Europe: Euro tremors

Greece shakes the eurozone foundations

The ‘reforms’ demanded by the EU powers, led by German capitalism, have been called appropriately a ‘tsunami of attacks’. Cuts on the scale now being proposed would savage social services and bring huge increases in taxes, beginning with VAT. Moreover, these misnamed ‘reforms’ are being put forward by a ‘socialist’ (PASOK) government of George Papandreou. However, the tsunami has already been met by ‘rivers of fury’, with a series of massive, nationwide strikes and protests.

“The bureaucrats in Brussels want … to see blood on the streets of Athens”, wrote one mass newspaper. “We are at war with the government”, commented a former left MP, “because it is clearly at war with us”. “Why should I as a worker pay for the errors in policies?” asked one teacher on a public-sector demonstration. “The worker can’t be the scapegoat. So we have to defend ourselves”.

Eurozone crisis

A few capitalist commentators, however, are warning that cuts on the scale now being proposed in Greece will cause an explosive social and political reaction, not just in Greece but throughout Europe. “If you tighten the way the markets seem to want, you will get a political response that is nonviable”, commented Joseph Stiglitz, an economist who advocates Keynesian policies. “These are democracies – not dictatorships”. (Cost of Debt Puts Strain on Europe’s Weakest Links, International Herald Tribune, 6 February)

The events in Greece, which will be echoed in Spain, Portugal, Ireland and elsewhere, mark a new period of social revolt and political struggles that will reverberate around Europe.

Greece is one of the weakest of the European capitalist states. Its accumulated national debt is almost Euro 300 billion, about 112% of GDP – and this is expected to rise to 130% by 2013, unless there are savage cuts in spending combined with tax increases. Moreover, the current debt may be even higher than it appears in the national accounts, due to the use of various complex financial instruments designed to hide the real level. The huge mountain of debt has been accumulated through the gross mismanagement of successive governments, and has certainly not benefitted the Greek working class. There is massive tax evasion, for instance, among the wealthy and even the prosperous middle class. Only workers, who have their tax deducted at source, actually pay official levels of tax. It is estimated that the government loses Euro 30-40 billion a year through tax evasion. Corruption is rife throughout the state bureaucracy.

Greece was hit hard by the global recession, with a 1.1% fall of GDP last year and an estimated 1% fall coming during 2010. The slump has resulted in mass unemployment, especially among the youth.

Greece’s national debt was accumulated over a period and was no secret. However, the debt crisis was provoked in December when the Fitch rating agency downgraded Greek bonds from A-minus to BBB. This pushed up the rate of interest the Greek government had to pay on its bonds to almost 7%, 3.8% above benchmark German government bonds. The ‘bonds market vigilantes’, the big global bond traders, began to raise the spectre of a default by the Greek government. This inevitably raised similar doubts on financial markets about other heavily indebted economies, particularly Spain, Portugal and Italy

The euro straitjacket

The eurozone economies have been severely hit by the global downturn. There was a fall from peak to trough of -5% (compared, for instance, with a 3.8% fall in the US economy). The latest figures for the fourth quarter of 2009 show negligible growth in the biggest economies, Germany and France, with continued negative growth in the peripheral countries: Portugal, Italy, Greece and Spain, unflatteringly known as the PIGS – or PIIGS if Ireland is included.

The eurozone downturn has been exacerbated by the common currency. The rise in the value of the euro during the downturn (mainly because of the decline of the US dollar), raised the export prices of euro economies when there was a sharp fall in world demand for exports. At the same time, the divergence between the eurozone economies is now threatening a deep crisis for the euro itself. Germany, the Netherlands and France, for instance, have been able to implement debt-finance stimulus packages. The debt-laden PIGS, however, do not have that luxury, as the ‘markets’ (ie banks and speculators) are not prepared to tolerate Keynesianism in the weaker economies.

At the same time, the euro yokes economies with large current account surpluses (for example, Germany, the Netherlands) with economies with big current account deficits (the current account is the trade balance plus current payments, such as repatriated profits). With separate currencies, the currencies of surplus countries would tend to appreciate while those of the deficit countries would decline, tending to correct the imbalances. This is not possible within the one-size-fits-all eurozone.

