The Euro on a Knife Edge

“Bloody Greeks—corrupt and lazy, born cheaters who think the world owes them a living. Why should the hard-working taxpayers of the euro zone core economies like Germany have to fund billion-euro rescue packages for those scoundrels?” That’s the vicious tone of Germany’s tabloids and conservative politicians towards Greece’s galloping public debt crisis and the Greek people’s protests against the austerity programs imposed on them by the European Union, European Central Bank and the International Monetary Fund (the “troika”) as the price of bail-out funding.


In Australia, columnist Paul Sheehan offers his September 14 Sydney Morning Herald readers a cruder version of this caricature. Not only are the Greeks (whose “national sport is cheating”) bludging off German taxpayers, they’re devaluing Aussie superannuation payouts (see “Throw out cheating Greece before the rot cripples rest of the world").

But Sheehan’s “solution”—to cut off the gangrenous limb to save the euro and “the rest of the world”—finds very few supporters in Europe. That’s because Greece can be “thrown out” of the euro, but its 350 billion euro debt and tottering banking system can’t be “thrown out” of the European and world economies.


In Germany, the Rosa Luxemburg Foundation has answered the German tabloid version of Sheehan’s slanders with some simple facts:


Average hours worked (before the crisis struck): 44.3 for Greek workers, as against 41 for Germans. Since the crisis fewer Greek workers have had the chance to prove they aren’t lazy—the troika’s austerity policies, including cuts of 80,000 public sector jobs, have helped boosted official unemployment to 15%.

Greek wages: 73% of the European average, with 25% of workers earning less than 750 euros [A$1015) a month.

Holidays: Greek workers have a right to 23 days a year—as against 30 days for German workers.

Pensions: The average is 617 euros [A$830] a month: two-thirds of Greek pensioners have to survive on less than 600 euros a month.

Tax evasion: Yes, it’s pretty common in Greece, especially among the self-employed, but the culture of tax evasion was the work of Greek capitalists and rich: Greek shipowners, for example, pay no company tax at all. No wonder the popular reaction has been: “If the fat cats don’t pay tax, why should we?”

Budget deficit: It’s true that Greece ran large public sector deficits even in the boom years up to 2008. But that was because it was much more convenient for the conservative government to borrow on money markets at very low rates of interest than to get the rich and corporates to pay their share of tax.

Transparency: Yes, the Greek government lied about the size of its budget deficits in order get into the euro. But this was not a purely Greek sin.


In the words of Citi chief economist Willem Buiter: “What Greece did was just an exaggerated version of the deliberate data manipulation, distortion and misrepresentation that allowed the vast majority of the euro area members states to join the Economic and Monetary Union, including quite a few from what is now called the core euro area. The preventive arm of the euro area, the Stability and Growth Pact, which, if it had been enforced would have prevented the Greek situation from arising, was emasculated by Germany and France in 2004, when these countries were about to be at the receiving end of its enforcement.”


Greece: Europe’s weakest link

Come the 2008 financial crash, the vicious cycle began for Greece: easy credit disappeared, the interest rate on debt started to climb and the already inadequate tax take collapsed, in turn widening the deficit and increasing the need for Greek debt to find buyers.

At the same time, also as a direct consequence of the crash of 2008, private bank debt across Europe was shifted onto public sector balance sheets, with the taxpayer bailing out the banks and bank deposits guaranteed.


Yet in Europe it was decided, under German pressure, that bank deposit guarantees would not be backed by the European Union (through the European Central Bank) but by the individual member states.

This lack of a common, shared mechanism to issue European debt (“Eurobonds”) exposed the weaker, more indebted European states to the doubts and speculative raids of players in the government (“sovereign”) debt market.


After the November 2009 default of Dubai’s sovereign fund, the market and the rating agencies started to look for the next likely candidate: Greece came into the frame as the weakest link in the chain of euro economies.


This was the context in which the Greek government—with the economy deep in recession, private investment at a standstill, major exports (shipping and tourism) down 15% and depositors shifting their money into Swiss and German banks—approached the EU-ECB-IMF troika for a bail-out package.


The austerity measures imposed as the price of receiving funding from the newly established European Financial Stability Facility were described by ratings agency Fitch as the most draconian ever imposed on an advanced economy.


They have had disastrous consequences. Greek gross domestic product has been shrinking faster and faster, by 2% in 2009 and 7.6% in 2010. Since the crisis broke in 2008, it has fallen by 15% and Greek finance minister Evangelos Venizelos expects negative growth to continue for 2012.


Over the year to March 2011, 65,000 companies went bankrupt and private consumption fell by 18%. Tax revenue also collapsed: first quarter 2011 revenue was 7% below first quarter revenue for 2010. Also, the 50 billion euro privatisation fire sale dictated from Brussels is sure to rake in much less than projected.


The end result is that Greece's budget deficit is now poised to leap as high as 8.2% of GDP, more than the 7.4% target set by the finance ministry at the time of the second troika bailout package in July. Some economists believe the deficit could hit 10% of GDP by year’s end.


