Eurozone’s economic crisis tests EU leaders political unity
Over the summer the economic recovery of the major western industrial states stuttered then flatlined. The main reason is that the positive effect of the massive monetary and fiscal injections by several governments in 2009-10 to stave off a global depression has waned. To make matters worse the even more powerful negative effect of the deficit-reducing cuts in public spending has kicked in.
As this became clear over the summer the global stock markets fell sharply, in some cases wiping out all the gains they had made over the last year or more. The feverish rise in the price of shares in late 2010 and early 2011 was based on the huge injections of electronic money into the financial markets by the world’s central banks (quantitative easing).
This resulted not in any great uplift in lending to firms for investment or to households for spending, but rather simply put a lot of cash into the hands of banks and hedge funds which they used to speculate on the stock market, hence bidding up share prices.
For six months or so “the markets” convinced themselves that the propaganda of the OECD, IMF and G7 governments was correct; namely, that as public deficits were pared back, the private sector’s inherent dynamism would generate more than enough investment and jobs to kick-start a lasting, strong economic upturn. Early in 2011 strong GDP growth figures for Germany gave the markets hope, but this mild euphoria collapsed in early summer as grim economic data piled up.
In spite of profits standing at record levels (a function of falling real wages, job shedding and a rise in productivity), sovereign debt, budget deficits, the after effects of the Japanese tsunami and ongoing uncertainty around the future of the Euro, all combined to push the west back towards stagnation if not recession.1
The US grew just 1.3% (annualised) in the second quarter of 2011, a rise from 0.4% in the first quarter, but still too weak to seriously dent unemployment, which remained above 9%. The Eurozone slowed to just 0.8% down from 3.2% in the first part of the year, while Japan, suffering from the tsunami and its aftermath, fell -1.3% in the second quarter, following a slump of -3.6% in the first.
When it became clear that government and independent agencies’ economic growth projections for the US and the EU in 2011-12 were grossly optimistic (and hence also the future profit projections underpinning the share price boom) it was only a matter of time before the latest stock market “correction” should occur.2
The fragility of the Eurozone and US capitalism is obvious as final demand has collapsed sharply. Working and middle class consumption is being hit. Wages as a proportion of national income have fallen in the US to 62%, down from a post-war peak of 69% in 1980. At the same time, US households have been using much of this declining income to save hard, as families have tried to pay down debts and banks have written-off the value of bad loans.
Meanwhile, faced with the uncertainty of the recovery, firms have used their cash-rich balance sheets to depreciate existing investments (i.e. write down their value) rather than increase their fixed capital stock; hence, investment is at historically low levels. Non-residential fixed investment has fallen from $357bn in 2008 to $155.2bn in 2010, its lowest level in 30 years. This largely explains the on-going stagnation of the US economy.
Capitalists prefer to squeeze every dollar they can from investments made in the run up to the credit crunch, while simultaneously writing their value down to guard against the possibility of future crises.
In short, the US and Eurozone (and UK) are in the grip of stagnation whose ultimate cause is the mountain of debt (sovereign and private) that was inherited from the long boom of the 1990s and 2000s, when re-cycled savings and profits from the rapidly expanding Asian economies were used to finance cheap credit to US consumers (necessary, as real wages stagnated), and underpin speculative expansion of property markets in the US and parts of Europe.
Much of this lending was undertaken by the large banks, and the value of the assets bought with the loans boosted bank profits and market valuation. When the expansion of this credit/debt cycle collapsed in 2007-08 so too did the value of the assets and the worth of the banks. At the same time many banks held sovereign debt in the form of government bonds, which governments issued to pay for public spending projects.
As economies shrank in 2009-10 much of this debt too became unsustainable, demanding an ever-higher proportion of national income to service the interest payments on the bank loans.
The banks, faced with this huge deterioration in their balance sheets, still struggling in the aftermath of the credit crunch and suffering an ongoing crises of confidence around the Euro, continue to shore up their capital base, increasing the ratio of assets to loans. This limits the availability of credit to working and middle class consumers, further hitting consumption.
Both private sector banks and governments in Europe are in the throes of “de-leveraging”, that is, writing off and paying down the debts they have accumulated in the last two decades. Various proposals from regulatory authorities and governments, which are likely to be passed into law in the coming years, are set to deepen this process in the short to medium term as they seek to increase the amount of capital banks must hold and limit credit expansion.
