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Monetary, fiscal farce in Europe continues

First published at RGJ.com http://www.rgj.com/story/money/economy/2014/06/15/robert-barone-monetary-fiscal-farce-europe-continues/10515411/

The  European Union economies have been in, or nearly in, recession since the financial crisis in ’09. Greece has had to be bailed out several times. Spain, too, and in the case of Cyprus, bank depositors bore much of the cost. Italy and Portugal are lucky they avoided such bailouts.

But that doesn’t mean they are healthy. The unemployment rates in the major European Union  nations, except for Austria and Germany, are, in a word, “pathetic.”

The overall unemployment rate in the Eurozone is 11.7 percent. Greece’s is 27.5 percent, Spain, 25.1 percent, Italy, 12.7 percent, and Portugal, 14.6 percent.

In France, Germany and Austria, the rates are 9.7 percent, 6.7 percent and 4.9 percent respectively. Meanwhile, Switzerland, right in the middle of the EU but not a member, has an unemployment rate of 3.2 percent and the rate in the U.K. is 6.8 percent.

The ECB to the rescue

In the immediate aftermath of the financial crisis, like the Fed, the European Central Bank stepped up and made cash available to the notoriously overleveraged banking system. That, in fact, is the basic and most vital function of a “lender of last resort.” So, Bravo!

But now, because the hands of the various EU governments are tied, given that budget deficits have to be brought under control, it is the ECB that has by default become the supposed white knight that is now expected to somehow recharge the faltering EU economy.

The major tool or nuance announced on June 5 by the ECB was a negative interest rate on bank deposits (reserves) held by the EU banks at the ECB. The theory is that rather than pay the 0.10 percent negative interest rate on those deposits, the banks will lend the funds to the private sector.

Let’s examine the logic here. If the banks haven’t been making such loans to date, it is most likely because they can’t find an adequate risk/return tradeoff. The fact is, it is the capital requirements of the ECB’s bank stress tests that severely discourage private-sector lending. So why will a few basis points make a difference?

What is really shocking is that the financial media is convinced that this is going to work. But the banks have other viable and more appealing alternatives that  are more likely to occur than an increase in private-sector loans. Two of them are: 1) buy short-term fixed income assets with the ECB deposits; 2) charge or increase fees on bank depositors’ accounts to make up for the cost of holding ECB deposits.

A political way to grow GDP

In the aftermath of the financial crisis, most of the EU governments were forced to adopt austerity budgets because the recessions reduced tax revenues while the social welfare payments grew. They have since defined their budgets in terms of a deficit/GDP ratio and all adopted targets and time frames in which to meet those targets.

In the recently held European elections, the anti-austerity parties made significant gains. So the politicians now have to adapt to take voter preferences into account.

Like all ratios, the deficit/GDP ratio has two components, the deficit and Gross Domestic Product. The ratio can be impacted positively either by reducing the size of the deficit or by increasing the GDP. Growing the GDP, of course, is the ultimate objective because a larger pie benefits all. Without a growing GDP, the monetary size of the deficit must shrink, probably the most difficult task for a politician.

But let’s not underestimate their ingenuity.

Italy and all of the EU countries have now found a way to reduce the deficit/GDP ratio without doing much of anything. They are simply redefining what the GDP is. Under an EU directive, Italy and all EU countries will count the “underground” economy as part of their GDP. This includes the monetary values of prostitution, drug-dealing and any transaction where both parties in the transaction consent to the transaction and agree on a price.

The reason for even thinking about counting the underground economy is the fact that the tax rates in the EU are so high that there is a lot of “under-reporting” (i.e., tax cheating). Many small businesses don’t report some of their cash transactions and tourists who know can negotiate for a lower price, and often do.

One recent study concluded that legitimate transactions in Italy’s underground economy would increase the GDP by 16.5 percent. When criminal transactions are included, the GDP would be 21.4 percent larger than currently reported. So, expect Italy’s reported GDP to grow at double-digit rates this year!


Really, you can’t make this stuff up. Rather than trying to solve the real problems, provide incentives to work, reduce tax rates and legitimately grow the economy, the politicians would rather resort to redefining the GDP to make their deficit/GDP ratio look better just to buy themselves a few more years when, after they retire from public office, it will be someone else’s problem.

The reality is that to have any chance of economic growth, the euro must fall significantly in value vis-a-visother currencies, so that exports rise, imports fall, and tourism increases significantly.

Except for Germany, Austria and a scant few other EU countries, it’s their only hope. And that is why it is inevitable that the ECB will be pressured to adopt significant QE-style (i.e., money printing) policies in the near future.

Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value Advisors (UVA), Reno, NV, a Registered Investment Advisor.  Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.  Robert is available to discuss client investment needs. Call him at (775) 284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV  89521.  Ph: (775) 284-7778.


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