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Austerity cannot drive consumption and recovery

Publication Date : 04-05-2012

 

Over the next two to three months, Europe might be forced to come to terms with the failure of its unification.

For now, the focus is on France's presidential election on Sunday. The leading candidate, Francoise Hollande, has been calling for further deficit spending to boost growth and to avoid the next crisis. Nicolas Sarkozy, the incumbent president, would like to regain investors' confidence by cutting the government budget deficit and reducing the debt.

France's unemployment rate almost touches 10 per cent, compared to 6.8 per cent for Germany.

If Hollande were to win the election and get the spending increase he wants, where would the growth come from amid the tonnage of toxic assets?

Still, the general mood in Europe is against austerity. Spending cuts and debt reductions are unpopular. In the Netherlands, the government resigned recently after disagreement over fiscal prudence.

Marches and protests across Europe on May Day reflected the mass resentment against high unemployment and shrinking standards of living.

Unemployment in the 17 countries that belong to the euro zone rose to 10.9 per cent in March from 10.8 per cent in February, according to Eurostat, the European Union's statistics agency. In the same period last year, the rate was 9.9 per cent.

This shows that the euro area is facing a deterioration of its economy, with flat growth prospects.

Greece is facing a full-blown crisis, whereas Spain's unemployment has reached 25 per cent.

This is a dilemma facing the euro zone. For any further increase in debt spooks investors and the bondholders. At the same time, deficit reductions will unleash social unrest and street demonstrations.

Germany might be the strongest economy in the euro area for now. But who will buy its manufactured goods when most Europeans run out of money?

The European Central Bank is doing its bailout role. It is now up against the wall, with a bailout of more than US$1.2 trillion to prop up the banks and sovereign debts. Sovereign governments and banks are also saving each other from drowning. They give money to the banks to prevent the banks from collapsing. The banks in turn use the proceeds to buy up the government bonds. This merry-go-round scheme can't continue forever.

The International Monetary Fund's recent attempt to recapitalise by $600 billion reflects the fact that more firepower is needed to bail out the banks and the sovereign debts. The amount of money needed to bail out the global financial system is mathematically impossible to generate.

In the United States, it is a matter of time before the Federal Reserve unleashes a third round of "quantative easing" (QE3). Interest rates have been kept at zero per cent since December 2008.

The Fed officials have signalled that they will maintain this ultra-low monetary policy at least until 2014. This is unprecedented in the history of US monetary policy, when a zero interest rate policy will be kept for a long-running period of at least seven years. It also means US deflation continues unabated.

At the same time, China is experiencing a slowdown. When the purchasing power of the world goes down, so will the Chinese economy weaken. Thailand and other emerging markets will also take a hit.

To further complicate the problems, tension between the US and Iran has intensified by the day. The Philippines, backed by the United States, is standing up to perceived Chinese aggression in the South China Sea. South Korea and Japan have warned North Korea over its next rocket launch.

This is a testing time - not only for Europe, the Middle East and Asia, but for the whole world. It seems that we are heading towards a course of self destruction with fewer options left on the table.

 

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