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A União Europeia confronta-se com uma crise de legitimidade que se tem acentuado com o avolumar de contradições que podem ser melhor compreendidas, por exemplo, no contexto do debate que opôs Karl Polanyi a Friedrich Hayek e que colocou a economia reconfigurada em função de uma ordem social democrática e igualitária contra um neoliberalismo onde as estruturas não mercantis são valorizadas apenas na medida em que forem instrumentais ao alargamento da esfera de ação dos mercados.

No discurso de Thorstein Veblen dir-se-ia que os valores do cerimonial económico do modelo de governação em crise de legitimidade são os de uma religião onde o mercado é central e ao qual todos os restantes factores da economia, incluindo o trabalho, se subordinam; os de um regime de globalização que permite às grandes empresas transnacionais interferir na capacidade democrática de organização colectiva; os de uma cultura de consumismo ostensivo associada a uma emulação pecuniária que impede a prossecução de objectivos racionais e equitativos de provisão geral; os de um sistema financeiro com lógica de casino; os de um sistema industrial marcado pelo desperdício e pela sabotagem.

Quando a partir do final de 2007, em sequência de um longo período de especulação financeira praticamente irrestrita, a mão invisível começou a faltar ao encontro com o equilíbrio prometido e os EUA, primeiro, e a Europa, logo a seguir, mergulharam numa crise que só encontra paralelo na Grande Depressão de 1929, os mercados desregulados não só não rejeitaram a intervenção do Estado como dela inteiramente dependeram, tendo o colapso certo sido (provisoriamente?) evitado com quantias absolutamente gigantescas de dinheiro público; longe de produzirem a prometida prosperidade universal, os cortes na despesa pública que se seguiram mais não fizeram que aprofundar a crise.

Na zona Euro, o endividamento público caiu de 72% para 67% entre 1999 e 2007 (início da crise financeira) enquanto o endividamento das instituições financeiras, no mesmo período, aumentou de menos de 200% para mais de 250% do PIB; ao contrário do que afirma a narrativa ainda dominante, a explosão na dívida pública que se verificou a partir de 2007 resultou da necessidade de socorrer o sector privado, e em particular o subsector financeiro, e não o contrário.

Na Europa e em Portugal, a crise resulta essencialmente da arquitectura disfuncional de uma moeda única que, desenhada na crença da tendência sistémica para o equilíbrio das economias onde o estado está ausente, pressupõe que o trabalho, assumido como variável única de ajustamento, é uma mercadoria como outras.

Ao contrário do que afirma a utopia neoliberal, o trabalho não é mercadoria e nenhum modelo de governação que o pressuponha pode subsistir; nas palavras de Karl Polanyi, “[t]rabalho é apenas outro nome para a atividade humana que é a vida em si mesmo” e “[p]ermitir que o mecanismo de mercado seja o único administrador da sorte dos seres humanos e do seu ambiente natural, ainda que apenas no que diz respeito à quantidade e uso de poder de compra, resultaria na demolição da sociedade”. 

A 15 de Setembro último, a sociedade defendeu-se do extremismo mercantil e uma massiva manifestação de descontentamento popular, exigindo alternativas, rompeu o fabricado consenso austeritário. Agendado para 5 de Outubro próximo, o Congresso Democrático das Alternativas propõe-se reunir ‘todos os que sentem a necessidade e têm a vontade de debater e construir em conjunto uma alternativa à política de desastre nacional consagrada no memorando da troika’. Lá estarei; peço-te que ponderes, também, a tua presença.

*Texto também publicado no sítio do Congresso Democrático das Alternativas.

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Desincrustada da sociedade, a tal economia de mercado, que tende para o equilíbrio desde que o Estado não estorve, criou na América do Norte e na Europa esta interessante circunstância: “(…) excess debt has created a situation in which everyone is trying to spend less than their income. Since this is collectively impossible — my spending is your income, and your spending is my income — the result is a persistently depressed economy (…)”.

E agora?

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The forces of contagion in the eurozone appear unstoppable. On Thursday investors drove yields on both Italian and Spanish debt to new highs, as fears grew that last month’s Greek rescue deal would prove insufficient to stop Europe’s financial rot. Without swift action from the European Central Bank, this will prove to be a contagion process with a disastrous end.

Why do we face these problems? Government bond markets in a monetary union are inherently fragile. Eurozone nations issue debt in a “foreign” currency, over which they have no real control. As a result, they cannot guarantee to the bondholders that they will always have the necessary liquidity to pay out the bond at maturity. States which issue their own bonds, however, can guarantee that the cash will always be available, because they can always force the central bank to create the money. And there is no limit to the amount of money a central bank can create.

