September 2011, Week 4


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Wed, 28 Sep 2011 23:18:27 -0400
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The Eurozone: A Crisis of Policy, Not Debt

    The European authorities' doctrinaire decision to
    use debt issues to force austerity on Greece made
    the situation so much worse

by Mark Weisbrot

Guardian (UK)
September 27,  2011


Three months ago, I wrote here about the risks that the
European authorities were posing to the US economy and asked
what the US government was going to do about it. It was
clear at that time that "the Troika" - the European
Commission, European Central Bank (ECB) and the
International Monetary Fund (IMF) - was once again playing a
dangerous game of brinksmanship at that time with the
government of Greece. They were trying to force the Greek
parliament to adopt measures that would further shrink the
Greek economy and therefore make both their economic
situation and their debt problem worse, while inflicting
more pain on the Greek electorate. The threat from the
Troika was putting the whole European financial system at
risk, since it raised the prospect of a chaotic, unilateral
Greek default.

My hope was that someone in the US Congress would step up to
the plate and try to hold the US Treasury Department
accountable. Treasury is still overwhelmingly the biggest
power within the IMF - in fact, it has dominated the fund
for the past six decades. Since the IMF is one of the three
key decision-makers in Europe, the US government could at
least use this avenue of influence to prevent them from
making things worse there. And since that crisis in June,
the Troika has also played a similar game of chicken with
Italy - a country with more than five times the sovereign
debt of Greece.

Last week, President Obama woke up to the fact that the
Troika could pull the US economy down along with Europe and
sent Tim Geithner to crash the eurozone ministers' meeting.
His job was to tell them to get their act together before
their mess spreads across the Atlantic and costs Obama his
re-election. On Monday, Obama took the even more unusual
step of making his criticisms public, saying that the crisis
in Europe was "scaring the world" and that the European
authorities had not acted quickly enough.

Yet, there is no sign that the administration is even using
its influence within the IMF to avoid disaster. One of the
main triggers to the most recent financial turmoil was
another fight between the IMF and Greece over a measly 8
billion euro loan disbursement.  The fund - presumably with
US approval - has been threatening to hold up this money
unless the Greek government implemented further budget
tightening. In the face of massive protests and Greek public
opposition to further punishment, this intransigence by the
IMF once again threatened to push Greece to a chaotic
default. That, in turn, could bring major European banks to
insolvency and risk a full-blown financial crisis. And all
because the Greek government couldn't meet its budget
targets for an 8 billion euro loan disbursement.

If that sounds incredibly irresponsible or even stupid, it
gets worse. The reason that Greece cannot meet its budget
targets is that the policies imposed by the Troika have
succeeded in shrinking the Greek economy and therefore its
tax base. The IMF has repeatedly had to adjust downward its
forecast for the Greek economy; it is now projecting a
decline in GDP of 5% this year, as compared to one of 3%
just six months ago. When the first "bailout" package for
Greece was negotiated in May of 2010, the country's debt was
about 115% of GDP; it is now projected to hit 189% of GDP
next year. Clearly, the Troika's policies have had the
opposite effect of their stated intention.

Now, the IMF has revised its projections for Italy downward
as well, most likely because of the $65bn budget tightening
that the Italian government has agreed to in the last month.
This can set in motion a process similar to what has
happened to Greece, where the economy slows and budget
targets get more difficult to meet, and then interest rates
on Italian bonds rise, increasing the government's budget
deficit. Bondholders and speculators then sell or short the
country's bonds, driving interest rates up further and
reducing the value of the bonds held by European banks. A
London bond trader described the process from his own point
of view on 4 August:

    "The SMP [the ECB's Securities Market Program] is back
    but it's not in the right places - what's going to stop
    us attacking Spain and Italy over the summer months,
    [be]cause I can't think of anything. There is no buying
    of Italy and Spain going on and there won't be, so why
    can't we push these markets to 7% yields. I think we can
    quite easily."

Of course, this kind of unrestricted speculation is also
part of the problem. But in the first sentence, the trader
was describing what had opened up his opportunity at that
moment: the ECB was threatening not to buy Italian bonds, in
order to pressure the Italian parliament into more budget

The European authorities have the ability and the potential
firepower to do whatever is necessary to resolve the crisis:
restructure the Greek debt; end speculation against Italian
and Spanish bonds by buying enough of them to push interest
rates down, and committing to keep these rates down; and
guaranteeing liquidity for the banking system. The US
government has repeatedly shown its willingness to provide
dollars as necessary to prevent any foreign exchange crisis.

But most importantly, the European authorities have to
reverse course and ditch the contractionary fiscal policies
that are at the heart of the problem.

There are a number of technical fixes under discussion,
including allowing the European Financial Stability Fund to
leverage its resources by loaning to another entity that
could issue bonds. But the main point is that the ability to
provide the necessary resources is there. The Fed has
created more than $2tn since our recession began, without
any detectable impact on inflation here; the European
central bank can do the same. There is no risk of inflation
getting out of control: in fact, the IMF projects that
inflation in the eurozone will fall from 2.5% this year to
1.5% next year. If Angela Merkel is listening to her FDP
coalition partners' bizarre rants about the threat of
inflation, she needs to be thinking about another coalition.

The "European debt crisis" is misnamed; it is not so much a
crisis of debt as a crisis of policy failure. There are
always alternatives to a decade without growth, trillions of
dollars of lost output and millions of unemployed that the
European authorities are offering to the people of Spain,
Portugal, Ireland, Greece and now Italy. All that is lacking
is the political will and competence to change course.

[Mark Weisbrot is co-director of the Center for Economic and
Policy Research, in Washington, D.C. He is also president of
Just Foreign Policy.  He is also co-writer of Oliver Stone's
documentary South of the Border.]


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