are only available through state exchanges (as one of the law’s designers openly admitted), it seems like this should be a slam-dunk decision.

But given what happened back in 2012, when Chief Justice Roberts put politics above the Constitution, it’s anybody’s guess what will happen with King v Burwell.

Just for the sake of argument, however, let’s assume the Supreme Court decides the case correctly. That would mean a quick end to Obamacare subsidies in the dozens of states that refused to set up exchanges.

Sounds like a victory, right?

I surely hope so, but I’m worried that politicians in Washington might then decide to amend the law to officially extend subsidies to policies purchased through a federal exchange. Or politicians in state capitals may decide to set up exchanges so that their citizens can stay attached to the public teat.

In other words, a proper decision by the Supreme Court would only be a good outcome if national and state lawmakers used it as a springboard to push for repeal of the remaining parts of Obamacare.

If, on the other hand, a good decision leads to bad changes, then there will be zero progress. Indeed, it would be a big psychological defeat since it would represent a triumph of handouts over reform.

I guess I’m vaguely optimistic that good things will happen simply because we’ve already seen lots of states turn down “free” federal money to expand Medicaid.

P.S. Let’s close with some unexpected praise for Thomas Piketty. I’m generally not a fan of Monsieur Piketty since his policies would cripple growth (hurting poor people, along with everyone else).

But let’s now look at what France 24 is reporting.

France’s influential economist Thomas Piketty, author of “Capital in the 21st Century”, on Thursday refused to accept the country’s highest award, the Legion d’honneur… “I refuse this nomination because I do not think it is the government’s role to decide who is honourable,” Piketty told AFP.

It’s quite possible, perhaps even likely, that Piketty is merely posturing. But I heartily applaud his statement about the role of government.

Just as I applauded President Hollande when he did something right, even if it was only for political reasons.

But let’s not lose sight of the fact that Piketty is still a crank. His supposedly path-breaking research is based on a theory that is so nonsensical that it has the support of only about 3 percent of economists.

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At the beginning of the year, I was asked whether Europe’s fiscal crisis was over. Showing deep thought and characteristic maturity, my response was “HAHAHAHAHAHAHAHAHA, are you ;@($&^#’% kidding me?”

But I then shared specific reasons for pessimism, including the fact that many European nations had the wrong response to the fiscal crisis. With a few exceptions (such as the Baltic nations), European governments used the crisis to impose big tax hikes, including higher income tax rates and harsher VAT rates.

Combined with the fact that Europe’s demographic outlook is rather grim, you can understand why I’m not brimming with hope for the continent. And I’ve shared specific dismal data for nations such as Portugal, France, Greece, Italy, Poland, Spain, Ireland, and the United Kingdom.

But one thing I’ve largely overlooked is the degree to which the European Central Bank may be creating an unsustainable bubble in Europe’s financial markets. I warned about using bad monetary policy to subsidize bad fiscal policy, but only once in 2011 and once in 2012.

Check out this entertaining – but worrisome – video from David McWilliams and you’ll understand why this issue demands more attention.

I’ve openly argued that the euro is not the reason that many European nations got in trouble, but it appears that Europe’s political elite may be using the euro to make a bad situation even worse.

And to add insult to injury, the narrator is probably right that we’ll get the wrong outcome when this house of cards comes tumbling down. Instead of decentralization and smaller government, we’ll get an expanded layer of government at the European level.

Or, as I call it, Germany’s dark vision for Europe.

That’s Mitchell’s Law on steroids.

P.S. Here’s a video on the five lessons America should learn from the European crisis.

P.P.S. On a lighter note, the mess in Europe has generated some amusing videos (here, here, and here), as well as a very funny set of maps.

P.P.P.S. If all this sounds familiar, that may be because the Federal Reserve in the United States could be making the same mistakes as the European Central Bank. I don’t pretend to know when and how the Fed’s easy-money policy will turn out, but I’m not overly optimistic about the final outcome. As Thomas Sowell has sagely observed, “We all make mistakes. But we don’t all have the enormous and growing power of the Federal Reserve System… In the hundred years before there was a Federal Reserve System, inflation was less than half of what it became in the hundred years after the Fed was founded.”

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I’ve been worried for quite some time that the European Central Bank was losing its independence, thus undermining the long-run prospects of the euro.

Well, yesterday’s announcement that the ECB would buy the dodgy debt of nations such as Spain didn’t make me feel any better.

Central banks should not be bullied into creating too much money simply because politicians are too corrupt, venal, and short-sighted to control spending.

Here is some of what Allister Heath of City A.M. wrote earlier today. He begins with a wise warning about moral hazard.

There is nothing markets love more than a good dose of monetary activism, especially when they detect a hidden bailout, so it is no wonder that traders and investors reacted so positively to Mario Draghi’s bond buying plan. …Yet generally speaking these days, the more the markets like a central bank intervention, the more I worry. This is because all too often investors are trying to get central banks – and ultimately, the taxpayer – to monetise debt to protect themselves, or because they believe that there are monetary solutions to real, structural problems. I disagree on both counts: excessive debt needs to be written off, with the cost born by the creditors, not redistributed to the taxpayers of more prudent countries or inflated away. It is right that investors should be able to make a fortune if they make a correct bet – but it is equally right that they should lose their shirt when their investment goes sour. This habit of quietly enjoying the former but loudly refusing the latter is one of the main reasons why the City’s reputation is at such a low ebb.

He then explains that the ECB shouldn’t try to mask reality.

…there is a perfectly good reason why the yields of peripheral Eurozone nations have shot up over the past year. It is because the markets have finally started to price risk properly. Higher yields on Spanish or Greek debt reflect the reality of deeply troubled, structurally uncompetitive nations… The market is sending a clear and precise signal, and warning the world that there is a major problem that needs resolution; buying vast amounts of bonds to try and distort or even entirely eliminate that signal and pretend that nothing is wrong with Europe’s weaker economies would be an absurd act of delusion.

I’m not as optimistic as Allister is in this next section, largely because the supposed conditionality will lead to the kind of fiscal gimmicks and moving goal posts that we see in Greece.

…while there are many problems with Draghi’s plans, he is actually being relatively sensible. He will not help Portugal, Ireland and Greece until they are able to access bond markets; even more importantly, Spain and Italy will need to ask for European bailout fund support, and accept the ensuing conditionality, before ECB bond-buying starts. It will theoretically be unlimited in scale but Draghi only wants to “do whatever it takes” as long as politicians toe the line. Given that they won’t, and that many countries will soon be borrowing even more, the crisis will soon flare up again. The simple reality is that the Eurozone in its current form is doomed. Draghi’s plan will buy some time, and his next one even more, as will the one after that. But eventually the size of the fiscal and competitiveness crisis, combined with voter anger in both Northern and Southern countries, will overwhelm all of his attempts at papering over the cracks. It’s just a matter of time.

But I obviously agree with his conclusion. Unless European politicians decide to reduce the burden of government spending, the continent is in deep trouble.

Last but not least, the problem in Europe is not the euro. It is the welfare state. I’m not a huge fan of the single currency, but it is way down on my list of reasons that nations such as Spain, Italy, and Greece are in trouble.

P.S. America will be in the same boat at some point in the future if we don’t reform entitlements.

