As you read these words, disaster may be about to strike in the galloping crisis of the European financial system and the euro. Or it may not — yet.
On November 30, the imminent threat of a banking system implosion stirred the European Central Bank (ECB), the US Federal Reserve, Bank of England and central banks of Japan, Canada and Switzerland, into taking the minimum action needed to prevent a “Lehman Brothers event” collapsing the European financial system.
Most people will breathe a sigh of relief if this last-minute ECB-coordinated intensive care operation has prevented the European financial system from bleeding to death.
The nightmarish alternative is bank collapses with the loss of personal savings followed by a rapid descent into depression, unemployment and poverty.
However, even if financial breakdown is avoided, the course of treatment for the eurozone crisis now being haggled over by French, German and Italian leaders Nicolas Sarkozy, Angela Merkel and Mario Monti and by ECB president Mario Draghi will still prove deadly over the longer run.
The central banks’ action — to make dollars available to European banks through the ECB to compensate for private US banks’ flight from lending to Europe — carried a double message.
On the one hand, the central banks will not stand idly by and allow European private banks to collapse.
On the other, the debt crisis is vast: effectively the Federal Reserve is being forced to extend “quantitative easing” (printing ever more dollars) to European banks, and expose itself to the questionable “assets” (like Greek state debt) they will offer as collateral.
Thus, the only weapon being used to keep the huge European crisis under some sort of control is the unlimited capacity of the central banks to create liquidity.
This might stop stagnation and recession from turning into a Europe-wide, and possibly global, depression. But it might not.
Certainly it will do nothing to stop the decline in the economies in the European “periphery” most subject to the austerity policies being imposed by the “troika” of the ECB, European Union and International Monetary Fund.
The central banks’ action came after a week in which the warning lights went beserk:
• Portuguese, Hungarian and Belgian government credit ratings were all downgraded and a €6 billion German 10-year bond auction attracted only €3.9 billion in bids, forcing the Bundesbank to acquire the rest;
• In the third quarter of 2011, long-term bond issues by European banks raised only 15% of the amount achieved over the same period in 2009 and 2010.
• On the short-term dollar market (used to finance trade) loans to French banks plunged nearly 20% in November (69% since the end of May). US money market funds have pulled 42% of their money out of European banks.
• Billions of euros continued to flood out of Europe’s banking system through bond and money markets. A Citi Group report said “we are starting to witness signs that corporates are withdrawing deposits from banks in Spain, Italy, France and Belgium” and the rate of withdrawals from Greek banks continued to grow.
• European banks abandoned efforts to sell off trillions of euros of loans, mortgages and real estate after potential buyers — like private equity firms, hedge funds, foreign banks and insurers — offered them only bargain basement prices.
• With banks increasingly worried about each other’s solvency, interbank lending began to dry up and ECB lending to banks reached its highest level in two years. Simultaneously, private bank depositing at the ECB also hit record highs (€314 billion on December 1).
So how did a sovereign debt problem in late 2009 in Greece, a country that accounts for only 2.4% of eurozone production, turn into a systemic crisis for the whole European economy?
Much is made of the high level of sovereign (government) debt in the eurozone, but no European state has as high a ratio of debt to Gross Domestic Product as Japan (220%).
Moreover, all European economies with the exception of Italy and Greece have a lower ratio of debt to GDP than the US (93.2%).
The Greek public debt burden became a detonator of the present European financial crisis for four reasons.
First, because the ECB abstained from buying Greek debt on secondary markets until interest rates on the debt were too high.
Second, because the German government has vetoed any consideration of pooled European state debt (“eurobonds”).
Third, because of ECB interest rate rises at the first glimpse of inflation breaching the 2% limit.
Lastly, and most of all, because the austerity policies imposed by the troika have driven the country deep into a deadly spiral of shrinking growth and rising indebtedness.
Once interest rates on Greek public debt took off and the spectre of default appeared, the market value of the debt started to decline.
With European banks holding US$52 billion in Greek government debt a default was going to have a huge impact on their balance sheets.
