The Road to Absurdistan: A European Policy Dilemma

It is not that significantly new measures have not been tried: a few days ago, the Eurozone finance ministers backed a 100 bn € bank rescue fund for Spain (after Ireland, Portugal and Greece), so Spain could rescue its ailing banks. As “conditionality” required by the finance ministers, the ECB and the IMF, the Spanish prime minister had just pushed through another 65 bn € austerity package, in order to prove that Spain was serious about “savings”. At the same time, the Spanish government lowered its already measly GDP forecast for 2013 from 0.4% to a minus -0.5%. This, of course, will once again make it more difficult to repay the old and the newly incurred Spanish debt. And this even more so, as the financial markets “rewarded” the Spanish and European efforts (to repay them) by increasing the requested yield on Spanish government bonds to a staggering 7.2% – a rate far from affordable, let alone sustainable.

If the reader is confused, she has any right to be so: Spain’s previous government was one of the poster-children of the Eurozone: low government debt, budget surpluses, strict banking supervision. Then the real estate bubble, mainly fed by regional banks which also had been re-financed by some of the largest European banks, burst, the non-performing loans of savings banks increased, the government tried to save them and racked up sizeable government debts and deficits. Unfortunate merging decisions of ailing Cajas were made, and suddenly Spain was deemed more than high-risk by its international lenders. One of the rating agencies recently downgraded Spanish government bonds to junk status. The newly formed government, whose leader when in opposition had rejected participation in budget consolidation, caved in to the requests of the “markets” and the Troika and imposed another severe austerity burden on the already suffering Spanish economy.  Let us not forget, that Spanish unemployment is above 20% and youth unemployment more than 50%! Many commentators had rejoiced that finally the new Spanish government had been brought to heel by the markets…

But, as Spain undergoes this counter-productive consolidation program, in order to please markets and EZ governments, the markets decide that this reduces Spain’s ability to service its debt. I am no sympathizer of the new Spanish government, but what should the poor blokes do? At high political cost, at the danger of having the country erupt in anarchy and protest, they have done what markets and EZ governments asked them to do: their reward is even steeper re-financing costs, an economy in deep recession with unemployment exploding – and with one region after the other coming to the central government for financial help.

At their last summit, EU heads of state made some important, if tentative and incomplete steps into the right direction: to create the semblance of a banking union with joint supervision, with banks being able (in the too-distant  future) to be re-capitalized directly by the European Stability Mechanism, etc.  And private creditors of Spain being given the assurance (at the cost of 100 bn €) not to lose their money. But then the markets and EZ governments  wanted “guarantees” from Spain (Finland even got  extra collateral for part of its credit), that the country, i.e. taxpayers would contribute to solving the Spanish debt problem. Spain’s government duly responded – and gets punished once more by downgrades and higher yield requests.

The EU has already poured a lot of money into “peripheral” countries. The EZB has gone extraordinary ways to provide liquidity and to calm the fears of the markets of government defaults. The result is ever more rising debt ratios, deep recessions spreading to the whole EU – and beyond – and ever increasing demands from the financial markets. It is high time that the EU authorities, and the member states, realize that this carousel with gigantic private gain generation, serviced by staggering public (taxpayer) debt leads to deep recession, and can never be won – unless the model of financing government debt by private “investors” is radically altered. It is utterly irresponsible to have democratically elected governments thrown before the greedy teeth of profit-seeking private investors. Their legitimate interest is not to increase the welfare of citizens, but to feed their own pocket books. This model has worked remarkably well (for them) for the last 30 years, but has brought the world economy to the brink of collapse. Government finance must be put in the hands of democratically elected institutions and be accountable to the taxpayers. There is no room for private profit in government executing its fiduciary role for its populations!

In the short run, however, it becomes clearer every day that the debt burdens of governments  (and some banks) cannot be repaid in full. To shift them to the next generations, in the hope that future economic growth will make repayment, or at least the interest repayments, possible, is provingan illusion. The EU policy of requesting fast and significant budget and debt consolidation is driving the EU economies down. Taxpayers are saddled with extremely high repayment costs for decades to come. Thus, the most urgent task is the swift introduction of a government debt restructuring mechanism, in addition to a bank default mechanism. The debt burdens must be borne in any case: either by generations of taxpayers (and at the expense of more productive government expenditures), or by those private and public creditors who recklessly lent gigantic sums of money, driven on by gurus of “new economic thinking” who had espoused the wisdom that business cycles were a way of the past and a new blissful age of permanent growth (and thus limitless repayment capacity) had been reached.

EU heads of state and finance ministers in general are a sober lot. They need to live up to the fact, belatedly but still in time, that they have been taken for a ride by financial market actors: they allowed them to take immense risks, take all the gigantic profits and shift the risk on to the unwitting taxpayer  – and at the same time take the world economy down. This game should be over, the welfare of the people must dominate once more.   



Filed under Crisis Response, European Union, Financial Market Regulation, Fiscal Policy, Global Governance, Socio-Economic Development

2 responses to “The Road to Absurdistan: A European Policy Dilemma

  1. Dr. Peter Neumann

    Hi Kurt!
    Your analysis seems to me to be to the point in that it sheds light on the mostly underexposed – yet critical – role of the financial markets in extending ever increasing credit to sovereign governments. Clearly, the risk of default is here assumed to be less than for lenders to the private sector – but should there not be some risk if one is to avoid the accumulation of unstainable debt burdens ? That the answer must be in the affirmative, seems to be implied by your suggestion to introduce 1) a government debt restructuring mechanism and 2) a bank default mechanism. In the Greek crisis, a “hair-cut” was accepted by major european banks after intensive negotiations, which has helped these banks to sharply reduce their exposure to a Greek default. That leaves the lenders in the public sector, i.e. the ECB and the EZ governments. But have not the public in the EZ been assured that the Greek economy would turn around and all emergency loans repaid? How can leading politicians go back on such statements ? Will this political fact not prevent what might otherwise be a sensible measure??

    Peter .

    • kurtbayer

      Peter: yes, you are correct: the Greek case has shown that there is sovereign bond risk – in spite of the fact that voters had been reassured that there would not be any (the financial markets between the start of Euro and the start of the crisis also had assumed zero risk, but have since attributed excessive risk to some of the countries – so they did not trust the EU politicians.
      The fact that no country debt restructuring mechanism exists resulted in the private banks being the only ones receiving a haircut on their credits, while the ECB and EZ countries stayed away.
      The dilemma is how to deal with countries like Greece which clearly have non-refundable debt levels: if they default on their own (without negotiations) they will be cut off from sovereign funding for years/decades (like Argentina) and will sink into politically very dangerous long-term misery with people leaving the country in droves. This is why in the meantime “non-conventional” measures by the ECB are attempted, but again they have such safeguards that they do not really help. To require Greece to engage in ever more austerity measures leads to an ever deeper recession in Greece and defeats the success of Greece ever being able to pay back their mounting debt levels.
      We need much more radical thinking: keep looking at my blog

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