P.P.S. Allister is the author of this great article explaining why tax competition and tax havens are so important and valuable in the global economy.

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Like Sweden and Denmark, Germany is a semi-rational welfare state. It generally relies on a market-oriented approach in areas other than fiscal policy, and it avoided the Keynesian excesses that caused additional misery and red ink in America (though it is far from fiscally conservative, notwithstanding the sophomoric analysis of the Washington Post).

Nonetheless, it’s difficult to have much optimism for Europe’s future when the entire political establishment of Germany blindly thinks there should be more centralization, bureaucratization, and harmonization in Europe.

The EU Observer has a story about the agenda of the de facto statists in the Christian Democratic party who currently run Germany.

“Harmonization über alles!”

…what Merkel and her party are piecing together is a radical vision of the EU in a few years time – a deep fiscal and political union. The fiscal side involves tax harmonisation, a tightly policed Stability and Growth Pact with automatic sanctions for countries that breach debt and deficit rules, and the possibility of an EU Commissioner responsible for directly intervention to oversee budgetary policy in a crisis-hit country. …On the institutional side, the CDU backs a directly elected President of the European Commission as well as clearly establishing the European Parliament and Council of Ministers as a bi-cameral legislature with equal rights to initiate EU legislation with the Commission.

Keep in mind that the Christian Democrats are the main right-of-center party in Germany, yet the German political spectrum is so tilted to the left that they want tax harmonization (a spectacularly bad idea) and more centralization.

Heck, even the supposedly libertarian-oriented Free Democratic Party is hopelessly clueless on these issues.

Not surprisingly, the de jure statists of Germany have the same basic agenda. Here’s some of what the article says about the agenda of the Social Democrat and Green parties.

…its commitments to establish joint liability eurobonds and a “common European fiscal policy to ensure fair, efficient and lasting receipts” would also involve a shift of economic powers to Brussels. While both sides have differing ideological positions on the political response to the eurozone crisis – they are talking about more Europe, not less.

The notion of eurobonds is particularly noteworthy since it would involve putting German taxpayers at risk for the reckless fiscal policies in nations such as Greece, Italy, and Spain. That’s only a good idea if you think it’s smart to co-sign a loan for your unemployed and alcoholic cousin with a gambling addiction.

All this makes me feel sorry for German taxpayers.

Then again, if you look at the long-run fiscal outlook of the United States, I feel even more sorry for American taxpayers. Thanks to misguided entitlement programs, we’re in even deeper trouble than Europe’s welfare states.

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Considering the spectacular incompetence of the Italian government, I’m not surprised that the Italian people take extraordinary steps to protect their income from the tax police.

But I have a hard time cheering their actions, since they routinely vote for corrupt politicians and also seek to mooch off the government that they don’t want to pay for.

Sicily is a useful example. Here are key passages from a New York Times report.

…one region in particular has been in the spotlight: Sicily, which some fear has become “the Greece of Italy” and is at risk of defaulting on its high public debts. …an official in the Sicily branch of Italy’s leading industrialists association called for the island to be put into receivership by the central government to clean up its finances. …Sicily highlights the challenges that Mr. Monti is facing in trying to use pressure from European leaders and international markets to push Italy’s politicians to cut costs. Those expenses have ballooned after decades of a patronage system in which the state has been the primary means of employment in Sicily.

We know there’s a mess. And, to give credit where it’s due, the New York Times does discuss the bloated bureaucracy in Sicily.

…critics say Italy — and Sicily in particular — has been driven into dire financial straits not by austerity but by the rampant public spending of the past, the product of an entrenched jobs-for-votes system that helped keep Italian governments in power and Sicilians employed. Today, Sicily’s regional government has 1,800 employees — more than the British Cabinet Office — and the island employs 26,000 auxiliary forest rangers; in the vast forest lands of British Columbia, there are fewer than 1,500. Out of a population of five million people in Sicily, the state directly or indirectly employs more than 100,000 of them and pays pensions to many more. It changed its pension system eight years after the rest of Italy. (One retired politician recently won a case to keep an annual pension of 480,000 euros, about $584,000.)

Not surprisingly, the political class doesn’t want to fire any of the deadwood, which means an enormous burden on taxpayers and lots of suffering for young people.

“Of course that’s too many,” Mr. Lombardo said of the forest rangers. But he said it was difficult to cut back because state workers have job protection. “We have to wait for them to retire.” That system has come at a cost. Last month, Italy’s audit court issued a scathing report saying that Sicily had 7 billion euros, about $8.5 billion, of liabilities at the end of 2011 and showed “signs of unstoppable decline.” Sicily’s unemployment rate is 19.5 percent, twice the national average, and 38.8 percent of young people do not have jobs.

Lombardo must have spent time in Chicago

By the way, the head of the Sicilian government is a very accomplished politician. It’s not uncommon for lawmakers to go to prison after a stint in government, but it takes a special politician to then go back into “public service.”

Mr. Lombardo, who belongs to the Movement for Autonomy — which believes that Sicily should secede from the Italian state, as unlikely as that is to happen — said he would step down as agreed. (He is under investigation for Mafia ties. He denies the accusations and has not been formally charged. He was jailed on corruption charges in the early 1990s, though he was later acquitted.)

At least some residents have figured out how the political system works.

Many Sicilians, for their part, take a world-weary view of the political class. “If I steal a little, I go to jail; if I steal a lot, I advance my career,” Gioacchino De Giorgi, 34, said as he worked in a tobacco shop in downtown Palermo.

Needless to say, this story is yet another example of why bailouts are a bad idea. As I’ve explained before, governments will only make the right reforms as a final option. Bailouts, by contrast, simply give politicians more time to delay, while also making the debt bubble even bigger as reforms are postponed.

This is true, regardless of whether bailouts come from national governments, the European Commission, or international bureaucracies such as the International Monetary Fund.

And it’s true whether we’re talking about an Italian province, or an American state that also is governed by short-sighted and corrupt politicians. Like California.

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The mess in Europe has been rather frustrating, largely because almost everybody is on the wrong side.

Some folks say they want “austerity,” but that’s largely a code word for higher taxes. They’re fighting against the people who say they want “growth,” but that’s generally a code word for more Keynesian spending.

So you can understand how this debate between higher taxes and higher spending is like nails on a chalkboard for someone who wants smaller government.

And then, to get me even more irritated, lots of people support bailouts because they supposedly are needed to save the euro currency.

When I ask these people why a default in, say, Greece threatens the euro, they look at me as if it’s the year 1491 and I’ve declared the earth isn’t flat.

So I’m delighted that the Wall Street Journal has published some wise observations by a leading French economist (an intellectual heir to Bastiat!), who shares my disdain for the current discussion. Here are some excerpts from Prof. Salin’s column, starting with his common-sense hypothesis.

…there is no “euro crisis.” The single currency doesn’t have to be “saved” or else explode. The present crisis is not a European monetary problem at all, but rather a debt problem in some countries—Greece, Spain and some others—that happen to be members of the euro zone. Specifically, these are public-debt problems, stemming from bad budget management by their governments. But there is no logical link between these countries’ fiscal situations and the functioning of the euro system.