This situation makes bond markets in a monetary union unusually prone to forces of contagion, very much like in banking systems. If one bank experiences a solvency problem, deposit holders start doubting the solvency of their own bank, and run to convert their deposits into cash. When everybody does this at the same time the banks will not have enough cash. This banking system instability was solved by mandating the central bank to be a lender of last resort – and the neat thing about this solution is that, when deposit holders are confident that it exists, it rarely has to be used.

The problem faced by the member countries of a monetary union such as the eurozone is exactly the same. Therefore, the solution is the same. Contagion between sovereign bond markets can only be stopped if there is a central bank willing to be lender of last resort. The only institution able to perform this role is the ECB.

The ECB initially performed this role in a timid way, while making it clear that it was unwilling to continue doing so. Indeed, this reversal in the ECB’s policy is the most important factor explaining why the forces of contagion in the eurozone’s sovereign bond markets cannot be stopped.

Europe’s leaders have tried to solve this problem by creating a surrogate institution, the European financial stability facility. Yet the EFSF will never have the necessary credibility to stop the forces of contagion – precisely because it cannot actually print money. It depends for its resources on the member countries of the union, and these are limited. As a result, it cannot guarantee that the cash will always be available to pay out sovereign bond holders even if its resources are doubled or tripled. Only a central bank that can create unlimited amounts of cash can provide such a guarantee.

The ECB argues that it can abandon its responsibility as lender of last resort, because to provide that guarantee gives wrong signals to politicians. It creates a temptation to add excessive government debt, because the ECB will eventually foot the bill. While this moral hazard risk is indeed a serious one, it is no different from the same risk in the banking system. The way to deal with this is not to abolish the role of lender of last resort, but to create rules that will constrain governments in issuing debt.

Stopping Europe’s current crisis requires fundamental overhaul of the eurozone’s institutions. But the most important part of that overhaul is to ensure that the ECB takes on full responsibility as a lender of last resort in the government bond markets of the eurozone. Without this, the markets cannot be stabilised and crises will remain endemic.

At the same time, further steps towards political unification must be taken, without which control on national government deficits and debts cannot be implemented. Some steps in that direction were taken recently when the European Council strengthened control of national budgetary processes and on national macroeconomic policies. These decisions, however, are insufficient, and more fundamental changes in the governance of the eurozone are needed. These should be such that the ECB can trust that its lender of last resort responsibilities in the government bond markets will not lead to a never-ending dynamic of debt creation.

By Paul De Grauwe, The writer is professor of economics at the University of Leuven, August 3, 2011 


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Updated at 15.00 London time

It looks like there will be deal on a eurozone package for Greece. The full details are still missing, but it appears that the eurozone is forcing Greece into a selective default. As part of such a package, short-term Greek debt will be more or less forcibly converted into long-term debt. The wretched bank tax is mercifully off the table. And the European financial stability facility will most likely be allowed to purchase Greek debt at a discount. Let us not mince words here. This would be a default, the first by a western industrialised country in a generation. I am not quite sure how it is possible for the European Central Bank to agree to this, or to all of this. But I will surely be intrigued to hear how Jean-Claude Trichet will manage to be consistent with what he said a few days ago. There are also reports that the eurozone leaders may accept a more flexible EFSF beyond those bond purchases.

So would this be a good deal? Those who are in the thick of it are running the danger that they got so obsessed with the formidable technical complexities that they lose sight of the bigger picture. The problem of the eurozone is not Greece, or some other small country on its periphery. The existential danger is the rise in market interest rates of Italy and Spain, two large countries in the eurozone’s core. To state the goal of today’s meeting in simple terms would be to say: the survival of the eurozone depends on whether its leaders will be able to take decisions that would allow Italy and Spain, and everybody else as well, to remain inside the eurozone on a sustainable basis. Greece is now just a side-show.

If that is the goal, I would judge today’s outcome in terms two priorities. The first, and most important, is the size and flexibility of the European financial stability facility, the rescue umbrella. At present, the overall size of the EFSF is €450bn. With a second Greek credit about to be agreed and second programmes for Ireland and Portugal very likely, the ceiling will not be big enough to bring in Spain, let alone Italy. To do that that the ceiling would have to be doubled, or trebled. Without this increase, it is inconceivable that the eurozone can get through this crisis intact. One could think of other constructions, such as having no fixed limits at all or sliding limits. The structure of the EFSF would have to be changed if it was going to be made this big. It would have to be properly capitalised. Italy’s 18 per cent share in the EFSF would otherwise not be credible.

This will not be agreed today and this alone is why the summit will fall short of what is required. As it stands, the eurozone has a mechanism that can deal with GreeceIreland and Portugal, but no other country.

