Home > crisis, The Economy > Eurozone Has A Crisis of Policy Failure, Not Debt

Eurozone Has A Crisis of Policy Failure, Not Debt

from Mark Weisbrot

Three months ago I wrote about the risks that the European authorities were posing to the U.S. economy and asked what the U.S. government was going to do about it. It was clear at that time that “the Troika” – the European Commission, European Central Bank (ECB), and the International Monetary Fund (IMF) – was once again playing a dangerous game of brinksmanship, at that time with the government of Greece. They were trying to force the Greek parliament to adopt measures that would further shrink the Greek economy and therefore make both their economic situation and their debt problem worse, while inflicting more pain on the Greek electorate.  The threat from the Troika was putting the whole European financial system at risk, since it raised the prospect of a chaotic, unilateral Greek default.

My hope was that someone in the U.S. Congress would step up to the plate and try to hold the U.S. Treasury Department accountable.  Treasury is still the overwhelmingly biggest power within the IMF – in fact it has dominated the Fund for the past six decades.  Since the IMF is one of the three key decision-makers in Europe, the U.S. government could at least use this avenue of influence to prevent them from making things worse there.  And since that crisis in June, the Troika has also played a similar game of chicken with Italy – a country with more than five times the sovereign debt of Greece.

Last week President Obama woke up to the fact that the Troika could pull the U.S. economy down the toilet along with Europe and sent Tim Geithner to crash the eurozone ministers’ meeting.  His job was to tell them to get their act together before their mess spreads across the Atlantic and costs Obama his re-election.  Yesterday Obama took the even more unusual step of making his criticisms public, saying that the crisis in Europe was “scaring the world” and that the European authorities had not acted quickly enough.

Yet there is no sign that the Administration is even using its influence within the IMF to avoid disaster.  One of the main triggers to the most recent financial turmoil was another fight between the IMF and Greece over a measly 8 billion euro loan disbursement.  The Fund – presumably with U.S. approval – has been threatening to hold up this money unless the Greek government implemented further budget tightening.  In the face of massive protests and Greek public opposition to further punishment, this intransigence by the IMF once again threatened to push Greece to a chaotic default.  That, in turn, could bring major European banks to insolvency and risk a full-blown financial crisis. And all because the Greek government couldn’t meet its budget targets for an 8 billion euro loan disbursement.

If that sounds incredibly irresponsible or even stupid, it gets worse. The reason that Greece cannot meet its budget targets is that the policies imposed by the Troika have succeeded in shrinking the Greek economy and therefore its tax base.  The IMF has repeatedly had to adjust downward its forecast for the Greek economy; it is now projecting a decline in GDP of five percent this year, as compared with a forecast of -3 percent just six months ago. When the first “bailout” package for Greece was negotiated in May of 2010, the country’s debt was about 115 percent of GDP; it is now projected to hit 189 percent of GDP next year.  Clearly the Troika’s policies have had the opposite effect of their stated intention.

Now the Fund has revised its projections for Italy downward as well, most likely because of the $65 billion budget tightening that the Italian government has agreed to in the last month.  This can set in motion a process similar to what has happened to Greece, where the economy slows and budget targets get more difficult to meet, and then interest rates on Italian bonds rise, increasing the government’s budget deficit.  Bondholders and speculators then sell or short the country’s bonds, driving interest rates up further and reducing the value of the bonds held by European banks.  A bond trader described the process from his own point of view on August 4:

“The SMP [ the ECB’s Securities Market Program] is back but it’s not in the right places, what’s going to stop us attacking Spain and Italy over the summer months, cause I can’t think of anything,” said a trader in London.

“There is no buying of Italy and Spain going on and there won’t be, so why can’t we push these markets to 7 percent yields, I think we can quite easily,” the trader said.

Of course this kind of unrestricted speculation is also part of the problem.  But in the first sentence the trader was describing what had opened up his opportunity at that moment: the ECB was threatening not to buy Italian bonds, in order to pressure the Italian parliament into more budget tightening.

The European authorities have the ability and the potential firepower to do whatever is necessary to resolve the crisis: restructure the Greek debt, end speculation against Italian and Spanish bonds by buying enough of them to push interest rates down, and committing to keep these rates down; and guarantee liquidity for the banking system. The U.S. government has repeatedly shown its willingness to provide dollars as necessary to prevent any foreign exchange crisis.

But most importantly, the European authorities have to reverse course and ditch the contractionary fiscal policies that are at the heart of the problem.

There are a number of technical fixes under discussion, including allowing the European Financial Stability Fund to leverage its resources by loaning to another entity that could issue bonds.  But the main point is that the ability to provide the necessary resources is there. The Fed has created more than two trillion dollars since our recession began, without any detectable impact on inflation here; the European Central Bank can do the same.  There is no risk of inflation getting out of control — in fact the IMF projects that inflation in the eurozone will fall from 2.5 percent this year to 1.5 percent next year.  If Angela Merkel is listening to her Free Democratic Party coalition partners’ bizarre rants about the threat of inflation, she needs to be thinking about another coalition.

The “European debt crisis” is misnamed; it is not so much a debt crisis as a crisis of policy failure. There are always alternatives to a decade without growth, trillions of dollars of lost output, and millions of unemployed that the European authorities are offering to the people of Spain, Portugal, Ireland, Greece and now Italy.  All that is lacking is the political will and competence to change course.