Salin then looks at how the artificial link was created between the euro currency and the fiscal crisis, and he makes a very good analogy (and I think it’s good because I’ve made the same point) to a potential state-level bankruptcy in America.

The public-debt problem becomes a euro problem only insofar as governments arbitrarily decide that there must be some “European solidarity” inside the euro zone. But how does mutual participation in the same currency logically imply that spendthrift governments should get help from the others? When a state in the U.S. has a debt problem, one never hears that there is a “dollar crisis.” There is simply a problem of budget management in that state.

He then says a euro crisis is being created, but only because the European Central Bank has surrendered its independence and is conducting backdoor bailouts.

Because European politicians have decided to create an artificial link between national budget problems and the functioning of the euro system, they have now effectively created a “euro crisis.” To help out badly managed governments, the European Central Bank is now buying public bonds issued by these governments or supplying liquidity to support their failing banks. In so doing, the ECB is violating its own principles and introducing harmful distortions.

Last but not least, Salin warns that politicians are using the crisis as an excuse for more bad policy – sort of the European version of Mitchell’s Law, with one bad policy (excessive spending) being the precursor of additional bad policy (centralization).

Politicians now argue that “saving the euro” will require not only propping up Europe’s irresponsible governments, but also centralizing decision-making. This is now the dominant opinion of politicians in Europe, France in particular. There are a few reasons why politicians in Paris might take that view. They might see themselves being in a similar situation as Greece in the near future, so all the schemes to “save the euro” could also be helpful to them shortly. They might also be looking to shift public attention away from France’s internal problems and toward the rest of Europe instead. It’s easier to complain about what one’s neighbors are doing than to tackle problems at home. France needs drastic tax cuts and far-reaching deregulation and labor-market liberalization. Much simpler to get the media worked up about the next “euro crisis” meeting with Angela Merkel.

This is a bit of a dry topic, but it has enormous implications since Europe already is a mess and the fiscal crisis sooner or later will spread to the supposedly prudent nations such as Germany and the Netherlands. And, thanks to entitlement programs, the United States isn’t that far behind.

So may as well enjoy some humor before the world falls apart, including this cartoon about bailouts to Europe from America, the parody video about Germany and downgrades, this cartoon about Greece deciding to stay in the euro, this “how the Greeks see Europe” map, and this cartoon about Obama’s approach to the European model.

P.S. Here’s a video narrated by a former Cato intern about the five lessons America should learn from the European fiscal crisis.

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For quite some time, I’ve thought of Herman van Rompuy as the poster child of Europe’s incompetent political elite.

Virtually unknown to people in the real world (his sole claim to fame is that a British MEP, in a speech that went viral on YouTube, said he resembled a “low-grade bank clerk”), the President of the European Council manages to blunder from one mistake to another.

But Jose Manuel Barroso, President of the European Commission, is trying very hard to be an even bigger joke.

Well, Barroso now has done something else that deserves mockery and scorn. He’s whining that some of his opponents are happy about the mess in Europe.

Here’s some of what the EU Observer reported.

European Commission President Jose Manuel Barroso Tuesday (3 July) launched an angry attack on British Conservative’s in the European Parliament, accusing them of “taking delight” in the eurozone debt crisis. …Barroso’s outburst in Strasbourg followed a speech by Tory MEP Martin Callanan, who heads the eurosceptic ECR group.

Since I also experience some Schadenfreude about the mess in Europe, I suspect Barroso is right that the Tories are enjoying the situation. But that doesn’t give Barroso any moral authority to complain since the fiscal crisis largely exists because of policies he supported.

I also can’t resist adding this passage from the story.

President Barroso said he was “puzzled” that British eurosceptics were encouraging countries to leave the euro adding that this was “in stark contrast” to statements made by UK Prime Minister David Cameron.

Barroso is right. There is a gulf between the views of British MEPs and the attitude of the U.K.’s Prime Minister. But that’s because David Cameron is a wobbly statist with no strong beliefs (other than that he should be Prime Minister).

Arguing over who’s the biggest buffoon

Barroso’s comments, in other words, are akin to an American leftist saying that Republicans shouldn’t attack Obama’s statist agenda because Bush supported the same big-government policies when he was President.

In closing, I will acknowledge that I agree with Barroso on one point. He warned that democracy could collapse in Europe if economic conditions continue to unravel, and I think that could happen. But, as I’ve explained before, Europe’s future is somewhat bleak because of the policies supported by Barroso and his fellow travelers like van Rompuy.

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With all the fiscal troubles in Greece, Spain, Ireland, Portugal, and Italy, there’s not much attention being paid to Cyprus.

But the Mediterranean island nation is a good case study illustrating the economic dangers of big government.

For all intents and purposes, Cyprus is now bankrupt, and the only question that remains to be answered is whether it will get handouts from the IMF-ECB-EC troika, handouts from Russia, or both. Here’s some of what has been reported by AP.

Cyprus’ president on Thursday defended his government’s decision to seek financial aid from the island nation’s eurozone partners while at the same time asking for a loan from Russia, insisting that the two are perfectly compatible. …Cyprus, with a population of 862,000 people, last week became the fifth country that uses the euro currency to seek a European bailout… The country is currently in talks with the so-called ‘troika’ — the body made up of officials from the European Commission, the European Central Bank and the International Monetary Fund — on how much bailout money it will need and the conditions that will come attached. Locked out of international markets because of its junk credit rating status, Cyprus is paying its bills thanks to a €2.5 billion ($3.14 billion) Russian loan that it clinched last year. But that money is expected to run out by the end of the year.

So what caused this mess? Is Cyprus merely the helpless and innocent victim of economic turmoil in nearby Greece?

That’s certainly the spin from Cypriot politicians, but the budget data shows that Cyprus is in trouble because of excessive spending. This chart, based on data from the International Monetary Fund, shows that the burden of government spending has jumped by an average of 8.3 percent annually since the mid-1990s.

My Golden Rule of fiscal policy is that government spending should grow slower than economic output. Nations that follow that rule generally enjoy good results, while nations that violate that rule inevitably get in trouble.

Interestingly, if Cypriot politicians had engaged in a very modest amount of spending restraint and limited annual budgetary increases to 3 percent, there would be a giant budget surplus today and the burden of government spending would be down to 21.4 percent of GDP, very close to the levels in the hyper-prosperous jurisdictions of Hong Kong and Singapore.

Actually, that’s not true. If the burden of government spending had grown as 3 percent instead of 8.3 percent, economic growth would have been much stronger, so GDP would have been much larger and the public sector would be an ever smaller share of economic output.

Speaking of GDP, the burden of government spending in Cyprus, measured as a share of GDP, has climbed dramatically since 1995.

A simple way to look at this data is that Cyprus used to have a Swiss-sized government and now it has a Greek-sized government. Government spending is just one of many policies that impact economic performance, but is anyone surprised that this huge increase in the size of the public sector has had a big negative impact on Cyprus?

Interestingly, if government spending had remained at 33.9 percent of GDP in Cyprus, the nation would have a big budget surplus today. Would that have required huge and savage budget cuts? Perhaps in the fantasy world of Paul Krugman, but politicians could have achieved that modest goal if they had simply limited annual spending increases to 6 percent.

