An Austrian economic view

Nov 12, 2011·Alasdair Macleod

In the last two weeks the headlines have switched from Greece to Italy. Financial and economic commentators who dismissed Greece as a small cog in the Euroland machine are now seriously alarmed and see no solution to Europe’s sovereign debt crisis other than the short-term expedient of getting the European Central Bank to print lots of money.

They castigate Germany’s sound money approach, ignoring the fact that it has been central to Germany’s economic success, preferring to commend the loose-money economics of the unsuccessful “PIIGS” (Portugal, Ireland, Italy, Greece and Spain). And when listening to them, just remember that none of them foresaw this crisis, when it was obvious to Austrian economists in the early days of the banking crisis.

Keynesian and monetarists believed that the problems surfacing in the PIIGS would be resolved by economic growth, which would follow so long as governments maintained their deficit spending. As events are now proving, this analysis was flawed, which is why Keynesians are now confused. They should open their minds and absorb Austrian economic theory to gain a proper understanding of human actions and how people are affected by money and credit.

The first thing they will learn is that the economic benefits of credit expansion are a myth. All it does, by a process of capital redistribution – from savers to those who are first in line to receive the new money – is distort the economy and restrict its long-term potential. By lowering interest rates and diverting private sector resources from genuine production to government spending, the economy becomes less efficient and malinvestments occur. The mistake has been to only consider the visible benefits, such as short-term job creation, while ignoring the destructive effects of deficit financing.

The distortions created by easy money and deficit spending will naturally try to reverse themselves as surely as night follows day. The recession that follows the temporary boom is the way an economy cures itself from unsound money and government intervention. This is hard for interventionist governments to accept because it strikes at the heart of their existence. And while printing money and credit is always popular with an electorate that does not understand what is happening to their money, reversing the process is readily noticed and immensely unpopular.

This brings us back to Euroland’s problems. The creation of the euro twelve years ago allowed banks to expand credit massively in the mistaken belief that sovereign risk had been eliminated. The result was that spendthrift governments availed themselves of cheap credit. Eurozone governments, particularly the PIIGS but also France and Belgium, have squandered huge sums to prevent the unwinding of malinvestments and other economic distortions, preferring to perpetuate existing malinvestments. The only solution is for them to let the unwinding happen, which is what the financial markets (for which read reality) are now forcing them to do.

What we are seeing, the markets unwinding economic distortions from the past, is a necessary process and therefore beneficial, a point which goes completely unrecognised. If only governments had the sense to understand this, it is not too late to plan wisely for regenerated economies and a sounder Europe. Unfortunately, the gut reaction of the political class and its advisors is to continue as before at all costs, deferring this necessary adjustment and increasing its eventual severity.

There is no joy for the informed spectator in seeing continuing economic destruction. However harsh it may be in the short-term, the EU elite needs to start paying attention to Austrian School remedies to Europe’s financial woes – and fast.

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