Eurozone endgame

The following is taken from the October edition of Socialism Today issue 152


After a year and a half, the Greek debt crisis is far from resolved. In fact, with Greece on the verge of a social explosion, a default and exit from the euro appears almost inevitable. The eurozone is threatened by an interlocking sovereign debt and banking crisis, compounded by near-zero growth. Capitalist leaders are in complete disarray. Competing national interests are a barrier to cooperative measures. LYNN WALSH analyses the latest twists and turns of the eurozone crisis.

ON 21 JULY, the eurozone leaders proclaimed at their summit that they had agreed on a package to stabilise the Greek debt crisis. This, they claimed, would avert the threat of a Greek default and precipitous exit from the euro. There would be a further €109 billion (following the 2010 €110bn package), while the role of the European Financial Stability Facility (EFSF – with proposed €440bn funds) would be extended to allow intervention to support governments and banks. There would, moreover, be a bond exchange that would involve a 21% ‘haircut’ for the holders of Greek bonds.

This package, however, was more a promise of future salvation than an immediate, practical solution. The whole deal is dependent on the approval of the 17 eurozone governments or parliaments, and this is not likely to happen until the end of September or the beginning of October. The 20% ‘haircut’ for Greek bonds will provide very minimal debt relief for the Greek government – Greek government bonds are already trading at less than 50% of their nominal value on the secondary bond markets. If the bond exchange goes through (it requires the agreement of 90% of the bondholders) it will be a good deal for the banks and a raw deal for the Greek people. In fact, it would require a ‘haircut’ of at least 50-60% to make any real difference to the debt mountain weighing down the Greek economy.

There is no guarantee whatsoever that all 17 governments will agree on an increase in the funds available to the EFSF or to increased powers of intervention. The eurozone leaders are reportedly arguing in tense, behind the scenes negotiations about where the EFSF funds will come from. Some leaders are proposing that they would mainly come from the European Central Bank (ECB). This would be, in effect, another form of ‘quantitative easing’, printing money in order to bail out governments and banks through the EFSF. This is strongly opposed both from within the ECB and by a number of governments, such as Germany and Netherlands, who see it as a road to escalating inflation. Regarding the €109 billion loans package, the government of Finland is demanding collateral (security) for its share of the loan. Other governments, such as Slovakia and Austria, are likely to make similar demands. These governments are demanding that a slice of government revenue or physical assets, such as land or buildings, should be allocated to them as security. This is reminiscent of the demands for reparations made on Germany after the first world war.

The wrangle over this new package demonstrates once again the way national interests stand in the way of common agreement. The 17-strong eurozone is an alliance of national states, not a confederation with a unified governing body.

Soon after the July summit, moreover, there were precipitous falls in the shares of major French banks, reflecting fears about the repercussions of a Greek default. At the same time, European banks were finding it increasingly difficult to borrow dollars from US banks to finance their current business. The ECB, which under Jean-Claude Trichet had been extremely reluctant to intervene, was forced to step in to offer unlimited dollar loans to eurozone banks. The ECB also started buying the bonds of the Italian and Spanish governments in order to prevent a precipitous rise in the borrowing costs of Italy and Spain.

Meanwhile, growth in all the major eurozone economies slowed to near zero, indicating a renewal of the recession that began at the end of 2007. The British economy also slipped into stagnation. This renewed slowdown is partly the result of fears about a sovereign debt meltdown and banking crisis, but more especially the result of austerity measures that have cut demand and reinforced the spiral of weak demand, falling investment, and rising unemployment. This in turn reduces government tax revenues, and actually leads to bigger deficits.

Piling the pressure on Greece

AT THE EUROZONE summit on 17 September, the troika – the European Council, International Monetary Fund (IMF) and ECB – who police the austerity measures imposed on Greece, postponed payment of the latest €8 billion loan due under the 2010 package on the grounds that Greece has not carried out sufficient cuts in state employment, spending, etc. Georgios Papandreou, the Greek prime minister, duly scurried back to Athens in order to carry out the troika’s orders.