This process of de-leveraging is in essence a process of destruction of defunct useless, excess capital that cannot earn a profit and must be destroyed and purged from the system. It means the writing off of large parts of the existing sale value of millions of homes that have been built but never lived in. It means the sacking if hundreds of thousands of public sector workers whose jobs depended on stable or growing government revenues, which are now being slashed. It means the loss of similar numbers of private sector jobs that depended on the spending of incomes of those public sector workers.
The purpose of such a crisis of capitalism is to restore profitability and hence the conditions for a future upturn in investment. A crisis devalues capital and squeezes the working class by increasing productivity and cutting wages and in so doing it restores the mass and rate of profit.
This is what is happening now. At the top of the last boom in mid-2006 US corporate profits peaked at $1,655bn, they fell back to $971bn at the end of 2008, but by the second quarter of 2011 had risen to $1,885bn, a new record. The current production rate of profit, the proportion of profits in current production not including the fixed capital stock3, rose from 22% in 2009 to 34% in 2011, in the sharpest recovery in corporate profitability since 1929 and probably therefore, in the history of capitalism.
But this process of profitability recovery is a contradictory one, since the very pre-condition for it – deleveraging, jobs cull, wage stagnation – is at the same time intensifying the problem that gave rise to the crisis of profitability in the first place, namely the burden of debt.
The politics and economics of austerity, of deficit reduction, are causing growth to stagnate at best and, in cases like central Europe and Ireland in 2009-10, and in Greece today, to collapse completely. This makes the debt burden (ratio of debt to GDP) worsen even as the nominal amount of debt is reduced. In turn the financial markets raise the interest levels on loans to these stricken countries to such levels that they are effectively frozen out of the market for such loans, raising the spectre of sovereign debt default.
Eurozone: heart of the crisis
The crisis convulsing the Eurozone economies is at root an objective economic one:4 the uneven competitiveness of member states has been masked since monetary union by low interest rates for loans to the peripheral southern European countries (and Ireland). The credit crunch all at once stripped away the mask revealing Ireland and Greece above all to be burdened with huge and unpayable sovereign debts, threatening in turn the solvency of banks that hold that debt.
But as important as this economic root is, the key factor in explaining the depth and duration of the present crisis is the crisis of political leadership within the EU and the inadequate nature of the EU institutions tasked with providing a solution.
What is needed to restore European capitalism’s stability and calm the financial markets is an orderly default of the sovereign debt burden by Greece. But this is being prevented by the competing political pressures on German and French governments, on the European Central Bank and by the massive, semi-insurrectionary resistance on the streets to debt-reduction measures in Greece. This forestalls economic recovery on a capitalist basis and hence is making the debt crisis even worse and, possibly, not containable within the framework of continued monetary union.
In May 2010 when the European sovereign debt crisis first threatened the Euro, a $900bn European bailout fund was arranged by the ECB, IMF and the US. Within months this was seen as inadequate by the financial markets, insufficiently large to cover all potential liabilities of the European banks.
But anything larger and more comprehensive was ruled out by the EU’s leading economy and political leader, Germany, as its government would suffer a huge blow to its electoral fortunes if it was seen to be writing a blank cheque to the Greek population using German taxpayers money.
For a year the Greek government was caught between the hammer and the anvil; between a mass revolt by its people who refused to accept savage spending and welfare cuts and tax rises lying down, and IMF/ECB officials refusing to release aid unless major austerity was imposed not just announced. The result? The austerity was draconian enough to collapse the Greek economy (a 7.5% fall in GDP is likely in 2011) but the aid was not big enough to ease Greek’s financial plight or restore the economic conditions for recovery.
The second Greek bail-out in July this year was an attempt to go further. Until this summer the Eurozone capitalists have insisted that the Greek people alone foot the bill for the state’s massive and often illegal borrowing over the last decade.
But faced with repeated general strikes, violent protests and the prospect of a Greek revolt of insurrectionary proportions, the latest deal indicated a slight shift in priorities.
While insisting that more austerity is the pre-requisite for any further funds, a far-reaching privatisation programme requiring the fire sale of most Greek state assets is part of the deal. In addition, this time the Europeans forced private sector bankers to pay at least some of the bill. A “voluntary5” haircut from private sector banks worth around 21% of their debt was agreed. The European Central Bank (ECB) reduced debt interest payments on its own debt from 5% to 3.5%, an effective write down of around a further 20%, and extended the length of repayment by up to 30 years.6
The Euro authorities will provide a further €109bn of AAA-rated funds alongside a pro-growth fund from the European Commission of around €15bn. Euro governments will provide up to €20bn of new capital for the Greek banks and up to €35bn of guarantees for Greek government debt pledged to the ECB as collateral. In addition the rescue mechanisms can now provide funding for bank recapitalisations and can, under certain conditions, buy bonds in the secondary market.
