The stated purpose of the enormous €750bn bailout package announced by the European Union was to stabilise financial markets and halt the slide of all Euro-denominated financial assets including the currency. Although the initial reaction was to boost financial markets both in Europe and beyond, the relief was short-lived. Geek long-term interest rates are climbing back up to 8 per cent, leading European stock markets have lost between 5 and 6 per cent of their value since the announcement was made and the Euro fell from over 1.28 versus the US Dollar to under 1.22 in just three weeks.
This negative reaction is a repeat of the response to the earlier ‘rescue package’ of €120bn, which then prompted the much larger €750bn announcement. Ostensibly, the bailout is supposed to rescue Greece. Yet there is not a single cent in the package which will be aimed at reviving the Greek or any other economy. Instead, the bail-out is to provide a guarantee against a debt default by Greece and other European crisis-hit economies. It is therefore entirely a bail-out for holders of Greek government debt. According to the Bank for International Settlements (BIS), at the end of 2009 total foreign claims on all Greek entities amounted to US$217bn, of which US$193bn was held by European banks. The major European banks are the holders of Greek debt and the recipients of its interest payments. So the bail-out is to their benefit, ensuring the continuity of interest payments and capital repayment to them. Since taxpayers’ funds are being used to bailout these banks holding Greek debt, the €750bn is in effect an international version of the national bank bailouts which have created massive population opposition across the world.
In Europe only the 1930s provides the precedent of such deep and widespread measures that have now been adopted. The austerity policy failed then and worsened the Great Depression.
The authors of the austerity programmes have no explanation as to why an austerity package supposedly designed to reassure financial markets has led to the opposite. This is because the effect of fiscal austerity measures has been disastrous for the minority of European economies that have adopted them. Services, welfare, incomes and pay have all been slashed. Because of this, the taxes which governments rely on to service their debts have also plunged, and actually led to wider deficits. Feeding the parasitical bank shareholders is killing these economies.
The verdict from the Standard & Poor’s (S&P) ratings agency is clear. S&P sparked the latest episode in the crisis by downgrading both Portugal and Greece, in effect arguing that the risk of defaulting on their debts has increased. In relation to Spain’s downgrade it argues that the new factor is slower growth caused by austerity measures.
That is, because fiscal contraction is disastrous economically, it also increases both the budget deficits and the interest rates on government debt. The Fitch ratings’ agency echoed this view in its downgrade of Spain.
Core Versus Periphery
Fiscal austerity measures have only been forced on a minority of European governments. Previously, the Spanish Socialist government had resisted demands for bigger cuts, arguing they would be damaging and counter-productive. By contrast, what remains the majority of EU economies, as well as non-EU economies such as the US, China and Japan, did the opposite and adopted fiscal stimulus to restore the economy, and the tax revenues which it generates - with varying degrees of success. In Britain, the 2009 Budget was a stimulative one which softened the recession and actually lowered projections for the deficit. Unfortunately, the stimulus was not repeated in the 2010 Budget.
The big European powers, the ECB and IMF have forced on the weaker EU countries a policy which is the opposite of their own, successful stimulus measures. Fiscal contraction has also been applied across the board in Eastern Europe. High levels of government borrowing in some of these countries and the proportion of that debt in foreign hands (mainly Europe’s banks), increased their vulnerability. That was certainly the case for Greece. But that is not an explanation for which countries have had fiscal austerity forced on them.
The table below shows the level of government debt in the Euro Area economies, as well as the proportion of that debt held overseas. It is taken from the ECB’s latest Financial Stability Review.
The difference between the so-called core group and those who have had austerity forced on them is the relative weight of their banking sectors. The banks of Germany, France, the Netherlands, Belgium and Austria have net external assets of $1,780bn according to BIS data. This rises to $2,058bn if Luxembourg is included. By contrast the Mediterranean group of Italy, Spain, Portugal and Greece, has net external liabilities of $417bn. (The Netherlands’ membership of the core group is a partial anomaly as it has net liabilities. But the sheer size of its banking sector, almost the same as Italy and Spain combined, buys the ticket).
The bail-out is aimed at restoring the balance sheets of Europe’s ‘core’ banks, all of it funded by European and other taxpayers. The periphery are being written off, on the basis that their banks are already net debtors. Neither the €120bn was ever enough to bail out Greece nor was the €750bn enough to cover all the Mediterranean country debt. But then they are not the intended recipients. Instead the latter sum does correspond almost exactly to the potential write-down of all the Euro Area banks’ loans and debts, which the ECB’s December 2009 Financial Stability Review estimated to be €740bn.This estimate has subsequently been lowered, but was the best estimate at the time of the May 8-9 bail-out agreement. At the same time, the ECB announced it would buy European government debt and other bonds from the banks, even though European governments are themselves prevented from doing so, and the ECB’s statutes appear to rule it out. That decision is now facing a legal challenge in the German Constitutional Court.
Role of the IMF
In announcing the IMF’s participation in the bail-out of Europe’s core banks, its Managing Director Dominique Strauss-Kahn said, ‘The Greek government should be commended for committing to an historic course of action that will give this proud nation a chance of rising above its current troubles and securing a better future for the Greek people.'
Verbiage aside, the role of the IMF is a wholly pernicious one. The focus is its traditional one of urging deregulation, low wages and taxes and privatisation with a particular emphasis on those sectors which will benefit US capitalism, telecoms, insurance and above all banking. It specifically rules out any ‘restructuring’ of government debt, which would involve bondholders having to accept a discount on the value of their government debt, even though it has recently been possible to buy these debts in the market at 60 per cent of their face value.
It is widely argued that the crisis for Europe as a whole and the peripheral Euro Area economies in particular is simply a function of a burst housing bubble. But Figure 1 below, from the ECB's Financial Stability Review, shows that housing is the lesser component of the much larger decline in gross fixed capital formation. Both housing and other forms of investment are required for social need and to revive activity. The cause of the crisis remains a private investment strike.
This is highlighted by Figure 2 below showing EU Commission data and foreasts for GDP and investment in the Euro Area. Declining investment has been the driving force of the European recession, falling by 13.6 per cent while the contraction in GDP has been 4.1 per cent. Investment is forecast to contract further in 2010, projected to rise by a miserable 1.8 per cent in 2011. There can be no robust or sustained recovery until investment recovers. The transfer of huge amounts of capital from taxpayers and the poor to the banks will only postpone that investment recovery further.
With governments hamstrung by austerity packages and depressed tax revenues, restructuring is an option which may prove unavoidable in any event, just as it was in Latin America. Better by far to include it in an overall package of stimulating growth, cutting military spending and taxing the rich. The European Commission forecasts that the Euro Area will grow by less than one per cent in 2010 and little more than that in 2011, with investment continuing to decline. A stimulus package focused on increasing public investment would restore growth and halt job losses, and so revive tax revenues. Otherwise, the Euro Area will continue to lurch from on crisis to the next .