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Greek austerity: the end of the line

May 16, 2012

This was originally published on the NEF blog at: http://www.neweconomics.org/blog/entry/greek-austerity-the-end-of-the-line

This is not a Greek crisis. It is a European crisis, in two parts. First, the financial crash of 2008 provoked a global recession of exceptional severity. Combined with bailouts for the banks, this led to sharply increased debts and deficits for most large economies – including those in the Eurozone.

As tax receipts fell and unemployment rose over 2008-9, government deficits widened. To plug the gap, governments borrowed, pushing up their debts. For countries in the Eurozone, much of this borrowing was taken from European banks. The banks were happy with this arrangement, as they assumed it was not possible for a Eurozone member to default and therefore the loans were low risk. The governments were happy, as they appeared to be getting cheap financing.

But there was a problem. For the decade of the euro’s existence, it effectively fixed exchange rates of member countries relative to each other. The option to revalue a currency inside the Eurozone was no longer available. Germany, with weak productivity growth, drove the wages and salaries of its workers downwards, with falling real average incomes for seven years. It became more competitive, relative to other euro members, as a result. Normally, this would lead to a rise in its exchange rate. But the euro itself prevented that.

Instead, German exports appeared very cheap for southern European countries. They began importing more from Germany (and northern Europe in general) than they sold. A trade gap opened: widening deficits in the south were matched by widening surpluses in the north, all inside the Eurozone. The deficits needed financing. This is the second, critical, part of the crisis. To finance the deficits, countries borrowed, exploiting Europe’s newly emboldened financial system. For Spain and Portugal this borrowing appeared as private debt, helping a finance an enormous property bubble as rising prices drove rising borrowing. For Greece, it led to high levels of public debt – Greek households saved, rather than borrowed, during the boom. But in all cases, the total amount of debt in the economy began to rise rapidly.

The financial crash, with its increased demands borrowing, ran straight into this existing imbalance. The spark for the crisis was revelation, in October 2009 by a new Pasok government, that Greece’s public debt was far larger than the previous administration had admitted.

It is not a crisis of public spending. Spain and Portugal ran consistent government surpluses, spending less than they received in taxes, until the crisis erupted – unlike Germany and France, which were continually in deficit. Greece spends less, as a share of GDP, on its public sector than do either Germany or France – although it suffers from chronic tax evasion by its wealthy.

This is a crisis of the financial system, and of the euro itself. Without resolving both sides of that unhappy pairing, it will not end.

Two years of failure

Successive attempts to solve the crisis by the major powers have graphically failed. They have followed a set pattern: alongside bailout funds, now amounting to €240bn, intended to enable the Greek state to meet its creditors’ demands, come the insistence on austerity measures of increasing severity. Overseen by the EU/ECB/IMF ‘Troika’, successive Greek governments have shovelled growing piles of cash at international creditors, while squeezing greater and greater sacrifices from the Greek people. The impact on society has been devastating. To pick just one example, Greece used to have the lowest suicide rate in Europe. Suicides have increased by 40% in the last year.

The Troika plans were never going to work. Austerity is self-defeating. Government spending cuts – and sharp tax rises – suck demand out of an economy. If the economy is weak – and Greece is seriously weak – it weakens further, as falling demand leads to fewer goods sold, fewer people employed, and falling wages. A vicious circle of decline sets in, just as it did when governments attempted the same course during the 1930s. The Greek economy has now shrunk by 16% in five years, while unemployment has skyrocketed. And the debt burden, far from shrinking, is ballooning as a result, having risen from 130% of GDP in late 2009, to around 160% today.

The only way to remove a debt is to repay it, or to cancel it. The bailouts do neither. They simply help maintain the flow of repayments, with interest, enabling Greece to meet its creditors’ demands. As the economy collapsed – the direct result of austerity – this mechanism has become increasingly obscene: a whole country starved by austerity, but then kept on a bailout drip for the benefit of its creditors. It should be no surprise that so many Greeks voted for anti-austerity parties. There is no reason at all for anyone in Greece to accept this miserable settlement.

Syriza, the Coalition of the Radical Left, have emerged as winners, rising to second place in the last elections and now polling around 27%, ahead of all other parties. Syriza won its support in urban, working class areas, supplanting Pasok. It has insisted on the suspension of debt payments and an end to austerity as the conditions for any future coalition government. If no coalition is formed, fresh elections will be held in mid-June.

The weeks ahead

Two years of ignominious failure by the Troika are finally grinding to a halt. The situation is complex. Subject to significant uncertainty, the pattern over the next few months looks like this. The table below shows the amount Greece is expected to pay to meet its creditors over the rest of the year.

Schedule of Greek debt payments, 2012 (million euros)

May June July August September October November December
11546 2991 3030 9676 1019 1171 85 2324

Source: Bloomberg

Major individual repayments include the €3.1bn due for the ECB on 20 August. But any single missed payment before that date would trigger a default.

It is not now possible for the Greek state to both meet those repayments, and pay its own employees. If payments are made, it must continue to receive bailout funding from the EU. The EU has, until now, insisted that receiving bailouts requires Greece to honour the Memorandum of Understanding, signed last year, that commits it to strict austerity measures. If these measures are not adhered to, funding will be cut off, forcing a default. It is possible, but not certain, that the EU is now wavering on this, with Jean-Claude Juncker, Prime Minister of Luxemburg and head of the Euro Group, hinting on Monday that some leniency may be permitted.

