The end game for the euro?

August 18, 2011 by michael roberts

The next chapter in the evolving global economic crisis has been reached.  And it could be the final chapter for the euro.    Bailing out the banks and paying for the Great Recession has required a massive intervention by the state to save capitalism.  As a result, there has been a huge increase in government spending.  As tax revenues fell, governments have run very large deficits on their budgets.  This had to be financed by massive borrowing.  As a result, the debt levels of the governments of the major capitalist economies have reached levels not seen since the second world war.

Public sector debt levels in the US, Britain and in many European countries are up 40% pts of GDP and heading to 100% of GDP.  This is a level regarded historically as unsustainable, namely that at these levels it just keeps on rising, threatening the ability of governments to pay it back.  The spectre of default has appeared for governments like the US, the UK, Japan, France and Italy.

America’s political leaders have been locked in a struggle to find a way to reduce government deficits and get debt levels down.  This culminated in a fight between the Democratic president and the Republican-controlled Congress over whether legal ‘ceiling’ on the growing government debt should be raised.  Both sides were agreed that the annual budget deficit at 10% of GDP should be eliminated as soon as possible and that the debt level must be lowered.  But the Republicans, driven by the Tea party ‘crazies’ wanted to do it with no tax rises so the rich were protected, while the Democrats wanted some tax rises.  But both wanted huge cuts in welfare and basic government services anyway.  A temporary deal has been reached until later this year when the battle for how to cut living standards may well be resumed.

But is it necessary to cut these deficits and the debt?  The Keynesian economists say it is not.  They argue that it is a political choice, not an economic necessity.  Governments can spend more, run deficits and borrow as much as they want because they can pay for it by printing money.   As long as this does not lead to raging inflation, it will help capitalism grow and avoid a reduction in services and a loss of jobs.

The Keynesians are right that it is a political choice.  But it is not one that the supporters of capitalism want to make, for two reasons.  If government spending is not financed by taxation but by borrowing through the printing of money, it will eventually drive up inflation.  That eats into the living standards of households, but more important for capitalist production, it drives up interest rates and thus reduces profitability.  And that matters for capitalism.

Second, a larger government sector created by extra spending encroaches on the private sector and the power of capital to make profits.  So state spending must be cut as it’s not ‘productive’ and interferes with capitalist production.  So the rising government debt in the major economies is a real problem for capitalism and not just an ideological argument.

So far the US has been unable to get a grip on its debt crisis.  The debt ceiling battle ended with a major credit rating agency ‘downgrading’ US government bonds from their triple-A rating (a level indicating that they are safest borrowers in the world).  If American debt can be downgraded, then the sovereign debt crisis is really threatening to the well-being of the global economy.

It will mean higher interest rates and lower growth in output in the US and elsewhere.  Indeed, already the US economy has slowed to snail’s pace (just over 1% a year).  It’s the same story in the UK, Japan and many parts of Europe.  And trying to get the debt down, called deleveraging, will at best, keep economic growth at well below previous trend for several years ahead.   At worst, it could drive the major capitalist economies back into a new slump.

The sovereign debt crisis continues to ricochet around Europe.  The governments of the weakest Eurozone economies (Ireland, Portugal and Greece) have been forced to go cap in hand to their stronger neighbours for money to bail them out.  That’s because bond markets and banks are no longer willing to fund these governments because they reckon, such is the size of their debt relative to the smallness of their economies, that they will not be able to pay it.  Indeed, Greece has already conceded a ‘technical default’ as part of its latest bailout.  And the fear of default on government debt across Europe is no longer imaginary.

There is a stark choice facing the ruling elites in France and Germany.  Do they wish to save the weak Eurozone states from default and preserve the euro in its current form, or not?  The issue is being forced because Italy, Spain and even France have now been put in the frame by ‘speculators’ over the value and riskiness of their government bonds.  These speculators are the financial institutions that buy government bonds and hold the bulk of the government debt.  They fear that they will not be paid in full by those Eurozone governments running large budget deficits and with high debt levels.  So they want higher interest rates for the extra risk of lending more.  Of course, higher interest costs for governments just add to the debt and increases the problem of paying it back.  It’s a vicious circle.
Up to now, the Eurozone leaders have been prepared (reluctantly) to bail out the small Eurozone countries from their debt traps with extra funding and government guarantees on bonds.  So far, it has not been too expensive; just €100bn so far for Greece, Ireland and Portugal.