Size and flexibility go together. At present the EFSF can only lend money to governments. In turn, the applicant countries are subject to a full European Union/International Monetary Fund supervised austerity programme. You are either in or out. It is important that the EFSF can act pre-emptively, even in respect of countries that are not part of an official programme. The EFSF should also be able to purchase bonds on primary and secondary markets, help refinance banks or give emergency credits during a crisis. It cannot do any of these things now. The bigger and the more flexible the EFSF becomes, the greater the chance that Italy and Spain can get through the crisis.

Second, of course, would be a plausible programme for Greece. The construction currently discussed has some merits, but I am still not sure to which extent it will help Greece. If one accepts the logic of an involuntary private-sector participation, and the advent of a selective default rating, then one should better make sure that one ends up in a situation where Greece defaults, and yet is still not in a position to repay its debt in the long run.

What’s the point of default in such a scenario? If the final construction leads to a reduction in the Greek debt from an estimate year-end level of 175 per cent of gross domestic product to 130 per cent after a default – with no changes to its real exchange rate – it is not clear at all how Greece can be solvent at such a still high level of debt.

The outlines of the agreement, as they have been presented so far, still fall short of the main goals – to have an EFSF capable of dealing with Italy and Spain – and to have a Greek package that reasserts debt sustainability one way or the other. Like all decisions in the European Council, this is a compromise for sure. But there are limits to compromises when you are dealing with a contagious debt crisis. You either do enough, or you do not. They are still lacking a strategy to deal with the wider crisis.

Munchau
Wolfgang Münchau

The writer is an associate editor of the Financial Times and president of Eurointelligence ASBL

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Ferguson illustration

The biggest question in any debt crisis is whether a credible path back to solvency can be found. For Greece, this now seems very unlikely. The same is true, to a lesser extent, for Ireland and Portugal. This raises three further questions. First, how big is any required restructuring? Second, who should bear the cost? Finally, is restructuring enough? If the answer to the last question is No, then one has to ask whether the currency union will last in its current form.

On the first of these questions, an analysis by Citigroup provides a negative answer. According to this analysis, by 2014 the ratio of gross debt to gross domestic product will have risen to 180 per cent in Greece, 145 per cent in Ireland and 135 per cent in Portugal. In none of these cases will the debt ratio start moving downwards over this horizon. Spain looks far better, with a debt ratio at about 90 per cent of GDP in 2014, though its path, too, will not have turned down. (See chart.)

The assumptions behind these forecasts are: a cumulative fiscal tightening between 2011 and 2014, inclusive, of 10.8 per cent of GDP in Greece, 8.3 per cent in Portugal, 7.3 per cent in Ireland and 5.7 per cent in Spain; interest cost of new funding rising from close to 5 per cent to 5.6 per cent in 2014 for Greece, Portugal and Ireland (determined by a weighted average of rates from the International Monetary Fund and the European Financial Stability Fund) and higher rates for Spain, since the latter will rely on the market; and, finally, privatisations and bail-outs. The analysis also assumes that a percentage point of fiscal tightening would lower growth by half as much.

Assume that these countries could borrow affordably in private markets at a gross debt ratio of 80 per cent of GDP. Assume, too, that European governments ensure that the IMF takes no losses. Then, the reduction in value of the rest of the debt would need to be as much as 65 per cent of GDP for Greece, 50 per cent for Ireland and 45 per cent for Portugal. The total “haircut” would be €423bn: €224bn for Greece, €107bn for Ireland and €92bn for Portugal.

One can quibble over the figures: these may be too pessimistic. But, without a big restructuring, these countries are now most unlikely to be able to finance themselves in the market on bearable terms. That is also what markets are saying: spreads on 10-year bonds over yields on German Bunds are 1,340 basis points, or 13.4 percentage points for Greece, 875 basis points for Ireland and 818 basis points for Portugal. This is why they are all now in official programmes. Worryingly, spreads for Spain are also now uncomfortably high, at 240 basis points, while those for Italy have reached 190 points. The eurozone, in short, is confronting a frightening sovereign debt challenge, aggravated by the dependence of its banks on support from its states and of its states on finance from its banks.

Now turn to the second question: who should bear the losses? If all the haircuts were to fall on private creditors, their losses in 2014 would be 97 per cent of their holdings of Greek debt, 63 per cent of their Irish debt and 60 per cent of their Portuguese debt. Official creditors would, by then, have to bear a substantial part of the total losses. Since governments would also need to bail out some of the holders of the restructured debt, particularly the banks, the eurozone would be revealed as a “transfer union”. Note, moreover, that this would occur despite a big fiscal effort in the affected countries. But even that would be insufficient to reverse the unfavourable debt dynamics in the medium term, partly because GDP growth is likely to remain so weak.

