Beyond the door marked “Austerity”
Europe has become the weak link in the global economy. In the next phase of the world economic crisi
When it gets dark, Exarchia Square in Athens comes alive with the murmur of drug dealers. Students wander past them, deep in political argument. Posters denounce capitalism; graffiti denounces the police harassment that has intensified since the general strike on 5 May. Exhausted riot cops lounge on street corners.
This is the civilisation the European Union was created in order to build: layered, tribal, intensely urban, sporadically violent, intellectual, tolerant and - until now - resilient. Today, it faces its biggest challenge yet. For Europe has become the weak link in the world economy.
As China has boomed to busting point, and a trillion-dollar fiscal stimulus has pushed the US towards a weak recovery, events have forced the eurozone through a door marked "Austerity". In the next phase of the global crisis, which we are about to enter, the eurozone will either consolidate or collapse. And it will test Europe's distinctive social model to breaking point.
Europe is suffering now for the same reasons that it survived the first 18 months of the global economic crisis: social welfare, state intervention and the single currency. The banking crisis of 2008 hit Europe hard, but did not originate within the European system. It was assumed that this was an infection rather than a disease of the DNA. The banks which failed were those that had been contaminated by derivatives and property speculation: Depfa, Hypo, Fortis, Dexia. As the disease spread, threatening the survival of bigger banks, the state was big enough to shore them up.
Europe got to the end of the first phase of the global crisis - marked by the G20 summit in London in April 2009 - with its financial systems mostly intact. Italy's barely modernised banking sector had stood up well; Spain, where tough banking regulations had kept groups such as Santander financially robust, had survived the test. While Barack Obama struggled to get a one-time-only fiscal stimulus through Congress, Europe's "automatic stabilisers" had already kicked in, pumping welfare benefits and industrial subsidies into a system geared to distributing them.
If there were worries in Europe, they lay outside the eurozone: Iceland was bankrupt; Latvia's politicians were leading it defiantly into depression; and the wannabe countries of eastern Europe had stoked unsustainable housing booms - not to mention the Brits with their broken banking system and disgraced regulators. Then came phase two: the stimulus, which ended in the early hours of 10 May 2010, when the rules of the eurozone were torn up.
The eurozone comprises a currency and a central bank without a government. But a currency is only as sound as the public finances of the state that issues it. In the eurozone, fiscal discipline was supposed to be enforced through treaty obligations and common oversight. But it was not. This is the systemic flaw, previously hidden behind what the journalist Gillian Tett has called "social silence", that was exposed by the global crisis.
To understand how that silence was constructed, and whom it served, you have to go back to the Maastricht Treaty of 1992. Maastricht wrote the principles of an economic doctrine into a political constitution. The doctrine was neoliberalism. Now that it has died, the provisions of Maastricht and successive EU treaties seem all the more arcane.
Under Maastricht, the mission of the European Central Bank (ECB) was to ensure price stability. This was logical, because "inflation targeting" was being adopted in Washington and London, and would underpin a long period of moderate, stable growth. In Europe, however, there was an added imperative for monetary discipline: countries on the periphery of the EU would boom on entry, boosting inflation. To pursue the long-term goal of harmonising Ireland and the Mediterranean with the industrialised countries of northern Europe, the monetary policy of the ECB would have to be austere.
The ECB's inflation target was set at a maximum of 2 per cent - at a time when the UK's central bank was already moving to a more flexible "symmetrical" target around the same figure. The ECB's "independence" from politics, and therefore from democracy, was absolute in a way that never happened with either the Bank of England or the Federal Reserve. It had no growth target. Crucially, it set its own inflation target - unlike the Bank of England. And, although it protected itself ruthlessly from political influence, it was always prepared to exert it. It was the ECB, for example, that insisted on writing the goal of price stability into the Lisbon Treaty.
As such, since its foundation, the ECB has followed a rigid, doctrinal monetarism. It exerted downward pressure on growth in northern Europe as the price for "harmonising" southern Europe into the system, raising interest rates in the face of the global downturn at the start of the 21st century.
The Maastricht Treaty decreed strict rules: all countries must keep budget deficits below 3 per cent and debt below 60 per cent of GDP; no bailouts would be available to states facing deficit problems; even state aid to failing banks was technically disallowed; and the ECB would never intervene in the bond markets to prop up the currency arrangement.
By the mid-2000s, however, this arrangement was based on a falsehood. We now know that the Greek government misstated its borrowing and tax revenues; Goldman Sachs helped it, perfectly legally, to move parts of its debt "off balance sheet" using currency swaps. Eurostat, the Luxembourg-based body charged with monitoring Greek adherence to the Maastricht criteria, had failed to do so.
