Can you hear that great sucking sound? It’s the sound of government shrinking around the world, as Portugal just joined Greece, Ireland and soon many others in acknowledging they are bankrupt and asking their European brethren for a bail-out. What is frightening to the big government advocates is this collapse was caused by a doubling of Portugal’s borrowing costs in just three weeks. The klaxon horns are going off in Europe and America; cut deficit spending or be destroyed by rising interest rates.
Over the last two decades, governments in Europe and the United States have been massively using taxpayer subsidies to sponsor favoured industries, under the smoke screen of National Industrial Policy. The theory, developed by Harvard economist and former Secretary of Labor in the Clinton Administration, Robert Reich, stated that governments must “deliberately and strategically” speed the movement of capital and labor into “higher-valued production” or suffer social decline; with infant mortality rates rising and employment and life expectancy falling. Reich championed National Industrial Policy planners would more efficiently allocate capital and labor resources to satisfy consumer demand than large corporations who inefficiently use marketing to bend customer demand to their needs. He claimed it was the duty of government to induce through direct subsidies and worker retraining grants uncompetitive companies to scrap production and steer investment in industries of the future.
Europe adopted National Industrial Policy through the introduction of the Euro currency and banking deregulation. Southern European countries like Portugal, Italy, Greece and Spain got low-interest German and French bank loans to scrap supposedly uncompetitive local manufacturing and “cushion” the transition of workers into leisure services and retirement housing development. Germany and France got elimination of competition and export growth to Southern Europe. Europeans were ecstatic for 15 years; the South had a real estate and banking boom, the North had a manufacturing and banking boom.
The U.S. adopted a National Industrial Policy during the Clinton Administration in 1999 by tying bank deregulation to a colossal expansion of the Community Reinvestment Act. The big banks got unlimited ability for multi-state banking and abolition of the 1933 Glass-Steagall Act prohibitions against banks engaging in high risk securities and derivative trading for their own accounts. Planners got huge quota requirements for loans to inter-city and rural communities. President Clinton hailed that the signing of the Gramm-Leach-Bliley Act “establishes the principles that, as we expand the powers of banks, we will expand the reach of the [Community Reinvestment] Act”.
Fed Chairman Ben Bernanke would later blame this legislation for a surge in bank mergers and an explosion of sub-prime lending. Now that real estate has crashed, Europe and America are suffering the dark side of National Industrial Policy.
The initial bail-out costs for Greece, Ireland and Portugal, which make up only 5% of $15 trillion European Union GDP, are $338 billion. The Portuguese default now threatens defaults by Spain and Italy, which are also heavily indebted and have economies 450% larger than Greece, Ireland and Portugal combined! Metastasizing Europe’s problems is a banking system that is also leverage at 11.1 times versus the international standard of 4 times. The reason Germany and France are providing bail-outs to these PIIGS (Portugal, Italy, Ireland, Spain & Greece), is their banks are the prime holder of PIIG debt. The European Central Bank, headquartered in Germany has been lending to banks at “zero interest rates” to keep real estate prices from taking another plunge, but Portugal’s demise will multiple increases in rates over the two years.
The United States got into National Industrial Policy ten years after the Europeans. After an epic bank bail-out and a doubling of the national debt on dubious stimulus spending, Americans are now serious about cutting deficit spending. Senator Chris Dodd, the architect of expanding the Community Reinvestment Act and the elimination of Glass-Steagall, retired rather than face certain defeat in last year’s Congressional wipe-out of big spenders. Major U.S. banks have restructured to eliminate low-quality loans and curtail risky trading practices. For the first time in history, Congress is aggressively debating curbs on entitlement spending and irresponsible politicians in California, Illinois, and other municipalities who maximized spending and public employee are ion notice U.S. taxpayers will not provide new bail-outs.
Who would have thought a quaint little country like Portugal could rattle international finance to its knees. Portuguese planners were obedient followers of the Southern European plan. Tourists and retirees flocked to their sun-drenched beaches and historic villages along the Atlantic coast. But Europe has reached its financial tipping point; interest rates are rising and deficit spending is about to get slashed. As the crisis builds across the continent, expect big tax increases and widespread layoffs to fill the streets with violent right-wing and left-wing protestors. National Industrial Policy planners claimed they would be more efficient masters of market forces. Their legacy will be unleashing of brutal market forces that will strangle nations trying to unwind staggering debt burdens.