The crisis in Greece could lead to a second financial crash and threatens the survival of the Euro – James Meadway argues that the construction of a European movement against austerity is both possible and necessary.

Four Horsemen AcropolisUnrest continues across Greece. Its debts cannot be repaid. Austerity measures are tearing society apart. The country will fail to meet the payments demanded of it. A new government, forced on the country by its creditors, crawls through a Parliamentary confidence vote. EU and IMF continue to row over the costs of a fresh bailout. And markets everywhere are braced for a second financial crash in just over two years. The spectre of default is haunting Europe.

A year of failure

The figure emerging from negotiations for a further bailout is around ‚Ǩ160bn, with details to be agreed – perhaps – at a eurozone finance ministers’ meeting on 3 July. But this will be in no sense a solution to the problem. It is, instead, simply a continuation of the austerity programme introduced with the first IMF/EU bailout, in May 2010, imposing draconian cuts on a society already bled white. And most important of all, these bailouts are not intended to help ordinary Greeks.

Last year’s ‚Ǩ110bn package had two principle aims: first as a combination of carrot and stick to drive Greece into meeting austerity targets, returning to growth in near-miraculously short order; and second, and most importantly, to stabilize the European financial system.

By any measure, it has failed. For the Greek economy, austerity has been calamitous. There is a simple reason for this. Cutting spending reduces demand in an economy. As the government spends less, firms have less to sell. They will also look to cut their spending – including cutting wages and making redundancies. The whole economy is steadily dragged downwards by collapsing demand.

For a country already in recession, this downwards spiral can be overwhelming. Ireland is a pristine example, having diligently followed IMF prescriptions for two years. Cuts in government expenditure have prolonged and worsened the recession there. Greece is suffering from the same grim logic. Government cuts, far from stabilising the economy, can lead to yet more cuts. The Greek economy shrank by far more than anticipated over the last year.

Further cash is required to meet Greece’s immediate financing needs, with ‚Ǩ12bn due over July and August, and some ‚Ǩ30bn of assets sales – privatizations – are being set up. The IMF/EU is demanding an additional 10 per cent cut in public spending and a staggering one-third reduction in the public wage bill as conditions of fresh funding. The failure of previous cuts is calling forward demands for still greater cuts. This is the lunatic logic of austerity.
Deutsche Bank estimates that Greece needs to produce a 10.1 per cent surplus this year if it wants its debt to stop growing. Last year, it ran a 14 per cent deficit. Current projections suggest it will soon be paying 15 per cent of its entire GDP in interest alone. There is no chance at all of Greece even stabilising its debt, let alone repaying it – and efforts to do so would, in any case, deepen the social catastrophe as welfare was chopped to nothing and every last asset privatised.

Default – cancellation of all or part of the debt – is now an inevitability. The only questions are when – and how. Panic is rising across Europe as the possible consequences become clear. The IMF/EU bailout has not only failed to rescue Greece. It has left the entire European financial system exposed to collapse.
To understand why, we need to find the roots of the current crisis. These have nothing to do with the witless morality tale offered by much of the media and our own government.

Greek myths

Three lies are central to the story being peddled about Greece.

The first is the claim that Greeks are lazy – they simply don’t work hard enough to compete. This is racist nonsense. Greeks, on average, the longest hours in Europe: 2,120 hours a year, compared to 1,473 hours a year for the average German, or 1,712 for the typical Brit. Of the developed countries in the OECD, only Koreans work longer hours. They retire, on average, later than the average European, at nearly 62 years old, but enjoy only 23 days annual leave – compared to (for example) 30 in Germany.

The second is the claim that the Greeks are profligate, lavishing money on public spending they cannot afford. This, too, is rubbish: over 2001-2007, Greek government expenditure made up 44.6 per cent of GDP – under the EU average for the whole decade, even before the crisis hit.

It is true that Greece had a relatively high level of public debt before the crisis broke. But these high debts date from the early 1980s, as Greece moved away from dictatorship. The real fiscal weakness for the government is the low level of tax revenue.