Against this background, proposals for rollovers by the banks, whether or not deemed technically a default, are neither here nor there. Much more to the point would be debt buy-backs at levels close to current market prices, as discussed in last week’s statement on Greece of the Institute for International Finance, which brings together the biggest international banks. That would crystallise losses. So be it. Let reality be recognised. As the Financial Times has also argued this week, the case for offering a menu of options with partial guarantees, similar to those under the 1989 Brady plan for Latin American debt, is powerful.

The question is whether such voluntary debt reductions would be enough, particularly for Greece. The answer is No. Governments would also have to play a part, by either accepting losses on the face value of their loans or ensuring lower interest rates, as proposed by Jeff Sachs of Columbia University. These are just two ways of achieving a lower net present value of debt service.

The dangers of debt relief are great. But the chances of success with denial are close to zero. True, it is possible for an ever greater share of the debt to be assumed by governments, so bailing out private creditors. Yet, ultimately, the cost of the debt owed to official sources will have to be cut by lowering interest rates or reducing sums outstanding.

It is not a question of whether such adjustments will have to be made, but of when. The history of such crises strongly suggests that it should be done sooner rather than later. Only after debt is on a sustainable path is confidence likely to return. Allowing foolish lenders, incompetent regulators and sloppy policymakers to hide past mistakes is a bad excuse for endless delays.

The doubt, in truth, is not over whether relief on the present value of the debt service is required. The real questions are elsewhere. One is over how to manage a co-operative debt restructuring. The other is over competitiveness and the return to growth. Some point to the success of Latvia in managing its so-called internal devaluation. But its GDP is 23 per cent below its pre-crisis peak. That is a depression. Moreover, the more successful a country turns out to be in cutting its costs, the worse the debt burden becomes. Thus, debt restructuring is merely a necessary condition for an exit. It is unlikely, in all cases, to be enough. Some economies may just wither away.

Alternatively, politicians may pull their countries out of the eurozone regardless of short-run costs. It is far too early to assume this will be the outcome, though some already do. But if there is to be any chance of avoiding this outcome, realism is required. At some point, the present value of the cost of debt must be drastically lowered. This does not have to happen today. But it has to happen soon enough to give people hope. In its absence, failure is not just likely. It is close to a certainty.

Moment of truth for the eurozone, Financial TimesBy Martin Wolf.

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The economic, and democratic, crisis in Europe raises questions. Why were policies that were bound to fail adopted and applied with exceptional ferocity in Ireland, Spain, Portugal and Greece? Are those responsible for pursuing these policies mad, doubling the dose every time their medicine predictably fails to work? How is it that in a democratic system, the people forced to accept cuts and austerity simply replace one failed government with another just as dedicated to the same shock treatment? Is there any alternative?

The answer to the first two questions is clear, once we forget the propaganda about the “public interest”, Europe’s “shared values” and being “all in this together”. The policies are rational and on the whole are achieving their objective. But that objective is not to end the economic and financial crisis but to reap its rich rewards. The crisis means that hundreds of thousands of civil service jobs can be cut (in Greece, nine out of ten civil servants will not be replaced on retirement), salaries and paid leave reduced, tranches of the economy sold off for the benefit of private interests, labour laws questioned, indirect taxes (the most regressive) increased, the cost of public services raised, reimbursement of health care charges reduced. The crisis is heaven-sent for neoliberals, who would have had to fight long and hard for any of these measures, and now get them all. Why should they want to see the end of a tunnel that is a fast track to paradise?

The Irish Business and Employers Confederation (IBEC)’s directors went to Brussels on 15 June to ask the European Commission to pressure Dublin to dismantle some of Ireland’s labour legislation, fast. After the meeting, Brendan McGinty, IBEC director of Industrial Relations and Human Resources, warned: “Ireland needs to show the world it is serious about economic reform and getting labour costs back into line. Foreign observers clearly see that our wage rules are a barrier to job creation, growth and recovery. Major reform is a key part of the programme agreed with the EU and the IMF. Now is not the time for government to shirk from the hard decisions.”

The decisions will not be hard for everyone, following a course that is already familiar: “Pay rates for new workers in unregulated sectors have fallen by about 25% in recent years. This shows the labour market is responding to an economic and unemployment crisis” (1). The lever of sovereign debt enables the European Union and International Monetary Fund to impose the Irish employers’ dream order on Dublin.

The same view seems to apply elsewhere. On 11 June, an Economist editorial observed that “Reform-minded Greeks see the crisis as an opportunity to set their country right. They quietly praise foreigners for turning the screws on their politicians” (2). The same issue analysed the EU and IMF austerity plan for Portugal: “Business leaders are adamant that there should be no deviation from the IMF/EU plan. Pedro Ferraz da Costa, who heads a business think-tank, says no Portuguese party in the past 30 years would have put forward so radical a reform programme. He adds that Portugal cannot afford to miss this opportunity” (3). Long live the crisis.

