European Austerity Has Only Just Begun

Simon Johnson

Simon Johnson is co-author of "White House Burning" and a contributor to Economix.

Updated May 22, 2012, 11:56 AM

In the early 1930s, much of Western Europe faced a situation very much like today -- if countries wanted to keep their existing fixed exchange rates (a constant value for their currency), they needed to engage in considerable austerity. Governments held long and hard to the notion that to change the exchange rate -- devaluing against gold in the 1930s case -- would be akin to ending civilization.

High levels of public and private debt, denominated in euros, means that further austerity is in store.

Today countries like the Netherlands and Spain again have to make a decision. Do they want to maintain a rigidly fixed exchange rate relative to their trading partners, i.e., stick with the euro? In that case, there is little alternative but to continue with some form of austerity. Germany will not boost its economy by enough to make a difference and the European Central Bank will not at this point significantly ease monetary policy further. In this situation, bond investors are both very powerful and running scared -- this combination continues to push interest rates on government bonds ever higher.

The alternative is to break with the euro. Suspending the convertibility of currencies into gold in the 1930s proved not as traumatic as many feared -- in fact, those that clung longer to the gold standard generally had a harder time establishing a viable economic recovery.

But Western Europe today has another problem -- high levels of public and private debt, denominated in euros. Government budgets were not carefully managed during the boom, and warnings were not heeded. There is no domestic currency at hand to replace the euro and, even if there were, a big devaluation for a country would likely mean widespread default across its economy. The relatively “easy” option of the 1930s -- devaluation -- is not readily available.

Modern European austerity has only just begun.

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Topics: Economy, Europe, France, Spain

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