European Cuts Threaten to Cause Global Deflation

Many governments in Europe need to cut their budget deficits, but they need to do it long after the global recovery moves beyond just the green shoots. However, financiers (the very people who got the world into the current mess) have started screaming about excessive deficits. Several governments, especially those that lean to the right, are heeding the sirens' call to make cuts now. Suddenly removing demand from staggering economies is the very mistake FDR and others made in 1937, prolonging the Great Depression. Now, the world may get a decade of deflation because governments seem to want to cut too early.

In Germany where the government has created difficulties for itself by bailing out Greece (as if it had a choice given that German banks hold huge piles of Greek debt), the Merkel government will cut 80 billion euro from the budget by reducing family tax credits, holding off on construction projects and sacking 15,000 government workers. One has heard reports that military conscription may also go (which would be a net positive for German society but economically negative in the short run) and that the VAT on food could rise to 19% from 7%. The latter would be devastating to lower income Germans.

Britain's Prime Minister David Cameron has warned of huge cuts that are "unavoidable," "painful" and "inevitable." The public spending cuts will "affect our whole way of life," Mr. Cameron cautioned. The government wants £6.2 billion in "savings" immediately (meaning the jobs of 30,000 public-sector workers), but in the coming weeks and months, the desired goal is £60 billion a year, just shy of 10% of current public spending plans. Over 5 years, that's the elimination of 1 million jobs. Plans also include increasing the VAT to 20% from the current 17.5% further hurting the poorest.

Elsewhere across Europe, governments either have gotten the message (e.g., Ireland) or are setting about fixing things (e.g., Spain). Portugal is halting construction of a new airport. Greece and France are raising the retirement age of state employees. Last week, Spain approved a 15 billion euro austerity package (by a single vote in the Cortes).

Many of these plans are modeled on the Canadian experience of the 1990s, when Prime Minister Jean Chretien wiped out the budget deficit in the three years between 1993, when it stood at 9% of GDP, and 1996. The national debt fell from 70% of GDP to 30%. What's different is the huge growth experienced by the world in that period and the opening of the huge US market thanks to a free trade deal.

Europe is facing a world economy nowhere near as robust. The patient isn't well enough just yet for the needed surgery. By moving too quickly, the nations of Europe threaten to snuff out their own recovery, and Europe is big enough to threaten that of the rest of the world. If they stifle demand as they seem to intend, they will impose severe hardship on their people, and at the same time, they will see tax receipts fall, undermining the reason for the cuts in the first place. If finance ministers and central bankers aren't careful, Britain's emergency budget on June 22 may be the beginning of the completely unnecessary Great Deflation.

© Copyright 2010 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Ubuntu Linux.

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