Catering only to rentiers

Portuguese democracy is just 30 years old. Its young leaders were showered with carnations by crowds grateful for the end of a long dictatorship and colonial wars in Africa, the promise of agrarian reform, literacy programmes and power for factory workers. Now, with reductions in the minimum wage and unemployment benefit, neoliberal reforms in pensions, health and education, and privatisation, they have had a great leap backwards. The new prime minister, Pedro Passos Coelho, has promised to go even further than the EU and the IMF require. He wants to “surprise” investors.

US economist Paul Krugman explains: “Consciously or not, policy makers are catering almost exclusively to the interests of rentiers – those who derive lots of income from assets, who lent large sums of money in the past, often unwisely, but are now being protected from loss at everyone else’s expense.” Krugman says creditor interests naturally prevail because “this is the class that makes big campaign contributions, it’s the class that has personal access to policy makers, many of whom go to work for these people when they exit government through the revolving door” (4). During the EU discussion on funding Greek recovery, Austrian finance minister Maria Fekter initially suggested: “You can’t leave the profits with the banks and make the taxpayers shoulder the losses” (5). This was short-lived. Europe hesitated for 48 hours, then the interests of rentiers prevailed, as usual.

To understand the “complex” mechanisms underlying the sovereign debt crisis, you need to know about constant innovations in financial engineering: futures, CDs (credit default swaps) etc. This level of sophistication reserves analysis for select experts who generally profit from their knowledge. They pocket the proceeds while the economically illiterate pay, as a tribute they owe to fate, or to an aspect of the modern world that is beyond them.

Let’s try the simple political explanation instead. Long ago, European kings borrowed from the Doge of Venice or Florentine merchants or Genoese bankers. They were under no obligation to repay these loans and sometimes neglected to do so, a neat way of settling public debt. Many years later, the young Soviet regime announced that it would not be held accountable for money the tsars had borrowed and squandered, so generations of French savers suddenly found they had worthless Russian loans in their attics.

But there were more subtle ways of getting out of debt. In the UK, debt declined from 216% of gross domestic product in 1945 to 138% in 1955, and in the US it fell from 116% of GDP to 66%. Without any austerity plan. Of course, the surge in post-war economic development automatically reduced the proportion of debt in national wealth. But that was not all. States repaid a nominal sum at the time, reduced each year by the level of inflation. If a loan subscribed at 5% annual interest is repaid in currency that is depreciating at the rate of 10% a year, the real interest rate becomes negative to the benefit of the debtor. Between 1945 and 1980, the real interest rate in most western countries was negative almost every year. As a result, as The Economist remarked: “Savers deposited money in banks, which lent to governments at interest rates below the level of inflation” (6). Debt was cut without much trouble. In the US, negative real interest rates were worth the equivalent of 6.3% of GDP per year to the Treasury, from 1945 to 1955 (7).

Why did savers allow themselves to be cheated? They had no choice. Capital controls and the nationalisation of the banks meant that they had to lend to the state, and that is how it got its funds. Wealthy individuals did not have the option to invest on spec in Brazilian stock index-linked to changes in the price of soybeans over the next three years. There was a flight of capital, suitcases of gold ingots leaving France for Switzerland the day before devaluation or an election in which the left might win. However, this was illegal.

Up to the 1980s, index-linked wage rises (sliding scales) protected most workers against the consequences of inflation, and controls on free movement of capital had forced investors to put up with negative real interest rates. After the Reagan/Thatcher years, the opposite applied.

The system has no pity

Sliding wage scales disappeared almost everywhere: in France, the economist Alain Cotta called this major decision, in 1982, “[Jacques] Delors’ gift [to employers]” (8). Between 1981 and 2007, inflation was destroyed and real interest rates were almost always positive. Profiting from the liberalisation of capital movements, “savers” (this does not mean old age pensioners with a post office account in Lisbon or carpenters in Salonika) make states compete for funds and, as François Mitterrand said, “make money in their sleep”. Moving from sliding wage scales and negative real interest rates to a reduction in the purchasing power of labour and a meteoric increase in returns on capital completely upsets the social balance.

Apparently this is not enough. The troika (European Commission, ECB and IMF) has decided to improve the mechanisms designed to favour capital at the expense of labour, by adding coercion, blackmail and ultimatum. States bled by their over-generous efforts to rescue the banks, and begging for loans to balance their monthly accounts, are told to choose between a market-led clean-up and bankruptcy. A swathe of Europe, where the dictatorships of António de Oliveira Salazar, Francisco Franco and the Greek colonels ended, has been reduced to the rank of a protectorate run by Brussels, Frankfurt and Washington, the main aim being to defend the financial sector.

