Aside from rampant pessimism about the US economy, the mini-panic now swamping international stock markets is also being attributed to worries about the eurozone and the increasing likelihood that at least five members of eurozone will default on their debt unless rescued by the other countries. The problems of three countries, Greece, Ireland, and Portugal, have been well known for at least a year and a half. But the problems of Spain and Italy, which had been thought to be manageable and unlikely to cause a crisis, have suddenly become critical as well. Because of their size and the size of their debt burdens, it is unclear whether any rescue package would be feasible if the debt of all five countries had to be rescued by the eurozone governments.
It has been fashionable to blame the crisis on the fecklessness of the politicians in these countries, the greediness of their public employee unions and the overly generous pensions that they have extracted from taxpayers, overly generous welfare benefits, and an unwillingness to work hard and save like the good old solid Northern Europeans. There probably is some truth in that assessment, though there is probably some exaggeration as well.
However, assigning blame in this way is really a distraction from the true cause of the crisis, which is a stagnation of income growth, making it impossible to pay off debts that were undertaken when it was expected that incomes would be rising. Since the debts are fixed in nominal terms, the condition for being able to pay off the debts is that nominal income (NGDP) rise fast enough to provide enough free cash flows to service the debts. That hasn’t happened in the five countries now unable to borrow at manageable rates.
Using official data of the European Commission, I calculated the average annual rate of growth in NGDP for each of the 15 countries in the eurozone since the third quarter of 2008 when the eurozone went into recession and for each of the 16 countries in the eurozone since the third quarter of 2009 when the recovery started (Slovakia having joined in eurozone in the second quarter of 2009) through the first quarter of 2011.
Here are the two lists arranged in order from the fastest to the slowest growth rates of NGDP
The five countries primarily implicated in the debt crisis are at the bottom of NGDP growth rates. The only other countries in that range are Cyprus and Slovenia. Cyprus bonds also seem to be problematic, but Slovenia bonds are still rated AA by S&P.
The European debt crisis can thus primarily be laid at the doorstep of Chancellor Merkel and Jean-Claude Trichet, President of the European Central Bank who, in their inflation fighting zeal, have spurned calls for monetary easing to speed the recovery. We are now all reaping what they have sown.
Chancellor Merkel is following in the worst tradition of one of her predecessors, the unfortunate Chancellor Heinrich Bruning, who in his obsession with proving that Germany was unable to pay off its World War I obligations to the Allies, drove Germany mercilessly into a deflationary spiral in the early 1930s paving the way for Hitler’s ascent to power. This time, Germany has largely been spared the pain caused by the tight monetary policy for which Chancellor Merkel has expended so much effort. The pain has mostly been borne by others. But Germany ultimately cannot escape the costs of its unyielding attachment to tight monetary policy. Mr. Trichet, too, can look for inspiration to the tragically misguided Emile Moreau, governor the of the Bank of France who presided over the disastrous accumulation of gold by France in the late 1920s and early 1930s that was perhaps the most important factor in triggering the international deflation that led to the Great Depression.
UPDATE (11/25/2011): In working on a new post about the euro crisis, I discovered that I seriously misstated the growth rates from Q3/09 to Q1/11 for the eurozone countries reported in the above table. Although I got the numbers wrong, the general relationship among the growth rates in the various countries was not wildly off, so the mistake does not affect the central message of the post, but in my haste, I negligent in checking the numbers. There were also a few mistakes in the column reporting reporting growth rates from Q3/08 to Q1/11,but only a few of those number were mistaken, not the whole column, as was unfortunately the case for Q3/09 to Q1/11. Here is a revised table, which aside from correcting my own mistkaes is also based on revised data from the EU.