Mike Lofgren: The Austerity Trap – Is Past Prologue? – Should Germany Grant Debt Relief as It Was Granted Debt Relief?

Economics/True Cost, Politics
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Mike Lofgren

The Austerity Trap: Is Past Prologue?

Mike Lofgren, Huffington Post, 10/11/2012 9:42 pm

A German chancellor touts austerity as the sovereign remedy for the worst global economic crisis in most people's memory. Why? The great inflation of 1923 is still so seared into the consciousness of the German political class that keeping the stability of the currency is paramount. Therefore the decree goes out: wages, salaries, and pensions must be cut, government spending slashed, taxes on the middle and working classes raised. Predictably, the unemployment rate rises above 25 percent, riots and demonstrations ensue, and an extreme right-wing party rapidly gains adherents. What this will mean for Europe's political future is unclear.

If this sounds like Chancellor Angela Merkel's hard line on Greece's sovereign debt repayment, the country's dreadful economic tailspin, the social chaos that has resulted, and the rapid growth of the Greek extremist party Golden Dawn, they are events with an eerie historical parallel. In all the particulars I have outlined, they echo another crisis eight decades before the present one.

In March 1930, as the Great Depression was descending on the world like new Ice Age, Heinrich Brüning became chancellor of Germany. An exponent of economic orthodoxy, Brüning immediately proposed austerity measures to cut salaries, pensions, and unemployment compensation, while at the same time tightening credit. These measures got a cool reception in the Reichstag, which rejected some of them. But just as the present-day European Central Bank — essentially a tool of German policy — is able to lay down the law to debtor countries regardless of popular sentiment, Brüning was not to be dissuaded. He invoked article 48 of the Weimar constitution (the so-called emergency clause) and implemented his measures by decree.

The results were predictable. Unemployment surged towards 30 percent. Industrial production eventually sank to 58 percent of the 1929 level. Most ominous of all, in the September 1930 election, the hitherto obscure National Socialist German Workers Party, which had previously held only 12 seats in the 577-seat Reichstag, surged to 107 seats, making it the second largest party in the assembly. By the time Brüning was two months out of office, in July 1932, the Nazis had 230 seats, making them Germany's largest political party. They were poised to reap the harvest of Brüning's folly.

Heinrich Brüning was not an evil man. He succeeded in keeping the Nazis out of government coalitions, and even banned public demonstrations by the Brownshirts. But his economic policies, analogous to bleeding an anemic patient, more than nullified whatever good he had attempted to do.

Then as now, during a time of sharp economic contraction, one simply cannot cut one's way to recovery and fiscal balance. Austerity is a trap. The fall of purchasing power and industrial production resulting from austerity means that future revenues will shrink as fast as government spending falls — or even faster. The budget deficit will hardly be improved (if at all), and the only real difference will be that the economy will have contracted. This state of affairs in turn makes it more difficult to balance the budget in future years, because the economy will be starting out from an artificially depressed base.

That is not to say that the Greeks are wholly innocent actors here. There have been fraud and boondoggles galore in the Hellenic Republic. In retrospect, a small country with a population smaller than that of Ohio would have been well advised not to blow $11 billion on the 2004 Olympics. What the prophets of fiscal rectitude are loath to admit is that Greece had plenty of help along the way — from the Eurocrats (including Germans) who winked at Greece's application to join the Eurozone, to the European banks that lent it money, to Goldman Sachs, who cheerfully assisted the country in camouflaging its financial imbalances.

But pursuing the chimerical quest for fiscal stability becomes problematic if it endangers social stability. The neo-Nazi Golden Dawn, already the fifth largest faction in the Greek parliament, would, according to polls, become the third largest if elections were held today. It is not unthinkable that Europe's miraculous post-World War II prosperity and social solidity could unravel one country at a time.

The Germans should not cry too hard in their Oktoberfest beers. The Eurozone has been a remarkable absorption mechanism for the German export industry, allowing it to pile up enormous trade surpluses. One cannot reap all of the upside and disclaim any responsibility for the downside. And if one looks back in history far enough, every country is a welsher. For all the harm Brüning did, his government did catch one break. During his administration, the Allied Powers permitted a moratorium on the reparations payments that Germany owed pursuant to the Treaty of Versailles. Germany was initially supposed to pay 132 billion gold marks. Despite the country's repeated defaults on reparations payments throughout the 1920s, the sum was formally cut in half in 1929, suspended in the debt moratorium of 1931, and finally cancelled by the Lausanne Treaty of 1932. At that point, seven eighths of the original reparations total would have been due.

Germany never paid another penny.

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