These states still have their own governments, but only to ensure that orders are carried out and to endure abuse from the people who know the system will never take pity on them, however poor they are. According to Le Figaro, “Most Greeks see the international supervision of the budget as a new form of dictatorship, like the old days when the colonels were in charge, between 1967 and 1974” (9). The European ideal will not gain from being associated with a bailiff who seizes islands, beaches, national companies and public services and sells them to private investors. Since 1919 and the Treaty of Versailles, everyone knows that such public humiliation can unleash destructive nationalism – and all the more so as provocations increase. The next ECB governor, Mario Draghi, who – like his predecessor – will issue strict orders in Athens, was vice chairman and managing director of Goldman Sachs when the bank was helping the conservative government in Greece to cook the books (10). The IMF, which also takes a view on the French constitution, has asked Paris to insert a “rule to balance public finances”; Nicolas Sarkozy is already working on it.

France has let it be known that it would like the Greek political parties to follow the example of their Portuguese counterparts, “join forces, and form an alliance”; and the prime minister, François Fillon, and European Commission president, José Barroso, have tried to persuade the Greek conservative leader, Antonis Samaras, to take this course. ECB head Jean-Claude Trichet considers that “the European authorities could have the right to veto some national economic policy decisions” (11).

Honduras has established an enterprise zone, in which national sovereignty does not apply. Europe is currently establishing a debate zone for all the economic and social issues no longer discussed by the political parties because these areas have gone beyond their control. Inter-party competition now concentrates on social matters: the burqa, the legalisation of cannabis, radar on motorways, the angry gestures or foul language of a reckless politician or intoxicated artist. This confirms a trend already noticeable 20 years ago: real political power is shifting to areas where democracy carries no weight, until the day when indignation finally boils over. Which is where we are.

But indignation is powerless without some understanding of the mechanisms that caused it. We know the alternatives – reject the monetarist, deflationist policies that deepen the crisis, cancel part of the debt if not all of it, take over the banks, get finance under control, reverse globalisation and recover the hundreds of billions of euros the state has lost by tax cuts that favour the wealthy (?70bn in France in the past ten years, more than $1 trillion in the US, especially for the top 1% of income earners). And knowledge of these alternatives has been shared by people who know at least as much about economics as Trichet, but do not serve the same interests.

This is not a technical and financial debate but a political and social battle. Of course, the economic liberals will claim that what progressives demand is impossible. But what have they achieved, apart from creating a situation that is unbearable? Perhaps it is time to remember how Jean-Paul Sartre summed up Paul Nizan’s advice to people who bottle up their aggression: “Do not be ashamed to ask for the moon: we need it” (12).

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The European authorities have had a year to address the sovereign-debt-come-banking crisis in the euro area. They have failed. The situation is much worse than a year ago, the latest manifestation being another downgrade of Greek sovereign debt. There is a real and present danger of contagion and the disorderly break-up of the euro area.

The economics of the problem are very simple. The economics of its solution scarcely more complicated. Alas, the political problems are thorny. For political, not economic reasons, default is looking as if it may be the default option. A break-up of the euro area is a distinct possibility. No-one can seriously assess the outcomes of such a scenario – although that does not stop some commentators pronouncing on the issue as if they did. In my view, it is highly risky. Above all it is completely unnecessary. It can and therefore should be avoided.

Let’s start with the simple, but often neglected, basic economic facts about sovereign debt.

Government debt dynamics depend on precisely four variables. The existing level of debt, the size of primary deficits or surpluses (where ‘primary’ means excluding interest payments), the nominal interest, and the economic growth rates (where ‘nominal’ means at current prices).

A country that owns its own currency can never go broke and need never default. (At least not in its own currency: it can, of course, if it unwisely takes on debt denominated in another currency.) Whatever the government’s debts and deficits, and quite apart from its capacity to oblige the private sector to pay taxes, it can create the currency to service its debts. ‘Printing money’ drives the interest rate down and the nominal growth rate (that is real growth plus inflation) up thus reducing nominal debts as a share of nominal GDP. Such a policy may have negative consequences (notably inflation), but the point remains that a monetary and fiscal sovereign can always service its own-currency-denominated debts. And that very fact reassures investors. It makes a run on government bonds unlikely and is the reason why genuine, in the monetary sense, sovereigns pay a lower interest rate than private sector actors. This is why the US, Japan and the UK can still issue bonds at very low rates of interest despite debt and deficit numbers that are, on the face of it, as bad or worse than those of euro area countries facing default and exorbitant bond rates.

