As fear spreads across the world's stock markets, political leaders offer no real solutions. This might be the end of the Euro in its current form, argues James Meadway.
£150bn has been wiped off the value of the largest UK companies. The US stock market has fallen by the largest amount since the early days of the financial crisis in 2008. The panic has now spread to Asian markets, while UK markets continued to slide this morning. The banks, locus of the 2008 calamity, have been worst affected, with Barclays, Lloyds Banking Group and RBS halting trading in their shares after prices collapsed.
Fear has gripped the citadels of financial capital. But financial panic, and the spread of that panic through contagion, leaping from market to market, is motivated by real economic news.
Two elements are decisive. First is growing evidence of chronic weakness in the US economy, coupled with a sclerotic political system. Unemployment, already high, is rising, with fresh figures due out today. The numbers of long-term unemployed are at record levels.
Growth is weak, and liable to fall further. The world’s largest economy is on the verge of a second recession, with no clear strategy ahead.
Second, and relatively more serious, is the unresolved crisis in the eurozone. It might have been expected that the announcement of the second Greek bailout last week would buy Euroland more time – perhaps a few months. Instead, the bailout announcement provided at best a few days of breathing space. In no sense did it address the underlying problems of the eurozone – low productivity growth and a dysfunctional financial system.
It was never intended to. Europe’s political leaderships - split between different countries, the EU institutions, the European Central Bank (ECB), assisted by the inevitable IMF -lack the authority and the capacity to meaningfully resolve the crisis on anything other than the most temporary terms. The financial crisis of 2008 was resolved through its transformation into a crisis of state debt – states bailed out the financial system, but in doing so seriously weakened their own balance sheets. Inside the euro area, longstanding imbalances, the product of faulty institutions and weak economies, were chronically exacerbated. Greece was worst affected, its already high public debt becoming unmanageable, but Ireland and Portugal also suffered greatly.
The solution offered was austerity, and bailouts. Neither were aimed at assisting the mass of European society. Both are intended to support the crippled financial system: austerity, by ensuring bond-holders are paid their dues at the expense of wider society through tax rises and spending cuts; and bailouts, to prop up the collapsed prices of assets held by European banks. The hope was that the bailouts would create sufficient breathing space to allow a recovery to kick in. For the last year now, this has not worked. What we are witnessing is an end to the smoke-and-mirrors trick through which everyone deluded themselves it might.
The particular focus, inside Europe, is now Italy. The ‘troika’ – EU, ECB, and IMF – attempted to provide a sufficiently large bailout fund to cover the worst-affected economies. It is probable, but not guaranteed, that sufficient funds could be found to cope with a default or threatened default in Greece, Ireland and Portugal. But by ringfencing these three, it became obvious to the markets that there was no realistic chance of bailing out Spain or Italy – two of the world’s largest economies. No-one inside the EU can afford the cost. Should either go – and the markets are betting particularly against Italy – the system will be sunk.
It is likely we are witnessing the end of the euro in its current form. Because this is a disorderly process, it is not yet clear how far its consequences will spread. Over the boom years of the 2000s, European and US financial systems became closely intertwined, trading trillions of dollars’ worth of financial assets between them. European banks became heavily entangled in the madness of sub-prime mortgages and the exotic financial instruments used to deal with them – the collateralised debt obligations (CDOs) that exploded so spectacularly over 2007-8. When the subprime mortgage market collapsed, it hit European banks hard.
Something similar could occur this time round. US banks have significant exposures to the EU. Although direct holdings of sovereign debt, such as Greek national debt, are low, US money market funds critically important pools of ready cash for the financial system – hold about $1tr of European bank debt.
European banks hold sovereign debt and so default – or even the threat of default – will hit those banks. Credit rating agencies have already expressed deep concern about the potential exposure of German and, particularly, French banks to the risk of a country default.
But since the US institutions have a large exposure to European banks, they too will be hit. This is how contagion can occur. Because the financial system sets up long chains of linked debt and assets, trouble in one part of the system can spread rapidly throughout the entire chain. Throw in exotic financial assets like CDOs and credit default swaps (CDSs), with their ‘counterparty risks’, and the dangers multiply. With major economies already weak, financial difficulties can rapidly translate into real economic hardship as lending dries up and demand collapses.
It is not clear how far the crisis will spread. At present it is concentrated on Old Capitalism – the historic core economies of the world system in North America and Europe. For these economies, it is an extension of the crisis of 2007-8 and there is no real resolution in sight. Major recessions, historically, have acted as the means by which capital could be written off and an economy restarted: old investments wiped out through bankruptcies and fire-sales, clearing the path to a new round of accumulation and economic growth. The recession begets the recovery.
This has not occurred. The links between the different parts of the system are now so densely woven that a major bankruptcy – for example, Lehman Bros in September 2008 – threatens the system as a whole. If one part of the chain of financial links break, the whole chain can go. In response to this systemic threat, governments resorted to bank bailouts. But that means that the mechanism by which redundant capital is cleared out of the way, and new capital brought in has not functioned.
A major country default, in this situation, could perform the same purging function as a bankruptcy. By taking on bad bank assets, states weakened their own balance sheets. A defaulting country would, in effect, wipe out billions of euros of its bad debts – it would act to clear old capital out of the way, allowing further accumulation to occur. But if the bankruptcy of a major private bank was systemically important, a whole major economy could be still more so; and, inside the eurozone at least, could have potentially devastating political consequences.
So sclerosis reigns inside Old Capitalism. It cannot rely on capitalism’s usual corrective mechanism because the whole system is so tightly entwined through finance. Whatever the immediate outcome of this panic, it is likely to remain locked into in a permanently weakened position.
For New Capitalism - those economies that have, over the last decade, been growing steadily, lead by China – the situation could be different. They largely avoided the worst impacts of the 2007-8 slump through a combination of controls over financial capital, and their own internal growth dynamics. However, many are heavily dependent on export earnings, and a serious collapse in foreign demand threatens to expose their excess capacity, provoking further recessions. China, in particular, could be at serious risk. Asian stock markets this morning have also taken a dive under the looming threat of a major, global depression.
Critical later today will be the US non-farm employment data. Signs of a recovery here, however weak, may well be taken by jittery traders as evidence that all is not yet lost. It is possible that some of the cash now fleeing the US for the ‘safe havens’ of Swiss francs and Japanese yen will return. Early indications are that figures will be marginally positive. Any further deterioration in US employment figures, however, will spark further panic.
In either case, the outlook for the economies of Old Capitalism is particularly bleak. Their political leaderships have no real solutions. All that is being offered is austerity – the brazen attempt to foist the immense costs of the bankers’ crisis onto workers and the rest of society. It is already creating immense hardship for millions, and as it clamps down on spending, it will simply worsen the recession.
The European Conference Against Austerity, taking place in London on 1 October, will be an important first step in pulling together a Europe-wide resistance to austerity and the crash. It is vital, as the deepest spending cuts for a generation or more begin to bite, that we start to assemble a mass movement of all those opposing austerity, continent-wide, offering an alternative to the rule of finance.
This article was re-posted from the Europe against Austerity website. Register for the European Conference Against Austerity here.
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).