What's with the 3% deficit ?

I never understood the rational behind the limit of 3% of deficit. As a matter of fact I didn't understand also the limit of 60% of debt.

Don't get me wrong, I'm not in favor of allowing deficits greater than 3%.

I'm in favor of prohibiting deficits. Period. Anything that is below 0% shouldn't be allowed.

For years the Euro Socialists (and others) were arguing that a country can't be managed like a household. Yeah, right! Results are there for everyone to see.

A country should be run just like a household.

And because, generally speaking, people seem unfit to run well their households, they cannot run well their countries.

In credit card terms, the deficit is the difference between what you spent that month and the credit you made to pay the credit card.

Likewise, the total debt is your current negative credit card balance.

Part I - The Deficit (as in income statement)

A deficit means you are spending more than you are earning. It is in corporate language, the net income. In case of a deficit is actually the net loss. Thus, it is the bottom line of an income statement.

I don't know any company that has recurrent, year after year, negatives net incomes, ie, deficits. Why not? Because those companies go bankrupt and cease to exist. Kaput!

The companies that have negative net incomes they will probably run out of cash. When they do, they must borrow, ie, start owing money to someone. Thus, they start paying interests.

Likewise, a country that has run out of internal funds, and have a 3% deficit (ie, 3% GDP of negative net income), that country would have to borrow at least 3% of GDP.

Now is where the economists enter the room and say I'm foolish, because if that country has an economy that grows, than it could sustain that deficit. I disagree, since that is true only provided some ranges of total debt and grow must be observed. I could prove otherwise but that discussion will be for another post. Irrelevant, though! Europe is not growing structurally if you remove the consumption based on acquired debt.

So now you understand that currently (since any country in Europe as a sizable amount of debt), any percentage point in deficit will require an equal percentage point increase in the debt. It is a vicious circle.

Thus, deficits should be prohibited. Period! Countries ought to be forced to build surplus. But that is not people's money? Yes, it is, and should be used wisely, in times of possible depression, to increase public investment. Wisely means spending a little bit of it, not all of it in year of elections to gain votes.  (However voters tend to be not so wise in the year of elections and vote for the guys that give them money that year even if those guys drive the country to ruin).

Part II - The Debt (as in balance sheet)

The debt is nothing more than the accumulated deficits during a period of time. Note that included in the deficit of the current year are included the interest we have to pay regarding the current outstanding debt.

People dealing with negative credit cards balance know this reality too well.

They know that even if you don't spend nothing during one month, you still have to pay interests regarding the current negative credit card balance. As the debt grows bigger and bigger, even your credit aren't enough to pay the interests alone. That's the time to call your parents and ask to move in because you lost your home.

That's why the Maastricht Treaty stipulated a 60% to GDP limit of total debt. To keep the debt under limits, so that countries could at least still pay their interests. 

Part III - The Irrational Stuff

As it should be clearer, as debt increases, the interest paid increase also. Thus, the deficit component that regards the interest increases. When the interest paid reaches 3%, that means the State cannot have any deficit regarding its current operations. In corporation terms, it means that the EBIT (earning before interest and taxes) must be zero or positive.

As you reach the 60% of the Maastricht Treaty, the deficit must be zero. Otherwise you must borrow, but that leads to increase the debt, and overtake the 60% limit. 

Ohhh nooo! Because the economy is growing so fast that it can actually accommodate that deficit. Yeah right! And I'm Santa Claus! Oh, wait, I'm not Santa Claus! Yeah, right, neither an European economy ever grew fast enough to absorb those 3%.

You see the irrational stuff. Even a kid in 6th grade can do the math.

Part IV - Even more Irrational Stuff

But wait, politicians didn't stop here. At some point in time they decide that Keynes is always right, so they kind of abolished the 60% debt rule.

As if... it was possible to unlink the 60% debt rule with the 3% deficit limit. The 3% deficit rule (already a stupid one, because it should be a 0% rule) now is not linked to anything. Thus, politicians continue to argue that is possible to have public finances stabilized with this rule.

Tick (60% debt), tack (63%), tick (67%), tack (81%), tick (86%), tack (92%), tick (100%), KABUM!

Portugal, Spain, Italy, Cyprus, Greece are already or near the final countdown. France and others are working hard to get there too. And they will succeed !

Part V - A Death Wish

A lot of European debt was spent in three major ways:

1) Building a lot of stuff: roads, bridges, more roads, more hospitals, more airports. Those in favor say we needed those things. My personal view is that we could live well waiting a little bit longer for those infra-structures and not borrowing money for building them. As it seems with too many TGV, HighWays and empty Theme Parks, we would be better off without some of them.

Europeans have 5,000 years history, we could have delayed 10 or 15 years some stuff and not destroy the next 30 years for our children.

2) Spending too much in health care, public schools, social care and so on. The unemployment subsidies only favored situations like Ni-Ni (ni estudia, ni trabaja). It isn't by any means a monopoly of Spain this phenomenon. But I think the "Ni-Ni" is the best I have seen in acronym land.

3) To give employment. The rational is that if the private sector don't create jobs, that the state will create them. Guys! Hello! If the private sector is at danger, don't create public jobs! Maybe, spend a little bit of money, following Keynes suggestion, and award the private sector some contracts.

Please note that the public sector is like a back-office of a company. It is the least of the two evils. Either you spend some money, or your company collapses due to the lack of support processes. But I never, never saw a back-office in a company to be a revenue center, it is always a cost center. And, as all costs, should be kept to a minimum.

So, as European governments did all three things at the same time, with very or few restrictions, I can only assume they had a dead wish. Well they succeeded.

Greece - done;

Ireland - done;

Portugal - done;

Spain - errr, the bailout that it isn't a bailout, but that looks like a bailout, but it is not assumed as bailout... you see what I mean.

Cyprus - oh, yeah, tomorrow we will see the next episode of the soap opera.

Italy - tick, tack, the bomb is still tick tacking, a good sign .... until it explodes.

You get the picture. Now a final quiz:

How many countries in the Euro zone have their debt below 60%?