A country that does not control its own currency, such as a member of a currency union, cannot avoid the inexorable logic of the mathematical link between the debt and deficit and the interest and growth rate variables; specifically, lacking control of the nominal interest rate, it is forced, on its own, into a real rather than nominal adjustment. The problem facing euro area members – Greece, Ireland, then Portugal, and prospectively also Spain, Italy and Belgium, can be stated succinctly as follows. The post-crisis combination of high government debt and large current deficits is such that, given the prospects for nominal GDP growth, and at the prevailing interest rates demanded by the market, government debts cannot be brought under control. (The italicised caveat is crucial: statements as to whether a country’s debt is sustainable or not are meaningless without specifying the interest and growth rate.) This is because, under these prevailing conditions, fiscal policy would have to be tightened (in order to achieve the required primary surpluses) to an extent that is either politically impossible, or that will damage growth prospects so badly that even drastic enforced consolidation will not ensure sustainability. (The second point is also crucial: it is not just a question of lily-livered governments unwilling to wield the knife.) Once markets perceive a risk of unsustainability, investors become unwilling to lend; the interest rate demanded rises, substantially worsening the problem. The prospect of consolidation worsens further and the country is essentially shut out from market finance. In the absence of outside intervention it must default.

And that is where the politics starts to come in.

The essence of the EU/ECB/IMF packages for Greece, Ireland and Portugal is to avoid the country having to access private capital markets to roll-over its debts (i.e. to pay creditors as their bonds fall due). Instead, the needed refinancing is provided, in various ways, and by a combination of public authorities; the precise form is irrelevant in economic terms, but may be important politically. This support is provided at a politically determined rate of interest and conditional on a set of fiscal consolidation measures required by the lending authorities and designed to bring government debt dynamics under control such as to permit a subsequent return to the markets.

Yet the provision of such support alters nothing about the fundamental requirement that the combination of debt level, primary deficits/surpluses, interest and growth rates be such as to ensure debt sustainability. The simple fact is that with the EU/IMF packages this is not the case. And that is why the crisis is getting worse and not better. The interest rate is too high, and the austerity measures are either unfeasible or self-defeating by virtue of the damage they wreak on growth prospects. This failure was predicted (GreeceIreland). The failure manifests itself either in ever more bail-out packages, and possibly contagion to other countries, and very possibly in the default that the packages were intended to avoid.

The economics of the implied policy choices are thus simple. If the debts are to be repaid in full, the interest rate must be lower and/or the nominal economic growth rate must be higher. If not, there will have to be some form of default (call it restructuring, voluntary, forced, what you will). And that is what the whole confused and confusing political debate is, at heart, about. Eurobonds, Brady/Trichet bonds, blue bonds, restructuring, reprofiling, privatisation, even selling the Acropolis; it is all about these basic choices.

But, in economic terms, it is, or should be, a non-debate. For the balance of costs, benefits and risks is so blindingly obvious. Consider:

One, collectively the euro-zone countries and the ECB are in control of their common currency. Two, the three currently affected countries account for a mere 6% of euro area GDP. And three, getting these countries on their feet quickly is in the interest of all of Europe, not just of the citizens directly affected. Taking these three basic facts together, the economic solution is self-evident. Some combination of the Member States and the ECB, who can, respectively, borrow and create money more or less at will announce that all sovereign debts in the euro area will be honoured in full. Immediate effect: the massive interest-rate spreads, which are a function of default fears (and not a conspiracy by ratings agencies) melt away. External finance is provided for a defined but extended period at a low interest rate and steps are taken to shore up nominal growth such that the balance between interest and growth rates puts debt ratios on a credible downward path. The government agrees to a politically feasible medium-run trajectory for the primary budget balance that ensures sustainability over a reasonable time-frame. This system is maintained for until such time as the markets are willing to resume lending at ‘normal’ rates of interest. This will not be very soon, but it will be for a limited period: all that markets need, in addition to the short-run no-loss guarantee, is to see debt ratios credibly falling.

In an appendix to this column I provide an illustrative and simplified calculation, using round numbers that approximate to the Greek case.

It’s really that simple. It costs nothing: other eurozone governments merely have to lend on what they themselves can borrow on the markets. For the euro area economy the magnitudes are entirely manageable. The euro area could, in theory, pay off every last euro of the combined government debt of Greece, Ireland and Portugal overnight, by borrowing some 9% of GDP. The peripheral countries stabilise quickly and begin to grow, avoiding the threat of a collapse in export demand from other eurozone countries. Avoiding the risks of banking collapses. Avoiding the risk of contagion.

Given this option, why take the risk of even talking about various default options? All they do is push up spreads further. Risk-averse financial institutions dump the government paper of the peripheral countries as fast as they can, ensuring more of it ends up in (quasi)public institutions anyway. (According to reports in the German media, German insurers have sold around half of their holdings of Greek bonds, and banks around one third).

