Eurozone Crisis Q&A BY BY Hugo Radice, Ed Lewis

16 November 2011 — New Left Project

Political economist Hugo Radice is a Life Fellow at the School of Politics and International Studies at the University of Leeds.  In an interview with NLP’s Ed Lewis, he addresses a series of questions on the escalating crisis in the Eurozone.

Q: We are being told that the eurozone faces a sovereign debt crisis. Is this true and, if so, what does it mean?

A: Yes, it’s true.  The crisis is centred on the unwillingness of global investors to purchase euro-denominated bonds issued by Eurozone governments that are deemed to have accumulated excessive levels of sovereign debt.  On a day-to-day basis, the evidence for this unwillingness is reflected in the market price of bonds already issued by these governments.

Q: A virtually universal feature of discussion in the British media is that the problems Europe now faces are significantly caused by huge debts taken on by the Greek and Italian states in order to pay for high levels of spending on welfare and public sector pay. The financial meltdown of 2008 sometimes features in the background of discussion, deeper causes for that (e.g. wage inequality) are virtually invisible. What’s your assessment of the mainstream diagnosis of the crisis? What would a more honest media be saying?

A: The mainstream diagnosis is firmly based on a belief that ‘free’ markets – free, that is, from public regulation or interference – are naturally efficient, meaning that they always tend to give a ‘true’ valuation of financial assets.  Keynes rightly pointed out that most traders just follow the herd; so if a sufficient proportion of them think that the Greek government can’t or won’t meet its debt servicing and repayment schedule, then it becomes a self-fulfilling prophesy.  Nevertheless, there has to be some basis in objective facts at the start of this process of collective judgement.  In this case, the ‘objective fact’ is that the financial meltdown of 2008-9 pushed some ‘peripheral’ Eurozone states into levels of public debt that were clearly much harder to service than those of Germany.  To the markets, it then made sense to demand much higher interest payments from the peripheral countries, when compared to what they demanded from Germany (or Britain, for that matter).

Q: The media certainly need to qualify the mainstream view.  When individuals or banks lent money to the Greek government in the years before the crisis, it was because at that moment the lenders thought that Greek bonds were the best (i.e. most profitable) available investment.  The ‘haircut’, by which is meant a willingness to accept less than the nominal value of the bond when it falls due for repayment, reflects the need for those lenders to take responsibility for their past misjudgement.  More generally, in this specific case, we have to ask why there were no more profitable investment opportunities in Germany, if their economy is such a shining example of good economic and political management.  Or, for that matter, why didn’t they invest in the production of goods and services in the Europeriphery, rather than in financial assets and property speculation?

A: A major reason for this investor behaviour is the globalisation of finance.  If you’re restricted to investing in your own country, you can keep track of the prospects of different parts of the economy much more easily.  But the existence of global markets means that instead of spending lots of money finding out about the real prospects of, say, Greek government bonds, you just reduce the risk that arises from your ignorance by spreading your bets – buying the bonds of lots of different governments.  What is more, the increasing availability and falling cost of global asset markets means that you can (you think) always flog off the Greek bonds if they start looking dodgy, and hold on to other more apparently safe (say) French bonds.  In short, globalisation reduces the average knowledge of investors, and increases their capacity for self-delusion; it also provides an ideal environment for contagion, in which rumours turn into reality very quickly.

Q: You say that part of the responsibility for the debt crisis must be borne by investors who misjudged the profitability of Greek bonds. But the question of responsibility that is being focused upon is to do with Greek and Italian public spending. Was there any irresponsibility on the part of these states with respect to over-generous public spending?

A: To be a bit more precise, the investors misjudged the risk of Greek bonds, that is, the possibility that they might not be serviced and redeemed according to the terms on which they were issued.  But yes, the Greek and Italian governments were culpable.  They knew that ever since the Maastricht Treaty (agreed in 1993) EU member states were supposed to limit their debt to 60% of GDP.  Although the extent to which any particular level is sustainable depends on unpredictable variables such as the rate of economic growth and the rate of inflation, in a crisis these factors are overridden by market sentiment – and the 60% limit has long been accepted by the bond markets as if it really was a definite limit.  The problem is that quite a number of EU states have breached that limit, some (like Belgium and Italy) for many years, without suffering any consequences; there was therefore a degree of complacency among both lenders and borrowers during the years of easy money up until 2008. In short, the 60% limit is ‘irrational’ in that simple form, but it has a very real effect once market confidence has slumped. 

Q: There has been much discussion about countries defaulting on their debts. Before we focus on particulars, can you tell us what defaults by governments involve, who generally stands to benefit from defaults and who tends to lose. And are there different ways of defaulting that have significantly different consequences?

