Wednesday, September 11, 2013

Secundary Effects of Austerity are Coming Back to Haunt Us

The consensus of the austeritians about what was ailing the eurozone was the lack of competitiveness. More precisely, productivity did not increase in line with the wages in the crisis countries, therefore they became less competitive, which led to a negative trade balance. The only cure they saw was imposing harsh austerity on these countries, which resulted not in increasing competitiveness; but caused mass unemployment and outright destroyed industries. Of course, the imports completely collapsed in the program countries, which lead to fast "improvements" of the trade balance. But the policy has not only failed completely in the eurozone, since we are still not back to the level of 2008 and will not be until 2015, no it now also becomes quite clear that the secondary effects on especially Asian countries might even endanger the minimal signs of hope we have seen in the second quarter of 2013.

Austerity improved the trade balance not through internal devaluation by reducing wages and prices. The wages remained quite rigid and significant VAT increases - which were part of the policy package - prevented any deflation to take place. At the same time no significant steps were taken to fix the banks in the crisis countries. The Spanish banking sector is now worse of than before attempts were taken to fix it late last year. The firms were forced to lay off workers which in turn had a negative impact on bank balance sheets; and the lack of financing kept companies from investing, therefore prevented any productivity gains through better equipment. Austerity completely failed in Europe, but nobody seems to have thought about the effects it would have on countries outside of the eurozone.

The GDP in the eurozone remains significantly below the peak in 2008, but in the mean time the balance of trade is improving, which negatively affected the exports of the BRIC countries. This more so than possible future FED policy changes, can be seen as the reasons for the turmoil caused in Asia and elsewhere at the moment. The BRIC countries were moving towards current account deficits because of austerity in the eurozone negatively affecting their exports. Which reduced the demand for additional investment, so money flowed out of these countries causing the recent depreciation.

In fact, the euro strengthened significantly against all BRIC currencies, except for China's Renmimbi compared to last year (as of 9-11-2013):
  • Brazil: 16.9 %
  • Russia: 7.3 %
  • India: 18.8 %
  • China: 0.2 %
All competitiveness improvements compared to Russia, Brazil, and India of the last three years in southern Europe were completely wiped out within a single month. At the moment, all three currencies look stronger than just a few days ago, but it seems unlikely that they will move back to the levels of earlier this year. Yes, this means less investment in the BRIC countries, but the exports will increase.

What about Germany? Well, both lower investment in the BRIC countries and Abenomics (the euro is 33 % stronger against the yen than last year) are starting to have an impact on machinery producers(new orders, blue domestic, yellow foreign orders), industrial production decreased 2.1 % in July and exports in the first half of the year were 0.6 % lower than during the same period last year (remaining unchanged in July). The BRIC countries are ordering less machines and if they do it is far more likely that they choose a Japanese product than a German one. So it seems likely that the decrease of 4.5 % in non-domestic new orders in July was just the beginning of a downward trend.

The discussion about a possible BRIC crisis on the horizon doesn't really make sense, except for China. Instead, the recent development there and in Japan should make everybody very worried about the eurozone, once again. All austerity efforts have now completely failed; and if the euro remains this strong it is likely that we will hit a brick wall before the year ends. This time Germany will not be able to come out relatively unscathed. Everything that is happening seems to be specifically designed to hurt German exports. Let's also not forget that the German constitutional court might rule this month that the Bundesbank must not participate in any bond buying schemes; and in the USA the republicans have decided that another round of mindbogglingly stupid brinkmanship must happen again this fall. So, there is significant downward risk to an already bleak looking situation.

No comments:

Post a Comment