Euro calamity

by Michael Roberts

What a mess!  The Euro summit ended with the UK refusing to sign up to a fiscal austerity pact. The other EU leaders agreed to stick to a fiscal compact that means austerity for life for the 99% in Europe, in the hope that financial markets will be convinced that no Eurozone state would ever again default on its debt owed to the banks, as Greece has done.

But ‘markets’ remain unconvinced; partly because the pact will not be enshrined in any binding new treaty, but is only an agreement; and partly because Eurozone governments (in particular, Germany) refused to stump up any more real cash to fund the likes of Italy and Spain if it becomes too expensive for them to borrow from the banks, pension funds and insurance companies which hold all the government bonds.

The holders of government bonds were hoping that cash could be found to buy their bonds and pay for new ones through the European Central  Bank (ECB) being prepared to print euros.  But the ECB’s new president Mario Draghi, under pressure from the German Bundesbank, having hinted before the summit that he might be prepared to do just that, then categorically ruled it out at the monthly ECB meeting.  He cut interest rates and offered banks three-year unlimited loans, but he refused to consider buying government debt with printed euros.  So the euro governments were left with trying to convince the holders of their bonds that they could find extra cash by borrowing more through their emergency funding body, the EFSF, or by getting some more money from the IMF.  But the markets are not convinced that it is enough, or that even the new drastic proposals under the fiscal compact will work.

And boy, are they drastic!  The EU leaders (except the UK) agreed to insist that each government must run an annual ‘structural deficit’ of no more than 0.5% of GDP and achieve overall balanced budgets.  A structural deficit is as loose in definition as a pannacotta, but is supposedly calculated by taking out that part of government spending that changes with the cyclical ups and downs of economic growth.  So it is supposed to measure the ‘underlying’ balance between government revenues and spending.  Any government that fails to meet this target will be automatically subject to a fine equivalent to 0.2% of annual GDP (which presumably it would have to find from somewhere!) unless a ‘qualified majority’ (87%) of euro members agree to let them off.

Also, the Euro governments agreed that if their public sector debt ratios were above 60% of GDP, they must take steps to reduce it to that level over the next 20 years.  If you are Germany with a debt ratio of 87%, that’s about 1.3% of GDP reduction a year.  So, in addition to balancing the budget, the Germans have to find another 1.3% each year to get their debt down.  But for Italy, at 120% of GDP, it means finding another 3% a year until 2032!  As for Greece, it means (even after the default of 50% of their debt owned by the private sector) around 4% of GDP more a year until 2032!  This means a generation of fiscal austerity and massive privatisation of state assets. Mind boggling!  As the Financial Times put it: “Contrary to what is being reported, Ms Merkel is not proposing a fiscal union. She is proposing an austerity club, a stability pact on steroids. The goal is to enforce life-long austerity, with balanced budget rules enshrined in every national constitution. She also proposes automatic sanctions with a judicially administered regime of compliance”.

Now, of course, the UK famously did not sign up to this.  But this was not because the right-wing coalition government was opposed to fiscal austerity.  On the contrary, as we know, the British government is trying to impose a dire fiscal austerity programme of its own (see my post, The best laid plans of mice and George Osborne, 29 November 2011).  No, the Brits refused to sign up because the European leaders wanted, as part of their plans to ‘harmonise’ policy across the EU, new regulations to be imposed on risk-taking banks and to introduce a financial transactions tax on banks.  The UK rejected the EU deal because it wanted to protect the City of London and its huge banking sector from regulation and taxation, not to protect its people from government spending cuts and tax rises.  It is estimated that 35% of the revenues from any financial transactions tax would be paid by London’s banks and the British are worried that such a tax could mean a switch to other financial centres like New York or Switzerland to avoid the tax.

