Speaking in Rome on September 15, Lorenzo Bini Smaghi, Italian executive board member of the European Central Bank (ECB), said of the design of the euro: “The assumption was made ― largely theoretical ― that there would be no crises.”
Oh, indeed. And now with Europe and the world showing every sign of dipping into a recession that will further stress Euope's common currency, what is to be done?
In immediate terms, the crisis of the euro is driven by the risk that “peripheral” European economies, starting with Greece, will default on their public debt repayments. The fear is that this will send French and German banks chock-a-block with that debt to the wall, or at least drive them into a growth-killing credit crunch to survive.
After last week’s escalation of gloomy news, this precipice looms much clearer.
* Key indicators reveal a turning point in world production and trade. The Chinese purchasing managers index showed manufacturing shrinking for a third month in succession. The World Trade Organisation revealed that goods trade in the second quarter of 2011 was 0.5% less than in the first (the first fall since mid-2009).
* On September 22, world stock markets crashed by about 4% and are now down 20% since beginning of year. A September 23 statement by Group of 20 (G20) treasurers and central bankers committing “to a strong and coordinated international response to address the renewed challenges facing the global economy” failed to spark recovery.
* The International Monetary Fund’s (IMF) Global Financial Stability Report revealed that “nearly half of the 6.5 trillion euro stock of government debt issued by euro area governments [about 5% of annual world production] is showing signs of heightened credit risk”. The 10 biggest US money market funds have taken fright, reducing their short-term lending to European banks to the lowest level since late 2006.
* The IMF’s World Economic Outlook estimated that a full-blown credit crunch arising from the default of the most indebted European economies would knock 3.5 percentage points off growth in the euro area and 2.2 percentage points in the US. That sort of downturn in a country like Spain would add an extra 2 to 3 million to its 5 million unemployed.
Europe is the epicentre of this latest phase in the global crisis. Yet, even with the vicious feedback loop between slowing growth, rising sovereign debt and looming bank insolvency in clear view, economists, politicians and governments are locked in wrangles over which crisis symptom to tackle first and with what medicine.
Their disputes about the right mix between monetary (interest rate) and fiscal (budget) policy has been hugely complicated by the issue of whether Greece should be allowed to default and leave the euro.
Would that provide relief for the rest of the euro area or just intensify the crisis?
That’s the increasingly nasty sort of lesser evil choice being faced. Despite the September 23 joint statement by G20 finance ministers, the differences on how to treat the crisis remain sharp.
And lesser evil for whom? When German federal president Christian Wolff insisted in August that euro economies and institutions like the European Central Bank have to “stick to the rules”, was he thinking about the economic destiny of Greece and its people or the interests of German bankers and exporters?
As in all capitalist crises, the looming slump has three intertwined aspects: it is a debt crisis, a crisis of the banking and finance system, and a crisis of investment.
However, this particular crisis was unleashed following an unprecedented build-up of debt. Because this debt has since been shoveled across to public budgets, the overriding concern has been to reduce it as quickly as possible. Hence the stress from late 2009 on winding back public budget deficits.
Yet the unfolding Greek disaster shows that the “tackle debt and deficit first” approach (applied by the “troika” of the European Central Bank, European Union and IMF) is not only socially sadistic (see article by Afrodity Giannakis), but plain counterproductive.
The reason lies in the aversion of all schools of mainstream economic policy to seriously addressing the root cause of the recession ― the collapse in fixed investment (which for Europe between the first quarter of 2008 and the second quarter of 2011 was more than the collapse in growth as a whole).
Even if debt were temporarily tamed and the financial system stabilised, without a recovery in investment the slump and unemployment will continue. In turn, this would unravel the effort to wind back debt and fix the finance sector.
However, important “players” in Europe are focused on a different enemy. The hard money school in control of the German Bundesbank fears that inflation could still re-emerge to undermine the euro ―especially given the vast increases in money supply that have been unleashed over the past three years.
For them, a strong euro is essential to controlling inflation and restraining wage claims, and maintaining European (especially German) competitiveness.
This school includes former ECB executive board member Juergen Stark, who recently resigned in protest at its purchases of Spanish and Italian debt.