But that was too “draconian” for Cypriot politicians, so they increased spending by an average of more than 8 percent each year.

What’s the moral of the story? Simply stated, the fiscal policy variable that matters most is the growth of government. Cyprus got in trouble because the burden of government grew faster than the productive sector of the economy.

That’s the disease, and deficits and debt are the symptoms of that underlying problem.

Europe’s political elite doubtlessly will push for higher taxes, but that approach – at best – simply masks the symptoms in the short run and usually exacerbates the disease in the long run.

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Spain’s received a bailout, Greece is having another election tomorrow, and the European political elite is pushing for more centralization.

In other words, business as usual in the continent where voters think you can get nothing for nothing (this satirical cartoon is now European reality) and politicians think every problem can be solved by more borrowing.

Regarding the Spanish bailout, here’s an amusing video of Nigel Farage, head of the United Kingdom Independence Party, commenting on this latest European “success.”

Farage is an entertaining speaker, as you can see in other videos here and here. Indeed, the Brits serving in Brussels all seem to have a way with words, as you can see from these videos of Dan Hannan and Godfrey Bloom.

While England’s euro-skeptics make good points, what matters most is whether Germany agrees to endless subsidies for its profligate neighbors. There are signs that patience is wearing thin, as seen by these excerpts from a Frankfurt-based Bloomberg columnist.

Germany is feeling more and more like the rich uncle in a poor family. Its spendthrift relatives in the euro area are lining up to shake down their wealthier kin for loans that they may never be able to repay. Actually it’s worse than that: Those poor relatives seem to have forgotten that their uncle has already given them a lot of money. …Hans-Werner Sinn, a government adviser, …noted in a New York Times op-ed that Greece has already received the equivalent of 29 Marshall Plans from Germany… But how can a case be made for even more support when Germany’s biggest neighbor wants to put his feet up at the age of 60 — as French President Francois Hollande is planning by reversing the increase in retirement age — while Germans are expected to keep working until 67 before they get their (steadily declining) state pensions? Let’s not even talk about Greek pensions, which until recently had been paid to many dead people.

But the centralizers in Europe seem oblivious to these concerns. The clowns in the European Parliament think it would be great to have a fiscal union, which is basically a means of having German taxpayers subsidize Italian moochers.

The European Parliament on Wednesday (13 June) approved draft laws that would strongly increase Brussels’ power over eurozone countries’ budgets. …”This is the core of a fiscal union,” said Austrian MEP and socialist leader Hannes Swoboda. …They want a European Debt Redemption Fund that would bring together the debt of eurozone countries that is greater than 60 percent of GDP, allowing it to be repaid in the long term at lower interest rates. The draft would bind the commission to proposing a “roadmap” for establishing eurobonds (the mutualising of eurozone debt) once the legislation comes into place.

Not to be outdone, the buffoons in the European Commission want political union as well, which also is a mechanism for letting Spanish looters pilfer the German taxpayers.

European Commission President Jose Manuel Barroso has said member states must agree to a big common budget, a future banking union and – ultimately – political union in order to save the EU. …Barroso’s final step – fiscal and political union – would see EU countries issue joint bonds, co-ordinate tax policy and co-ordinate national spending on everything from healthcare to schools and social welfare. …Belgian liberal Guy Verhofstadt said the summit paper should be a legal proposal for creating a “federal union” and that commission budget plans should call for “own resources” – direct taxation of EU citizens by Brussels.

It’s not terribly surprising that the deadbeats of Europe want access to the money of German taxpayers, but it is rather shocking that German politicians are willing to play this no-win game. Indeed, Frau Merkel actually is an advocate of political union. Sort of like a sheep voluntarily joining two wolves in a debate over what to have for lunch.

And keep in mind that “co-ordinate tax policy” is nothing more than a deceptive way of saying tax harmonization, which would mean an end to tax competition, thus achieving a long-held goal of Europe’s political elite.

In other words, the mess in Europe is a steroid-fueled example of Mitchell’s Law, as each government-caused screw-up is used as an excuse for the next government-caused blunder.

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There’s always been a simple and desirable solution to Europe’s fiscal crisis, but nobody in Europe wants to do the right thing because it means admitting the failure of big government and it would result in less power for the political elite.

So we get the spectacle of never-ending emergency summits as the political class blindly searches for some magical solution. Not surprisingly, the “solution” concocted by the latest gathering is not getting good reviews.

Here’s what Ambrose Evans-Pritchard wrote in the Daily Telegraph.

What remarkable petulance and stupidity. The leaders of France and Germany have more or less bulldozed Britain out of the European Union for the sake of a treaty that offers absolutely no solution to the crisis at hand, or indeed any future crisis. It is EU institutional chair shuffling at its worst, with venom for good measure. …There is no shared debt issuance, no fiscal transfers, no move to an EU Treasury, no banking licence for the ESM rescue fund, and no change in the mandate of the European Central Bank.

And here’s what Felix Salmon wrote for Reuters.

It all adds up to one of the most disastrous summits imaginable. A continent which has risen to multiple occasions over the past 66 years has, in 2011, decided to implode in a spectacle of pathetic ignominy. …Europe’s leaders have set a course which leads directly to a gruesome global recession, before we’ve even recovered from the last one. Europe can’t afford that; America can’t afford that; the world can’t afford that. But the hopes of arriving anywhere else have never been dimmer.

So why is everybody upset? For the simple reason that the supposed “solution” doesn’t address the immediate problem.

Europe’s short-run crisis is that the fear of default. Simply stated, governments have squandered so much money that they are now deeply in debt. As a result, investors no longer trust that they will get paid back (either on time or in full) if they buy bonds from various governments.

This is why interest rates on government debt are climbing and nations such as Greece, Ireland, and Portugal already have received direct bailouts. Moreover, the European Central Bank has been engaging in indirect bailouts of other welfare states such as Spain and Italy.

But these direct and indirect bailouts have simply made the debt bubble bigger.

Yet the new agreement from Europe’s political elite doesn’t deal with this crisis. Simply stated, there is no short-run bailout strategy, not even one that kicks the can down the road.

There are only four ways of dealing with the mess in Europe, one good and three bad.

1. No bailouts, thus forcing nations to do the right thing (like the Baltics) or letting them default. This imposes the costs on the people who created the mess, addresses the short-run crisis, and promotes good long-run policy.

2. Crank up the proverbial printing presses and have the European Central Bank buy up most of Europe’s dodgy debt. This imposes the costs on all consumers, addresses the short-run crisis, and promotes bad long-run policy.

3. Have the Germans (and some other northern Europeans) guarantee the debt of the less-stable welfare states, either through Euro-bonds or some other mechanism. This imposes the costs on taxpayers in Germany and other nations that have been more prudent, addresses the short-run crisis, and promotes bad long-run policy.

4. Have the Americans and the rest of the world bail out Europe’s welfare states via the International Monetary Fund. This imposes the costs on the entire world (with U.S. taxpayers picking up the biggest part of the tab), addresses the short-run crisis, and promotes bad long-run policy.

In a remarkable display of ignoring the elephant in the middle of the room, none of these options was selected.