Once in default, there is little point Greece remaining inside the Eurozone. International banks have spent the last year ditching their Greek bonds, with official sources (like the ECB), Greek banks, and risk-addicted hedge funds being the only remaining buyers. A default will not hit banks outside of Greece too hard, and the ECB can withstand the losses. But those inside Greece will be wiped out. They will need recapitalising – stocking up with fresh funds – most likely under tight government control. Recapitalising banks in euros will not be possible without access to a ready supply of euros – and the ECB and others will not be keen to supply them. Recapitalisation in a new currency, however, is a possibility, the central bank effectively printing money to cope. A Greek banking collapse could quickly lead to a euro exit.

The most likely date for elections is the 10 or 17 June. Germany has insisted that if Greece has no government after this, it will not receive the next tranche of EU assistance, due in June. This, too, would lead rapidly to a default, and so drive Greece towards the euro door.

But a government that honours its debt commitments – if, somehow, one can be formed – would be in an extremely vulnerable state. Its dependency on further EU subventions would be terminal. Greece’s primary deficit – the difference between the state’s taxes brought in, and expenditure made, minus interest payments – is 1% of GDP. This is not huge, but still needs covering. If it is not covered, for whatever reason, the state would run out of money to pay its employees pretty shortly, perhaps by July. It may be forced to issue promissory notes – offers to pay in euros at a later date – and these, in turn, would start to take on some of the functions of money, being accepted in shops and so on. Euros would disappear from circulation, becoming too valuable to use in either exchange or entrust to Greek banks. A de facto, almost accidental euro exit would occur.

The chances of all sides negotiating their way through the next few months, and Greece remaining a euro member, are low. Although the outcome is uncertain, and dependent on political processes, even if Greece gets through the next few months and out of the election period as a euro member, the crisis will not be resolved. The public debt will overwhelm every other consideration, and, with no realistic hope of repayment and a collapsing economy, the issue of its euro membership will merely reappear.

Contagion and collapse

In theory, Greece can be contained. The EU and ECB, between them, have spent two years constructing a series of “firewalls” to block the spread of the crisis beyond its borders, with €750bn theoretically available. Its former private creditors have been ditching their holdings of Greek debt, reducing their exposure to a minimum. In theory, the crisis in Greece can be held there.

But this is not a Greek crisis. Spain, Portugal and Italy are all part of the same debt-creation mechanism, driven by the euro’s imbalances. During the euro’s boom years, Spain and Portugal ran up immense private sector debts. A property boom drove borrowing for property, which in turn drove rising prices – until at one point more than 20% of the Spanish workforce was employed in construction. Private debts ballooned. When the crash came, those debts became unpayable. Spanish banks are threatening to collapse, with the third-largest, Bankia, quietly nationalised by the government last week. Italy, meanwhile, suffers from permanently low growth and a €1.3tr public sector debt. It, too, is caught in the trap.

Any eruption in Greece could spread rapidly to these three – Spain, in particular. A run on the banks could begin, as panicked depositors believe their governments to be incapable of supporting failing banks, and begin withdrawing their cash – sparking a real bank run. Or bond market traders, believing that heavily-indebted economies will see major bank failures that governments will not be able to rescue – driving up interest rates, and forcing governments to seek bailouts. Or private investors and speculators, believing that these countries cannot support their banks, begin withdrawing capital elsewhere, provoking capital flight and the collapse of banks.

Or, indeed, some combination of all three. Interest rates for Spanish and Italian government bonds have already started rising sharply, as traders start to fear the risks of a widespread collapse. Credit ratings agency Fitch have announced they will downgrade euro members in the event of a Greek exit. The EU’s firewalls, the temporary European Financial Stability Facility and the permanent European Stability Mechanism, appear to be able to cope – on paper. In practice, they rely not on actual funds, but on promises by signatory members to pay if needed. And a promise to pay is not the same as having the cash to hand – especially if those promising to pay, like Spain, are also those requiring bailouts. Both could soon be overwhelmed by a general conflagration. The risks of a second, severe recession are significant.

Next steps

There are two main routes out of a crash. One is to try as far as possible to cling to the old ways of working. This is the Troika’s preferred route. It has not worked so far, and it will not work in the future.

The other is to impose a sharp break with a failed past. Syriza have been absolutely correct to insist on refusing to make debt repayments, and vowing to end austerity. Neither are for the benefit of ordinary Greeks, or European society in general. They are right, too, to raise the use of unorthodox financing, like forced domestic borrowing – compulsory loans, with those who can afford them as creditors, set at low rates of interest. Preventing the spread of contagion, and the containment of financial crisis, will require capital controls – restrictions on the free movement of capital, either directly or indirectly, to prevent panic spreading. Even the IMF now admits the efficacy of such measures in a crisis. The wealthy must be taxed effectively to cover costs, and banks run in the interests of society, not private profit.

What is needed, in other words, are the first steps away from a failed economic system. The movement against austerity in Europe is growing. Greece could be about to take those first steps out of the wreckage. If a new, anti-austerity government is formed there, the pressure on them to break will be immense. Our solidarity will be crucial.

 

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