The fault lines beneath the euro crisis

Issue 

Facts are stubborn things. It is now clear even to German Federal Bank board members that the brutal austerity applied to the eurozone “periphery” ― Greece, Portugal, Spain, Ireland and Italy ― is not just bleeding these economies white, but starting to hurt the Eurozone “core” and world economy.

As a result, the investors, the nurturing of whose fragile confidence has been the whole justification for austerity, feel like investing even less.

“This time Europe really is on the brink,” said economists Nouriel Roubini and Niall Ferguson in a June 12 Der Spiegel commentary.

Nine days later, the alarm became official, reaching the International Monetary Fund (IMF), until recently aresolute partner in austerity with the European Union and European Central Bank (the “troika”).

The July 21 concluding statement of the IMF mission to the Euro Area said: “The euro area crisis has reached a critical stage. Despite extraordinary policy actions, bank and sovereign markets in many parts of the euro area remain under acute stress, raising questions about the viability of the monetary union itself…

“Contagion from the further intensification of the crisis―including acute stress in funding markets and tensions involving systemically important banks―would be sizeable globally.”

The IMF statement, which European Union economics commissioner Olli Rehn also made a point of endorsing, urged “strong commitment towards a robust and complete monetary union that would restore faith in the viability of the euro” and a program of “long-term adjustments” and “short-term actions” to restore growth.

And yet, despite the rising panic, the June 22 Rome meeting of the leaders of the eurozone’s four largest economies (Germany, France, Italy and Spain) could only agree on one proposal to put to the critical June 29-30 European Summit.

This was a 130 billion euro fiscal stimulus package, the precise content of which remains to be clarified. Crystal clear, however, was German Chancellor Angela Merkel’s rejection of the sort of action needed to address the immediate emergency of “acute stress in funding markets”.

To the brink

The half-measures and short-term fixes adopted to date have brought the Eurozone to the brink. Take the European Central Bank’s Long Term Refinancing Operation, a 1 trillion euro three-year loan at 1% interest to more than 800 banks last November and February.

Using this godsend Italian and Spanish banks purchased their government’s public debt, making themselves a pretty penny on the difference between the borrowing cost and its 5% plus yield.

This operation temporarily drove down interest rates on public debt, but they have since risen again in response to the Spanish banking mess. The result is that in Spain and Italy, over-indebted banks and over-indebted government increasingly hold each other’s debt.

It is a situation described by one commentator as “two drunks leaning on each other so as to stay on their feet”.

In Rome, Merkel said that without the states’ guaranteeing the repayment of bank recapitalisation loans, nothing would prevent beneficiary banks blowing them as they saw fit. However, making the states responsible, as in the case of the 100 billion euro “line of credit” extended to Spain’s Fund for Orderly Bank Restructuring (FROB), directly adds to a country’s public debt burden.

But Brussels can’t bail out Spain or Italy ― it doesn’t have the money.

After allowing for the 100 billion euros intended for the FROB and the 248 billion euros already lent to Greece, Portugal and Ireland, the European Financial Stability Facility and its successor, the European Stability Mechanism, have €400 billion in their war chest.

Combined Spanish and Italian financing needs to the end of 2014 already amount to 1.56 trillion euros.

This means that there are insufficient funds to purchase Spanish and Italian debt, as floated at the recent G20 meeting.

The IMF could help out, but only if its own funds were increased by member states, especially the US ― very unlikely as the US presidential poll approaches.

But why doesn’t the ECB step in and buy enough Spanish and Italian debt to drive down yields to sustainable levels? It could ― and has ― but views this as a last resort because it reduces the incentive on the governments to “reform” (implement austerity), provoking tensions with Germany.

Germany does not rule out eventually issuing common Eurozone debt (“eurobonds” or “eurobills”) but insists that the priority is “incentives” for “reforms”.

This position, pushed by Merkel in Rome, only raises the possibility of a Eurozone break up.

Creditors and debtors

At bottom, all the complicated proposals around eurobonds, bank recapitalisation and monetary and fiscal policy are about the trillions of debt (now 8.1 trillion euors in public debt alone) that had piled up by the time the crisis hit in 2008. This suffocates bank balance sheets and public sector budgets.

Who is going to pick up the tab? How can a repeat be avoided? How to stop speculative trading in all that debt from endangering the euro?

The lending and borrowing binge that lasted from the introduction of the euro to 2008 saw the divide between the creditor core (Eurozone north) and debtor periphery (Eurozone south plus Ireland) open up sharply.

This is reflected in huge current account deficits (more is spent on imports than is earned in export revenue) in the periphery and current account surpluses in the core.

The main creditor institutions are multinationals concentrated in the northern Eurozone (German, the Netherlands, Luxembourg, Austria and Finland), which are owed 2 trillion euros. The main debtors are the real-estate developers and zombie banks in the south and Ireland.

The increasingly distrusted banks in the periphery have kept themselves alive by loans from their national central banks. These, in turn have borrowed from the ECB, which has borrowed from the central banks of the northern Eurozone.

As a result the German federal bank is owed about 700 billion euros.

In the creditor-debtor war unleashed by this crisis, the creditor institutions support policies that keep the value of what is owed them ― no relaxation of credit conditions, fight-inflation-first monetary policy, no change to repayment schedules and no schemes to create European debt or provide deposit guarantees on a European level.

For their part, the debtor institutions are desperate to reduce their burden by all means available. These include: partial debt cancellation, renegotiation of repayment schedules (passing burden of debt repayment further and further into the future), depreciation of the real value of the debt through inflation, and increasing growth.

Compromise?

The size of the gulf between the two sides has been starkly revealed by discussions over the proposal for a “European Redemption Pact”.

If agreed, it would reduce yields on the huge levels of debt that Spain and Italy have to auction each month. However, it is simply impossible for these countries to meet the conditions required to enter the the pact.

Spain is already failing to meet its agreed public debt reduction targets and any extra budget cuts ― assuming they didn’t produce an uncontrollable social explosion ― would only speed up the vicious circle of declining growth and tax revenue.

In Italy’s case, the budget surplus with interest payments deducted would have to be 4.2% for the lifetime of the pact. This would require a hike in taxes or a cut in spending so severe that it would kill growth.

But surely such an exacting proposal for debtors Spain and Italy would be welcome in Germany? Not universally. The pact's “compromise”, although supported by the opposition Social Democrats and Greens, has already sparked criticism because it would raise the cost of servicing German public debt above the 60% of GDP limit.

According to Der Spiegel, “During the 20-year lifespan of the debt repayment fund Germany's losses could add up to 100 billion euro or more.”

Powerful card

The debtors, however, have a powerful card. The break-up of the Eurozone would hurt the capitalist systems of European nations, but it would hurt German capitalism most of all, as admitted in a recent Federation of German Industries document.

As the June 28-29 European Summit approaches, all the major players have proposals for someone else to “do the right thing”. The IMF and EU want to see the ECB reduce interest rates and provide “ample liquidity support” to banks: the ECB is still refusing to provide such support.

Barring a major change of position by Germany, the prospect for the Eurozone remains more fudging and more crisis, with working people and the unemployed continuing to pay the price.



Comments

"The July 21 concluding statement of the IMF mission to the Euro Area said" - its July 3rd