James Meadway looks at another flare-up in the eurozone's slow-burn disaster as worries about Spain and Greece spook the markets
It took perhaps a little longer than usual, but the EU’s latest wheeze to rescue Europe’s struggling economies has again come apart at the seams. Borrowing costs for Spain have pushed back above 7% to their highest level since the single currency was formed. Greece will not meet its EU/IMF/ECB austerity targets. And even Germany has had its pristine triple-A credit rating tarnished by a “negative outlook” from ratings agency Moody’s.
The co-ordinates of the slow-burn disaster remain the same. Weak economies across the continent are lugging around crippled, wheezing, and in some cases plainly dead banks. These are the eurozone banks that, during the boom years of the last decade, beefed themselves and their balance sheets up with increasingly ropey loans. The eurozone itself facilitated this: the single currency, the apparent stability it provided, and the relaxed approach to regulation it fostered allowed banks to go on something like a spending spree, issuing greater and greater quantities of credit. Serious imbalances across the eurozone economies, with trade surpluses in the north matched by deficits in the south, were funded by the growth of debt. This drove an unsustainable boom over 2000-2008 whose underlying weaknesses were blithely ignored by Europe’s leaders.
The specifics have varied around that framework. In Greece, the pile of debt grew on the public side of the balance sheet, fuelled by chronic levels of tax avoidance amongst its local rich. In Spain, Ireland and Portugal, debt piled up in the private sector. All three ran surpluses on their government accounts before the crash of 2008, with the public authorities spending less than they took in taxation – in sharp contrast to Germany, which ran persistent deficits.
Spain: property bubble, property crash
For Spain, this ballooning of private debt was tied to an immense property boom. Spanish property prices increased by 150% between 1997 and 2006. That increase in prices both helped support, and was then fuelled along by, the boom in credit, with household indebtedness rising from 52% of disposable income in 1997 to 115% by 2007.
The crash threw the system into reverse. Property prices slid. Like the ebbing of a tide, they left much that was previously hidden suddenly exposed. Spanish banks - particularly the cajas, the smaller, regional banks - were stuffed full of bad debts and in danger of failure. The Spanish government was forced earlier this year to amalgamate and part-nationalise seven of these banks, creating Bankia, whose tribulations earlier this year kick-started the current panic.
Behind the banks stands the government. In theory, a state should be able to act as a lender of last resort, supporting the banking system and protecting its depositors. This should, in normal circumstances, be enough to prevent bank runs occurring – when depositors, fearing a bank has become insolvent, rush to remove their savings and, in doing so, force the bank into insolvency. In practice, with Spain trapped in a severe recession, turning a government surplus into an accelerating deficit as tax receipts shrink and unemployment payments rise, and with the exceptionally heavy burden of support needed for its banks, the Spanish state is struggling.
Spanish regions, enjoying a fair degree of fiscal autonomy, are confronting a severe recession, forcing them into deep budget deficits. They are forced to appeal to the Spanish state for funding, increasing the burdens on the central state.
That weakness of the state, in turn, has driven the attempts at rescue by the EU and ECB. They were afraid that if banks in Spain, the eurozone’s fourth largest economy, were to fail, the consequences across the rest of the continent would be immense. Because the eurozone’s banks are so tightly bound to each other, through their lending and their borrowing, a significant failure in one part of the system can threaten the rest. The UK, too, would be pulled rapidly into a eurozone banking failure, with our major banks having one of the largest exposures to eurozone banks of any economy outside of the single currency area.
A bailout for Spain is, in these circumstances – and despite Spanish PM Rajoy’s ostrich impersonation – close to inevitable. At least €300bn is mooted. But if the economics driving the crisis do not improve – a healthy return to growth and remarkable rebound in the property market being the minimum needed – even this monster sum will not be enough. The chances of a spontaneous economic miracle on the Mediterranean are, needless to say, minimal.
Greece: Exit ahead
Greece, locked into a strict regime of austerity for nearly three years, has reportedly missed 210 out of the 300 taxation and spending targets that the EU/IMF/ECB “Troika” set to monitor its progress towards reducing its deficit. Facing a 1930s re-run, Greece’s economy is in freefall, shrinking by close to 20% in nearly four years. And the harder it drives at austerity, the further it falls. Troika targets become harder and harder to meet; nonetheless, it’s likely that EU and IMF officials, in Athens this week, will demand another €2bn of cuts – threatening to cut off its financial lifeline.