Some people claim that the third option was used, but that’s whistling past the graveyard. Yes, there will be a €500 billion bail-out fund called the European Stability Mechanism at some point next year, but that simply replaces the current €440 billion European Financial Stability Facility. And nobody thinks the third option will be successful unless there is a multi-trillion euro bailout fund.

So if Europe’s politicians didn’t agree to deal with the problem, either with good policy or bad policy, what exactly did they do?

The agreement uses the short-run fiscal crisis as an excuse to propose permanent changes that will erode national sovereignty and impose more centralization, more harmonization, and more bureaucratization.

One can argue, though not very persuasively, that these changes will reduce the likelihood of fiscal crises in the future. But that’s not the same thing as coming up with a policy – good or bad – to deal with the immediate problem.

I’m not an expert on investing money, but I definitely won’t be surprised if financial markets (including the investors who want bad policy so they can be bailed out) react negatively to this latest faux agreement.

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I’ve joked on many occasions that bipartisanship occurs in Washington when the evil party and the stupid party come up with an idea that is simultaneously malicious and misguided.

The international version of two-wrongs-don’t-make-a-right occurs whenever the French and the Germans conspire on economic policy. The latest example is a joint proposal for “economic governance” for eurozone nations. Here are some blurbs from the BBC’s report.

The French and German leaders have called for “true economic governance” for the eurozone in response to the euro debt crisis. Speaking at a joint news conference, German Chancellor Angela Merkel and French President Nicolas Sarkozy urged much closer economic and fiscal policy in the eurozone. …They also advocated a tax on financial transactions to raise more revenues.

I don’t pretend to have any predictive ability, but I’ll bet dollars-to-donuts that “true economic governance” will lead to more spending and higher taxes. Why? Because “economic governance” is just a sanitized way of describing a cartel of governments.

When politicians don’t have to worry as much about jobs and capital migrating to jurisdictions with less oppressive tax law, they will behave in a predictable fashion by raising tax rates. In other words, the weakening of tax competition is a recipe for bigger, more expensive government.

Indeed, the tax on financial transactions is a perfect example. Any one nation would be unlikely to impose this perverse levy for fear of losing business to neighbors. But if there’s a one-size-fits-all eurozone government, then bad policy becomes more feasible.

The only good news is that Merkel hasn’t totally lost her mind. Perhaps because her de facto socialist party is not doing well in the polls against the de jure socialist party in Germany, she is temporarily resisting the idea of “eurobonds.”

Ms Merkel again played down the chances of introducing “eurobonds” – jointly guaranteed debts of the 17 eurozone governments – as a solution to the crisis. The idea has been advocated by the Italian finance minister, Giulio Tremonti, as well as billionaire investor George Soros as a way of providing cheap financing to struggling governments while also incentivising them to put their finances in order.

The more profligate European governments like eurobonds for the same reason that California and Illinois would like to jointly issue debt with Texas. It’s a way for the spendthrift to free ride off the frugal.

And speculators like eurobonds because their holdings can dramatically rise in value when downside risk gets transferred to taxpayers (nothing wrong with speculation, by the way, so long as losses aren’t socialized).

Eurobonds might temporarily calm European markets, but only by setting the stage for a bigger collapse in the near future when the Germans are pulled underwater by their reckless neighbors.

For those who want more information, this video is a primer on the importance of jurisdictional competition.

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I’ve already poked fun at Herman Van Rompuy, the nondescript über-bureaucrat who has risen to the non-elected post of European Council President. I’ve mocked Rompuy’s attempts to compete with other European politicians, and I encourage everyone to have a good laugh at this video of Van Rompuy getting eviscerated by a British MEP.

We now have a new reason to roll our eyes about Van Rompuy. He is whining about those mean, nasty bond traders who have decided that it is a somewhat risky proposition to lend money to Europe’s welfare states. Even though Van Rompuy has no experience with money (other than spending the fruits of other people’s labor), he imperiously thinks it is “absurd” to put Greece and Portugal in the same category as Ukraine and Argentina.

I guess he would prefer if everyone just pretended these countries were in good shape and able to pay their bills, sort of like a fiscal version of “The Emperor’s New Clothes.”

Here’s the relevant passage from an article in the EU Observer.

European Council President Herman Van Rompuy has lashed out at ‘bond vigilantes’ over the treatment of peripheral eurozone economies in recent months. Speaking in London after a meeting with Prime Minister David Cameron on Thursday (13 January), Mr Van Rompuy described recent events as “absurd” and said the likes of Greece and Portugal should not be treated the same as poor countries: “Recent market developments are sometimes rather strange. The spreads now show default risks for some eurozone countries bigger than for emerging countries like Ukraine or Argentina: that is absurd.”

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The news is going from bad to worse for Ireland. The Irish Independent is reporting that the Swiss Central Bank no longer will accept Irish government bonds as collateral. The story also notes that one of the world’s largest bond firms, PIMCO, is no longer purchasing debt issued by the Irish government.

And this is happening even though (or perhaps because?) Ireland received a big bailout from the European Union and the International Monetary Fund (and the IMF’s involvement means American taxpayers are picking up part of the tab).

I’ve already commented on Ireland’s woes, and opined about similar problems afflicting the rest of Europe, but the continuing deterioration of the Emerald Isle deserves further analysis so that American policy makers hopefully grasp the right lessons. Here are five things we should learn from the mess in Ireland.

1. Bailouts Don’t Work – When Ireland’s government rescued depositors by bailing out the nation’s three big banks, they made a big mistake by also bailing out creditors such as bondholders. This dramatically increased the cost of the bank bailout and exacerbated moral hazard since investors are more willing to make inefficient and risky choices if they think governments will cover their losses. And because it required the government to incur a lot of additional debt, it also had the effect of destabilizing the nation’s finances, which then resulted in a second mistake – the bailout of Ireland by the European Union and IMF (a classic case of Mitchell’s Law, which occurs when one bad government policy leads to another bad government policy).

American policy makers already have implemented one of the two mistakes mentioned above. The TARP bailout went way beyond protecting depositors and instead gave unnecessary handouts to wealthy and sophisticated companies, executives, and investors. But something good may happen if we learn from the second mistake. Greedy politicians from states such as California and Illinois would welcome a bailout from Uncle Sam, but this would be just as misguided as the EU/IMF bailout of Ireland. The Obama Administration already provided an indirect short-run bailout as part of the so-called stimulus legislation, and this encouraged states to dig themselves deeper in a fiscal hole. Uncle Sam shouldn’t be subsidizing bad policy at the state level, and the mess in Europe is a powerful argument that this counterproductive approach should be stopped as soon as possible.

By the way, it’s worth noting that politicians and international bureaucracies behave as if government defaults would have catastrophic consequences, but Kevin Hassett of the American Enterprise Institute explains that there have been more than 200 sovereign defaults in the past 200 years and we somehow avoided Armageddon.

2. Excessive Government Spending Is a Path to Fiscal Ruin – The bailout of the banks obviously played a big role in causing Ireland’s fiscal collapse, but the government probably could have weathered that storm if politicians in Dublin hadn’t engaged in a 20-year spending spree.