The package of additional austerity measures includes a property tax, together with more public-sector job losses – on top of the plan to sack around 150,000 civil servants (20% of the total) by 2014 – and draconian wage cuts. If implemented, the accumulated measures will mean an economic and social catastrophe. The troika is "holding a knife to the throat of the Greek government", as one Greek minister put it, partly to enforce deeper and more rapid cuts and partly as a warning to other governments like Portugal and Ireland to keep to their austerity packages. This is a very dangerous game, however, and could detonate a political explosion in Greece, propelling the country towards default and exit from the euro.

Economically, there is no way these measures will provide a way out of the ever deepening slump. In fact, further austerity measures will only push the Greek economy even deeper into slump, pushing up the outstanding debt and making it even harder for Greece to pay it off. After falling 4.5% last year, GDP will fall by at least 5% this year (second-quarter growth was 7.3% down over last year). Unemployment is officially 16%, but more realistically is over 20% nationally (with over 900,000 unemployed). The northern region of western Macedonia, where an estimated 20% of small businesses have shut down during the recession, has an official unemployment rate of 22%. Health, education and other public services are collapsing. There is a process of social disintegration.

Angela Merkel and other eurozone leaders have repeatedly denied that they are seeking to provoke a default on Greece’s debt or force Greece out of the eurozone. Other leaders, however, appear to contradict this line. For instance, Wolfgang Schäuble, the German finance minister, has threatened that if Greece does not meet the conditions set by the troika, payments will stop (regardless of the fact that Greece urgently needs cash to pay its bills and refinance debts in October). "Then Greece has to see how it gets access to financial markets without help from the eurozone", said Schäuble. "That’s Greece’s problem".

The Netherlands prime minister, Mark Rutte, went even further: "Countries which are not prepared to be placed under administratorship can choose to use the possibility to leave the eurozone". (International Herald Tribune, 9 September)

It may be that some of the eurozone leaders are bluffing, and their statements are intended to maximise the austerity measures implemented in Greece. However, they are playing an extremely dangerous game. Christine Lagarde, the head of the IMF, has recently warned about the rise of social tensions as a result of austerity measures. Massive strikes, demonstrations and other protests have continued unabated in Greece – and, at a certain point, will result in a social explosion.

Debt default and eurozone exit

PUSHING FOR EVEN greater austerity measures, eurozone leaders are ignoring the reality that Greece’s debts are absolutely unsustainable. While political leaders are repeatedly stating their determination to defend the eurozone and avoid a breakup, strategists closer to the investment banks and other financial institutions are quite clear that, sooner or later, there will be a Greek default. That would mean a Greek exit from the eurozone.

For instance, Nouriel Roubini, who has a far more realistic view than most commentators, argues that Greece will never resolve its debt problem within the straitjacket of the euro. In order to stimulate economic growth, the precondition of debt reduction, Greece would have to be able to devalue its currency in order to boost exports. Clearly, this would mean abandoning the euro and returning to the drachma. The drachma would undoubtedly sharply fall in value against the euro. This would enormously increase the foreign debt, in drachma values, of the Greek government, banks and businesses. In reality, Greece would (like Argentina in 2001) have to write off a significant part of these debts by revaluing the debt in drachma terms. Greece would undoubtedly become a pariah on financial markets, unable for a time to borrow from European and international banks. As in Argentina (comments Roubini), the situation would mean ‘bank holidays’ (denying or limiting savers access to their accounts) and capital controls to prevent a flight of capital out of the country.

Roubini argues that an orderly default and exit from the euro, although inevitably imposing extreme hardships on the Greek working class for a period, would be preferable to the "slow disorderly implosion of the Greek economy and society". He argues that there should be international, coordinated action to recapitalise the banks and other financial institutions suffering losses on their Greek loans. Moreover, international banks should step in to recapitalise the Greek banks, which would also suffer massive losses on Greek government bonds.

In theory, an approach along these lines, based on a coordinated, international intervention to mitigate the problem of unsustainable debt in Greece, would be preferable to blundering into an explosive collapse of the Greek economy and all the uncontrolled repercussions this would have in Europe and beyond. However, the capitalist markets do not function in an ‘orderly’ way, and recent events demonstrate the complete lack of policy coordination between the leaders of the advanced capitalist countries.

