Thursday, August 26, 2010

The Failure Of European Austerity Is Going To Be A Huge Story This Fall

The Failure Of European Austerity Is Going To Be A Huge Story This Fall

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Back in December of 2009 we predicted that the possibility Euro breakup would be THE big story of 2010, and through the first half of the year it definitely was. The Eurozone didn't breakup, but the seriousness with which people were talking about this possibility would have shocked just about anyone for most of last year.

But the acuteness of that crisis faded thanks to ECB intervention and the drive for austerity among the PIIGS.

Except now it's looking more and more like austerity may be a flop. See, everyone expected that austerity would be an economic drag. What they didn't expect is that austerity would worsen sovereign balance sheets (or at least not improve them).

Of course there were warnings. Ireland was an early austerity adopter and it did squat. Richard Koo has been slamming the austerians, using the Japanese lesson, for some time.

And now we're getting results from the recent wave, and so far they're not that encouraging -- in fact, Moody's is now warning that austerity will make the sovereign credit worse in many situations (though of course they're behind the ball, as bond spreads in Ireland and Greece are now showing).

If these initial results hold, this will definitely pose a policy dilemma. In theory it should cause people to question their previous assumptions, though it's hard to say what will happen. Most likely the pro-austerity camp will simply double down on their calls, claiming governments aren't going far enough.

Add into the mix a likely GOP win, and we'll be seriously debating the same questions in the US, making the European experience all the more relevant.

It should be interesting to see how it plays out, to say the least.

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