But Italy and Spain and, of course, France would be totally different propositions.  To fund the bonds of just the first two states would cost about €1.6trn over the next three years, the time needed to give these governments the room to cut spending, raise taxes, slash public services and reduce pension benefits.  That’s almost four times more than the current emergency Eurozone fund has available.  And to stump up this sort of funding would expose the stronger European governments like Germany to potential debt levels of their own above 100% of GDP.  This would impose a large burden on German public finances, much bigger than the burden when West Germany took over its east back in the 1990s.

The idea of imposing new taxes and higher interest costs on Germans to fund Greeks, Italians and French governments and banks which might not pay it back does not go down well in Germany.  And so the German leaders are not willing to support extra funding for the distressed European governments yet.  Instead, they are insisting on draconian cuts in public spending, wages and benefits in these countries – the Greek people face a 30% cut in living standards.  The Germans and other northern European states hope this will convince the bond markets that the distressed European  governments will not default and normality will be restored without further funding.

The leaders of the bailed-out states have agreed to all these demands.  Even the Italians are now introducing swingeing spending and welfare cuts.  And the French government is getting ready to do the same.   But markets are not convinced that they can succeed.  If the rising costs of borrowing continue, making it necessary for the likes of Italy and Spain also to require official aid from the rest of the Eurozone, then that may be a step too far for the Germans.

What happens then?  Well, the Germans and the French could decide that the Eurozone must be ‘restructured’ to exclude the weaker states.  There would be a new ‘Northern euro’ and the excluded countries would have to revive their old national currencies.  These countries would then face a huge increase in foreign debt because their currencies would be devalued against the northern euro.  Most banks in the Eurozone would be bankrupted as the bonds they hold would be defaulted on.  So Eurozone governments would have to bail them out with more taxpayers’ money.  Living standards would fall everywhere as the European economy ground to a halt.

Europe would no longer be a united economic power equal to the US or Asia.  But it could happen because the German and French leaders decided that this was better than trying to fund a load of failing states for decades ahead.  It would be the better of two evils.  The euro debt crisis puts in jeopardy the great vision of the capitalist leaders of Europe in the 1950 and 1960s that a united Europe could be created on the basis of a market economy that could challenge the economic and political power of the US and the then Soviet Union.

That vision was flawed because capitalism does not develop in a sustained and balanced way that would allow the weaker capitalist economies to integrate with the stronger gradually.  Instead, capitalism is subject to booms and slumps, regional imbalances and inequalities of income and wealth that disrupt convergence and drive the European states apart, not together.  The latest financial collapse and the ensuing Great Recession shows that.

There is another option to euro break-up: total fiscal union.  This is where the tax and spending policies of individual states are now decided by a Europe-wide government, in the same way that most of the taxes raised and spent in Scotland, Wales and the regions of England are decided by a national parliament in Westminster.  But that is probably a step too far for even the Greeks, let alone Italy or France.  And for the Germans, it means paying for Spain and Italy in the same way that Londoners pay for Cumbria or the North-East now.  Indeed, even within a nation state, capitalism’s imbalances and inequalities engender separatism; from Scotland wanting ‘independence to Londoners complaining about being taxed to finance the unemployed in Wales.

There is an alternative to these outcomes.  Socialist governments and labour organisations could come together in campaign to refuse to pay these onerous government debts to the banks.  The banks could be taken into public ownership and run as public services to provide loans to industry and households, while writing off their bond assets.  If all Eurozone governments were to do this, they could sustain a single currency in Europe – but it would mean establishing a predominantly planned economy that integrated further with Europe-wide investment, tax collection and spending.  

If some Conservative-led governments opposed such an alternative, as they would, the Eurozone would probably have to split anyway.  But at least those adopting a socialist alternative could combine to protect the living standards of the majority rather than the assets of their banks and the free market.
Of course, at the moment, it is completely unrealistic to expect current socialist governments in Europe to adopt such an alternative.  The socialists in Greece and Spain or likely future left governments in Italy, France or Germany see no alternative but the current ‘solution’ of fiscal austerity to pay down the debt to the banks.  So we have the prospect of a decade of fiscal austerity cutting living standards across a swathe of Europe or a new economic recession and inflation that would produce the same result.

We may be entering the final chapter in the story of the euro.  It’s just possible that the dire scenarios can be avoided, even on a free market capitalist basis.  Maybe the ECB and the EU leaders will agree to bail out countries for sufficient time until the weak European economies gain economic recovery and can start to pay down their debt.  Maybe the leaders will agree to issue Eurobonds backed by all the governments to service the debt of all in Europe.  And maybe financial markets may become convinced that these distressed governments can get their debt ‘under control’.  Then the euro experiment can survive to fight another day – probably only until the next global recession.  But the odds of the euro surviving in its present form are falling fast.