The following is the first of a 3 part serialized article by the same title that appears in the September 1, 2012 issue of ‘Z’ Magazine.
INTRODUCTORY COMMENTS: EUROPE’S ECONOMY IS IN RECESSION AND ITS BANKING SYSTEM CONTINUES TO STUMBLE TOWARD CRISIS. CHINA IS SLOWING RAPIDLY. JAPAN’S BRIEF POST-TSUNAMI RECONSTRUCTION SPENDING IS ENDING AND ITS EXPORTS DECLINING, AS IT WILL SOON ALSO ENTER ANOTHER RECESSION. ECONOMIES FROM INDIA TO BRAZIL ARE ALL FURTHER SLOW ING RAPIDLY HEADING TOWARD ZERO GROWTH.
GIVEN THIS SCENARIO, THE US ECONOMY CANNOT POSSIBLE EXPAND, REGARDLESS OF TALK ABOUT ‘FISCAL CLIFFS’. U.S. GDP REMAINS HOVERING AROUND 1%, A LEVEL UNHEARD OF IN RECENT MEMORY FOR AN ELECTION YEAR DURING WHICH ECONOMIC GROWTH TYPICALLY EXPERIENCES AT LEAST A MODEST BOOST INSTEAD OF A SLOWING.
ON THE HORIZON COME POST-NOVEMBER LOOMS THE LIKELY PROSPECT OF STILL MORE SPENDING CUTS, STILL MORE DECLINE IN CONSUMER HOUSEHOLDS’ REAL DISPOSABLE INCOME, AND CONTINUING SLUGGISH BANK LENDING AND BUSINESS INVESTING. THE SO-CALLED ‘FISCAL CLIFF’ IS A MIRAGE CONCOCTED BY CORPORATE INTERESTS TO JUSTIFY STILL MORE SOCIAL SPENDING CUTS TO PAY FOR STILL MORE BUSINESS AND INVESTOR TAX CUTS.
MIDDLE AMERICA HAS ALREADY SLID DOWN A GOOD PART OF THAT CLIFF SLOPE. ONLY BANKERS, INVESTORS, BIG CORPORATIONS, AND WEALTHIEST HOUSEHOLDS HAVE BEEN EXTENDED AN ECONOMIC RESCUE ROPE THE PAST FOUR YEARS. THEY’VE ALREADY CLIMBED BACK UP, LEAVING THE REST OF US PERCHED PRECARIOUSLY ON THE LEDGE. NEITHER ABLE TO CLIMB OUT AND TERRIFIED OF A STILL DEEPER FALL.
AS THE US APPROACHES ITS NOVEMBER ELECTION, THE MAJOR THEMES SHAPING UP AS BOTH PARTIES ENTER THEIR CONVENTION SEASON THE NEXT TWO WEEKS REDUCE TO ‘OBAMA’S ECONOMY’ VS. ‘ROMNEY THE INVESTMENT BANKER’S TAX RETURNS’.
WHICH THEME VOTERS IDENTIFY WITH COME NOVEMBER WILL DEPEND IN PART ON WHAT HAPPENS TO THE EUROZONE’S ECONOMY–THE WEAKEST LINK IN THE GLOBAL ECONOMIC LANDSCAPE AT PRESENT. THE FOLLOWING OFFERS THIS WRITER’S UNDERSTANDING OF THE RECENT EVENTS IN EUROPE AND THEIR SIGNIFICANCE FOR US ECONOMIC CONDITIONS in 2012-13:
What is the Eurozone and what does it mean to say it is in ‘crisis’? The Eurozone (EZ) is the collection of 17 european economies sharing a common currency, the ‘Euro’. The meaning of the term, crisis, does not refer to a condition that is simply serious or even severe. It means a condition in which the evolution of a problem has reached a depth of difficulty that represents a fundamental turning point. And so has the Eurozone today reached such a turning point—i.e. a bona fide ‘crisis’.