The red line in the chart shows the explosive growth of government spending. Irish politicians got away with this behavior for a long time. Indeed, government spending as a share of GDP (the blue line) actually fell during the 1990s because the private sector was growing even faster than the public sector. This bit of good news (at least relatively speaking) stopped about 10 years ago. Politicians began to increase government spending at roughly the same rate as the private sector was expanding. While this was misguided, tax revenues were booming (in part because of genuine growth and in part because of the bubble) and it seemed like bigger government was a free lunch.

Eventually, however, the house of cards collapsed. Revenues dried up and the banks failed, but because the politicians had spent so much during the good times, there was no reserve during the bad times.

American politicians are repeating these mistakes. Spending has skyrocketed during the Bush-Obama year. We also had our version of a financial system bailout, though fortunately not as large as Ireland’s when measured as a share of economic output, so our crisis is likely to occur when the baby boom generation has retired and the time comes to make good on the empty promises to fund Social Security, Medicare, and Medicaid.

3. Low Corporate Tax Rates Are Good, but They Don’t Guarantee Economic Success if other Policies Are Bad – Ireland used to be a success story. They went from being the “Sick Man of Europe” in the early 1980s to being the “Celtic Tiger” earlier this century in large part because policy makers dramatically reformed fiscal policy. Government spending was capped in the late 1980 and tax rates were reduced during the 1990s. The reform of the corporate income tax was especially dramatic. Irish lawmakers reduced the tax rate from 50 percent all the way down to 12.5 percent.

This policy was enormously successful in attracting new investment, and Ireland’s government actually wound up collecting more corporate tax revenue at the lower rate. This was remarkable since it is only in very rare cases that the Laffer Curve means a tax cut generates more revenue for government (in the vast majority of cases, the Laffer Curve simply means that changes in taxable income will have revenue effects that offset only a portion of the revenue effects caused by the change in tax rates).

Unfortunately, good corporate tax policy does not guarantee good economic performance if the government is making a lot of mistakes in other areas. This is an apt description of what happened to Ireland. The silver lining to this sad story is that Irish politicians have resisted pressure from France and Germany and are keeping the corporate tax rate at 12.5 percent. The lesson for American policy makers, of course, is that low corporate tax rates are a very good idea, but don’t assume they protect the economy from other policy mistakes.

4. Artificially Low Interest Rates Encourage Bubbles – No discussion of Ireland’s economic problems would be complete without looking at the decision to join the common European currency. Adopting the euro had some advantages, such as not having to worry about changing money when traveling to many other European nations. But being part of Europe’s monetary union also meant that Ireland did not have flexible interest rates.

Normally, an economic boom drives up interest rates because the plethora of profitable opportunities leads investors demand more credit. But Ireland’s interest rates, for all intents and purposes, were governed by what was happening elsewhere in Europe, where growth was generally anemic. The resulting artificially low interest rates in Ireland helped cause a bubble, much as artificially low interest rates in America last decade led to a bubble.

But if America already had a bubble, what lesson can we learn from Ireland? The simple answer is that we should learn to avoid making the same mistake over and over again. Easy money is a recipe for inflation and/or bubbles. Simply stated, excess money has to go someplace and the long-run results are never pleasant. Yet Ben Bernanke and the Federal Reserve have launched QE2, a policy explicitly designed to lower interest rates in hopes of artificially juicing the economy.

5. Housing Subsidies Reduce Prosperity – Last but not least, Ireland’s bubble was worsened in part because politicians created an extensive system of preferences that tilted the playing field in the direction of real estate. The combination of these subsidies and the artificially low interest rates caused widespread malinvestment and Ireland is paying the price today.

Since we just endured a financial crisis caused in large part by a corrupt system of housing subsidies for Fannie Mae and Freddie Mac, American policy makers should have learned this lesson already. But as Thomas Sowell sagely observes, politicians are still fixated on somehow re-inflating the housing bubble. The lesson they should have learned is that markets should determine value, not politics.

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The fiscal disintegration of Europe is bad news, though I confess to a bit of malicious glee every time I read about welfare states such as Greece, Ireland, and Portugal getting to the point where they no longer have the ability to borrow enough money to finance their bloated public sectors. This I-told-you-so attitude is not very mature on my part, but at least one hopes that American politicians will learn the right lessons.

Even though this is a big issue, I have not written much about the topic, in part because I don’t have much to add to my original post about this issue back in February. All the arguments I made then are still true, particularly about the moral hazard of bailouts and the economic damage of rewarding excessive government. So why bother repeating myself, particularly since this is an issue for Europeans to solve (or, as is their habit, to make worse)?

Unfortunately, it appears that all of us need to pay closer attention to this issue. The Obama Administration apparently thinks American taxpayers should subsidize European profligacy. Here’s a passage from a Reuters report about a potential bailout for Europe via the IMF.

The United States would be ready to support the extension of the European Financial Stability Facility via an extra commitment of money from the International Monetary Fund, a U.S. official told Reuters on Wednesday. “There are a lot of people talking about that. I think the European Commission has talked about that,” said the U.S. official, commenting on enlarging the 750 billion euro ($980 billion) EU/IMF European stability fund. “It is up to the Europeans. We will certainly support using the IMF in these circumstances.” “There are obviously some severe market problems,” said the official, speaking on condition of anonymity. “In May, it was Greece. This is Ireland and Portugal. If there is contagion that’s a huge problem for the global economy.”

This issue will be an interesting test for the GOP. I think it’s safe to say that the Tea Party movement didn’t elect Republicans so they could expand the culture of bailouts – especially if that means handouts for profligate European governments. Some people will argue that American taxpayers aren’t at risk because this would be a bailout from the IMF instead of the Treasury. But that’s an absurd and dishonest assertion. The United States is the largest “shareholder” in that international bureaucracy, and there’s no way the IMF can get more involved without American support.

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Jim Glassman has a thorough article in Commentary explaining that Europe is in deep trouble both because high tax rates discourage work and production and because excessive handouts encourage sloth and dependency. This should be a common-sense observation, but most politicians get votes by convincing voters they can have comfortable lives without producing. The inevitable result is what happened in Greece, though the negative effects of that debacle are being postponed (but also magnified) by the European bailout. Considering what’s happening, it’s hard to have any optimism about the long-term result. Here’s a long excerpt, but the whole article is worth reading since the same thing will happen in America if the Bush-Obama policies are not reversed.