But the markets, i.e. the capitalist financial speculators, did not buy it. “Too little, too late” was their response. The deterioration led inexorably over the summer to the worsening of the economic situation of the European banks that hold Greek sovereign debt, especially French banks, adding to and deepening the run on European stock markets in August-September.
An orderly, rational solution on a capitalist basis would require four things: first, the construction of a huge – limitless even – EU fund, backed above all by Germany, giving a cast iron commitment to the financial markets to act as lender of last resort to all sovereign debt in southern Europe at least. Secondly, greatly enlarged powers for the ECB to issue and buy bonds of member states in unlimited quantities in conditions whereby private banks have shunned them.
Third, a willingness of the ECB and private sector banks to write-off a considerable portion of the bad sovereign debts on their books and simultaneously a willingness of the Eurozone country banks to recapitalise the stricken banks with “good” capital.
Fourthly, a political-constitutional reform of the EU treaties to extend federalism and specifically the powers of the Brussels EU institutions to impose/supervise tax and spending limits on member states.
As the crisis has deepened and lengthened, Germany and France’s leaders have urged steps to a greater fiscal union, recognising the status quo is not an option and that either there must be greater union or a partial or full break-up of the Euro.7
Euro fights for survival
As the Eurozone crisis has deepened more and more credence has been given to the doomsday scenario: the break up of the Eurozone. The argument runs that the burden of membership on the highly indebted countries is so great due to theausterity measures needed to cut the fiscal deficit that it is better to quit and regain competitiveness by restoring an independent currency.
On the reverse side it is argued that it would be in the interests of Germany (and a few closely tied members) to be free of the Euro as the cost to it in terms of transfer payments to weaker members to keep the currency afloat is too great.
But both scenarios massively underestimate the political difficulties and the devastating economic consequences of leaving the Euro. In the first place there are no mechanisms in any treaty for leaving the Euro, nor for expelling a member state from the single currency union. Of course, a member state may quit unilaterally but every serious study of the effects underline how catastrophic this would be in the short term if undertaken within the confines of the capitalist system.
A recent study suggests the costs of a Greek default would likely exceed 50% of Greek GDP. This is because its debts, denominated in the new currency, would multiply massively and if it defaulted on them it would be frozen out of capital markets and unable to access any official aid. Being uncompetitive in most internationally-traded goods and not resource rich, the Greek economy would implode.
In short, it would be an economic catastrophe with severe social and political consequences. As USB said recently: “It is also worth observing that almost no modern fiat currency monetary unions have broken up without some form of authoritarian or military government, or civil war”8.
Of course, this does not make it impossible; the internal domestic balance of class forces in Greece, between an insurgent, nationalistic population desperate for relief from the pounding it is getting, and a weak, divided political leadership class, could led to steps that are not “rational” from a capitalist point of view.
The consequences for Germany too would be huge. It sponsored the creation of the single currency as a way of enlarging the penetration of its multinationals in Europe; a break-up or major shrinkage of this market would be a blow, as the Eurozone still accounts for nearly 70% of German trade. But at the same time many German multinationals are firmly oriented to the new non-European markets; BMW and Porsche both announced record profits on the back of exports to China. If the German mark replaced the Euro the new currency would appreciate massively and its exports (Germany is the world leading exporter) would take a hammering.
For all these reasons, the pressure on the Eurozone political leaders to solve the crisis through a combination of debt restructuring, more fiscal federalism and greater financial support is immense. Should the national pressures on them inhibit or prevent them from taking those measures then the European project will be dead, European imperialism’s role in the world retarded and the repercussions on the global economy will be far-reaching.
For the moment the markets do not anticipate a break-up of the Euro. If they did we would be seeing real signs of pension funds, hedge funds, banks and foreign exchange managers selling off Euro-denominated assets in anticipation of such move – but as yet there is not sign of this. At present they betting that the Euro is too big to fail.
When the credit crunch erupted in 2008 with the collapse of Lehman Brothers there was near-universal consensus among capitalist politicians and business leaders across the globe that governments and central banks had to step in with emergency financial support (and even nationalisation) for stricken banks to prevents a complete freezing of the money markets and with it international credit and trade.
The measures taken prevented a global depression in 2009 but not recession in important regions of the world, especially Europe and the US. The sums mobilised were enormous and this led to a considerable extension of public debt, either as a result of hand-outs to banks or increased welfare payments to the newly unemployed.
