What Can We Learn from Europe?

Between 1995 and 2008, which is prior to the onset of the current Panic, goods prices inflated by 67% on average in Greece, and by 56%, 47%, and 41% in Spain, Portugal, and Italy, respectively, in that same period.  German prices inflated by 9% over those years.  The difference between the PIGS and Germany centered on the nations’ domestic policies.

The Germans went through social, tax, and spending policy reforms which, among other things, limited the amount of money in their economy that didn’t have savings or goods to absorb.  The PIGS spent their money, and they also freely spent other people’s money which they borrowed, without regard for the amount of goods available from their domestic production, or from foreign imports, to absorb their money.  Indeed, as domestic prices rose, the PIGS spent more, tautologically from those increasing prices, and via printing and borrowing more in order to spend more in absolute terms in the face of those rising prices.  An additional result from those increasing prices is that the PIGS’ own production lost competitiveness in the international markets (including the rest of the EU), and so they couldn’t earn money from trade to cover their spending.


I suggest that there is a lesson for us, here in the US.  More money in our economy from government spending, whether fueled by borrowing or printing or both, will produce rapid inflation as our economy attempts to recover if there aren’t production increases to keep the growth in the supply of goods for sale in step with the growth of the money available with which to buy those goods.

It is the nature of demand and of production that the former can, and does, turn on a dime, while production can only increase slowly as plant is ramped up and as workers are hired and trained (with training an especially large problem today, given the length of time today’s used-to-be-experienced work force has been unemployed), and production can only decrease quickly at the expense of jobs.

Today’s American economy has already accumulated a vast overhang of funds (in the trillions of dollars) from Federal Reserve Bank printing and government spending and from subsequent funds retention by businesses and families in the face of ongoing economic uncertainty.  We are thus at severe risk of a burst of potentially ruinous inflation as those funds come out of their personal and business piggy banks to be spent on production that cannot meet that demand as the economy tries to begin a recovery.  That inflation will threaten what should be a robust post-recession growth period.  Some of this money, to be sure, is being absorbed by businesses and families paying down their own accumulated debt, but the present “stimulus” spending, borrowing, and money printing greatly outstrip absorption through private debt reduction.  And in the end, private debt reduction doesn’t reduce the overhang; it just changes the overhang’s location.  Further, this overhang shift is exacerbated by the current lack of employment in our economy.

This situation is made worse by repeated bouts of government spending.  Under present conditions, the overhang only increases: the money is simply sequestered in those business and personal accounts against future spending needs, rather than used for current spending, in anticipation of continued unemployment.  That unemployment and associated uncertainty about the future puts a premium on having savings with which to pay the mortgage or to buy food, since there is no income with which to pay for these things.

This is an important lesson in its own right.  But underlying all of this is the fact that the economic crisis faced by the United States and the European Union (of which Greece is only a present example) is at bottom a debt crisis, not an “ordinary” cyclic (if unusually deep) recession/spending crisis.  Solving the spending/inflation problem, important as it is, will do little to solve the debt crises; these can be solved only through actually paying down the debts or by going through default and bankruptcy.

The spending question can feed into debt crisis resolution in an important way, though: reducing spending below revenues, more than eliminating budget deficits, produces budget surpluses that then can go directly to paying the debts.  And reducing spending below revenues by reducing spending rather than by raising tax rates leaves more money in the hands of the individual citizens and their businesses, who are far better equipped to make spending—and debt repayment—decisions than any government has shown itself to be.

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