Default on the country’s debt and exit from the eurozone would not, in themselves, provide a solution for the working class of Greece. As in Argentina 1999-2002, the Greek ruling class would attempt to throw the burden of crisis onto working people. In time, the return to the drachma and devaluation would boost exports and possibly see a return to growth. In the short term, however, this would be on the basis of low wages, shortages of food, fuel and other essentials, and a degradation of public services.

To protect the interests of the working class it would be necessary to nationalise the banks and cancel the debt held by foreign big business and financial institutions, while protecting the savings of working people. It would also be necessary to take over the commanding heights of the economy (with minimum compensation on the basis of need) to ensure the supply of essential goods and services. Priority should be given to reconstructing public services such as health, education, etc. Control of the economy should be through bodies of democratically elected representatives from the trade unions, community organisations, and the wider public. On a capitalist basis there is no easy way out.
Eurozone banking crisis

THE EUROZONE SOVEREIGN debt crisis is interlinked with a Europe-wide banking crisis. In 2008, eurozone governments intervened to bail out a number of shaky banks. But they did not carry out the kind of large-scale recapitalisation of banks that took place in the US under the Troubled Asset Relief Programme. Only eight eurozone banks out of 91 failed the recent ‘stress tests’, a theoretical test to determine whether banks can withstand another financial crisis. The big investors and speculators, however, are not convinced that all the banks are healthy. In fact there was recently a leaked IMF report which said that eurozone banks need €273.2 billion of additional capital. Lagarde commented that the eurozone crisis was entering "a dangerous new phase" and called for part of the EFSF funds to be used to recapitalise banks. This provoked strong opposition, some from political leaders who object to EFSF funds being used to prop up banks, and some from the banks themselves which deny that they are in trouble.

Nevertheless, there are clear indications of a new crisis building up in the eurozone banking sector. For a start, banks are refusing to lend to one another, preferring to park their cash in the ECB, even if this earns them a lower interest rate. A more startling recent development is the fact that Siemens, the giant German engineering firm, has deposited almost half its cash reserves (€6bn) with the ECB, rather than with commercial banks. Eurozone banks have also had difficulty in securing dollar loans from US banks, vital funding to conduct their US and global business. The ECB was forced to step in and offer eurozone banks unlimited dollar funds on the basis of three-month loans (though this will cost the banks more than loans from the commercial money markets, which have begun to dry up).

In mid-August the focus turned to the French banks. A rumour circulated that Société Générale was in trouble, and there was a massive fall in its share price (with a 50-60% fall between June and September). Société Générale shares were worth €52.7 in February, while by early September they had fallen to €21.19. Société Générale holds €2 billion of Greek bonds, while BNP Paribas holds €4 billion and Crédit Agricole holds €800 million. Big investors and speculators fear that a Greek government default on its debts would precipitate a deep crisis for these three major French banks, which play a key role in the French economy. French government ministers assert that the fears about these banks are ‘irrational’. Any short-term liquidity problem (ie a shortage of funds to cover current business) would be covered by intervention by the ECB. They deny that there is a basic solvency problem, asserting that these banks have enough capital reserves to survive a Greek default and other shocks. French ministers have furiously rejected the idea that they are discussing plans to nationalise these banks. This is reminiscent of the position of Gordon Brown and Alistair Darling at the time of the Northern Rock bank crisis in 2007/08.

Lagarde, however, let the cat out of the bag. When she was previously French finance minister, she claimed there was no problem with the French banks. Since taking over as head of the IMF, however, she has called for a recapitalisation of the major French banks and other banks in trouble using the EFSF funds. There has been a furious reaction against this. On the one hand, any such bailout would confirm that these banks have a solvency problem, and could actually exacerbate their situation. On the other, existing shareholders are up in arms because a government bailout (which would involve the government buying shares in the banks) would effectively dilute the value of shares of existing shareholders.

