I’m off on a short holiday, but there will be no vacation for the euro this summer. Europe’s political leaders might have thought that their ‘agreement’ at the Euro summit at the end of June might give them some respite from ‘speculative attacks’ on the government bonds of Spain and Italy. But no such luck. The interest-rate demands by potential investors in these government b0nds has rocketed to new records i.e. around 7.5% on Spanish ten-year bonds compared to just 4% before the crisis began. And the euro has weakened to a two-year low against the dollar and the pound. Every day it is getting more expensive for the Spanish government to service its debt.
A crisis is brewing for the Spanish government that could well explode within the next few weeks. Spain’s economy is slipping deeper into recession, with the latest real GDP data showing an accelerating annualised decline of 1.6%. Spain’s 17 autonomous regional governments that are responsible for important public services like education and health are increasingly owning up to being bust. Both Valencia and Murcia have asked for a central government bailout. Others will follow. This is increasing the budget deficit and the debt level for the central government. Whereas Spain’s public debt ratio was under 60% in 2010, by the end of this year it will be 90% and that does not account for a lot of hidden debt that takes the contingent liabilities for the Spanish taxpayer to over 100% of GDP.
Given a contracting economy, that debt level cannot be contained, however much the government tries to impose an austerity programme on its people. The Conservative government, along with the all regional governments that it also controls, is trying to apply a massive austerity package of €67bn over the next three years designed to meet the fiscal targets set by the Euro leaders. They have demanded such targets in return for agreeing to lend Spain €100bn to bail out its banks. Many Spanish banks, particularly, the smaller regional savings banks, are bust because they lent so much to local real estate agents and households to support the housing bubble that exploded across Spain in the last decade.
This credit bubble also led to outright corruption in the banks. The management of Bankia, former executives of the IMF, are now under investigation for cronyism and covering up the accounts. The same thing happened in the Irish real estate bubble, where the leading mortgage bank, Anglo-Irish, went bust, leaving the taxpayer to pick up the pieces to the tune of 25% of GDP with public funding used to bail out all the bank’s bondholders at 100%! The chairman of Anglo-Irish has now been arrested for corruption and fraud.
The austerity measures won’t work in achieving the fiscal targets, even if the Spanish government can manage to impose them on the people. The cuts to public spending and the hikes in all forms of taxation (except corporate taxes, of course, that are being reduced to support the profitability of the capitalist sector) are destroying household spending, while the capitalist sector goes on an investment strike and tries to shift its profits abroad. The flow of cash being withdrawn from Spain by its corporations and foreign investors has become a river. The graph below shows the net outflow of private capital from Spain (blue line) and the consequent rise in ECB lending to cover the loss (Target-2, it’s called – red line). The Spanish economy is being drained of capital.
Spain’s economy minister, Luis de Guindos, met German Finance Minister, Wolfgang Schäuble, to plead with him to provide more support for Spain, but without further draconian fiscal strings attached. Guindos wants to avoid a full bailout package controlled by the dreaded Troika of the ECB, the EU Commission and the IMF. The Germans are playing tough, but they do so at the risk of Spain and Italy slipping into the abyss that Greece is already in. At best, Spain has until October when a massive debt repayment of €28bn must be made. At worst, things could come to a head within a month.
There is a temporary way out. The government has stopped paying its bills to creditors (hospitals and schools have stopped paying for services). So cash has built up in the government coffers to the tune of about €40bn. This could be used to pay back bond holders for the rest of the year. And the ECB could also step in and buy Spanish government bonds to relieve the pressure. But these tricks would only be a temporary sticking plaster and no solution longer term.
Spain faces a future that is already a reality in Greece. The narrow victory for the pro-bailout parties in Greece in June has solved nothing. On the contrary, the three party leaders in the coalition have bickered over how to find €11.5bn in further austerity measures without hurting the Greek people any more. The answer from these leaders has been at sixes and sevens. They say there will be no cuts in 2012 (arguing they can be piled up into the 2013 budget) and yet the dreaded Troika has arrived in Athens demanding that they be found, even though the government has not even decided where to make the cuts. They are talking about slashing pensions yet again.
The pro-business Greek PM Samaras has been trying to speed up the sell-off of Greek public sector assets as his solution. Yet his privatisation commissioner has resigned because of the lack of progress. Previous fiscal targets set by the Troika have not been met and won’t be. Indeed, it is now clear that the Troika will eventually have to put it to the Eurozone leaders that Greece needs yet another a bailout package of €60bn along with even more fiscal tightening to take it through to 2015.
Will the Germans be willing to cough up yet again and will the Greek people be prepared to take yet another hit? They are already being asked to swallow a reduction in the government deficit of 10% of GDP deficit in 2010 to an expected 5.5% surplus in 2014. This is an unprecedented ‘cold turkey’ cure and it won’t work. More likely is that Greece will be forced to default, after all, or funding will be cut off before the year is out. The Troika is supposed to recommend the payment of another €31.5bn in funding in September to keep Greece going – it may not happen.
Samaras has now declared that Greece is in a Great Depression like the 1930s.
Samaras won the June election narrowly by promising that he could renegotiate the terms of the bailout package to make it easier for Greeks to meet its terms. But his government has dismally failed to get any concessions whatsoever from the Euro leaders. Germany and other important international creditors are not prepared to extend further loans to Greece beyond what has already been agreed. The IMF has signalled it won’t take part in any additional financing for Greece. And Germany’s Merkel already has difficulty uniting her centre-right coalition behind recent bailout decisions in parliamentary votes and so would be unwilling to risk a rebellion in another rescue for Greece. German Vice Chancellor Philipp Roesler said: “What’s emerging is that Greece will probably not be able to fulfil its conditions. But if Greece doesn’t fulfil those conditions, then there can be no more payments.”