In January 2010, when the new Pasok government restated the Greek budget deficit from 6 per cent to 13 per cent of GDP overnight, the crisis began. Entirely containable at first, it grew into a wave that nearly swamped the euro because neither the ECB nor the Franco-German duopoly that dictates eurozone policy could summon the will to fight it.
Having allocated €30bn, then €45bn, to bail out Greece, the eurozone soon had to find €500bn to bail out the entire system - €440bn in bilateral loans and guarantees and a reserve fund of €60bn with the European Commission. Having vetoed the involvement of the IMF, the eurozone had to tap it for a €250bn loan facility. And after refusing to intervene in the bond market, the ECB is now sucking up stricken bonds like confetti. It is accepting junk where once it decreed that only gilt-edged securities could ever be posted as collateral at the ECB.
It is easy to point the finger at Eurostat and the former New Democracy government for the Greek budget misstatements, but the problem goes deeper. When a Greek man calmly tells you his country is systemically corrupt, that you have to pay a bribe to jump the hospital queue or to pass your driving test, and that politics too is corrupt, geared to patronage and incapable of cleaning up the system, it is a moment of disarming frankness. When the man in question is George Papaconstantinou, the finance minister, that illustrates the scale of the problem.
Greece, Portugal and Spain are, as the euphemism has it, "young democracies". Both Greece and Portugal lived through anti-militarist revolutions in 1974, and during Spain's transition out of fascism shots were fired by army officers in the parliamentary chamber as recently as 1981.
To those who remember southern Europe in the 1970s and 1980s, it is a region transformed. Entry into the eurozone gave impetus to the rapid growth, marketisation and modernisation that began in 1989. If, in the process, a rising middle class enriched itself, it was not exactly out of step with the spirit of the age. The systemic scam going on in Greece was tolerated because the appearance of Prada outlets and the sudden ubiquity of four-wheel drives signalled "harmonisation". In countries scarred by the living memory of fascism and civil war, it was, the politicians noticed, harder to remember that your grandfather fought my grandfather if we both owned sports utility vehicles.
When I met Papaconstantinou in late February, the situation looked containable. The civil service strike that had brought reporters hurrying to Athens passed off without trouble. The conditions imposed by the eurozone authorities on a Greek bailout appeared not to require huge cuts in public expenditure. A crackdown on tax evasion, plus real cuts in pensions and pay, looked as if they would be enough to tackle the deficit without permanently depressing private-sector growth. How we got from there to a continent-wide fiscal crisis is a story of blind adherence to neoliberal and monetarist norms - at the ECB and in Berlin.
The Greek government launched austerity plans in January and March that were approved as realistic by the European Commission. On 11 April, European finance ministers agreed a €30bn bailout package, but did not deliver. Germany's chancellor, Angela Merkel, with the press and her coalition partners the Free Democrats railing against Greek "profligacy", pushed for harsher conditions; Deutsche Bundesbank, the German central bank, warned the ECB against any retreat from its monetarist rules. Meanwhile, European governments railed against "speculators".
The failure to deliver a bailout opened the door to 28 days of speculation. Bond investors, mainly pension funds, began to fear the Greek crisis would lead to a partial default on Greece's debts; that the bailout would, in other words, inflict pain on them, as well as on the Greek public sector. Once established, the precedent of partial default would, they feared, be used to solve the fiscal crises in Portugal and Spain.
A crisis of confidence occurred not because Portugal and Spain were facing imminent fiscal meltdown, but because their own deficit reduction plans looked unrealistic. It was at this point, in late April, that the cost of borrowing for Portugal - its "spread" against Germany's - took off, and that of Spain also ticked upwards. This formed the background for an all-out speculative attack on the euro. Bets were placed on its rapid depreciation, the eventual break-up of the eurozone and a new banking crisis. The VIX Index - the nearest thing we have to a global Geiger counter of systemic risk - rose to levels it had reached after the collapse of Bear Stearns in 2008.
So, in order to prevent Greece from becoming the prelude to a Lehman-scale event with Spain, the European governments acted. They abandoned their objections to the IMF, to ECB intervention in the bond markets, to bailouts and to bad collateral at the ECB. With the aid of the US Federal Reserve, they reopened "swap lines" so that European banks could borrow and lend in dollars, preventing a new retreat by global capital to the safe haven of currency blocs.