Actually, the Brits knew that such a European tax cannot be introduced without a unanimous vote, so they could have blocked it anyway.  But the Brits went further; they wanted to end the use of qualified majority voting in any of these financial and tax matters.  In that way, they hoped to block any further European measures against the City and its bankers.  That was a step too far for Germany’s Merkel and France’s Sarkozy and they refused to agree to a return to unanimous voting that would give the UK a veto because it would leave them without any power to force decisions on other EU members.  So British left the room.  This could well be the beginning of the end of the UK’s 40-year membership of the EU.  But I’ll return to the question of whether that would be good or bad news for British capitalism and its people in a future post.  For now, let’s continue with what all this means for the future of the euro, the Eurozone economies and their peoples.

This fiscal austerity pact is totally unworkable.  It is demanding that the Italian people smash to smithereens what is left of their welfare state, pensions, labour protection and state assets and increase taxes on the majority for a generation.   Already, the EU leaders have imposed ‘technocratic’ bankers as governments in Italy and Greece to try and implement this pact (see my post, Italy and Greece, rule by the bankers, 10 November 2011 ).  But it can’t work for long.  The fiscal compact is designed to ensure that governments ‘honour’ their debts to the bankers and other financial institutions.  If they don’t, the banks and pension funds would be bust.  It is also designed to shrink the size of the state and allow the private profit sector to expand without hindrance i.e. so the non-financial sector does not pay too much tax to meet state debts owed to the financial sector.  This circularity shows that sovereign debts and deficits do matter, contrary to the view of the Keynesians.

Public sector debt ratios and government budget deficits have exploded for just two reasons.  First, the global financial crash forced governments to bail out the banks everywhere.  And second, the ensuing Great Recession led to a collapse of tax revenues and a huge rise in government spending to help the unemployed and small businesses.   The cumulative deficit on government budgets from 2008 will have risen by 72% pts of GDP by the end of 2012 in Ireland, by 53% pts in Greece, by 32% pts for the OECD as an average and 22% pts in the Eurozone.  No wonder debts are up.
Cumulative government budget deficits as % of GDP 2008-12

The rise in government borrowing has been much higher in the UK, the US or Japan than in the Eurozone.  So why has the so-called ‘sovereign debt crisis’ been centred there?  The answer is partly found in the unique nature of the whole European project.  It started with a free trade area and customs union back in the 1950s and 1960s and then moved to the free movement of capital and labour in the European Community and European Union in the 1970s and 1980s, based on good capitalist ‘neoliberal’ principles of deregulation of markets and labour.  But trying to ‘harmonise’ markets and provide a ‘level playing field’ for competition only works between different nation states under capitalism if there is sufficient economic growth to allow the weaker capitalist economies in any union to grow alongside the stronger.  If all boats rise with the tide, everybody is happy.  But when there is no growth, then the weaker economies are exposed to the ruthless competition of the strong – and centrifugal forces start to predominate.

Capitalism has developed as a mode of production within the confines of nation states.  Multinationals need a national base; even they are not totally free to float above the world without jurisdiction.  And nation states with elected parliaments want to tax and impose rules on the capitalist firms.  So there is an inherent contradiction between nation state power and the world capitalist economic process, even though governments are mostly pro-capitalist.  This contradiction can be overcome (for long periods) if capitalist national economies have fast growth and it seems in the interest of each national government to cooperate somewhat (world trade, peace agreements, the EU).  That was the idea and aim of the European ‘project’: to end national conflict and wars between nations on the European continent after two devastating world wars.  And given that no one European country could be a world power any more (although the British ruling class still had illusions), it also aimed to put ‘Europe’ on the map with equal status alongside the US and the growing powers of the East.

But such supra-national development only works if all can grow.  And capitalism does not grow evenly.  It can be combined development, but it is also uneven.  And the EU’s growth has been very uneven.  The Eurozone project started in 1999 with one currency, one central bank and fiscal straitjackets.  That was supposed deliver ‘convergence’ on interest rates, inflation and growth.  This worked for a while during the 2000s when there was credit-fuelled expansion.  But the financial crash and the Great Recession have now exposed the uneven development.