By 2011 the new consensus was that the public debt was “unsustainable” and austerity was needed to cut back the national debt to GDP ratio, otherwise the financial markets – which had caused the credit crunch in the first place and had been rescued from their mistakes by the taxpayer – would penalise these “profligate” governments by demanding high interest on government bonds.
A minority of commentators and opposition politicians, influenced by Keynesian demand-led economics, argued that while the debt/GDP ratio should be reduced, it was not so high (by historical comparison or by ability to sustain payments) that
it needed to be reduced so fast and as savagely as was being proposed. They argued that such measures would ensure only a slow recovery, if not a return to recession.
They were a voice in the wilderness, or were until the recovery faltered and the debt burden in southern Europe grew. Now even the OECD, a year ago a passionate advocate for austerity, admits that “stronger fiscal consolidation may have been exerting more drag on activity than anticipated”.
Critics of prevailing policies, such as Martin Wolf of the Financial Times, insist that governments can borrow at ultra-cheap rates at present and should do so to invest in infrastructure projects, to finance the investment needs of small and medium businesses (because banks will not); others like Martin Jenkins advocate “throwing money from helicopters”, that is, putting cash in the hands of consumers to kick start consumer spending and demand for goods and services.
In the US the Obama administration has launched a $450bn jobs bill9, which if implemented is large enough to provide a significant short term boost to the economy. It includes a $175bn payroll tax cut, $35bn for public services, $50bn for infrastructure and $49bn for unemployment benefits. Whether it will get through a Republican Congress is doubtful.
All these pro-capitalist critics are understandably afraid that without such adjustments to government deficit-reduction programmes the US and Europe face a decade-long period of stagnation or worse, just as Japan did in the 1990s after its property market bubble exploded.
The problem is that for the last three decades the anti-Keynesian ideology of neo-liberalism (privatisation, de-regulation, less state) has been so triumphant both in centre right and social democratic parties, as well as the offices of the OECD and IMF, that there is no political appetite for a change of course.
Naturally, the revolutionary solution is not even entertained on the airwaves never mind the corridors of power. The chronic financial instability in the Eurozone, the persistent holding-to-ransom of countries by money markets – none of this can be eradicated while the levers of credit and money are in the hands of private investors. Without the nationalisation of the financial markets – the pension funds, hedge funds, private equity companies and foreign exchange dealers – it will be impossible to remove short-selling, speculation, “irrational exuberance”, bubbles and busts, with all their destructive effects on millions of people’s lives.
Decisions on investment cannot be left to the profit-maximisers, those whose only god is “shareholder value”. Destroying this driving motive in economic and the political institutions of capitalism has to be the goal of all revolutionary socialists.
What happens next?
“The outlook for the rest of the world’s developed industrial nations is very bleak.” Such is the OECD’s assessment of the global economic outlook published in September. It said that growth in the G7 economies (with the exception of Japan) is likely to be less than 1% on an annualised basis, in the second half of this year. It could be much worse if the crisis in the Eurozone enters a new and more dangerous phase.
The ongoing divergence between the continuing, often strong, growth in the emerging markets and the relative stagnation of the western world continues to form the backdrop to the crisis. As the west slowed in mid-year, China and the emerging markets continued to grow, such that world growth as a whole remained above 4% annualised, while profits soared worldwide. Whether the present slow down will morph into a full-blown world recession remains to be seen.10
Much depends on politics. Obama’s $450bn jobs bill11 is large enough to provide a significant short term boost to the economy. It is designed to favour Republican tax cuts, but it will undoubtedly run into opposition in Congress and although it is likely something will be passed, its eventual form remains is unclear.
In the second half of 2011 Japan will begin to recover having overcome the effects of the Tsunami and nuclear energy crisis. China will continue to expand, even if at a marginally slower rate as is suggested by some -business surveys, and in the west sections of manufacturing, notably cars, previously hit by the Tsunami will resume growth.
But the ongoing uncertainty about the Eurozone crisis is a persistent sore – even if it is moving towards a resolution. The possibility of an economic/political debacle à la Lehmans bankruptcy, will remain until fiscal union is consummated.
An unstable equilibrium prevails in the world economy: relative stagnation in the US and Europe and strong growth in Asia, India and much of Latin America. Much will depend on whether the economic conditions in the west drag down the prevailing growth in the emerging markets by choking off their export markets; or whether the latter countries can “rescue” the old industrial and financial powers by providing the finance and markets they need to stay afloat while working their way through debt deleveraging.