The major dimensions of the EZ crisis are threefold: Starting out as what is called a ‘sovereign debt crisis’, it has progressively evolved to a EZ-wide banking crisis. The sovereign debt-banking crisis in turn has been rapidly transmitting the past year into a region-wide deep recession throughout the rest of the non-banking and non-government sectors of the Eurozone economy as well. The Eurozone crisis is thus a simultaneous triple crisis, with each of the three elements increasingly feeding off of, and exacerbating, the other.
Current structures of government finance (taxing, spending, debt management), monetary and banking institutions and relations, and policies addressing the deepening recession have all largely failed to date. A fundamental change is therefore necessary if the EZ is to extricate itself from its triple crisis. Without such change, the EZ will continue to slide into still deeper total debt, experience eventually a classical banking crash, and drift into a more protracted recession that will draw in a still wider periphery of European economies. Britain has already been sucked into the economic vortex and is experiencing a double dip recession—as have or will other economies within the broader 27 country European Union. Similarly, the crisis in the EZ has already begun to negatively impact the rest of the global economy. It has affected the already slowing economies in the U.S., as well as China, India, Brazil and elsewhere. It is the main force in the global contraction of manufacturing underway since late 2011 which has been gaining momentum in 2012.
In short, the Eurozone crisis is the focal point and weak link today in a global economic crisis that did not end in 2009 with the temporary stabilization (not recovery) of the US economy following the banking crash of 2008. U.S. policies since 2009, moreover, have not cured the global economic cancer. They have only temporarily succeeded in suspending the US economy in a state of temporary economic remission. Furthermore, U.S. policies since 2009 have permitted the economic cancer to metastasize to Europe, where today it continues to grow.
Background to the Eurozone Crisis
With the eruption of economic problems in the ‘euro periphery’ economies (e.g. Greece, Portugal, Spain, Ireland, etc.) circa 2009-10, the EZ crisis was initially represented in the press largely as a sovereign debt crisis—i.e. where governments in the euro periphery—Greece, Portugal, Ireland, Spain, etc.—had taken on too much debt. Economies in the euro periphery were thus experiencing a ‘Sovereign debt crisis’ due to their inability to repay principal and interest on prior incurred debt that grew too large and/or too expensive to repay in full and/or on time out of normal government income flows—i.e. from government tax revenue receipts.
But behind the appearance of the sovereign debt crisis has always been a maturing banking crisis—awareness of which only coming to the fore in the press over the past year as a result of a series of banking sector events that will be described shortly. The banking crisis has therefore always been a mirror reflection of the sovereign debt crisis. It is the flip side of the coin of the sovereign debt problem.
In order to avoid default on their debt—i.e. avoid failure to pay in full and on time—Euro periphery governments since 2009 have chosen to respond with the following policy alternatives: (1) borrow more debt to meet payments on the old debt; (2) restructure the old debt (reduce principal levels, change terms of payment, etc.) to enable existing tax revenues to cover debt payments in the future; or (3) introduce ‘austerity’ measures to supplement inadequate tax revenues. Austerity measures include raising taxes, reducing government spending, and selling off government (national) assets and properties. Austerity measures are designed in theory to raise governments’ income in order to help make interest debt payments coming due. In practice, all three alternatives tend to occur simultaneously for a government facing default on debt payments.
Lenders who would issue additional loans to a sovereign government unable to make its debt payments insist the sovereign, in order to make debt payments in the future, raise sufficient government cash flow by reducing government spending, raising taxes, or by selling off public assets (i.e. austerity). Similarly for those lenders who would, instead of issuing new additional loans, restructure existing debt that hasn’t been paid. Raising government cash flow by means of austerity is thus accompanied by reducing some debt principal and/or by changing terms of repayment to something less onerous for the borrower (the periphery government). In practice, some combination of additional loans and debt restructuring typically occurs, combined with some mix of the three forms of austerity policies (i.e. government spending cuts, tax hikes, government property sales).
What the foregoing scenarios all describe, however, is that debt is always a two-way street. It takes two to dance a sovereign debt tango—i.e. a borrower (sovereign government) and a lender. So who are the lenders who issue the credit and loans to sovereign borrowers that become the sovereign debt? First and foremost, it is Eurozone banks, and specifically the northern European ‘core’ banks, that loan to the periphery governments.
