By Mike Whitney
“Today we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time—perhaps for a long time.” –John Maynard Keynes, The Great Slump of 1930
The battered euro tumbled to an 11 month low on Wednesday while “safe haven” 10-year US Treasuries rallied. (1.93 percent) The flight from all-things-Europe continued with gusto after German Chancellor Angela Merkel rejected a recommendation that the eurozone bailout fund (EFSF) be increased to deal plunging bond yields in Italy and Spain which are increasing the probability of a sovereign default. The unmovable Ms. Merkel refuses to use the tools at her disposal choosing instead to stick with hard money policies that are strangling growth and thrusting the eurozone deeper into recession. Here’s the story from Reuters:
“From Athens to Dublin, and almost everywhere in between, administrations are imposing wave after wave of spending cuts and tax increases to persuade investors they are serious about improving their public finances and persuade them to start buying euro zone sovereign debt again.
The austerity zeal risks tipping the continent back into recession and a downward spiral of austerity as pitiful growth prospects undermine budgetary targets and ramp up debt burdens, meaning further austerity is required.
“The expansionary fiscal contraction story says that you cut, you show you are serious about cutting and then the confidence fairy will come along and she will start pulling in private investment,” said Stephen Kinsella, professor of economics at the University of Limerick. “But expansionary fiscal contraction story is a lie. You don’t cut your way to growth.” (“Analysis: Europe’s austerity zeal risks killing the patient”, Reuters)
Europe’s agenda-driven politicians have savaged economies in the south, slashed the flow of credit to capital-starved emerging markets, and extended a growth-choking pall across the continent. Whose idea was it to put the world’s future in the hands of ideologues who still think we’re on the gold standard?
Wednesday’s action in the currency, credit and stock markets proves that last Friday’s make or break summit in Brussels was a farce that will further hasten the downward slide into recession. Demand is drying up everywhere austerity measures have been implemented, triggering sharp cutbacks in government spending, deepening distress among middle class workers, and precipitating a steady uptick in street violence. The so-called “Summit to save Europe” was just more of the same, a bland rehash of the Stability and Growth Pact that substitutes pro-growth stimulus for legally enforceable penalties for debt sinners. This is Merkel’s idea of “fiscal union”, a confederation of broken eurostates each wearing his own deficit chastity belt that’s periodically tested by bureaucrats in Brussels or Frankfurt.
It took investors just one day to see that the summit was a hoax and start pulling their money out of equities. The Dow recorded triple-digit losses on the day.
Europe is in an existential crisis, but their leaders remain oblivious to the cause. The root is not the deficits, but the bulging account imbalances that were produced by excessive bank lending to wobbly sovereigns in the south. The capital flows vanished after Lehman crashed leaving many of the countries underwater without sufficient tax revenues to make up the difference. Here’s a clip from an article by The Center for European Reform titled “Why Stricter Rules Threaten the Eurozone” without question , the best and most comprehensive analysis of the debt crisis to date:
“How did the eurozone come to find itself in its current predicament?
The short answer is that the introduction of the euro spurred the emergence of enormous macroeconomic imbalances that were unsustainable, and that the eurozone has proved institutionally ill equipped to tackle….
It is wrong, however, to blame government profligacy for the rise in peripheral indebtedness: Greece is the only country where this holds true. In Ireland and Spain, it was the private sector (particularly banks and households) that was to blame. Indeed, in 2007, the Spanish and Irish governments looked more virtuous than Germany’s: they had never broken the fiscal rules, had lower levels of public debt and ran budget surpluses.
Creditor countries cannot be absolved of all blame. Not only was export-led growth in countries like Germany and the Netherlands structurally reliant on rising indebtedness abroad. But creditor countries in the core harboured plenty of vice: the conduits for the capital that flowed from core to periphery were banks, and these were more highly leveraged in countries like Germany, the Netherlands and Belgium than they were in the periphery (or the Anglo-Saxon world). The eurozone crisis is as much a tale of excess bank leverage and poor risk management in the core as of excess consumption and wasteful investment in the periphery.” (“Why Stricter Rules Threaten the Eurozone”, Simon Tilford and Philip Whyte, The Center for European Reform)
So, if Merkel and Co. do not yet grasp the source of their problem, how can they be expected to fix it?
Euro leaders are not just nipping at the edges either, they are making conditions demonstrably worse, which is why yields on Italian debt is rising, public confidence is eroding, and the centerpiece of the bailout strategy–the creation of a $440 billion emergency fund (EFSF)–”has only raised 16 billion euros from four bonds this year” according to the credit experts at macronomy.blogspot.com. That’s hardly a ringing endorsement of current policy.
It’s also why the entire eurozone has entered the crosshairs of the ratings agencies who doubt their ability to right the ship. Moody’s is planning to review the ratings on 26 of 27 EU countries by the first quarter of next year.
(The summit)… “offers few new measures, and does not change our view that risks to the cohesion of the euro area continue to rise.”
“Amid the increasing pressure on euro area authorities to act quickly to restore credit market confidence, the constraints they face are also rising. The longer that remains the case, the greater the risk of adverse economic conditions that would add to the already sizable challenges facing the authorities’ coordination and debt reduction efforts.” (Moodys)
Neither the bond market nor the ratings agencies have been hoodwinked by the summit-hype. There has been, however, some relief in the credit markets. Interbank lending eased slightly after the ECB announced that it would provide unlimited three-year loans on all types of dodgy collateral to counter a credit crunch. ECB chief Mario Draghi also said the central bank would purchase up to $20 billion in bonds per month in order to keep interest rates low, but he refuses to launch an aggressive quantitative easing (QE) campaign that would expand the ECB’s balance sheet and calm jittery investors.
Draghi is perfectly happy to use his power for political purposes–to force harsh labor-crushing reforms on debt-stricken countries in the south, while providing discount liquidity to underwater banks that should be restructured. Here’s how Reuters sums it up: ”The central bank revealed on Monday it had slashed bond purchases in the week before the EU summit as it raised pressure on the bloc’s leaders to act.”
There it is in black and white. The reason Draghi hasn’t pushed to be the lender of last resort is because he can simply “slash bond purchases” and effect the changes he wants. As a G-Sax alum his loyalty is to big finance, which means that his real aim is to implement policies that serve the interests of fatcat speculators. He doesn’t want a blank check to bail out the system. What he wants is a pressure point that allows him to impose his neoliberal vision on all of eurozone. The ECB’s bond buying program has become a form of financial coercion.
That said, we still expect that the ECB will be called on to bail out the financial system when bond yields in Italy and Spain spike suddenly sending tremors across global stock markets and wreaking havoc with EU bank balance sheets which are already bleeding red.
The eurozone has entered a new and “more dangerous phase of the crisis”; a phase in which more of the burden will fall on politicians to make a course correction, to abandon the policies of austerity and debt deflation, and to rebuild their flagging economies with generous doses fiscal stimulus to avoid a banking system collapse and another protracted slump.
God help us.