See article on original website

  1. merijnknibbe
    September 28, 2011 at 6:43 pm

    Give them a break…

    One of the problems of Greece was an indeed extremely large deficit on the current account (about 15% of GDP). This had to be fixed. The point – that is what’s happening, right now. There is no other EU country which manages to fix its deficit on the trade balance as fast as Greece, at the moment. During the first six months of 2011 nominal exports increased with 37% while nominal imports declined with 20% (trade balance). Again: no other country came even close to such a development: http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/6-16092011-AP/EN/6-16092011-AP-EN.PDF

    Even then, it gets an extremely bad press, while its in fact doing ‘better’ than anybody expected. http://www.voxeu.org/index.php?q=node/7033

    Yes, it still has a large deficit on the current account – but a country which in fact outperforms all other EU countries should get a chance. Fixing the current account will require years. They do have to get this time.

  2. September 28, 2011 at 11:17 pm

    Naturally, all of the above was destined from the beginning of fractional reserve banking with volatile Fiat Currency and no fixed values for fair & covenient exchange (for all). And, yse, it is a policy failure for sure, throughout the unFree world of the Plutonomy. There is a quick pilicy fix that Obama won’t use now: an emergency executive order declaring the whole fraud a fraud and abolishing the Fed, while at the same time instating the principles of the Kucinich/AMI American Monetary Reform Act. To jump start the process I suggest that all truly honorable, noble RWEs of integrity file a class action suit against Club Fed Inc. for abusing & defrauding us and the USA et al since the beginning of the conspiracy to wrongly enact it. I think we should ask for liquidated damages in an amount equal to the national debt. Our legal team should also ask the judge to award restitution & punitive damages equal to Club Fed’s share of the derivatives bubble (which is as doomed as the whole Ponzi Casino Economy Game anyway). Any right thinking American patriot would also demand that the DOJ arrest the suspects, freeze their assets, seize the books, start a full scale investigation & criminal prosecution for highest treason. In the interim, they could offer leniancy to Visa, MC, Amex, Discover and complicit small banks & credit unions for supporting the nonprofit Global Community Credit System and honoring its pure credit Trust Units (scrip awarded for positive contributions to humanity, culture, communities, & ecosystems). It will never work? You’ll never know if you fail to try. You want that on your conscience as you’re sucked into infinity with your last cowardly breath, on the way to your next miserably deluded life? No… I thought not. Better to have loved and lost and die a hero’s death than the billions of deaths of a treacherous coward. Why wouldn’t it work? As soon as he took office as President of China’s first, brand new democratic government, Gen. Chiang Kai Shek made currency trading a capital crime, punishable by summary execution. But, this is the USA and, as ol’ give ’em Hell Harry, Pres. Truman once said of the Fed, “Well, I’d have to say that it makes about as much sense as lettin’ the foxes run the hen house because they have lots of inside experience.” But, hey, just think, if it does work, your N-CE competitors go away with the other Perps, casi pronto. Sweet, well deserved revenge and justice, eh? A rare and precious treasure, right in the palms of your trembling hands. Let’s not waste it. OK? Demonocracy sucks, it doesn’t work, it’s been in breach of contract since the beginning, and it is time for a real change. Thanks, sincerely.

  3. Dave Taylor
    September 29, 2011 at 9:22 am

    Thanks for this, Michael. How delightfully articulate! I had thought myself that Merijn was missing the key point of Mark’s article, which itself was more concerned with a fix than addressing the problem:

    “My hope was that someone in the U.S. Congress would step up to the plate and try to hold the U.S. Treasury Department accountable. Treasury is still the overwhelmingly biggest power within the IMF – in fact it has dominated the Fund for the past six decades.” Since 1950!

    Would any honest American complain if the rest of the United Nations told the US (and UK?) to get lost and started a genuine Keynesian IMF, able to oversee and advise on restraining financial contagion by use of multi-level credit authorisation in which local currencies have only local scope? And surely traders and project managers – including governments only insofar as they are these – should be held responsible for and be able to justify their own use of credit and any inter-level trade? If that would restrict inter-level trade to what is necessary rather than what generates monetary imbalance, so be it: our world needs a rest. What it would do is permit local use of available people.

    What particularly gets up my nose is economists and media pundits proclaiming the “economy” needs to “grow” and “we” have to repay “sovereign debt” without ever defining, justifying and scoping their terms. Do they or anyone else know what they are talking about? If they do, are they … trying to pull the wool over our eyes?

  4. September 29, 2011 at 9:34 am

    By the way, as a humanistic Buddhist, I recommend some clemency for the convicted traitors (if they’re ever brought to justice for the Biggest Fraud in Modern History, i.e., Club Fed & Co.). Instead of a firing squad, thorough therapy and retraining (in nonparasitic occupations) should do well enough. That way, they could keep paying back some of what they stole. Also, it will be much more spiritually effective, more civilized & noble. As I think I mentioned in another comment, severe penalties could be administered to repeat offenders & incorrigible escapees, including banishment, branding, the removal of eyes, etc. (which could provide funds for restitution), but the main value would be deterrence. There’s nothing like awful punishments applied with real justice (in a mostly just culture with nontoxic money) to instill an abiding dread of committing capital crimes. Oh, in case it wasn’t obvious in my previous comment, spiritually & karmically, failing to counter evil deeds and massive injustice makes us accomplices. Fortunately, the universal Law of Karma is unbreakable and, since energy cannot be destroyed (only transformed or redirected) the quality, energy, momentum, and direction of our thoughts, words, and deeds determine the quality of our consequences, here and hereafter. That is why I recommend a strong focus on ethics and a heroic, high quality life, instead of the pitifully delusional existence of cowards (and the aftermath).

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