The third lie is in some ways most pernicious of all. It is the claim that greedy Greeks have taken the bailout funds, and then continued to live the Mediterranean high-life. Like spoiled children they are protesting when asked to clean up their act.

This is slanderous: austerity measures have already hacked Greek public spending to the bone. Many public employees have not been paid for months. Indeed, the government has been so successful in swinging the axe at IMF/EU behest that it has cut spending further than they demanded, by around ‚Ǩ700m. Tax revenues, it is true, are lower than predicted. But that is precisely because cuts have damaged the economy’s ability to pay taxes. And the shortfall itself is a relatively trifling ‚Ǩ1.2bn.

Last year’s ‚Ǩ110bn has not gone on supposedly lavish Greek lifestyles. It has gone to European banks, saddling Greece with still more debt and rising interest payments. A new bailout is not intended to pay for Greek welfare. It is to keep the cash flowing to the major financial institutions. Greece is not being bailed out – the banks are.
The three lies are needed to disguise the unpleasant truth. The crisis is not the fault of ordinary Greeks. It is systemic.

Origins of the present crisis

We are seeing the outcome of a collision between the collapse of the world financial system in 2008, and the weak Eurozone economy and institutions.
The bankruptcy of Lehman Bros in September 2008 in turn brought banks across the world to their knees. Governments bailed out their stricken financial institutions. Direct injections of cash and promises of support totalled, on IMF estimates, $7trillion globally.

The financial collapse induced a sharp recession that also forced up government borrowing. Unemployment skyrocketed just as tax receipts shrank, resulting in rising public deficits.
The financial crisis was transformed into a crisis of government debt in an effort to limit the damage. But the European financial and monetary systems are too weak to complete this shift successfully. As detailed by the Research on Money and Finance group, their structural deficiencies are causing the transformation to unravel.

Euro imbalances

Entry into the euro in 1999 fixed member countries’ effective exchange rates within the eurozone. Countries could no longer attempt to adjust their exchange rates, but would remain effectively stuck at the level at which they joined the euro. Germany, notably, entered at a low rate, making its exports cheaper for other euro economies. Southern European countries, in contrast, entered at a high exchange rate, making imports from other euro economies cheap.

This structural imbalance was compounded by a race to the bottom inside the eurozone. With countries unable to set monetary policy, now controlled by the European Central Bank (ECB), and with substantial constraints on fiscal policy – government taxation and spending – the burden of economic adjustment was pushed onto the labour market.

Europe’s workers bore the brunt of European integration. Labour market ‘flexibility’ and wage restraint were enforced across the eurozone. This was most successful in Germany, where real wages have been flat or falling for a decade, helping to mask weak productivity growth.

The combination of under-valued currency and wage restraint enabled Germany to export across the eurozone, running up huge, persistent current account surpluses. These surpluses were then recycled as cheap lending through the European financial system, fuelling more imports from southern Europe.

Rising surpluses and savings on one side were matched by rising deficits and debts on the other. The whole system was hopelessly imbalanced. And the financial system was the sluice, allowing debt to flow south, and export earnings to flow north.

When the financial crisis erupted, that sluice broke. Bank bailouts and the recession drove up government borrowing, with euro economies looking to borrow nearly €1trillion in 2009. But weakened financial institutions, burdened with southern debt, were not willing to then lend to governments. The price of borrowing for governments rose. Financial markets were biting the hand that fed them. Bailing out the banks led directly to the sovereign debt crisis.

The financial collapse was global. Few countries escaped its effects. But as we enter its second, deeper phase, its epicentre is in Europe – a direct result of the weaknesses of the European economy and institutions.

The twin crises

Portugal, Ireland, Greece and Spain – the so-called PIGS – are all under exceptional pressure. The burden of indebtedness – the direct result of euro membership – is a drag in all four. But it is in Greece that the crisis is now focused as it reaches a second stage. This second stage of the crisis is occurring as a result of the links between institutions inside the eurozone. State debt and private banks are intertwined.

