Eurozone threatened with end of the road

November 19, 2011
Anti-austerity protest in Paris.

World financial markets are increasingly staking billions on a bet that the eurozone is on its last legs. This bet on a euro break-up is looking more and more realistic, particularly because it becomes increasingly self-fulfilling as austerity programs bite and economic growth slows across Europe.

A very vicious circle is at work. Because of the rising wariness of financial institutions, in recent weeks the price of Italian and Spanish 10-year bonds has fallen. Their yield rose above 7% (bond prices and yields move in opposite directions).

The immediate impact is to increase the share of state budget expenditure that must go to paying off government debt.

Growing debt

As economist Mark Weisbrot pointed out in the November 9 Guardian, a year ago bond traders would accept 4% as the yield needed to buy Italian 10-year bonds. Two weeks ago these yields went as high as 7.7%.

Multiply the difference (3.7%) by the 356 billion euros in public debt that Italy has to refinance over the coming year, and the extra cost to the Italian state budget comes to 13.2 billion euros, about 1% of annual GDP.

If the 1.7% of GDP reduction in the Italian public sector deficit programmed for 2012 under pressure from Brussels is added, the result is a cut of 2.7% of GDP in funds available for public spending in Italy.

Given the present phase of very low or negative economic growth, this cut in public spending will not be offset by a rise in investment or consumption, especially as austerity programs will cut public sector jobs.

Overall growth will decline, further cutting the tax take, widening the budget deficit, and forcing the issuance of more debt at, in all probability, higher yields.

At the same time, the ratio of public debt to GDP will keep rising ― the exact opposite result to that intended by introducing brutal austerity packages aimed at getting Europe’s “periphery” to “live within its means”.

The pattern is already familiar. Government bond yields rise to a point where the ability of countries to pay off their debt comes into question, demand for their debt dwindles rapidly, market funding dries up and affected countries are driven to surrender to the mercy of international financial institutions.

Greece (10-year bond yield at 28%, official unemployment at 18%) led the way into this hell, to be followed by Ireland (8.2% and 14.3% respectively) and Portugal (11.3% and 12.4%).

So far, the small size of these economies has not seriously tested the financial capacity of the “troika” of international economic institutions ― the European Central Bank (ECB), European Financial Stability Fund (EFSF) and International Monetary Fund (IMF).

However, if Italy and Spain succumb to the same death spiral, the funds needed for “bailout” ― estimated at between 600 billion euros and 1 trillion euros in Italy’s case ― simply don’t yet exist. This is despite the EU voting to raise the firepower of the EFSF by four to five times.

Rising panic, blackmail

But why doesn’t the ECB simply repeat the response of the US Federal Reserve and Bank of England when faced with a parallel scenario in 2008-09, and make available whatever funds are needed to buy up debt? This could drive down bond yields and ease the pressure on state budgets.

It seems an obvious choice. In the words of John Stopford, head of bond-trading at investment firm Investec: “We are heading to a point where it is either the break-up of the euro or the ECB stepping in by buying bonds in size to save the monetary union.”

Yet the German foreign minister, Guido Westerwelle, repeated the Angela Merkel government’s opposition to this course in the November 17 Financial Times: “Some argue the euro can be saved only at the price of sacrificing monetary stability. This would be a momentous mistake.

“Putting the European Central Bank’s printing presses to work might at best bring some short-term relief. But it would have dire consequences, both raising inflation and dissipating vitally important incentives for reform.

“In the end we would end up with a depreciated currency and an even more destabilised eurozone. The ECB’s independence and firm commitment to price stability are of paramount importance to Europe’s economy.”

A day later, new ECB president Mario Draghi repeated the message, in effect telling panicked European politicians to stop knocking at the ECB door, speed up the implementation of EU decisions and get the EFSF fully operational as quickly as possible.

Clearly, under Draghi the ECB is not going to be a “lender of last resort”.

Why such intransigence? Some economists put it down predominantly to the wrong ideas in the heads of Europe’s economic policy makers: “Will the Euro be destroyed by ideologues?” asked Dean Baker of the Center for Economic Policy Research on the Al-Jazeera English website on November 17.

