Key Messages
The Truth Behind the Eurozone Debt Crisis: Why the Popular Narrative is Wrong and What You Need to Know
Austerity programs, often prescribed for countries in crisis, are bound to fail due to underlying problems with the advice itself.
The global financial crisis of 2007/2008 saw a debt crisis hit the eurozone, which news outlets blamed on profligate governments like Greece and Spain.
Reports emerged that fraud had occurred within their public administrations and that people had pretended to be blind in order to receive benefits.
In response, many proposed that austerity measures should be taken – cutting benefits, raising taxes and reducing the size of public administration – in order to pay off debts but this solution was flawed.
It shifted the blame onto irresponsible government spending; when actually there were other factors at play such as “swap derivatives” causing banks to go bust and historical precedents such as Hitler’s Germany following austerity rules set by Germany’s creditors during its economic crisis after WWI.
Therefore, austerity programs for countries in crisis are almost always doomed for failure because of these flaws.
The Ineffectiveness of Austerity: How National Budget Cuts Can Lead to More Debt and Suffering for the Lower Classes
Austerity measures weaken an economy, and those on the lower end of the wealth scale are often hit the hardest.
This is evidenced in nations throughout Europe who, in their attempt to recover from the financial crisis of 2007, have implemented austerity policies.
Austerity involves reducing spending by issuing budget cuts with the goal of making an economy more competitive and inspiring confidence in its businesses.
However, it’s become quite clear that this strategy – when applied on a national level – fails to generate growth and can even lead to further debt accumulation and economic strife.
For example, countries like Spain, Portugal, Greece, Italy, and Ireland have experienced economic hardship as a result of austerity policies used for damage control at a systemic level.
If every household suddenly stopped spending money at once, local businesses – burdened with expenses of their own – would suffer too.
To weather these difficult times businesses need to take out loans or lines of credit but without increased consumer spending they’re unable to make payments on these debts.
Additionally, when budgets are cut it usually hits welfare programs, unemployment benefits and social programs which benefit those most vulnerable on a socio-economic level; meaning that it’s those with fewer resources who will bear the brunt of austerity-induced harm.
Overall it seems clear that applying austerity measures on a national scale has very negative consequences – weakening economies while hitting those in society already struggling the hardest.
History Has Proven Austerity to Be a Poor Economic Strategy in Times of Recession
Austerity has a long-established record of failure when it comes to restoring economic growth.
The US experimented with austerity in the 1920s, under President Harding and later Herbert Hoover, and ended up in the Great Depression.
Germany suffered greatly from austerity during the post-WWI Treaty of Versailles period, ultimately leading to Hitler’s rise to power.
France, Sweden, and Japan also suffered when they adopted similar budget-slashing policies– none of these countries truly recovered until they stopped cutting budgets and instead invested money into growth initiatives.
Proponents of austerity may point to success stories like Denmark, Ireland and Australia — however, Denmark’s budget cuts were always made during an economic boom as opposed to a recession; Ireland experienced economic growth from 1986 onwards due to the devaluation of their currency; whilst Australia’s purported “budget cuts” were never observed in unemployment benefits or capital taxes at all.
The bottom line is that there’s a long history showing that austerity fails to heal the economy – investment is what yields high-impact results during times of financial recession.
The Cause of the 2008 Global Financial Crisis: Mortgage-Backed Securities and Credit Default Swaps
The economic crisis that shook the world between 2007 and 2008 was largely caused by the US banking system, namely their involvement in “repo markets” that allowed them to borrow short-term loans with one another using housing-mortgage securities.
These securities became worthless when homeowners started defaulting on their mortgages, leading to massive losses for banks.
The situation further deteriorated when people in the public panicked and began withdrawing money from the banks.
Banks were unable to keep up with withdrawals due to lack of cash, creating a circular problem wherein money was constantly being borrowed from another institution.
A key factor that led to this crisis were two key financial instruments: CDOs (Collateralized Debt Obligations) and Credit Default Swaps (CDSs).