Prosperity, it seems, can bring sloth, which in turn disrupts the virtuous cycle, though not immediately. There is a period, which I believe we are in right now, where the disruption is not apparent, where it can be obscured through government monetary and fiscal manipulation. But eventually, a simple rule will prevail: you can’t live well if you don’t work. It is hardly surprising that work produces well-being, and if work diminishes, then well-being, even in the most advanced economy, will slow down, stop, or shift into reverse gear. “Decadence,” with its connotations of self-indulgence and decline, is not too strong a word for the response we have seen to economic success, especially in much of Europe, over the past few decades. …In 2004, the year he won the Nobel Prize, Edward Prescott, an economist at the Federal Reserve Bank of Minneapolis, published a paper titled “Why Do Americans Work So Much More than Europeans?” The data were stunning. Prescott found that the average output per adult between 1993 and 1996 in the United States was 75 percent greater than in Italy, 49 percent greater than in the United Kingdom, and 35 percent greater than in France and Germany. “Most of the differences in output,” he wrote, were “accounted for by differences in hours worked per person and not by differences in productivity.” …Prescott showed that these differences are of fairly recent origin. During the period from 1970 to 1974, Europeans—including the French, Germans, and British—generally worked more than Americans. At that time, however, Europeans were less productive than Americans, so their overall output per person was about the same as it was in 1993-96: around one-third below the U.S. level. So, as Europeans became more efficient (producing more goods and services per hour of work), they cut back on their hours, choosing leisure over work. And the gap has widened. By the time Prescott won his Nobel Prize, Americans were working 50 percent more than the French. …In his paper, Prescott fingered the culprit: high taxes. “The surprising finding,” he wrote, “is that this marginal tax rate [difference between Europe and the U.S.] accounts for the predominance of differences at points in time and the large change in relative labor supply over time.” Taxation rates on the next euro of income became so high that people were discouraged from working—especially with the enticements of early retirement. But this explanation is incomplete. Why are taxes so high in Europe? Certainly not to maintain a strong defense but rather to pour money into a welfare state that provides lavish support to retirees, perennial students, and others who aren’t working. In other words, Europeans have chosen to have workers support non-workers in their leisure. …A financial crisis can pull the covers away to give us a clear look at what’s underneath, and the current crisis has exposed Europe as a fool’s paradise. “The fundamental cause of the financial crisis,” wrote the George Mason University economist Tyler Cowen on his blog, Marginal Revolution, “is people and institutions thinking they are more wealthy than they are.” …The same with nations. Europe supported its welfare state with borrowed money, a practice that can be perfectly healthy as long as both welfare state and debt are modest and loans can be serviced by diligent workers. Europe, however, is not nearly as wealthy as it thought it was, or as wealthy as its national way of life indicated. Take Greece. …Greece joined the European Union in 1981 and the eurozone—the continent’s monetary union—in 2001. Since the second event, especially, Greece has been behaving as if it were truly rich. The secret was borrowed money. At the end of 2009, the country had a public debt equivalent to 114 percent of its GDP. That’s on top of the 3 percent of GDP that the European Union contributes as direct aid each year. Meanwhile, Greece consistently violated the EU’s rules for minimum deficit and debt levels. The Greeks, however, lived better and better, with an official retirement age of just 58. Only three-fifths of adult Greeks under age 64 were in the work force. …Default can impose needed fiscal discipline on a government. But in an age of financial magic and euro-solidarity, default for a European nation is not a burden that has to be borne—at least not yet. On the brink of not being able to pay its debts earlier this year, Greece was bailed out with $100 billion in loans from the 15 other eurozone countries and about $50 billion from the International Monetary Fund. This year, the Greek government will make interest payments amounting to 15 percent of GDP on its loans (the U.S. pays less than 3 percent). With Portugal and Spain and perhaps Italy heading for similar trouble, Europe announced it would guarantee debts up to $955 billion. There are two problems with such bailouts. First, they do little or nothing to end the leisure-seeking practices, encouraged by high marginal tax rates and labor regulations, that led to the near-defaults in the first place. Greece may promise austerity as a condition for being saved, but don’t count on delivery. Second is the matter of moral hazard—the tendency of insurance against calamity to provide an incentive toward behavior that produces calamity. I warned of the dangers of moral hazard during the current financial crisis in an article in this magazine last year, and, unfortunately, we are seeing those predictions being realized. Much pain was caused by the crisis, but much was mitigated as well by government policies that kept profligate banks and other businesses alive that should have disappeared—and, of course, Washington took the occasion of the crisis to increase the size of its own welfare state. What the eurozone nations have done in bailing out Greece and pre-bailing Portugal and the others is to introduce a heaping helping of moral hazard that may seem nourishing at first but that inevitably will cause severe indigestion, or worse. …While the United States is not Europe, many of our states clearly have aspirations in the same decadent direction. With high marginal tax rates and regulations that discourage work, California this year is running a deficit of $20 billion, and a recent study found that the pension shortfall for government workers is $500 billion. Investors were recently paying about $300,000 to buy credit default swaps—that is, an insurance policy—on each $10 million in California municipal bonds. That’s a rate 50 percent higher than on bonds issued by Kazakhstan. As a monetary union, the United States may face a decision similar to that of the eurozone nations: should the federal government bail out California? If it does, we will have entered a fool’s paradise on this side of the Atlantic as well.

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The Wall Street Journal correctly pulls aside the veil and exposes the dubious gimmick that European politicians used to declare that banks are reasonably health. To put it bluntly, they assumed no government would ever default, which really means that the stress test was a fraud or German taxpayers are now on the chopping block to bail out every other nation.

Two months ago, credit markets in Europe nearly went off the rails over concern about what a sovereign debt default in Greece would do to the Continent’s banks. After last night’s release of the result of a Europe-wide stress test, we’re not much wiser. The EU’s committee of national bank regulators repeatedly says that its stress test includes a “sovereign shock” scenario. But crucially, “a sovereign default was not included in the exercise,” in the dry language of the committee’s summary report. This means the test only looked at government debt held in trading portfolios, while ignoring any government bonds listed as held to maturity. Earlier this month, regulators made it clear that they opposed testing the consequences of a sovereign debt default on European bank balance sheets. The German magazine Der Speigel reported that regulators felt including sovereign default in the tests might imply that the EU’s €750 billion ($960 billion) bailout fund wasn’t guaranteed to work. In other words, bank regulators in Europe think Greece, Spain, Portugal and the rest are too big to fail. Germany and France will always save them in the end, so the consequences of a default don’t even need to be considered.

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Barack Obama and Angela Merkel are the two main characters in what is being portrayed as a fight between American “stimulus” and European “austerity” at the G-20 summit meeting in Canada. My immediate instinct is to cheer for the Europeans. After all, “austerity” presumably means cutting back on wasteful government spending. Obama’s definition of “stimulus,” by contrast, is borrowing money from China and distributing it to various Democratic-leaning special-interest groups.
 
But appearances can be deceiving. Austerity, in the European context, means budget balance rather than spending reduction. As such, David Cameron’s proposal to boost the U.K.’s value-added tax from 17.5 percent to 20 percent is supposedly a sign of austerity even though his Chancellor of the Exchequer said a higher tax burden would generate “13 billion pounds we don’t have to find from extra spending cuts.”
 
Raising taxes to finance a bloated government, to be sure, is not the same as Obama’s strategy of borrowing money to finance a bloated government. But proponents of limited government and economic freedom understandably are underwhelmed by the choice of two big-government approaches.
 
What matters most, from a fiscal policy perspective, is shrinking the burden of government spending relative to economic output. Europe needs smaller government, not budget balance. According to OECD data, government spending in eurozone nations consumes nearly 51 percent of gross domestic product, almost 10 percentage points higher than the burden of government spending in the United States.
 
Unfortunately, I suspect that the “austerity” plans of Merkel, Cameron, Sarkozy, et al, will leave the overall burden of government relatively unchanged. That may be good news if the alternative is for government budgets to consume even-larger shares of economic output, but it is far from what is needed.
 