The price they demanded was austerity across southern Europe and, by implication, a new concept of fiscal sovereignty to underpin the euro. Draconian rules would be drawn up to enforce budget discipline. As with the Greek deal, parliaments would lose de facto sovereignty over their budget decisions. Northern Europe had, in effect, seized control of the fiscal policy of southern Europe.
Look at any graph of the costs of southern European borrowing in April and May this year and you will see a picture of rising risk. After the bailout of 10 May, the graph falls back. So where has the risk moved to?
A clue can be found in the name given to the €440bn European loan facility designed on 9 May: it is a "special-purpose vehicle" or SPV. Just like Enron's off-balance-sheet companies and the jointly owned hedge funds that triggered the credit crunch, the SPV is designed to obfuscate the risk - to make its ultimate size and ownership hazy.
But logic dictates that, if the €440bn is borne pro-rata by the 27 member states of the EU, it is France, Germany, Italy and the UK which bear the risk of southern European default. That is to say, the taxpayers of northern Europe. And, as members of the IMF, the industrialised countries of Europe are additionally exposed to the Fund's €250bn loan.
In return, they are demanding that the countries of southern Europe impose austerity at levels that will push them into stagnation for at least half a decade. The Greek economy will shrink this year by as much as 5 per cent as part of the austerity plan. Spain, tipped into deflation already, and with unemployment at 20 per cent, faces several years of downward adjustment. Core deflation in Ireland already stands at minus 3 per cent.
The new austerity will impose strains on social peace in southern Europe, but there is worse. With Britain a month away from an emergency Budget, the rigours of which could easily push the economy back into negative growth, the dangers were spelled out by the governor of the Bank of England, Mervyn King. Unless the world's big exporters stimulate their own domestic demand to allow countries in fiscal crisis to export their way back to growth, Europe faces a double-dip recession. King's plea was aimed, above all, at Germany. Its consumers have to learn to borrow; its voters have to learn to rubber-stamp bailout plans for southern Europe. Fat chance.
When he was still an academic, the chairman of the Federal Reserve, Ben Bernanke, codified the data from the 1930s into one big lesson: it was adherence to the gold standard, an international currency peg, that had tipped America into depression. Bernanke showed that those countries which came off gold first, and devalued their currencies first, recovered first.
This is what, quietly, modern governments have been trying to do: Britain's authorities silently rejoiced at the depreciation of sterling, hoping it would boost the export economy. The US authorities spend half their waking hours trying to devalue the dollar against the Chinese yuan. Now the collapse of the euro against world currencies changes the game again; analysts are suggesting that the euro may be heading for parity with
the dollar in 2011. But competitive devaluation has its limits. And once they are reached, there are few options left: either your taxpayers bear the cost of the crisis, or you force it on to somebody else.
Since 2008, the principal risk to the global economy has been a debt-deflation spiral, where the cost of meeting unpaid debts leads to low growth, falling prices, falling wages, the collapse of state finances and the need for governments to adopt policies which exacerbate the downturn. This is what happened in the early 1930s, and it is what the G20 leaders promised to avoid this time around.
Today, in Washington, London and Frankfurt, all that stands in the way of debt-deflation is the state: in the form of massive money-printing exercises through central banks; in the form of states underwriting the banking system; and in the form now of big states agreeing to stand behind small states.
The Greek bailout announced on 10 May does not make the risk disappear. It simply transfers the risk in southern Europe to the governments and taxpayers of northern Europe. The geostrategic implications of this shift are clear. Big states have bailed out little states and will demand reforms that change the lifestyle of people in these latter for ever. The eurozone is on the way to becoming a supranational, state-like entity.
Because every step in the EU project has been taken by elites, with the populations left to work out what was happening months and years later, we can trace very accurately where the risk has been transferred to. It has been transferred to the streets: streets such as the narrow warren around Exarchia Square, with its disgruntled students, angry workers and jaded riot police.
The eurozone has staved off crisis by ripping up its rules, defying its own ideology on the promise of a future consolidation into a fiscal superstate. Yet the path to that superstate cannot lie through electoral consent; it never has, not even in the good times.
So phase three of the global crisis poses the following danger: that the fiscal stimulus of the past 18 months produces bankruptcy at the level of nation states; that the markets demand austerity to prevent it, creating in the process debt-deflation and, with it, social unrest. This is particularly bad on the continent with the strongest labour movement, the highest ethnic tensions and the longest history of revolt.
Paul Mason is economics editor of BBC2's "Newsnight". His most recent book is "Meltdown: the End of the Age of Greed" (Verso, £7.99 paperback)
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