There is an element of truth. For example, when the ECB talks about the threat of inflation arising from its 200 billion euros purchase of the debt of the “peripheral” European countries ― amounting to a 200 billion euros increase in the euro money supply ― it is close to talking nonsense. The Federal Reserve has bought more than US$2 trillion in debt without any noticeable effect on the US inflation rate.

However, the “fight against inflation”, while important for the ECB and EU, is not their only or even most important goal. After all, IMF forecasts say inflation is Europe will fall next year to 1.5% as recession takes hold.

However, this will not divert ECB-EU attention from its main objective ― raising European “competitiveness” against its US, Japanese and Chinese rivals.

That is what most dictates the obsession with cutting wages, making sacking easier and slashing the welfare state. Germany and France require the “Club Med” countries to do their bit to build up European-wide competitiveness.

This explains why the ECB is not just restricting its activity to guarding its 2% inflation charter. It is also using its ability to reduce or increase yields on sovereign debt to squeeze governments into adopting austerity policies supported by Brussels.

For example, most recently the ECB chose, by not buying enough Italian debt, to raise the pressure on former prime minister Silvio Berlusconi to implement EU and G-20 austerity requirements.

It then took advantage of Berlusconi’s unpopularity to help impose Italy’s new government of unelected “technocrats” ― a ruling team freer to implement these requirements.

The same game was under way in the run up to the Spanish November 20 national election. The ECB did not try to cancel out the sudden leap in Spanish 10-year bond yields that took place on November 17.

By purchasing enough debt to only slightly trim back their spread over German 10-year bonds, the ECB was tightening the pressure on the likely election winner, the Popular Party’s Mariano Rajoy: he is to use any victory to introduce emergency “reform” measures, first and foremost against Spain´s “labour market inflexibilities”.

A dangerous game?

However, the ECB has to play its hand carefully. If any euro country, even one of the smallest, defaulted on its debt repayments, the knock-on effects into the heavily indebted European banking system would be devastating.

Big financial institutions (especially French, German and Dutch banks) loaded with government debt on the asset side of their balance sheets would collapse and the solvency of the entire system would be thrown into question.

This would be an equivalent event to the 1931 collapse of the Austrian Creditanstalt Bank, which set off a rolling wave of defaults that fed through into a deepening of the Great Depression. In today’s Europe, country after country would be forced out of the euro and depression would take hold of the continent.

Such an outcome is not in the interest of German and French capital. The trick for the rulers of Europe, beginning with “Merkozy”, is to use the crisis as much as possible to strengthen the position of capital against labour, but without provoking a catastrophic new phase of economic decline.

This is why the German government, over the three years of the crisis and often against considerable domestic opposition and its own inclinations, has supported the minimum measures needed to keep the euro afloat ― the establishment and expansion of the EFSF and ECB purchases of sovereign debt.

Semi-permanent crisis

The immediate prospect for the Eurozone is for continuing instability and crisis, with the common currency hanging by a thread.

So long as the left in Europe remains too weak to impose its own recipe of a comprehensive monitoring and restructuring of the European Union countries’ 9.8 trillion euro public debt burden, national economies ― even those now thought safe ― will be vulnerable to speculation on their public debt, especially given continuing austerity.

This situation of semi-permanent crisis is driving the continent’s leaders and opinion-formers to demand “more Europe”, starting with what Westerwelle calls “deeper integration through tighter economic governance and tougher rules for the stability pact”. This would “send a clear message to markets that the eurozone is determined to end the policies of debt-making”.

Is such a prospect politically thinkable? Already “Brussels” and “Europe” is synonymous in Mediterranean Europe with the brutal and unaccountable imposition of suffering and sacrifice.

This feeling has become only stronger since “Merkozy” strong-armed former Greek PM George Papandreou into dropping his “mad” scheme of actually asking the Greek people, via a referendum, if they supported EU-ECB-IMF plans for their country.

The imposition of “technocratic” governments to do Brussels’ bidding in Greece and Italy may give the European powers-that-be a little breathing space, but new waves of austerity will also give rise to more resistance and struggle.

That revolt may well have a much more decisive influence on the future of the euro than the manoeuvres of the bond-traders, the bankers and the ECB.

[Dick Nichols is the Green Left Weekly European correspondent, based in Barcelona.]


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