Think of the european nations as a herd of bison pursued by a pack of wolves. For long periods nothing seems to happen. Until, one of the bison gets separated from the herd and the wolves descend in a lightning coordinated assault. However, if the herd regroups and charges, the wolves have no chance and will back off again.
I’m grateful to Frozen Planet for this imagery, which isn’t exactly how financial markets work, but is helpful in explaining the political dimension of the sovereign debt crisis. The point is that the nations always have strength in numbers. The markets, which have been picking eurozone nations off one by one, can only do so as long as governments don’t unite against them. Politics trumps economics
The trouble is that the euro bison, instead of charging the wolves, are wandering around the tundra, nibbling the grass, butting heads and generally failing to get their act together. This is because there’s a failure of leadership: there is no dominant bison to call the others into line and charge the markets. Well, actually there is dominant bison – Germany – but for understandable historical reasons, Germany is reluctant to tell the rest of the herd what to do. A German dominated superstate is a very frightening prospect for countries, like France, who spent half of the 20th Century fighting them.
If the eurozone had a central authority, a proper central bank, or an institution like the Federal Reserve in America, the markets would be losers and would have to seek kills elsewhere – the cost of borrowing in Italy would be the same as in Germany because the Italian bonds would be european bonds, backed by the combined might of greatest economic force on the planet – the European Union. What is happening now is that the markets are testing highly indebted countries like Greece and Italy and the rest of the herd is leaving them dangerously exposed.
Last week, the cost of servicing Italy’s debts rose above 7% briefly. This is the tipping point beyond which governments cease to be solvent, ie able to pay their debts. Italy has to “roll over” or refinance e300bn of its e1.9 trillion debt next year, and if rates go higher, then the interest on the debt will gobble up most of the nation’s tax revenues. That’s exactly what happened in Greece.
Of course, you could say, and some do, that there wouldn’t be any debt crisis if the european governments hadn’t borrowed so much money from the financial markets in the first place. Britain alone blew over £1 trillion on the bank rescue – according to the Bank of England. In a sense they had little choice, faced with the 2008 financial crisis, but to borrow more to stave off a depression, though there was no justification for simply handing this to the banks without any guarantees that it would be re-invested. It didn’t help that Britain’s borrowings had increased during Gordon Brown’s boom years, when the government should have been paying down debt. But Gordon Brown had persuaded himself that, because he had ‘abolished boom and bust’, the debt would never have to be paid.
All Western governments suffered from this delusion, fostered by the Wall Street investment banks, that debt was an asset not a liability. Banks, like Goldman Sachs actually helped the Greek government to disguise its true debts by using sophisticated financial instruments called currency “swaps”. This allowed Greece to borrow at very low interest rates, even though the government had largely given up collecting taxes. But in the crazy sub-prime Noughties, anything seemed possible with financial engineering.
This delusion has now been shattered, which is why this present crisis is so dangerous and why financial analysts and even the business secretary Vince Cable, are talking about financial “armageddon”. A desperate pessimism has gripped the international financial sector. Just as with sub-prime mortgages, suddenly no one knows what sovereign debt is worth. Banks throughout Europe are sitting on hundreds of billions of Italian, Greek and Spanish bonds, which are worth a lot less than they paid for them. It’s like negative equity, banking style. They can’t afford to sell because they can’t afford to admit the losses.The banks are now becoming afraid of lending to each other because they are afraid many may not be able to repay.
This is exactly what happened when Lehman Brothers collapsed in 2008. The shock waves spread across the entire planet and plunged the world into recession. British banks had to be nationalised. The governments of the G20 launched a coordinated fiscal expansion – spent lots of money they didn’t have – to stave off an economic depression. That worked, but it boosted government debt. We are now approaching another “Lehman moment”, but governments have spent all the money they didn’t have and can’t borrow much more. As the economies of Europe slip into another recssion, there is a black hole opening up beneath the entire capitalist world.
Oh, and don’t think that because Britain has not adopted the euro that we are not going to fall into the same hole. Half of British exports go to Europe, so a recession there works back on us. British banks have huge investments in Italian, Greek, Irish sovereign debt, and if there is a default, many will go bust, causing another wave of financial distress and possibly a run on the banks as depositors rush to take out their savings. We have a sovereign debt problem too – a deficit, which is not far short of Greek levels. The government bought time by its austerity cuts, devaluing the currency and boosting inflation. But the austerity has stifled growth, and without economic growth, debt can’t be serviced. This is why the chancellor George Osborne has been so keen to promote the very European integration, “fiscal union” as it’s called, that the Tories have always been against.
It’s really hard to see a way out of this. Business is calling for a 50p cut in top tax, as a stimulus, which as well as being morally objectionable is economically illiterate. Rich people don’t spend money in the shops but save it or speculate with it. Far better to give the money to lower income households who will spend in the hight street. The idea of a cut in VAT might help, like the car “scrappage” scheme in 2009 which boosted some economic actitivity.But matters have gone too far for fiscal tweaks.
It’s as if everyone is going bust all at once: governments, big banks, families (British households owe 1.5 times annual earnings). Everything is interlinked; everyone is saddled with huge debts built up during the credit boom. Governments are making austerity cuts which is destroying economic growth. There is an acute danger that this will end in hyper-inflation as desperate governments resort to printing money.
The only hope is that they remember the bison. If the big beasts get together, they can sort this out. It will probably mean all of Europe’s banks being nationalised, an orderly run down of debt, a central european government, a huge economic growth strategy, a new international reserve currency, and a financial transactions tax to pay for future bank bailouts. It’s a big ask. . But it can be done – just as it was in World War 11, after the Great Depression. Only this time, hopefully, without millions having to die.