The logic here isn’t economic. Economic logic would demand an immediate end to austerity. The logic here is political. Allowing Greece off its austerity hook – worse, being seen to allow Greece off the hook – would undermine the ability of the Troika to police Europe’s other failed economies. If Greece is allowed a respite, why not Spain? Why not Portugal or Ireland? And so a whole country is sacrificed to preserve the illusion of Troika control.
The only route out of the austerity deadlock for Greece would be to decisively reject Troika demands: end austerity, default on the debt, exit the euro. Greece’s current government will countenance no such action. But their hand may be forced by the dire situation on the ground. With Greek banks essentially insolvent, wholly dependent on EU support, and with the economy continuing to slide, the risk of an unplanned euro-exit is real, a run on the banks – depositors withdrawing euros for safer locations, whether Switzerland or their mattress – acting as the cue.
For the time being, the pretence is maintained that Greece’s euro membership is inviolable. But with the delayed €500bn European Stability Mechanism bailout fund due to come on-stream, the opportunity may well be taken cut the Troika’s losses and allow Greece to find its way out of the single currency. Der Spiegel reports that the IMF’s willingness to continue sustaining Greek losses inside the eurozone has finally expired, while the patience of hardline German finance minister Wolfgang Schauble clearly evaporated some time ago. If it is believed that the costs of a Greek exit can be contained – in particular, containing financial contagion and possible further exits – the balance could easily swing in favour of swift Greek exit.
The latest 'rescue' package
The current panic has driven through the familiar rounds of crisis summits and attempted bailouts, backed up by demands for deeper and deeper austerity in an effort to close the government deficit. As ever, austerity is self-defeating: cuts in government spending means firms elsewhere selling less. As they sell less, they, too, cut back on their spending. As their spending falls, the earnings of their employees and their suppliers also drop, and they, in turn, cut their own spending. A vicious circle is set in train, and as demand collapses across the economy, the government earns less in taxes - while paying out more in unemployment benefits.
The latest rescue package, three weeks ago, introduced a further twist. Recognising the scale of the banks’ problems, across the whole eurozone, a “banking union” was now proposed. This would remove responsibility for countries’ banking systems from the individual states, and pass them on to an EU-wide institution. Instead of relying, for example, on the Spanish government to act as the backstop for Spanish banks, every euro member would act to support them. In theory, this should be a stronger arrangement than currently, since the stronger euro members could club together to support the weaker. In practice, there is insufficient desire on the part of stronger euro members – Germany especially – to want to bear the costs of doing so. Without much closer fiscal union – that is, a transfer of taxation and spending powers away from individual members – a banking union is a nonstarter. But without a banking union, banks in the eurozone’s periphery – like those in Spain – will remain at risk of collapse.
€100bn was set aside for the bank bailout. It is now clear that this is nowhere close to enough to maintain even Spain’s banks. With blowback from southern Europe now creeping into northern European credit ratings, the crisis has taken a further twist downwards.
A resolution to the disaster could well prove beyond the powers of Europe’s creaking authorities. The most recent round of talks at least recognised the need for a major institutional shake-up. Implementing even the minimum here, however, will take years, rather than the months or weeks available. And if the banking union is tied, as it is, to self-defeating demands for greater budget “discipline” within the eurozone, there are no realistic prospects for the kind of economic recovery that might stabilise the situation – to say nothing of the dire consequences for democracy in Europe a fiscal union would involve.
The paths out of the crisis look much the same as they have for the last three years. Greece is set for a further default, and a probable euro exit. Spain may end up likewise, even with a bailout. Northern Europe might be able to create a closer, smaller eurozone, with the central fiscal authority needed to underpin it. But the tolerance of Europe’s elites for the high costs needed to get there, and the willingness of its people to bear them, are wearing thin. In Finland – now the only eurozone member still preserving a stable triple-A credit rating – the nationalist, anti-bailout True Finns have made significant electoral gains. Finland is a plausible candidate for its own euro-exit. Elsewhere, the balance of costs and benefits turns against membership. Disintegration looms large.
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).