Public sector debt, which stood at 127.1% of GDP in early 2010 rose to 143% by the end of 2010. By the end of this year Citi group expects it to reach 167%.

Clearly, the Greeks, least of all Greek workers, pensioners and students, are not in the least responsible for this catastrophe—they are being scapegoated by those in Berlin, Brussels and Washington who are.


What would a Greek default mean?

What next? If Greece was forced out of the euro, what impact would it have—on Greece and the rest of Europe?


An impending reintroduction of the drachma would see a run on the Greek banks, as people raced to get their money out before the introduction of a currency that would instantly devalue against the euro. Willem Buiter predicts, “The Greek banking system would be destroyed even before Greece had left the euro area.”


Defaulting on loan repayments would invite also retaliation from foreign investors and banks, cutting Greek access to foreign funds. At the same time the price of imports would increase, potentially creating a situation of “stagflation” (combined recession and inflation).

According to Buiter: “The bottom line from Greece from an exit is … a financial collapse and an even greater recession than the country is already experiencing—probably a depression.”

A study by UBS economists Stefane Deo and Paul Donovan concludes that the cost of the euro break-up would be “horrendous”: “For a weak economy like Greece to leave the euro zone, it would cost citizens between 9500 and 11,000 euros in the first year, and 3000-4000 euros per subsequent year.”


Then there is the likely impact of a Greek default on the euro and the European banking system. A Greek exit would focus market attention on the next candidate with sovereign debt problems. Depositors would shift their savings into the safer “core” euro zone and out of the vulnerable “periphery”. Potential investors would shy away.


This funding strike and flight of deposits would create financial instability, and increase the chance of a recession in the Mediterranean and Eastern European euro periphery.

Exposed European banks, especially in France and Germany, would face bankruptcy, especially as it is impossible to judge the value of much of many of the financial instruments they still count as “assets”. (New IMF chief Christine Lagarde described Europe’s banks as “undercapitalised”.)


Germany and France would then face the choice that former US treasury secretary Hank Paulsen faced exactly three years ago when confronted with the moribund Lehman Brothers—let them fail or bail them out. And since the vulnerable European banks are “too big to fail” a variant of the US taxpayer-funded Troubled Assets Relief Program (TARP) would have to be put in place.


If a Greek default was followed by a cascade of other countries defaulting, leading to the end of the euro or its reduction to core economies, even the strongest economy, Germany, would lose out.


The value of the euro reflects the average of labour productivity across its European member economies. A new deutschmark (or even a “core area” euro) would have a higher value than the existing euro, and would undermine export competitiveness when the German economy is more dependent on export income than ever.


That appreciation would be amplified as speculators sought the “safety” of the new currency as the other post-euro currencies fell in value.


A new deutschmark or “core euro” would follow the recent path of the Swiss franc. Last week the Swiss National Bank began to try to hold down its rapid appreciation because it is hurting Swiss industry.


These facts of life explain why the European lead powers Germany and France, far from adopting the Sheahan “throw the bastards out” approach, are doing everything they can to keep Greece in the euro. They are supported in this by Barrack Obama, who sent US treasury secretary Timothy Geithner to last Friday’s meeting of European finance ministers to stress the urgency of the situation, and demand united action.


The question then is—if the euro crisis is so serious, why are the European powers finding it so hard to agree on a common solution?


That will be the subject of the second part of this article.


Part 2: Europe taking world economy over the cliff


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 the 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 and 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.


This precipice looms much clearer:

  • Key indicators reveal a turning point in production and trade. The Chinese purchasing managers’ index showed manufacturing shrinking for a third month in succession, while the World Trade Organization 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 around 4% and were down 20% since beginning of year. A September 23 statement by 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 Global Financial Stability Report revealed that “nearly half of the €6.5 trillion stock of government debt issued by euro area governments [roughly 5% of annual world production—DN] 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 2-3 million to its 5 million unemployed.


Europe is the epicentre of this latest phase in the global crisis. Yet, even the vicious feedback loop between slowing growth, rising sovereign debt and looming bank insolvency clear to 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 common currency. 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.


When German federal president Christian Wulff 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?


Strange ‘cures’

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 by late 2009 on winding back public budget deficits.


Yet the unfolding Greek disaster shows that the “tackle debt and deficit first” approach (applied there by the “troika” of the European Central Bank, European Union and IMF) is not only socially sadistic (see the Green Left Weekly 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—and in turn 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 it a strong euro is essential to controlling inflation and restraining wage claims, and so maintaining European (especially German) competitiveness. This school includes former ECB executive board member Jürgen 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, including 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 Sinndescribes 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 massive export successes.


This argument conveniently ignores some simple truths: not only that Germany’s trade surpluses within Europe have required other economies to run deficits, but that if growth in the whole world is slowing, winning the export competition increasingly becomes a zero sum game.


This is specially so given that the last three years have seen a rise in the protectionism of tit-for-tat “currency wars”.