How to end the zombification of the European economy

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BrusselsReport.eu
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By Nikola Kedhi, a senior financial consultant at Deloitte. His comment pieces have appeared in Fox News, il Giornale, CapX, The European Conservative, The American Conservative, The Federalist, Newsmax and Mises.org.

It took a while, but inflation has finally been added to the vocabulary of Western policy makers. During the pandemic, while central banks printed money, to finance government deficits, we were told that there were no inflationary risks. Later on, assurances came from politicians and experts that it would be transitory. A few months later, as inflation became more difficult to hide, Vladimir Putin’s brutal aggression in Ukraine became the sole culprit. While stating the true reasons for the skyrocketing prices appears to be verboten for politicians, at least now, it is finally possible to have a discussion on the topic that is fruitful to tackle the real causes.

Manufacturing orders in the domestic market in Germany fell 5% in July. The manufacturing index in the Eurozone fell to 49.6 in August, below the 50-point level, indicating contraction. In the second quarter, in Germany – often considered the strongest economy in the Eurozone – real wages fell 4.4%, while food prices rose 16% year-on-year.

Meanwhile, the same left-wing policies have been followed in Great Britain, even though it has a so-called conservative government. The result is the highest level of business bankruptcies since 2008, inflation and a budget deficit at record levels and the pound at its lowest level against the dollar since 1985. That’s not to mention Italy, whose GDP in the last decade of technocratic rule has declined 1.4%, while its Debt-to-GDP ratio jumped from 119% to 150.8% and fiscal pressure has gone from 41.3% to 43.5%.

The dilemma for policy makers

Will tightening monetary policies continue in the West, in a bid to curb inflation? Or will governments continue with expansionist policies to avoid an expected recession and a debt crisis in the US and the EU? Policy makers in the West are confronted with this dilemma – which is one of their own making.

The Brussels’ bureaucracy, and until recently also the American government, despite not saying it openly, are following the principles of an economic theory called “Modern Monetary Theory”. This is one of the root causes of the current price increases of basic goods and energy. Basically, the theory says that debt and unbridled spending have no negative effects, since a country can print as much money as it wants. Generally, politicians like this theory, as it gives them more power, while the taxpayers are the ones left to pick up the costs.

A telling metric for the situation in Europe is how the cumulative loss of purchasing power in the Eurozone between 1991 to 2021 amounts to a whopping 74%.

To make matters worse, during the pandemic, governments shut down their respective economies with misguided lockdowns, sharply reducing activity on the supply side. As a result, production fell considerably, while the central banks in the EU and the US printed large quantities of money and handed them over as helicopter money, spending billions of dollars for aid packages – often unnecessarily. While the dollar up to a certain level benefited from its status as reserve currency, the euro and other currencies did not have such advantage, harming themselves trying to replicate US policies.

The cause of the disease is presented as the cure

It should not be forgotten that money in itself has no value, and it gets its value from what is produced in an economy. This growth in the money supply, which is much higher than the increase in the demand for money, associated with negative interest rates, and combined with a massive increase in debt by European governments, financial repression, high levels of market interventions, and regulations have all led to a continuous economic decline, a distortion of economic incentives, a high number of zombie companies, lower productivity, and higher taxes.

European bureaucrats have in effect created a hybrid system between crony capitalism and soft socialism. Europe is now a debt and cheap money addict, to which the cause of the disease is presented as the cure.

Argentina is one of the most significant examples of this phenomenon. In April 2022, annual inflation amounted to 58%, 6 times more than Uruguay, five times more than Chile, four times more than Brazil or Paraguay, which are neighboring countries with similar problems. What distinguishes Argentina is the growth of the monetary base by 43.8% in this year alone. During the last three years, the monetary base has increased by 179.7%, which was 1,543.8% during the last decade, as the Argentinian currency has lost 99% of its value against the dollar.

To see the absurdity of the Eurozone’s decisions, and the dangers for the US if it continues down the same path, it is enough to look at Switzerland, after the Argentinian example. Inflation there in June was only 3.4%, while core inflation was 1.9%. Even Switzerland feels the consequences of the war in Ukraine, given how it also depends on imports of gas, other assets or supply chains. But what Switzerland has not done is to massively print money, protecting its own currency from destruction and saving the purchasing power of its citizens.

Europe’s unsustainable economic policy model

Vladimir Putin’s unprovoked and brutal aggression has shown that the economic system of Europe – based on cheap energy from Russia, high debt and needless, unproductive spending – is unsustainable and headed for a crash. At the very best, experts and politicians have been complacent, short-sighted, and irresponsible, sacrificing innovation, production and Europe’s very own economic and energetic sovereignty and increasing reliance on foreign adversaries.

Rising costs of production, especially for food, are said to derive from the war in Ukraine. As noted by economist Daniel Lacalle, wheat exports from Ukraine and Russia were only 7.3% of global production in 2020. Together, in 2020, Ukraine and Russia produced nearly as much wheat as the entire European Union. European farmers have been producing at a loss, both before and after the pandemic. The main reasons for the high production costs include administrative and market regulations, environmentalist lobbying, and high fiscal burdens.

If Europe were competitive and would have economic policy models that encouraged production, supply crises from Russia or elsewhere would not be felt. It is not that the lack of supply from the east is without precedent. In 2010 there was a 6.3% decline due to a drought in Russia that reduced production by 20 million metric tons. There have been such declines in the years 1991, 1994, 2003 and 2018. The European Union has no reason to depend on other countries, even less on unfriendly ones, when it has all the production capacities. However, production occurs where there is a free market, non-interventionism, low taxes and economic development. Europe, unfortunately, has long since started the zombification of its own economy.

To tame inflation, interest rates must increase and taxes and state spending must come down

Moreover, if it were solely due to supply chain troubles, and if the supply of money were to remain little changed, only the prices of some products would increase. Yet, we are seeing an increase in all prices. Prices of products can only rise at the same time if the quantity of money goes up faster than the demand for it. Inflation is always and everywhere a monetary phenomenon. Hence, to tame inflation, interest rates should be raised, the tax burden on wages and products should be reduced, quantitative easing and reckless government spending should be stopped.

Unfortunately, there is insufficient political will in Western countries to take these measures. The Eurozone, with its highly indebted member states, is never going to raise the base rate to the necessary levels, as it would cause to a debt crisis.

The balance sheet of the ECB compared to eurozone GDP remains high, at above 70%, which compared with only 35% in the USA. Meanwhile, many eurozone member states have debt levels above 100% of GDP. Yet again, problems caused by government intervention will be solved by more government intervention, increasing the structural imbalances. Popular discontent in Western countries will force governments to present rescue plans that will increase spending, subsidies, debt and ultimately the money supply, leading to increased inflation, worsening the crisis.

For Europe – and the US – there is but one path towards growth and prosperity – a complete change in their economic policy model and a change of the relationship between the bureaucratic machine and individuals. The EU should be transformed into self-reliant nations cooperating with each other, embracing a truly free market economy, competition, and innovation, and rejecting the regulation, dirigisme, and taxation mentality.

The United States has long championed liberty, entrepreneurship, and freedom to pursue happiness. That is why it has thrived. It has successfully been done before! We only need to follow the policy recipes of the likes of former British Prime Minister Margaret Thatcher and former US President Ronald Reagan. Otherwise, Europe will continue its path towards geopolitical and economic irrelevancy, and the US will follow suit, shifting the balance of power towards the adversaries of the West.

 

Originally published in Italian on nicolaporro.it and Atlantico Quotidiano magazine.

 

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