CDOs were basically a bunch of seemingly random mortgage securities bundled up together, while CDSs gave investors an opportunity to bet against the bank and receive large payouts if the owner defaulted on mortgage payments.
Ultimately, insurance companies like American International Group (AIG) sold too many of these CDSs to banks around the world, which they weren’t able to cover when defaults began occurring.
This only made matters worse as investors tried desperately to sell off CDOs at vastly decreased prices, eventually bringing their problems across Europe as well.
How Bailing Out the Banks Doomed the PIIGS Nations to Austerity
It was no secret that the EU nations of Portugal, Italy, Ireland, Greece and Spain – the PIIGS nations – were struggling before 2008.
Every country had its own issues: from low birth rates and aging populations to bursting property bubbles and declining industries.
To make matters worse, all of these countries had taken on additional credit via the euro currency – credit they weren’t able to pay back.
Unfortunately, instead of coming up with creative solutions to their economic woes, it was decided to bail out their banks instead – which only made matters worse.
It turns out that European banks were “too big to fail” as well as “too big to bailout” due to their combined value being nearly three hundred percent of their respective GDPs!
In order for these countries to pay for the bank bailouts, they put themselves in a position of permanent austerity by using up most if not all of their resources.
This move doomed them to long-term economic hardship with no means to improve their situation.
Iceland’s Refusal to Bail Out Banks Showed the Dangers of Austerity for Nations and Citizens
Ireland and Iceland have vastly different stories when it comes to austerity.
Ireland elected to bail out its banks with €70 billion, while Iceland decided to let its banks go bust—and the results are telling.
In Ireland, public-sector salaries were cut by nearly 20 percent and social benefits were drastically reduced.
Despite these attempts at austerity, the country’s growth rate only edged up to 1 percent in 2011 and unemployment rates rose steadily until they reached 15% in mid-2012.
On top of that, the debt-to-GDP ratio climbed from 32% in 2007 to 108% in 2013—hardly a sign of success.
Contrast that with Iceland’s story.
By allowing their banks to fail, they managed not only a 6.5 percent decline in GDP in 2009 and 3.5 percent drop the following year, but also saw positive growth begin again in 2011 which continued into 2012 with 3%.
Moreover, government measures such as additional support for social welfare programs, higher taxes on wealthier groups and lower taxes on middle and low income earners allowed Iceland economic wellbeing far away from the predictions of doom made by the IMF.
We Should Let Banks Go Bust and Raise Taxes on the Wealthy to Avert Financial Crises
When it comes to financial crises, austerity measures simply aren’t the answer.
If we look to history, we can see that there are better solutions.
Take the case of Iceland: rather than bailing out the troubled banks and draining the state’s resources, they created new banks with 20% of their GDP — a move that was far more cost effective in the long run.
Other nations should take a closer look at their banking systems and ask themselves what services they’re really trying to protect with a bailout.
Simply put, if banks don’t provide an essential service like food or energy then they most certainly shouldn’t be bailed out.
Moreover, increasing taxes on the wealthy is another viable alternative to austerity.
For example, German economists discovered that by collecting 10 percent of net wealth over €250,000 from just 8 percent of its population, it could increase its GDP revenue by 9 percent!
Similarly, American economists proposed raising income tax on the wealthiest 1 percent from 22.4 to 43.5 percent which would result in 3 percent increase in GPD revenue for the country.
Wrap Up
The final message in the Austerity book is that austerity is not a sustainable solution for economic and social stability.
The private sector caused the international banking crisis, but it was the public sector that had to bare the brunt of it when bailouts resulted in cuts to public services and social benefits.
This meant that those who were already struggling financially were hit particularly hard, while the wealthy remained largely protected.
There are alternatives to austerity as a means of restoring economic stability and this book encourages more people to educate themselves on what happened ten years ago to ensure this has not been forgotten and a different result in times of crisis.