Bank to peripheral government lending may be direct, but most often occurs jointly with core banks participating with banks in the periphery economies. But government debt is not just composed of direct bank to government loans. When the sovereign debt crisis appreciably worsens, other Eurozone governments also loan to those periphery governments accumulating debt. This government to government lending occurs to ensure ‘their’ northern core banks continue to get paid on their prior loans to the periphery governments. So debt may be government to government in origin, as well as bank to government.
As government debt repayment difficulties deteriorate still further, at some point core government lenders decide it is better to ‘amortize’ the need for further loans to indebted periphery governments. At that point pan-Eurozone rescue funds are created to further provide loans for purposes of sovereign debt refinancing. In the case of the EZ there are two supranational bailout funds: the European Financial Stability Fund (EFSF) and the still not yet formally or fully approved European Stability Mechanism (ESM) designed to supplement the EFSF. The EFSF and ESM together have mustered about $1 trillion for sovereign debt rescues—an amount that is totally inadequate today for the deepening Eurozone periphery Sovereign Debt crisis.
The IMF is a third possible government debt bailout fund. However, its committing of loans to rescue periphery sovereign governments requires the agreement of its other international participants, like China, Brazil and others. Unable to obtain that agreement, the IMF has proven reluctant to date to provide much lending to the Euro periphery. It remains largely on the sidelines.
There is yet a potential ‘fourth source’ of government debt bail out funding. That’s the European Central Bank (ECB). It’s ‘rescue funding’ is potentially limitless, and could be applied theoretically both to sovereigns and to private banks. But the broader European Union Treaty prohibits the ECB from providing financing to periphery or other euro governments with debt problems. Nevertheless, the ECB found a way around the prohibition in 2010 and again in 2011 when the Euro government debt crisis rapidly deteriorated. But it did so only modestly, to the tune of buying only a couple hundred billion euros of the estimated trillions of euro outstanding government debt, and furthermore did so in the face of stiff German resistance to such direct government bond buying.
The sovereign debt crisis picture is one in which the cumulative government debt amounts to several trillions of dollars, but the funds from which governments in the periphery (and increasingly elsewhere in the Eurozone) amount to only somewhere between $500 billion to $1 trillion at most. The IMF as a bailout source remains on the sidelines by choice. And a political battle continues to rage over, and to what extent, national governments in the ‘core’ north and their national central banks will allow the ECB to usurp their roles as lenders to governments. Were the latter to occur, investors in national government bonds, like the German Bunds, would experience significant losses on their already issue bonds.
The preceding provides possible means by which both peripheral sovereign governments (Greece, Spain, etc.) could theoretically be ‘rescued’, or bailed out, in the event of a further deterioration of their debt and subsequent defaults and some of the problems and political obstacles preventing that from actually happening. But it doesn’t explain how that excess sovereign became a problem in the first place. Nor how that sovereign debt is part of an even larger, more potentially disrupting, private sector banking debt and crisis.
Origins of the Eurozone Crisis
The EZ crisis has its roots in the creation of the Euro as a common currency in 1999, at a time of concurrent, expanding global financial speculation.
The introduction of the common currency, the Euro, made possible a massive increase in trade and money flows between the EZ northern ‘core’ and periphery economies. More trade in the form of more purchases by the euro periphery of goods and services produced in the northern core economies (France, Germany, Netherlands, etc.) meant more profits for businesses and banks in the ‘core’ north. So northern banks were more than eager to lend to the periphery economies. Sometimes the lending went directly to businesses in the periphery. Sometimes to periphery banks and/or branches of northern banks established in the periphery. And sometimes to northern core non-bank businesses relocating to the periphery economies—much like US businesses in the northern industrial states relocated to the south and southwest in the 1970s-1980s. Money flowed from the north to the periphery, especially its southern, Mediterranean tier. GDP and income consequently rose in the periphery, especially its southern Mediterranean tier. Periphery consumers, businesses and governments then purchased more goods and services from the northern core economies; or from businesses that relocated from the north. The lending to the periphery thus came back to the core in the form of purchases of internal ‘imports’ from the north. Germany was a particular beneficiary of this arrangement. Its banks’ lending to the periphery, and its non-bank businesses relocating to the periphery in part, resulted in a major expansion of intra-Eurozone purchases of German goods and services. German banks and businesses thus prospered significantly.