It also confirmed that the June 2010 “stress tests” that certified the solvency of most big European banks were, as many had suspected, worthless. They had assumed that the real value of the sovereign debt they held was the same as its face value.
This drastic devaluation process didn’t just apply to government debt. In Spain, the burden of non-performing private debt — especially that based on real estate lending — has bankrupted the credit union system and forced a chain of amalgamation of financial institutions.
What scale of numbers is involved?
The so-called PIIGS (Portugal, Ireland, Italy, Greece and Spain) are sitting on €3 trillion in debt. Financial analysts are assuming losses could ultimately reach 50 cents in the euro — a €1.5 trillion hit to the financial system.
Moreover, even if the European financial system is saved in one form or another, to meet new bank capital adequacy standards established after the 2008 crisis, it will have to carry out a €5 trillion lending contraction over the next three years — roughly equivalent to about 20% of Europe’s total annual economic output.
The active speculation against, or passive shunning of, European financial assets means the ECB will be forced to carry out more operations like the recent coordinated liquidity injection.
Regardless of German resistance, it will also either have to pool the debt of European states in the form of eurobonds, or become a lender of last resort like the Federal Reserve or Bank of England. That is, buying up huge quantities of sovereign bonds from indebted eurozone members (beginning with Italy, which has to refinance €300 billion of its maturing debt next year).
How is this role to be made acceptable to the “core” countries of the eurozone, beginning with Germany?
Speeches by Draghi, Sarkozy and Merkel spelled out the price, which European Union member states will be asked to endorse at the next leaders’ meeting over December 8-9.
Their proposal involves accelerated agreement on what Draghi called a “fiscal compact” between the 17 eurozone members to enforce much stricter budget discipline and debt control.
The idea is that if that is achieved, the markets will increasingly trust eurozone countries, because they will have become, in effect, agents of German monetary and fiscal policy.
In that context, eurobonds would have the quality of German bunds.
If Merkel gets her way in the final negotiations, there will be automatic sanctions, enforcement of the rules in the European Court of Justice, and a “budget commissioner” to blow the whistle on miscreant countries.
Attacks on workers
The blackmail for peripheral Europe is clear — if they want to save the euro, austerity has to become permanent. The euro crisis is to be used to turn the balance of forces against workers across Europe.
Sarkozy was barefaced when he said on December 1: “Retirement at 60 and the 35-hour week were serious mistakes for which we are still paying the consequences and which we had to fix …
“We must continue to reduce public service staffing levels by maintaining the rule that only one in every two retirees will be replaced.
“By reducing our deficits, we reduce the hold that the markets have over us, we maintain command of our destiny.”
Sarkozy said he would be holding a “summit on employment”, where the “social partners” will be asked to “have the courage to face the big questions and to remove the taboos about the brakes on French productivity”.
The German and French leaders are following the old conservative adage — “never waste a good crisis”. The rest of Europe will be asked whether they really want to wreck the euro (and face the huge economic destruction and surge in poverty involved).
If not, they will have no choice but to create an enforceable European fiscal policy.
However, disciplined grinding austerity is not the forgone conclusion of Europe’s debt crisis. Across the old continent, companies and governments are also working on Plan B — what to do in case of euro collapse.
One anonymous “insider” in the City of London commented last week: “We seem to have entered the last days of the euro as we currently know it. That doesn’t make a break-up very likely, but it does mean some extraordinary things will almost certainly need to happen — probably by mid-January — to prevent the progressive closure of all the euro zone sovereign bond markets, potentially accompanied by escalating runs on even the strongest banks.”
The British Daily Telegraph reported: “As the Italian government struggled to borrow and Spain considered seeking an international bail-out, British ministers privately warned that the break-up of the euro, once almost unthinkable, is now increasingly plausible.
“Diplomats are preparing to help Britons abroad through a banking collapse and even riots arising from the debt crisis.
“The Treasury confirmed earlier this month that contingency planning for a collapse is now under way.”
[Dick Nichols is Green Left Weekly’s European correspondent, based in Barcelona.]