Eurozone leaders’ disarray

UNDER THE IMPACT of the economic crisis there has been a sharpening of national tensions within the eurozone. There are also divisions within the leadership of the German government, the key power in the eurozone. Merkel has faced growing opposition from leaders of the Bavarian Christian Social Union (CSU) and the Free Democratic Party (FDP), the Christian Democrats’ coalition partners. These leaders have been playing the euro-sceptic card, reflecting the growing opposition in Germany to bailing out Greece and other so-called peripheral states.

The lack of decisive action at eurozone summits shows that the eurozone leaders are in complete disarray. Each time they proclaim everything will be fine, Greece will not be allowed to default or be pushed out of the eurozone. The big investors in financial markets, however, do not take these reassurances seriously. Most of the strategists who speak for investment banks, etc, now believe that a Greek default is inevitable and will result in an exit from the eurozone.

The leadership of the ECB is also divided. While buying Greek, Portuguese and Irish government bonds in order to keep down interest rates for their respective governments, Trichet and other ECB leaders repeatedly stated that they were against large-scale intervention to support other eurozone governments. However, the speculation against bonds of the Italian and Spanish governments, which was forcing up their interest rates at the beginning of September, forced the ECB to intervene with large-scale purchases of these bonds. This provoked the resignation of the German representative, Jürgen Stark. There is now an intense battle between those ECB leaders who believe that an even bigger intervention is required. They argue that unlimited support for the bonds of threatened governments would stave off a sovereign debt crisis. However, other ECB leaders are still intransigently opposed to this kind of intervention. They believe that the ECB’s role should be strictly limited to monetary policy, ie setting interest rates and regulating the money supply.

There is also a growing difference between capitalist leaders over economic policy. The prevailing policy, upheld by Merkel and other eurozone leaders, is that ‘fiscal consolidation’ is imperative to reduce deficits. This means severe austerity policies. However, this has produced a new downturn in the European economy and, as Timothy Geithner, the US Treasury secretary, has warned, now threatens the whole global economy. The fall in government spending and massive cuts in public-sector jobs have set in motion a downward spiral: declining consumer spending, weak investment, higher unemployment, and a decline in tax revenues that can result in even bigger deficits.

The ultimate stress test

A WARNING WAS recently sounded by Lagarde. While advocating continued austerity for countries like Greece, she is – without naming names – calling on the major European economies to adopt short-term stimulus measures, while maintaining the aim of fiscal consolidation in the longer run. She warned: "A vicious circle [of weak growth and weak government balance sheets] is gaining momentum in Europe and the US". "Political dysfunction" was feeding policy indecision in a "dangerous new phase of the crisis". "Social strains", she warned, "are evident in many parts of the world, not just in the countries undergoing severe [fiscal] adjustment". (IMF, 15 September)

Since then, the IMF has published its latest economic outlook. This forecasts global growth for 2011 to be 4%, but warns that, unless there is concerted action to revamp economic policies, there is a strong possibility of growth falling below 2%. In the US and Europe, growth will certainly be under 2% and is likely to be virtually stagnant, while there is zero growth in Japan. But, as the Wall Street Journal comments (21 September): "It is unlikely that either the IMF or the G20 will manage to produce a cooperative plan of action this weekend, given the sharp political discord within the US and Europe".

However, it may be too late for the major capitalist economies to avoid a prolonged stagnation or a further downturn. The ruthless pressure on Greece to intensify the austerity measures can detonate an explosion in that country, which in turn would detonate a meltdown of the eurozone. It is hard to imagine that Greece could default on its debt and remain in the eurozone. That would undermine the credibility of the whole eurozone. In any case, the only way Greek capitalism could escape from its crisis would be through readopting the drachma and devaluation. And if Greece takes this path, why should others stick with the pain of eurozone austerity measures?

On the basis of the relatively strong growth of the world economy since 2000, the eurozone appeared to become a success. But the growth was based on huge volumes of debt, which are now at the heart of the current crisis. Since the financial meltdown and economic recession of 2007-09, the eurozone is being subjected to a severe stress test – from which it will not emerge intact. At a certain point it will break up; but how long the process will take and through what permutations it will twist and turn cannot be predicted. The eurozone has entered its endgame, only the moves and timescale are uncertain