Portugal, Italy, Greece and Spain are all to varying degrees heavily laden with debt, whether in the public sector, the business sector, or household indebtedness. Greece is currently running a budget deficit of 12.7% and an accumulated national debt of Euro 112 billion. The boom time growth in Spain and Ireland, moreover, was heavily dependent on housing bubbles, which have now deflated. The peripheral economies took advantage of low eurozone interest rates and cheap credit to finance their debt-driven growth. Although every government issued its own bonds, the apparent ‘security’ of the euro enabled them to borrow money at lower interest rates than otherwise. As separate economies, governments of whatever complexion might have raised interest rates to try to curb the growth of bubbles. In the eurozone, however, the European Central Bank (ECB) set a common, low rate which particularly suited larger economies like Germany. The prevalence during the previous upswing of low interest rates and a high euro, which favoured surplus exporters like Germany, the Netherlands and France, encouraged profligate spending and borrowing in the weaker economies.

“The crisis in the eurozone’s periphery is not an accident: it is inherent in the system”. (Martin Wolf, Financial Times, 6 January)

Under the EU’s Economic and Monetary Union (EMU) and ‘stability pact’, current deficits are limited to 3% of GDP, with national debt limited to 60%. It was widely suspected when Greece entered the eurozone in 2001 that the government cooked the books to meet the ‘convergence criteria’. With the onset of crisis, however, the EU Commission, the ECB and, ultimately, the major eurozone powers (Germany and France) were forced to accept much higher levels of deficit and national debt not least because they exceeded the norms themselves.

This highlights the basic contradiction of the eurozone: the 16 countries are participating in a currency union, but without the basic elements of a political union. There is no centralised economic power capable of keeping the different national economies within the norms required by a stable euro currency. The EU Commission and ECB have periodically admonished national governments for breaching the rules, but have been effectively powerless to curb their expenditure. There are no eurozone institutions, for instance, with powers similar to the International Monetary Fund (IMF). If it is called in to support a floundering currency, the IMF has draconian powers of surveillance, and has imposed draconian conditions for loans. This is why Merkel, Brown and others now favour the intervention of the IMF in Greece. By turning to the IMF, however, the ECB and eurozone would signal their own weakness. In fact, such a move could further undermine the euro.

Now, however, faced with the prospect of a breakup of the eurozone, the key economies, particularly Germany, are demanding savage cuts from Greece and the other peripheral economies. This is the price they will try to exact for preventing a default by the Greek and other governments.

The major eurozone powers, especially Germany, are averse to specifying a rescue package for Greece. They have confined their support to vague promises of ‘solidarity’ in the hope that this will reassure financial markets. As the International Herald Tribune comments (6 February): “There is still a game of chicken among sovereign states, with Greece counting on help and other countries holding back until Athens pays a steep price for its profligacy and manipulation of statistics”.

“It’s highly unlikely Greece will be allowed to default”, economist Antonio Missoroli commented. “But no one wants to say that out loud to take the pressure off the Greek government. So it’s a fragile balancing act, how much pressure can you exercise on Greece and how much can it bear?” Another commentator, Simon Tilford, said that “the EU wants to humiliate the Greek political establishment and to see them taking difficult decisions”. (International Herald Tribune, 6 February)

This is a dangerous game. A Greek default, under pressure from financial markets, could trigger a domino effect throughout the eurozone. Yet even after the European summit on 10/11 February, the subsequent meeting of European finance ministers on 15 February demanded even bigger cuts. This was despite the Greek government’s promise to cut its deficit by four percentage points to 8.7% of GDP by the end of this year – in itself a savage and politically explosive reduction.

A way out for Greece?

Before joining the euro, Greece would have had the option of devaluing its currency (the drachma). A weaker currency would mean a cheapening of Greek exports on world markets, possibly boosting exports and reducing the trade deficit. British capitalism, for instance, gained a certain advantage from the fall of the pound in the recent period, which marginally cushioned the downturn (otherwise the slump would have been even worse).

At this stage, however, an exit from the euro would not provide an easy solution for Greek capitalism. A return to the drachma, which would inevitably be weaker than the euro or other major European currencies, would undoubtedly boost tourism to Greece. However, even if there was a cheapening of exports through devaluation, a significant growth of exports would depend on a broader European recovery, as most of Greece’s exports are to other European countries. Until now, Greek capitalism has not been export oriented: 70% of GDP is accounted for by consumer spending, highly dependent on debt. Two major industries, construction and shipping, are in crisis as a result of the collapse of the property bubble and the global downturn.