The reality is that Greece was and is a very weak capitalist economy run by one of the most inept and corrupt capitalist class anywhere. Its people work the longest hours in Europe and have raised productivity considerably since joining the EU and the Eurozone (see my post, Europe: default or devaluation, 16 November 2011). But big business and the political elite in Greece have squandered the value created by their workforce, by taking it abroad or engaging in conspicuous tax-avoiding consumption. The World Bank ranks Greece at 100th (just ahead of Papua New Guinea) in the list of ease of doing business. It’s easier to do business in the Republic of Yemen than in Greece. It takes 77 days (and probably a few bribes) for a business to turn on electric service; in Germany, it takes 17 days. Greece ranks 70th on the most recent press freedom index, behind Bhutan and ahead of Nicaragua. Only one in ten Greeks think there are enough corruption prosecutions or strong enough punishments for financial offences. During the crisis, Greece’s governing elites have not dealt with corruption but instead imposed austerity on their people, mainly by destroying their pensions and public services.
I have discussed before how this euro crisis will turn out (The euro end game?, 5 June 2012). On a capitalist basis, there are two possibilities. The first is that the Germans and the other solvent Eurozone states agree to boost the transfer of funds to the likes of Greece, Spain and Italy. Currently, they are pledged to about €500bn and have about €200bn left. They need to pledge at least €1trn, or around 10% of Eurozone GDP. This would be enough to cover government borrowing needs for the three countries over the next three years. But it means doubling the fiscal commitment and potential exposure for Germany and the other Northern European states to defaults and losses. Longer term, the Euro leaders will have to introduce permanent mechanisms for full banking and fiscal union, like the federal US or Australia, or the centralised UK, where a deficit on government spending or in private transactions between say, Wales and London, or New York and Mississippi, are just settled by federal fiscal and monetary transfers.
In Florida, Arizona, and Nevada, automatic fiscal stabilisers – lower tax liabilities to the federal government and increased receipts of transfers, including unemployment insurance, food stamps, Medicaid payments, and welfare – operate. The effect of these automatic stabilisers is typically to offset as much as 40 cents of every $1 decline in state GDP. The net fiscal transfer from the federal government to Florida, Arizona, and Nevada during the worst of the recession may have amounted to 5% or more of their GDP. Nothing of comparable magnitude exists within the Eurozone (see http://www.voxeu.org/article/club-med-and-sun-belt-lessons-adjustment-within-monetary-union).
And the crisis in the Eurozone is worse because of the linking of sovereign risk and banking risk, which is partly the result of large holdings by banks of bonds issued by their national authorities. Unlike the Eurozone, US states do not have to bear the cost of restructuring their banks and can rely instead on federal vehicles. The persistence of crisis in Greece, Ireland, and Spain is less to do with the so-called ‘inflexibility’ of labour markets and more to do with the lack of a fiscal union, the absence of counter-cyclical transfers and the link between sovereign risk and banking risk.
Not that US fiscal union has solved the imbalances of income and wealth between US states – it has not. But the lack of fiscal union in the Eurozone exacerbates the crisis that began with the failure of capitalist production across the developed economies. Also, the relatively new Eurozone has a very large gap in costs between Germany and the European periphery – as much as a 25% difference – while nothing of comparable magnitude exists within the US. For example, between 2003 and 2011, the mean hourly wage in Florida, Arizona, and Nevada remained about 10% less than the US average and consumer prices diverged little as well. So the crisis has been more protracted and painful for Greece and Spain, even had they been able to rely on a more supportive federal system.
It remains to be seen which way the Franco-German leadership want to go: to find more credit for Spain and Greece, or not. If they cough up more cash in the next few months, it will mean extra costs for Germany and a very weak euro for years (although that will help exports). But the alternative of a euro break-up is also very expensive. I have made an estimate of the cost of a total euro breakup for each country relative to their GDP. It ain’t pretty for Germany – and even worse for Greece.
Defaults on loans made to Greece or Spain would hit German pockets directly through their banks and government finances. And if Italy, Spain etc reverted to their own national currencies and devalued heavily, then their exporters could start to take market share from German suppliers and thus hit German GDP growth, much dependent on exports. Of course, devaluation would mean that many corporations in Spain and Italy will default on their euro debts, causing wide scale business disruption and a huge jump in unemployment from already high levels. On balance, it would be marginally worse for Italian or Spanish capitalist sector to leave the euro than it would to stay in and suffer austerity. Either way, it is hugely painful for the average household.
There is the socialist alternative that I have also outlined in previous posts (An alternative programme for Europe, 11 September 2011). This is the adoption of a Europe-wide policy by governments through a fully publicly-owned European banking sector aimed at supplying credit for businesses and households. Debts run up by governments to bail out these would be written off at the expense of bondholders (i.e mostly banks and hedge funds). A pan-European plan for investment, employment and growth based on an expanded public sector would be drawn up. Of course, this alternative is not possible while there are no governments in Europe willing to back it and instead are committed to preserving the rule of capital in the Eurozone. So we must await the decisions of the French and German elites to cough up more money or not and/or the reaction of the Spanish, Italian and Greek people to the prospect of more austerity. This is no holiday.