The answer, in short: it’s the politics stupid. Core-country politicians have utterly failed to explain to voters the basic facts: properly conceived, bail-outs are costless. Pro-cyclical austerity policies are not in the interests of either peripheral or core countries. They are a senseless waste of resources and a serious threat to the future of the European integration project.

Currently, nationalistic parties fan the flames of resentment, unchallenged by mainstream parties who either don’t understand the issues or are running scared of voters (or both). Some on the Left see an opportunity to ‘hit the banks and the speculators’ by calling for a default. I agree that hitting the speculators is preferable to hitting public sector workers and the users of public services. But it is a high-risk strategy and it is, in principle at least, unnecessary. The banks are not separate entities from the economy. All will be hurt if they come crashing down. It is not the real alternative. The real alternative is between nationalistically inspired austerity policies and European growth-oriented policies. The former has been tried and has failed. It will continue to fail if policymakers persist with it. The task of progressives is to fight for the second strategy.

Frankly speaking, I don’t have an answer to how to overcome the political barriers to European solutions Europe. There is certainly no way forward as long as the debate is couched in terms of ‘the core won’t lend any more and the periphery won’t reform any more’. The fact is that most Member States and all the European institutions are in the hands of conservative-liberal majorities. Elsewhere I have proposed a ‘blueprint’ which, if implemented, would enable the various problems afflicting the euro area as a whole and its individual countries to be tackled together. In that way burdens can be shared and political solutions found on the basis of a common understanding of common interests.

The purpose of this column was more limited. To make the economic arguments clear, and to point out where the problems lie. In the politics, stupid!

Appendix: An illustrative and simplified calculation using round numbers that approximate to the Greek case

The debt to GDP ratio is 150% and the current deficit is 10% of GDP.[1]

The EU lends the country sufficient funds to shield it from capital markets at the same rate at which Member States  can borrow on the markets (roughly 3%), a costless transaction. This is instead of the penal roughly 6% being charged under EU/IMF programmes.

What about the nominal growth rate going forward? On the one hand there is a massive output gap implying a large potential for rapid catch-up real economic growth. On the other, the peripheral countries have an overblown nominal price and wage level, implying a need for low inflation. Real growth could be stoked by EU-supported investment. Price and wage inflation could be held in check with an incomes policy. Let us suppose an average of 3% real growth and 1% inflation. (3% real growth may seem high to some, but we are talking about the future, not the past. Depressed economies do bounce back, once confidence is restored. Encouragingly Greece grew at an annual rate of 2.4% in the first quarter of 2011, even if this is not expected to continue.)

This growth-interest-rate constellation would mean, taken by itself, that the country’s debt would fall every year by around 1½ pp of GDP a year. This is already a start: the debt ratio is on a declining, rather than an exploding trend, although the pace of improvement is slow.

Now what about the primary balance? The interest rate burden is 4.5% of GDP (3% * 1.5). If the country posts, on average during a consolidation phase, a balanced budget, then it is running a primary surplus of 4.5%. Add to this the 1.5% resulting from the growth-interest differential, and every year Greece would reduce its debt by 6 percentage points. Note: This requires merely that the government spends no more than it takes in in current taxation. This would represent a sensible average pace of debt reduction, comparable to that achieved, for instance, by Belgium during the 1990s and 2000s, which steadily brought its deficit ratio from around 120% to 80% of GDP. As such it would be convincing to market actors, who would be willing to lend money again to the government in question on favourable terms, once the effective consolidation became apparent.

The figures mentioned are averages over the consolidation phase. In fact, because it takes time to reduce current deficits if growth is not to be unduly stifled, the consolidation path would not be at this average rate across the period; initially debt to GDP ratios will in fact rise, and it is precisely during this crucial period that external financing is needed. However, as confidence returns and growth picks up, fiscal policy can be tightened further, accelerating the path of debt-paydown.

I have made some simple simulation calculations (to be presented in the near future) which show how a low interest-rate support strategy, coupled with measured fiscal consolidation (and ideally some externally financed, growth-enhancing public investment) might compare with the current strategy of high interest rate and enforced and pro-cyclical fiscal consolidation. On plausible assumptions, fiscal consolidation performance, in terms of the debt-to-GDP ratio, is worse under the growth-inhibiting austerity approach, in spite of the faster reduction in current deficits and the much higher primary surpluses than under one based on European solidarity and growth. And it goes without saying that real incomes recover much faster under the latter strategy and also perform much better in a longer term perspective.


[1] The actual figures for Greece for 2010 are debt: 143% and deficit -10.5%. The figures for Ireland and Portugal respectively are: debt: 96% and 93% and 32% and 9%. The calculation simplifies somewhat: after the first year the basis is no longer 150%, but 146%, but the basic dynamic is unchanged.

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Eurozone Economics are Simple. It’s the Politics Stupid!.

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