Greece would face other problems as well. In anticipation of a return to the drachma, wealthy Greeks would transfer their savings to euro accounts in other eurozone countries to avoid devaluation. This may already be happening to some extent. Moreover, Greece’s debts, primarily the government debt but also many mortgages, and business and private debts, would still be denominated in euros, and they would become more expensive to pay off with a devalued drachma.

Given the huge scale of Greece’s state debt, Greece would still require a bailout. Clearly, neither the ECB nor the major eurozone powers would be any longer responsible for taking action. Outside the eurozone, Greece would be forced to go to the IMF, which could try to impose even more savage conditions for loans to prevent a collapse of Greece’s state finances.

From an economic standpoint, draconian cuts, whether imposed by eurozone institutions or the IMF, will not resolve the crisis. Leaving aside the social and political consequences for a moment, savage cuts will undermine any possibility of recovery of the Greek economy. Cuts on the scale now being demanded are likely to prolong the slump and lead to an even more severe downturn in the next few years.

Greece and the other weaker European economies are not being allowed the option of a Keynesian package, that is, deficit finance stimulus packages accompanied by injections of additional liquidity (through quantitative easing – printing money – etc). One investment bank economist commented: “If the peripherals were to choose a Keynesian approach, they would be slaughtered by markets”. (Investor Headwinds Lash Euro Solidarity, Financial Times, 9 February)

At this stage, it seems likely that the Papandreou government will attempt to remain within the eurozone. It calculates that the ECB and major eurozone governments will be forced to bail Greece out, as a Greek default would have a devastating effect on the viability of the euro. However, events will not be under the control of either the major powers or the Greek government.

At the European summit on 10/11 February there were public promises of support for Greece. The message was that they would not allow a default by Greece. However, there was no concrete package of financial support. This had been blocked by the Merkel government. In recent days, the ECB president, Trichet, has made new statements promising to defend Greek bonds. However, financial markets, that is, the big speculators who trade in government bonds, are not convinced. The Greek government is being forced to pay higher and higher interest rates on its bonds, which will exacerbate the accumulation of public debt.

The possibilities of exit or expulsion

Given the contradiction between the operation of a common currency and the rivalry between 16 national states, a breakup of the euro is inevitable at a certain point. Timing, of course, is more difficult to predict, as are the lines on which the eurozone will fracture. The crisis may well be protracted.

The euro may survive for a time, if only because the breakup of the eurozone would trigger a massive economic and political crisis for European capitalism. A breakup could begin with the exit (or even expulsion) of one of the weaker economies (with Greece and other PIGS as prime candidates). Until recently, exit or expulsion was considered ‘inconceivable’ by EU governments and commission bureaucrats. However, the possibility of exit is provided for in the Lisbon treaty, and the ECB has recently been studying the implications of exit/expulsion.

It may not be one of the weaker economies which goes first, however. One possibility is of a German government, faced with a popular backlash against bailing out weaker, ‘profligate’ economies, leaving the eurozone. “Instead of Greece and others leaving the euro, Connelly Global Advisers, a consultancy, suggests Germany could leave instead. Berlin would get back to its strong deutschmark, and the devalued rump euro would provide remaining countries with the escape valve they lack. It is an extreme suggestion but, among so many extreme scenarios, the alternatives don’t seem much better”. (Lex: A Sov Story, Financial Times, 6 February) Germany, moreover, could be accompanied by others, such as the Netherlands and Belgium, in a new deutschmark zone (a new version of the European Exchange Rate Mechanism rather than a common currency).

The pace of developments regarding the euro will also depend on the trajectory of the European and world economies. A recovery by major capitalist economies could extend the lifetime of the euro. This could be assisted by a devaluation in the value of the euro against the dollar and other currencies (including the Chinese yuan/rmb which is pegged to the dollar). Ironically, this devaluation is the result of the debt crisis of the PIGS. So far, the euro has declined about 15% against the dollar (5% of this from the beginning of 2010). This is a correction of the overvaluation of the euro, brought about by the competitive devaluation of the dollar. While the US Treasury claimed it supports a ‘strong dollar’ policy, it has been encouraging a fall which has reduced the US trade deficit. A weaker euro will help the exports of major manufacturers like Germany, but as most of Greece’s exports are within Europe, it will not gain much advantage, except with tourism.

