Wednesday, April 18, 2012

Europe: Still in the News

The Lehmann Letter (SM)

The European debt crisis remains in the news.

Today's New York Times carries a story about renewed concerns whether or not Europe's peripheral nations, such as Spain, will be able to meet their obligations.

Some in Europe, including the International Monetary Fund, suggest that increased assistance flow to troubled debtors. Germany resists this, insisting that fiscal discipline will only occur when borrowers confront their obligations. Call it a deterrent policy.

This letter has described the "tough medicine" approach as a throwback to the rules-of-the-game of the gold standard from 100 years ago. According to those rules, currency devaluation - like abandoning the euro today - was not an option. Nations were supposed to impose austerity on their economies and soldier on, adhering to the gold standard at all costs. Germany's prescription is reminiscent of those rules.

But there are some, such as Paul Krugman, who believe this approach is self-defeating. See his op-ed column in Monday's New York Times.

Prof. Krugman argues that Spanish austerity will only exacerbate conditions. The Spanish economy will shrink as Spain attempts to raise taxes and cut its expenditures. That will reduce income, output and employment even further, thereby making it more difficult to collect taxes and resolve the debt crisis. Prof. Krugman believes Europe, by these policies, is placing itself in jeopardy of a severe recession.

Even if a worst-case scenario does not develop, it's entirely possible that Europe soldiers through its debt crisis but consequently suffers for it.

We will see

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© 2012 Michael B. Lehmann

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