Supporters are fighting to block measures that most in Europe (including German big business) regard as the absolute minimum needed for containing the present threat to the euro.
These measures are adoption by the Bundestag of expanded funding and powers for the European Financial Stability Facility (to run bail-out operations) and a European version of the US Troubled Assets Relief Program (to rescue banks and financial institutions).
Even where there is agreement on these measures ― as with Bundesbank president Jens Weidmann ― it goes with the demand either that the policing arm of the euro area, the Stability and Growth Pact, be applied in earnest or that member states’ budgets be controlled by a restructured EU.
As for the broadly supported proposal to create European debt instruments (eurobonds), for Weidmann these “in and of themselves would actually be rather counterproductive to solving the fundamental problem that led to the outbreak and spread of the sovereign debt crisis” ― fiscal indiscipline. (German neoliberal economist Hans-Werner Sinn describes eurobonds as “a little piece of socialism” that “doesn’t belong in our economic system”.)
This school of thought also likes to claim that if other European countries behaved like Germany, boosting efficiency and competitiveness and controlling wage growth, they could repeat Germany’s huge export successes.
This argument conveniently ignores some simple truths: not only that German trade surpluses within Europe have required other economies to run deficits, but if growth in the whole world is slowing, winning the export competition increasingly becomes a zero sum game.
This is especially so given that the last three years have seen a rise in the protectionism of tit-for-tat “currency wars”.
Also, within the euro area, with devaluation excluded by definition, the main way to increase export competitiveness would be by further driving down wages and welfare spending ― and cutting domestic consumption.
On Greece, for the hard money school, departure from the euro zone is not only thinkable, but probably necessary. The challenge is to organise as orderly an exit as possible.
Without mentioning the country by name, Dutch PM Mark Rutte and his finance minister Jan Kees de Jager put the issue like this: “Whoever wants to be part of the eurozone must adhere to the agreements and cannot systematically ignore the rules. In the future, the ultimate sanction can be to force countries to leave the euro.”
Economist Nouriel Roubini, well-known as one of the few who foresaw the 2008 meltdown, is also for Greece leaving the euro, but for its own good ― like a painful but necessary divorce that’s preferable to remaining in a loveless marriage.
Greece’s situation is similar to that of Argentina when it tried to peg the national currency to the US dollar in the 1990s ― doomed to stagnation and breakdown. Roubini says: “The only issue here is not whether Greece’s real Gross Domestic Product … will be lower by 30%, as that outcome is sealed either way; rather, the issue is whether that result should be achieved over five or 10 years via an ever-deepening recession and depression triggered by massive deflation; or whether it should be achieved overnight via exit from the euro.
“The latter option ― exit ― has the benefit that economic growth and employment growth will resume right away.”
Such “choices” from widely differing schools of economic thought starkly dramatise the poverty of mainstream economic policy in the face of the slump. All hope against the evidence that some combination of debt relief and easy monetary policy will get private investment going again.
Yet the problem is not one of lack of funds (profits in the US are above pre-crisis levels), but that individual capitalist firms have no reason to invest. Given huge excess capacity in industry and very weak consumer demand, why would they?
Only a massive boost to public investment can get growth and employment moving.
This is exactly what China did when faced with the 2008 crash ― its core stimulus package aimed at infrastructure and housing has seen 30% growth in the country in three years (while in the US and Europe GDP is yet to return to 2008 levels).
Neither Weidmann economics nor Roubini economics are a solution. A working class and pro-people response to the slump ― based on the ideas that the bankers should pay for their own crisis ― would:
1. Increase public expenditure on socially and environmentally useful production.
2. Bring the banking system under public control to fund this and to organise debt restructuring (as has been done successfully in Iceland ― against the advice and desire of the EU).
3. Restructure the tax system, so that big capital and the rich pay their share.
4. Reduce the working week with no loss of pay.
What should be policy about leaving the euro (which could become a question of practical politics quite quickly)? That will be subject of final article in this series.
[This is the second part of a three part series. Read the first part here. Dick Nichols works in the European bureau of Green Left Weekly. For information on sources and statistics in this article contacteurodesk@greenleft.org.au .]