Greece has a total public debt of around ‚Ǩ340bn. Of this, about a third is held by Greek banks themselves – and that amount is increasing, as few lenders will now buy Greek government bonds. So a Greek default would wipe out Greece’s own private banking system, with banks’ own assets not able to cover their losses. The banks will need recapitalising – bailing out, once more.

Banks in the rest of Europe have also been lending to Greece – both to the state, and to private borrowers. External public debt held in banks has a value of around ‚Ǩ52bn, with about two thirds held by French and German banks. This, comparatively, is not overwhelming compared to the major banks’ asset bases – and the capacity of their governments to bail them out. (Holdings in the rest of the world are negligible.)

But if the Greek financial system becomes insolvent, private debts can also turn bad. Throw those in as well, and the total European exposure to Greece rises to ‚Ǩ136bn. It is on this basis that ratings agency Moody’s threatened to downgrade the credit rating of three major French banks. BNP Paribas and Soci√©t√© G√©n√©rale, for example, have Greek holdings equivalent to about 10 per cent of their primary capital reserves. So Moody’s believe the banks are overexposed to Greece, and as a result are also at increased risk of default. Non-eurozone banks have less exposure. But the UK tops the list, with ‚Ǩ10.35bn of Greek liabilities at stake.

The chain reaction does not stop there. Holders of debt can buy insurance, in the form of a credit default swap (CDS). This is a contract that pays its owner should a ‘credit event’ – a default – occur. But that means those offering these insurance contracts can face very large demands for payment. In 2008, this ‘counterparty risk’ wiped out US insurance giant AIG, which had to be nationalised. What should act as insurance against default can turn into a very effective mechanism for spreading the crisis with exceptional speed, in a process known as contagion.

Holdings of these derivatives can be opaque. The best available figures for Greek CDS suggest that while there are $79bn worth of contracts held across the globe (with 64 per cent in the US), these are balanced out by other, counterposing claims – the insurance is also insured, reducing the total impact after default. In theory, only $5bn is likely to be transferred. In practice, the chains of claims and counterclaims may not run so smoothly. At the very least, the price of insurance against other high-risk debt, such as Portugal and Spain, could increase sharply. If the crisis spreads outside of Europe, the most obvious route will be through the counterparty risks.

At the end of the intertwined chain of state debt and private institutions sits the European Central Bank. Alongside the IMF and the EU, it has been supporting private banks. Struggling banks have been able to swap their bad assets for comparatively healthy ECB loans, through the national central banks, while its ‘Securities Markets Programme’ has bought up government bonds from weaker economies. And the ECB’s weakness has, according to research by Open Europe, been ‘significantly understated’. Open Europe estimate that it has an exposure of about ‚Ǩ190bn in Greece, between banks and government. But its capital and reserves are only ‚Ǩ82bn. A Greek default of any reasonable size would wipe out its capital. The European Central Bank would then become insolvent. It would need its own bailout.


The financial crisis has locked European states and institutions into a tangled web of state debt and private losses; of demands for repayment and bailouts. Yet states are reaching the limits of their capacity to spend. The €750bn European Financial Stability Facility, established last year, would rapidly run out of cash if it were called on to bail out a major economy like Spain Рor even a series of smaller defaults. The pressure on states will mount. Squabbles between European powers over funding will intensify. Ultimately, all sides will seek to dump the costs on European society Рimposing austerity measures everywhere to maintain the financial system. But each state will want to minimise its own share of the costs.