Rising GDP laid the basis in the periphery economies for a real estate boom and bubble. Even more money capital flowed from banks in the north to the periphery. Heavily involved in this lending flow were French banks such as Credit Agricole and Societe General, UK banks, German Commerzbank, and others. Combined with a global shift toward financial speculation in mortgage bonds and real estate related derivatives, the real estate boom created a housing-construction bubble not unlike that which was occurring simultaneously in the USA at the same time. Still more money flowed into investments in the periphery, especially in real estate and financial speculation based on it. Meanwhile, with GDP and income rising, peripheral economy governments appeared able to afford to borrow more as well. Booming real estate required infrastructure development in the periphery. Government would borrow to finance that infrastructure. Peripheral governments further borrowed to expand social services and transfer payments to those segments of its population not directly benefiting from the investment, real estate, and financial speculation booms. Money capital flowed south and outward to the periphery to accommodate housing, infrastructure, general business, and financial speculative investing in ever larger magnitudes. Housing booms occurred not only in Spain but in Ireland and even far off economies like Latvia.
Banks in the peripheral economies, like Spain, may have done much of the direct lending to finance the local Spanish real estate bubble, and to pump ever larger amounts of loans to local governments for infrastructure and real estate expansion—but the money for such originated in loans by northern core banks to the Spanish banks or else from the national Spanish government’s budget, the latter of which became also increasingly dependent itself on loans from the north. So northern capital flowed into local real estate, local banks, local and even national governments in the periphery. The north was more than willing to do so, since rising economies and prices in the periphery meant ever greater profits in turn for northern banks and northern businesses.
This scenario raises the question: was the build up of excess debt in the periphery—bank and government debt—a result of excessive borrowing by the periphery or the result of excessive lending by the core north? Was behavior by the periphery at fault for the debt run-up? Who benefited? Clearly, the northern ‘core’ banks and businesses that lent money and/or sold their goods in ‘internal exports’ to the south and periphery. Perhaps even more than the periphery-south so if an appropriate accounting is undertaken. It’s like saying the subprime mortgage crisis in the US was due to homeowners who took on such mortgages they couldn’t afford. As if the banks and lenders of subprimes had nothing to do with the bubble that burst in 2007, dragging the rest of the highly connected network of bank credit and speculative interlocks with it.
Despite the fact that the northern European core banks and government ‘lenders’ were just as responsible as the peripheral-southern tier economies’ governments and ‘borrowers’, the Eurozone crisis was framed initially in terms of a peripheral (and especially southern tier) ‘sovereign debt crisis’. The role of core northern banks in it all was barely mentioned. It was all due to bad government practices and not bad banking practices—i.e. a line of argument that in essence serves to absolve the banking system from its responsibility in creating the debt crisis in the first place.
When the global housing bust occurred in 2008-09 it had the effect in the EZ of collapsing housing and commercial property assets there as well as in the US. The real estate bust meant losses by banks, both local banks and those in the northern core banks that had loaned to the periphery banks. Recessions that typically set in following such financial busts reduced both general business revenues as well as government revenues, especially local governments. More loans were subsequently needed to cover losses, both to local banks, businesses, and governments. National governments borrowed more, growing national debt as GDP declined. By 2010 EZ wide government borrowing ‘rescue funds’—like the EFSF—were created to accommodate the greater volume of loan refinancing needed. Austerity programs were introduced as conditions of the further lending. Austerity reduced government revenues, requiring still more emergency loans and more government debt. A vicious cycle set in: recession causing less tax revenues, requiring more loans from core governments and funds, accompanied by more austerity that deepened and prolong recession, resulting in still less tax revenues, and so on. This scenario is just what in fact happened in the case of Greece over the course of 2009-10, when its ‘debt crisis’ erupted publicly in the spring of 2010.
PART 2: EVOLUTION OF THE EUROZONE CRISIS FROM 2010 to Spring 2012 (to follow)