“Nein”!

Recently-appointed managing director of the International Monetary Fund, Christine Lagarde (above), drilled into the German-led press for strong austerity measures across the Eurozone, noting that without a combination of government spending directed at growth, such deficit-reduction measures could send Europe – and perhaps the global economy – into more than just the expected European recession. Speaking before the German Council on Foreign Relations on January 23rd, she analogized current thinking to the failed responses aimed at ending The Great Depression over 80 years ago. “"It is about avoiding a 1930s moment, in which inaction, insularity, and rigid ideology combine to cause a collapse in global demand… A moment, ultimately, leading to a downward spiral that could engulf the entire world.”

Most of the quasi-governmental global financial institutions (including the World Trade Organization, the World Bank and the IMF, all part of the World Economic Forum's Global Issues Group) agreed with this assessment, challenging the “austerity is the only solution” directive, issuing the following statement: “But entering 2012, we worry about: decelerating global growth and rising uncertainty; high unemployment, especially youth unemployment, with all its negative economic and social consequences; potential resort to inward-looking protectionist policies.” They warned that “fiscal consolidation” programs should be applied in a "socially responsible" manner, in order to promote growth and employment. Healthy economies in countries that buy German goods, they argued, are good for Germany. The plea is apparently falling on deaf ears, even as Italian Prime Minister, Mario Monti (who is implementing austerity in his country) has joined the chorus that some growth stimulus is needed.

Further, the European effort to shore up their banking system with capital infusions and requirements of additional equity have so far fallen decisively short of the mark: “Banks are hoarding the European Central Bank’s record 489 billion-euro injection into the banking system, thwarting attempts by policy makers to avert a credit crunch in the region. Almost all of the money loaned to 523 euro-area lenders last month wound up back on deposit at the Frankfurt-based central bank instead of pouring into the financial system, according to estimates by Barclays Capital based on ECB data.

“Governments are urging European banks to keep lending to companies and individuals while requiring them to raise an additional 114.7 billion euros of core capital by June to weather a deepening sovereign-debt crisis. Instead of raising equity, most lenders across Europe have vowed to meet capital rules by trimming at least 950 billion euros from their balance sheets over the next two years, either by selling assets or not renewing credit lines, according to data compiled by Bloomberg… The world economy will grow 2.5 percent this year, down from a June estimate of 3.6 percent, according to the World Bank. The IMF will cut its global growth forecast for 2012 to 3.3 percent from 4 percent when it publishes its World Economic Outlook… the Daily Telegraph said [January 22^nd]...” BusinessWeek.com, January 23^rd.

While reluctantly complying with the demand for more stable balance sheets, these European banks, many with severe exposure to failing sovereign wealth debt (particularly in Greece), are screaming like stuck pigs: “The banking authority has called on banks to raise the money through cuts in shareholder dividends and issuance of new stock. It has warned that the sale of any operation, particularly in banks’ home markets, that hurts business lending won’t be allowed… ‘Regulators are asking for the impossible,’ said Etay Katz, a banking regulatory partner at the law firm Allen & Overy in London. ‘They want banks to keep lending to the real economy, and there’s an expectation banks will have to swallow the bitter pill of offering new equity at times when investors’ appetite is negative.’” Struggling negotiations to replace existing Greek bonds with new issues at half the face value are facing severe resistance from the private lenders who will have to absorb the downgrade, and battles over the term and the interest rates threaten to sink the talks.

Germans endured a difficult, no growth decade at the beginning of the new millennium. They swallowed the bitter pill, endured a contraction in lifestyle as the nation reconfigured, investing in education, infrastructure and research, resurrecting the German export machine only in the last few years. The Germans believe passionately in thrifty austerity, for cultural reasons outlined in my December 3^rd Historical Fears blog. They do not believe in government stimulus as a way out of economic malaise, and most Germans think that the pain of austerity, even if it requires a recession, is simply an economic necessity. Suck up and take your medicine, Europe. They are bound by different principles than gave rise to the above statements from the IMF, World Bank and others. Theirs is a philosophy of “ordoliberalism, a conceptual blend of free markets and strong government. It says rigorous regulation is necessary, but only to help the free market achieve its full potential… Ordoliberals detest stimulative Keynesian policies.” BusinessWeek.com, December 2^nd.

But without German backing for a pan-European bond which can allow the weaker Eurozone nations (particularly Greece, Italy, Spain and Portugal) to access interest at a rate they can afford and a relaxation of the German mandate for austerity without stimulus, the seemingly inevitable European recession that Germans appear to be knowingly accepting as “necessary medicine” may migrate to tank whatever recovery was brewing in the rest of the world, including the United States. Could a depression follow? And so far, the German response, despite these global admonitions is, “Nein!

I’m Peter Dekom, and the missing ingredient in the German position appears to be common sense.