The mechanism can look like this. The crisis of sovereign debt that emerged from the financial crash will feed straight back into the financial system. We will then have twin crises. And each element reinforces the other: the sovereign debt crisis feeds the financial crisis. As banks face collapse, they call in their loans and dump risky assets, potentially forcing sovereign defaults elsewhere – Portugal, Ireland, or, worst of all, Spain. This, in turn, drives fresh financial crisis and fresh demands on state funding. Disagreements amongst the states intensify, worsening both crises. Money drains out of the system and the whole of Europe is dragged into a recession of exceptional severity. The UK, separate from the eurozone, would get caught: although UK banks have smaller direct holdings of Greek debt relative to French and German banks, the exposure to other weak eurozone economies is large – Ireland especially so.

The collapse of Lehman Bros created this same spiral of bad loans and collapsing values. But it did not involve intertwined private and public debt in the same way. A closer, if more disturbing, parallel is the bankruptcy of Austria’s largest bank, Credit Anstalt, in May 1931. Failed attempts to support the bank caused national bankruptcy, sparking bank runs across the world.

Halting the tide

The bailout won’t stop the eventual collapse. It may create a short breathing space, allowing Greece to meet the most immediate demands for financing. It will not reduce the debt burden and so do nothing to prevent a default or halt its consequences.

As Open Europe have suggested, the bailout simply creates more costs for EU states – to be passed on as either increased taxes, or more spending cuts. They estimate that the current EU exposure to Greek debt will be almost tripled if the bailout is introduced. So a default would become even more costly. Time bought through the bailout now merely worsens the eventual reckoning.

There are two main ways they could try to prevent the cataclysm while keeping financial markets open. Both require the authorities to grasp the nettle and admit the true scale of the problem.

The first option is to reduce the ‘haircut’ from default. The haircut is the extent of the loss imposed on holders of debt. These can vary substantially, and are determined essentially through a process of negotiation between creditors and debtors. At present, ratings agencies believe that a haircut of 50 to 70 per cent will be the outcome – meaning those holding Greek debt will lose 50 to 70 per cent of the value of the debt. The lower the EU and other creditors can get this haircut, the less damage will be felt on banks’ balance sheets. This may reduce the immediate side-effects of default.

Of course, the lower the haircut now, the greater Greece’s debt burden will be in the future. Reducing the losses from defaults helps the banks but hurts the Greeks. We will end up in exactly this situation again if the haircut is not big enough to meaningfully reduce Greece’s debt. Nonetheless, if it is possible to negotiate a relatively lower loss ahead of default, it may be possible to stabilise the situation.

Except that Germany’s attempts to even hint at banks taking losses, motivated admittedly by a desire to lessen the bailout costs, provoked a furious reaction. Banks, IMF and ECB sharply rebuffed any such talk, with Angela Merkel conceding defeat last weekend. States, not banks, would carry the burden – for the time being. They are delaying the inevitable.

The second option is to negotiate a ‘voluntary’ restructuring of Greek debt. That means, rather than declaring Greece in default, a deal can be negotiated between its creditors in which either some repayments are delayed, or the length of repayment time is extended. Either would reduce the effective burden of the debt on Greece. The singular advantage with this approach is that it could avoid both the immense political embarrassment of an EU economy defaulting on its debt; and that it may prevent the triggering of CDS insurance against default, reducing the spread of contagion. The ‘Vienna Initiative’, a 2009 voluntary agreement by banks to ease off on eastern European debtors, is being cited by EU finance ministers as the example to follow.

The credit ratings agencies, however, have made clear that any ‘voluntary’ rollover of Greece’s debts would be regarded by them as an actual default. So this path, too, is becoming blocked.
The ‘softer’ the default or restructuring now, the easier the ride in future. But to successfully pull off this trick will require clear political leadership – taking control of the default process. And amongst the bickering neoliberal ideologues and economic incompetents currently overseeing Europe, leadership is a quality in short supply.

Perhaps that is unfair. As the crisis is rapidly revealing, the EU is a house of cards: lacking the ability to tax and spend, and the ability to enforce transfers of resources between nations, its real political authority is diminishing by the day, and is reverting to its constituent nations – France and Germany especially. The IMF, battered as it has been over the last decade, has stepped in to lend its own special brand of assistance; as have, tellingly, the Chinese government. The chances of the motley collection of EU institutions, European states, and international bodies successfully steering their way through this mess are minimal to nonexistent, whatever the current round of negotiations throw up. Greece at some point will default, with or without the approval of the international institutions.