But a sustained recovery of European capitalism is far from assured. The major economies of Europe enjoyed a certain recovery in mid-2009, largely due to their various stimulus packages (especially vehicle replacement schemes). However, growth was faltering in the last quarter of 2009, and is still negative in the weaker economies. A period of stagnation (with high unemployment and a weak business cycle) or especially a downturn would undoubtedly increase the pressure on the euro. The strategists of European capitalism are extremely reluctant to abandon the euro. On the other hand, however, very few currently uphold the idea that the euro will steadily lead towards the economic and political union of Europe.

In a recent New York Times column, Paul Krugman makes some telling comments about the euro (The Making of a Euro Mess, 15 February): “To make the euro work, Europe needs to move much further towards political union, so that European nations start to function more like American states”. In the US, which is a federal state, automatic fiscal stabilisers come into play in a downturn. For instance, the collapse of the housing boom after 2007 caused a severe recession in Florida’s economy. However, the federal government continued to pay social security (pensions) and Medicare payments to people in the state. At the same time, the decline in earnings reduced tax contributions to the federal state. Moreover, Obama’s ‘stimulus programme’ included financial support for states. These kind of stabilisers do not operate within the eurozone. “But”, writes Krugman, “that’s not going to happen anytime soon”.

In fact, prolonged economic crisis and political upheavals will intensify the conflicts between the nation states now within the eurozone (especially with a strengthening of nationalism) – making a breakdown of the euro inevitable at some point of time in the future.

Bond market vigilantes

Greece has come under intense pressure from ‘financial markets’, in reality, big investment banks, bond traders and other speculators. They are daily denouncing the profligacy of the Greek government, raising fears of a default on Greek, Spanish and Portuguese government bonds. Their real concern, however, is not the fiscal rectitude of various EU governments, or the stability of the euro, but their own short-term profits. “The markets are not looking for what’s good for the long-term viability of the euro”, comments Joseph Stiglitz, “they are looking at what’s going to happen in the next 24 hours”. (Quoted by Larry Elliott, The Guardian, 9 February)

The situation is comparable to the 1992 crisis in the European Exchange Rate Mechanism (ERM). Then, speculators targeted the weaker currencies, particularly the British pound and the Italian lira, betting on a fall in their value against other currencies, while at the same time undermining these currencies through their currency trading activities. Eventually, they forced the pound and the lira out of the ERM, though they failed to undermine the French franc (strongly supported by the Chirac government).

Now, by boycotting the auctions of government bonds, and through rating agencies downgrading bonds, the big traders can force up the rates of interest that governments like Greece are forced to pay. Naturally, higher bond yields significantly increase the profitability of the traders. Banks and traders are still flush with cheap credit, not least because of the ECB’s quantitative easing measures (effectively printing money to buy financial assets from the banks). Banks can borrow money from the ECB at around 1% and use it to buy Greek government bonds that return an interest rate of almost 7%! How can they fail to make enormous profits?

Despite their hue and cry about default, moreover, they are confident the ECB and eurozone governments will, if necessary, bail out Greece. Moreover, speculators are also betting against a fall in the euro, profiting through ‘short’ trading. It is estimated that speculators trading on the Chicago Mercantile Exchange recently made more than $7.5 billion in bets against the euro.

This highly profitable activity, however, in no way inhibits the speculators from denouncing the ‘unviability’ of various government bonds or the ‘instability’ of the euro. Yet it has recently been revealed that Wall Street traders (and probably others based elsewhere) have been up to their necks in arranging dubious loans for the Greek government, and no doubt others. Between 2001 and 2004, for instance, the Greek government raised more than Euro 4 billion ($5.44bn, £3.47bn) from a series of complex financial manoeuvres, organised by the big investment banks – in return for huge fees. These deals involved large-scale interest rate and currency swaps that, it was deemed, did not have to be entered into the national accounts as debt. (Wall Street Helped Greece Hide Debts, International Herald Tribune, 15 February) These complex financial instruments were used for ‘window dressing’ the national accounts. “Banks eagerly exploited what was, for them, a highly lucrative symbiosis with free-spending governments”. In other deals, almost incredibly, the Greek government effectively mortgaged the country’s airports and highways, raising cash from financial markets in return for pledging landing fees, etc.

This financial chicanery reveals both the recklessness of successive Greek governments and the unscrupulous profit-seeking of the speculators.

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February 2010