For the first time in about 40 years, the UK has gone into a double dip recession. London’s Office for National Statistics reported a 0.2 percent contraction in GDP in Q1 of 2012. That drop, following a 0.3 percent fall in Q4, represents two consecutive months of economic contraction, meeting the technical definition of an economic recession.
The UK’s Chancellor of the Exchequer, George Osborne, said, “It’s a very tough economic situation. It’s taking longer than anyone hoped to recover from the biggest debt crisis of our lifetime… over many years this country built up massive debts, which we are having to pay off.”
That sums of the UK’s economic and fiscal conundrum, and that of other advanced economies. The austerity measures required to trim back government deficits represent a fiscal drag on the economy. That in turn retards economic growth and reduces government revenues, countering the intended goal of the austerity measures. On the other hand, maintaining high deficit spending is unsustainable. The politicians have created problem that defies solution.
The financial pundits and Eurozone boosters are gloating, with fingers crossed behind their backs. The recent auction of Spanish sovereign bonds by Madrid reached its target sale in excess of two and a half billion euros. But what the cheerleaders ignore is that the bonds sold for only two reasons; a substantial increase in the yield on the 10-year bonds from 5.4 percent to 5.74 percent. The increase of 34 basis points was also helped by the perception that the European bailout fund stands ready to assist Spain and her creditors.
Despite all the recent happy talk about the global economy allegedly “turning the corner” and the Eurozone sovereign debt crisis being ameliorated, the signs are all there for those with open eyes. The crisis remains, and despite the policy of kicking the can down the road, all the indicators point to deterioration rather than amelioration.
The director of the International Monetary Fund, Christine Lagarde, sounds very worried, while engaging in contradictory messaging in her speech before the Brookings Institution. On the one hand, she mimics what Fed Chairman Ben Bernanke did two years ago with his talk of “green shoots.” Lagarde speaks of the U.S. economy showing glimmers of positive data, while acknowledging, in her own words, that, “Only a few months ago, we seemed to be staring into the abyss.” She urges the advanced economies to take advantage of the glimmer of “good news” to invest in growth and more bailouts for the financial sector, while also warning about the sovereign debt crisis afflicting the Eurozone.
“Clearly, the risk that looms largest is that sovereign and financial stresses return with renewed force in Europe,” Christine Lagarde told the Brookings Institution. But what solutions does the IMF have to offer? Borrow more to recapitalize banks that made the wrong bet on risky loans while simultaneously boosting government deficit spending to “stimulate growth?” Or, cutting back on government spending, thus creating a fiscal drag that leads to negative growth without reducing deficits? The IMF and its leader, just like the politicians of the advanced economies, have run out of solutions, other than meaningless cliches.
The yield on Spanish government 10-year bonds has risen another 13 basis points, now standing at just over 5.8 percent. This is in line with the deteriorating economic and fiscal situation in Spain. Madrid has recently enacted draconian government spending cuts. However, the conundrum is this; previous government spending was unsustainable, but the most recent cuts are a massive fiscal drag, which will also exacerbate the government deficit in its annual spending. Investors know this, which is why Spanish bond yields are rising.
With the highest official unemployment rate in the Eurozone (23 percent)and the economy continuing to contract, there is increasing concern that the center of gravity in the Eurozone sovereign debt crisis has migrated from Greece to Spain. In the meantime, the European Central Bank continues its policy of stealthily monetizing debt throughout the Eurozone through its printing press.