The consequences for the entire EU project could be immense. The long, steady march towards political integration, from the Treaty of Rome onwards, would be thrown in reverse – particularly so if, as seems increasingly likely, Greece either opts to leave or is forced out of the euro. Economic integration would lead to political disintegration.


None of this is inevitable. The drama may unfold more or less quickly. There is an extent to which the prospect of chaos is being talked up to bully Greece into accepting fresh austerity measures. And the euro economies have, so far in this crisis, been comparatively lucky, relative to the huge economic strains now becoming apparent. They may continue to be so.
But because this crisis is a product not just of the short-term factors – financial instability or bad economic management – but of the entire euro system, it will not simply disappear. It will return, and return again, for as long as no decisive action is taken to halt it.

The future, then, is bleak. There are no easy options. There is the fantasy scenario that somehow, out of the car-crash that is the eurozone, will emerge a new, strengthened EU: one with meaningful political authority, fiscal powers, and a social democratic inclination. If this was always an unlikely conclusion to the elitist process of integration – enacted above the heads of the people of Europe – it now looks simply impossible. Far more likely a response, over the medium-term, will be a ferocious reassertion of neoliberalism. This is already taking place: the ‘Euro Plus Pact’, an attempt to create strengthened EU institutions, is being signed up to by EU powers, demanding tighter restrictions on spending and closer surveillance by the EU of countries’ debt. The economic policies that helped lead the EU into this debacle are, in other words, being reasserted with a vengeance by EU institutions.

And there will be a continuation of the disintegration. German finance minister Wolfgang Schäuble has already floated plans for orderly euro exits. The Schengen Agreement, allowing free movement inside the EU, is already being challenged. And a new, populist right is emerging in northern Europe, pushing an anti-EU, anti-migrant, anti-bailout line. It is in many ways closer to the US Tea Party movement than it is to the traditions of classical European fascism. The shocking success of the True Finns in recent elections, rising from nowhere to within a whisker of government, is the clearest example of the trend. But as the crisis deepens and its costs are pushed down onto ordinary Europeans by an unaccountable political elite, the appeal of anti-tax, anti-bailout, nativist organisations can grow.

The uprisings in Greece and Spain, with thousands occupying public squares in protest against austerity, have shown a glimpse of the alternative. They have had little to do with the existing left, which is either pathetically compromised by its entanglement with EU neoliberalism, or, on its radical end, divided and directionless. But the growing, continent-wide movement against cuts is taking the first steps towards breaking the grip of finance. As a first step, the logic of austerity has to be stopped and shattered. The organised left has to throw itself into these movements. The aim is to push the immediate costs of the crisis back onto those who caused it: the very richest – the bonus junkies in the banks and their assorted hangers-on.

That will require a direct challenge to finance and capital. That cannot be mounted through the feeble institutions of the EU. Only national states have the political capacity to do it. For Greece, the strategy is clear: default, exit the euro; nationalise the banks and introduce capital and currency controls; impose a confiscatory tax on the wealthiest, investing in green infrastructure and jobs to sustain demand. For southern Europe a similar assault on the citadels of finance must be made. And across the whole continent, the policies of neoliberalism must be thrown into reverse, country by country: halt financial contagion through exchange and capital controls; tax the rich to raise funds and kill off speculation; increase government spending to boost demand; invest to create green jobs. With workers at its heart, a European movement against austerity must be now constructed.

Thanks to Alexis Stenfors for the CDS figures

James Meadway

Radical economist James Meadway has been an important critic of austerity economics and at the forefront of efforts to promulgate an alternative. James is co-author of Crisis in the Eurozone (2012) and Marx for Today (2014).