Unfortunately, the United States no longer offers a competing vision to the European welfare state. Under the big-government policies of Bush and Obama, the share of GDP consumed by government spending has jumped by nearly 8-percentage points in the past 10 years. And with Obama proposing and/or implementing higher income taxes, higher death taxes, higher capital gains taxes, higher payroll taxes, higher dividend taxes, and higher business taxes, it appears that American-style big-government “stimulus” will soon be matched by European-style big-government “austerity.”
 
Here’s a blurb from the Christian Science Monitor about the Potemkin Village fiscal fight in Canada:

This weekend’s G-20 summit is shaping up as an economic clash of civilizations – or at least a clash of EU and US economic views. EU officials led by German chancellor Angela Merkel are on a national “austerity” budget cutting offensive as the wisest policy for economic health, ahead of the Toronto summit of 20 large-economy nations. Ms. Merkel Thursday said Germany will continue with $100 billion in cuts that will join similar giant ax strokes in the UK, Italy, France, Spain, and Greece. EU officials say budget austerity promotes the stability and market confidence that are prerequisites for their role in overall recovery. Yet EU pro-austerity statements in the past 48 hours are also defensive – a reaction to public statements from US President Barack Obama and G-20 chairman Lee Myung-bak, South Korea’s president, that the overall effect of national austerity in the EU will harm recovery. They are joined by US Treasury Secretary Tim Geithner, investor George Soros, and Nobel laureate and columnist Paul Krugman, among others, arguing that austerity works against growth, and may lead to a recessionary spiral.

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It’s been amusing, in an I-told-you-so fashion, to follow the fiscal crises in Greece, Spain, and other European welfare states.And I feel like a voyeuristic ghoul as I observe the incredibly misguided bailout policies being adopted by the political elites (who are trying to bail out the business elites who made silly loans to corrupt nations in Southern Europe). But I’m not sure how to describe my emotions (dumbfounded fascination?) about the latest bad idea emanating from Europe – to have a fiscal federation that would give bureaucrats in Brussels power over national budgets. It’s quite possible that this would result in some externally-imposed discipline for a basket case such as Greece, so it would not always lead to terrible results. But most of the decisions would be bad, particularly since the Euro-crats would use new powers to curtail tax competition in order to enhance the ability of governments to impose bad tax policy in order to seize more money. Moreover, fiscal centralization would exacerbate the main problem in Europe by creating a new avenue – cross-border subsidies – for people who want to mooch by getting access to other people’s money. The Wall Street Journal Europe has a good editorial on the issue:
Of all the possible responses to Europe’s sovereign debt woes, the notion of centralizing fiscal authority in Brussels may well be the most destructive. But that was exactly what European Central Bank President Jean-Claude Trichet proposed in testimony before the European Parliament Monday. Mr. Trichet’s idea is that an independent body within the European Commission should have broad power to sanction national governments for fiscal or macroeconomic policies that threatened the stability of the euro. This would amount, in Mr. Trichet’s words, to the “equivalent of a fiscal federation” for the euro zone. Mr. Trichet has spent nearly 40 years as a civil servant in one form or another, which may explain his belief that Europe’s budgetary problems can be solved by technocrats. …Fiscal centralization would also undermine competition between different fiscal and macroeconomic policies within the euro zone. That would delight some countries, and probably some at the European Commission as well. During this crisis, French Finance Minister Christine Lagarde has criticized Germany for becoming too competitive for the euro zone’s own good. And a decade ago, France was among the euro-zone countries that attacked Ireland for lowering its corporate income-tax rate to 12.5% to attract investment. …Ireland’s 12.5% corporate tax rate was an experiment that contributed to a lowering of rates around the world in the succeeding years.

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I hope the title to this blog post is completely wrong, but the news out of Europe is very grim. Politicians have been over-spending and going deeper and deeper into debt. This negatively affects the private sector in the usual ways (higher taxes, unproductive allocation of resources, etc), but also creates instability in the financial sector since many banks and other institutions have naively lent lots of money to corrupt and inefficient governments. And as this story from the Telegraph indicates, the European Central Bank has been forced to surrenders its independence and is now monetizing government debt. In theory, the ECB is taking other steps to compensate, but the problem is so large (and the political willingness to solve the problem by radically shrinking government is so small) that it is difficult to see a good ending to this saga.

Fitch Ratings has warned that it may take massive asset purchases by the European Central Bank to prevent Europe’s sovereign debt crisis escalating out of control. …The ECB agreed to start buying Greek, Portuguese, and Irish bonds in April to help buttress the EU’s `shock and awe’ package, known as the European Financial Stability Facility. Total purchases so far have been €47bn (£39bn). It has focused its firepower on Greece, mopping up some €25bn of government bonds. This has prevented a collapse of the Greek debt market but at the high political price of letting banks and funds dump their holdings onto the EU taxpayer. ECB council member Jose Manuel Gonzalez-Paramo said it was “not entirely correct” to assume that the ECB was the sole buyer of the debt. “We will continue buying bonds until the situation has stabilized,” he said. …Fitch said European banks must refinance nearly €2 trillion of long-term debt by the end of 2012 in an unfriendly market. “There’s an awful lot of debt coming due in 2011 and 2012, and that is becoming a concern,” said Bridget Gandy, the agency’s banking expert.

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Czech President Vaclav Klaus is one of the few European politicians to believe in the classical liberal ideals of individual freedom, personal responsibility, free markets, and small government. He has wisely warned about the European Union superstate being erected in Brussels is a dangerous mix of centralization, bureaucratization, and harmonization. The economic troubles in Europe show he has been right on the mark, of course, so we should all pay attention as he discusses the prospects for Europe in a column for the Wall Street Journal:

I have not rejoiced at the current problems in the euro zone because their consequences could be serious for all of us in Europe—for members and non-members of the euro zone, for its supporters and opponents. Even the enthusiastic propagandists of the euro suddenly speak about the potential collapse of the whole project now, and it is us critics who say we have to look at it in a more structured way. The term “collapse” has at least two meanings. The first is that the euro-zone project has not succeeded in delivering the positive effects that had been rightly or wrongly expected from it. It was mistakenly and irresponsibly presented as an indisputable economic benefit to all the countries willing to give up their own long-treasured currencies. Extensive studies published prior to the launch of the European single currency promised that the euro would help to accelerate economic growth and reduce inflation and stressed, in particular, that the member states of the euro zone would be protected against all kinds of external economic disruptions (the so-called exogenous shocks). This has not happened. After the establishment of the euro zone, the economic growth of its member states has slowed down compared to previous decades, increasing the gap between the rate of growth in the euro-zone countries and that in other major economies—such as the United States and China, smaller economies in Southeast Asia and other parts of the developing world, as well as Central and Eastern European countries that are not members of the euro zone. Economic growth in Europe has been slowing down since the 1960s, thanks to the increasingly damaging economic and social system which started dominating Europe at that time. The European “soziale Marktwirtschaft” is an unproductive variant of a welfare state, of state paternalism, of “leisure” society, of high taxes and low motivation to work. The existence of the euro has not reversed that trend. According to the European Central Bank, the average annual rate of growth in the euro-zone countries was 3.4% in the 1970s, 2.4% in the 1980s, 2.2% in the 1990s and only 1.1% from 2001 to 2009 (the decade of the euro). A similar slowdown has not occurred anywhere else in the world (speaking about “normal” countries, e.g. countries without wars or revolutions).

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