Convergence gave way to divergence in the ability of each Eurozone state to compete.  That can be measured by the costs of capitalist production:  Germany just outperformed the likes of Greece, even though Greek workers put in the longest hours and were paid the lowest (see my post, Europe: default or devaluation, 16 November 2011).   Look at unit labour costs.  Germany’s hardly moved as wages were held down and productivity was high.  Greece’s rose 35% compared to Germany’s even though Greek productivity increased and labour toiled.
Unit labour costs index = 100, 1995 to date

If you can’t compete, then you lose market share.  And that is what has happened.  While Germany and the northern European states have built up significant surpluses on their business with the rest of the world, the likes of Greece, Portugal and Italy are running deficits.  That means not only that governments must borrow more, but also capitalist companies and banks in those countries must do so too.  The net foreign liabilities of the weaker Eurozone states is now up to 100% of GDP, while Germany and northern Europe are net creditors.  The south owes the north by increasing amounts.
Net international investment position as % of GDP (net foreign assets or liabilities)

Now the Eurozone faces a renewed economic recession in 2012 (or a continuation of the ‘long depression’, if you prefer) and yet the weak EU states are being asked by the strong to impose even greater fiscal hairshirts on their peoples to pay for their debts.  This is a recipe for an eventual break-up.  If the Germans and French are not prepared to recognise that these fiscal ‘convergence’ targets cannot be met or that the ECB will have to print money to find the cash to pay the bankers, then governments may be forced to default or be replaced by others who will.

It could even mean that the German leaders may eventually opt for dispensing with the euro as it is and go for a strong northern ‘super-euro’; or go their own way.  They and the French don’t want to do this yet, as it means the end of the European capitalist ‘project’.  But Euro imperialism may have to give way to nationalism, if the Germans don’t want to pay for it.  The British are heading out of the EU; many southern EU states may be forced out too.

Muddling through as an option is fast disappearing.  There are two capitalist solutions other than break-up.  The ECB may eventually agree to print money as the Federal Reserve and the Bank of England have done to back up their government debts.  Many left Keynesians are calling for this policy as the way out.  It can deliver respite for the Eurozone leaders for a while.  But it solves nothing longer term.  The Federal Reserve and the Bank of England have printed up to 15% of GDP in new money to fund government debt in their countries.  That has avoided a debt crisis but it has not brought back economic growth.  So-called quantitative easing (expanding the money supply rather than cutting the cost of money) has not turned economies around in this long depression.  The debts remain on the books either of the government or their central banks.  They can only be serviced by either accelerating inflation or by higher taxation.  Both ways mean lower living standards for the average household and weaker real GDP growth.

This Keynesian solution also stretches to the idea that the imbalances of international competition can be corrected.  If the Germans start to spend more money, the Keynesians propose, then the weaker capitalist economies can sell more.  The surpluses in Germany will fall and the deficits in the south will narrow.  But this is naive international financial engineering.  Will the Germans decide to run large budget deficits and run up their debts so that Greeks can sell more goods to them?

The weaker countries could just leave, devalue their new currencies and restore their external balances that way, say some.  But as I have explained in previous posts (Europe: default or devaluation?, op cit), “history has shown that devaluing a currency to gain competitive advantage does not deliver for long” - especially if everybody does it.

The other solution is to write off the debts by defaulting.  But this form of ‘deleveraging’ on its own means that the banking sector goes bust and more state aid is needed.  That merely shifts the debt back again, while a state takeover threatens the very existence of the private sector and future profitability.
There is an alternative socialist solution.  I have spelled that out in previous posts. It is to reverse austerity, negotiate an orderly default of government debts, launch a pan-European programme of state-led investment using publicly owned banks and strategic industries, with funds saved from not paying back the bankers.  We need to do away with undemocratic Eurozone structures and a bureaucratic overpaid European Commission dedicated to ‘free market neoliberal policies.  And we need a fully democratic European assembly with full powers to plan investment, taxation and employment aimed to benefit the majority.  Of course, this is not on any European summit agenda.