Austerity measures failing as expected

In my earlier blog, why government austerity measures are a bad idea , I had mentioned how Austerity is a bad idea because it puts a spanner in the economic growth. Austerity alone does not deliver the rewards it is meant to and the threats of stunted economic growth and recession remain high in the Euro zone even today. Case in point is Portugal, a country that had taken the austerity route and followed all the rules but was still struggling with its debt problems.

There is a risk of that; look at Portugal, it has done all the right things, it has stuck to austerity, it has stuck to the programs set by the EU and others and yet Portugal's bond yields are incredibly high today.

The expectation from austerity was that markets reward countries for delivering austerity in the form of much lower borrowing costs and that hasn't happened. Despite the austerity drive, the euro zone was still plagued by talk of default and speculation that it might break up. These things effectively mean that austerity does not deliver the rewards it is supposed to deliver. The consequence is that you are left with countries that have zero growth, possibly recession and interest rates which are painfully high and that combination is unsustainable.

The failure of austerity put fiscal transfer back to the top of the agenda. Germany has been vehemently opposed to direct fiscal transfers from the better performing northern euro zone to the struggling southern countries. If they can't get the rewards from the markets, presumably there would have to be some kind of fiscal transfer mechanism to allow their yields to come back down. This brings the whole issue of what the ECB does, what happens with a fiscal union. It has to help these countries, not just deliver austerity.

Iran-West tension again setting stage for Oil to boil

Oil prices could spiral out of control and potentially herald deeper economic hardship for Europe if the European Union joins the US in banning Iranian oil imports. EU officials said that the European governments agreed in principle to ban imports of Iranian oil. China also suggested it would back US-led sanctions. But several countries within the EU are heavily reliant on oil imports from Iran, and none more so than economically struggling Greece, which currently imports 30% of its domestic oil from the country, according to the International Energy Agency (IEA).

Greece’s economy is already mired in deep recession and could feasibly collapse entirely if the sanctions were imposed. Were that to happen, the Greek economy could take its European neighbors down with it. But the likelihood would be that Greece would have to ignore the import ban and that the EU would have to allow it to in order to avert economic disaster.

Let’s assume the EU is stupid enough to go along with the US in imposing sanctions on Iran. That would only mean 250,000 barrels of heavy sour oil not coming into the EU. But the impact that would have on countries like Italy and Greece would be enormous, and the Greeks are not going to slit their own throats for the sake of an EU sanction when Iran is the only country willing to offer them oil on favorable terms. It would utterly destroy the Greek economy.

Saudi Arabia announced that it was ready to fill any gaps in the oil supply if needed, but market-watchers cast doubt on that possibility. Such a move by the Saudis would use up virtually all of that country’s spare capacity. The last time that happened, in 2008, oil prices climbed to almost $150 a barrel. Saudi Arabia’s continued ability to fill gaps in the oil supply in the future is questionable, considering, that its own domestic oil consumption could threaten its position as the world’s largest oil exporter and consequently pose a threat to the global economy.

Equally inflationary to oil prices—and dangerous for the global economy—is if military conflict breaks out between Iran and the West. Iran has threatened to close off the Strait of Hormuz following the announcement of US sanctions and given the already obvious tensions between the two countries fears over a military conflict have grown. Any such conflict in the Middle East between Iran and the US would have a catastrophic effect on oil prices.

What seems more likely however is an easing of tensions between Iran and the West before the end of the month, which would then feed into oil prices. My sense on the geopolitical situation is it’s saber-rattling on the part of Iran. If it were serious about closing the Hormuz Strait, I suspect it would do it first, rather than tell the world it was going to do it.

That view was reinforced when Iran’s foreign minister appeared to indicate at a joint press conference with the Turkish Foreign Minister that his country was willing to reopen negotiations over Iran’s nuclear program, suggesting the West had possibly won an international game of chicken. Of course, that may have been what the White House had intended to achieve all along. But whether it will have the ability to pull off such diplomatic tricks in the future is far from certain.