A: A default occurs when a government fails to meet the terms of the contract agreed with the original lenders.  Although this can in extreme cases involve the government not being able to make an interest payment when it falls due (as in Mexico in 1982), more typically it happens when the government cannot make the repayment required at the end of the loan period, because they do not have the cash in hand (e.g. from tax revenues), and cannot manage to raise further loans (this is what is meant by ‘rolling over’ loans).  Historically, almost every government has at one time or another defaulted on its debts – the UK is a very rare exception.  Defaults can take two main forms:  either the default is negotiated, or ‘orderly’, which means that the lender accepts some degree of responsibility for having ‘overlent’; or it is unilateral, where the government simply does not pay.  In the latter case, the result is usually that for some years – often not until there is a significant change in either the regime in the defaulting state, or the economic or geopolitical environment (e.g. discovery of natural resources) – the government is simply unable to borrow any more.  But you can end up somewhere between the two: thus Argentina defaulted in 2002, and while most foreign holders of Argentine government debt accepted a substantial loss, some have refused to do so, and as a result the Argentine government is still unable to raise loans abroad (although it is able to borrow domestically).

Q: There is already a plan in place for a ‘haircut’ of Greek debt. Do you agree with some on the left that Greece should fully default on its debts? And would this entail leaving the eurozone as well? 

A: If Greece fully defaulted, without the prior agreement of its creditors, it would lead to chaos and collapse in the European financial system.  While European banks (including UK ones) could absorb the cost from their existing reserves of capital, it is believed that ‘the markets’ would at once assume that Portugal or Spain or Italy would then feel free to do the same thing. But given the very small size of the Greek economy (2% of the Eurozone), an agreed total default is perfectly feasible, if the other Eurozone members (i.e., basically, Germany) were willing to accept this.  And while a unilateral total default would undoubtedly lead (in the ensuing chaos) to the departure of Greece from the Eurozone, an agreed default could and should take the form of a sort of Eurozone Marshall Plan, on the lines of the US aid to Europe agreed in 1947.

Q: What about Italy – what would the implications be of Italy defaulting and/or leaving the eurozone?  

A: Italy has a much bigger economy than Greece.  It is a major trading partner of Germany.  If it defaulted unilaterally without the agreement of creditors, the Eurozone would surely collapse.  A negotiated debt reduction in the context of a ‘Eurozone Marshall Plan’ would be feasible, but would require a major reconstruction of the zone’s institutions.

Q: Pressure on Germany to allow the European Central Bank to act as a lender of last resort remains intense. But the assumption underlying that pressure is that the ECB would then be in a position to put a floor under the crisis. Do you believe that assumption to be correct, or is the scale of the crisis such that no central bank could assuage bond holders? 

A: The assumption is indeed correct – the ECB could then provide guarantees of liquidity to both Eurozone member states and their banks.  But the bond markets would require convincing that member states were permanently committed to the new architecture that this would require, and especially the ‘fiscal union’ that would make it credible by having zone-wide tax revenues underpinning ECB lending.

Q: The UK government and its supporters have tapped into the mainstream narrative in order to portray the problems afflicting Greece and Italy as confirming the wisdom of its austerity measures. The credit rating agency Standard and Poor’s apparently agree, stating that its decision maintain a triple A rating for the UK’s long-term debt would face ‘downward pressure’ if the government changed course on austerity. What’s your view of this?    

A: The fact that the UK government and S&P share this view provides very clear evidence that there is a Europe-wide, indeed world-wide, strategy of making ordinary citizens pay for the mistakes of the financial services sector, by shifting all the blame onto governments and households.  Especially in view of the massive redistribution from poor to rich that has taken place in almost every country in the last thirty years (China being only the most egregious example), the whole problem could be solved immediately by expropriating a small proportion of the wealth of the richest 1%.  This is the fundamental truth behind the Occupy movement.

Q: Of course, credit rating agencies, such as S&P, are portrayed as having a politically neutral interest in the capacity of states to repay their loans. But you are saying that their commitment to austerity shows their political agenda, right?

A: I don’t think the rating agencies have an explicitly political agenda.  Rather, they reflect the agenda of their masters, who are the big global financial institutions that finance their work (and behind them, in turn, the super-rich).

Q: The left, of course, has been warning that the likelihood of a double-dip recession is increased by the UK’s austerity package. Do you agree with this diagnosis? What do you see lying ahead for the economy if we continue down our current path?

A: Yes, I certainly agree with this now. Through 2010 and early 2011, my view was that the momentum of the recovery in Asia and other ‘emerging’ economies, and the stimulus of extra public spending in Europe and North America, would be enough to keep a slow recovery going. But the Eurozone debt crisis has had a chilling effect on economic growth expectations everywhere, including in Asia, and now there seems little hope of avoiding a double-dip.  The only way to deal with it now (within capitalism, at least) is a coordinated programme of reversing austerity and investing public money in green energy, infrastructure, education and housing – creating jobs and leading to a recovery in confidence.

Q: Does what is happening now create opportunities for the left and, if so, what kind of response do you think would be effective?

Of course it creates opportunities; the problem lies in translating these opportunities into achievements.  After three years of crisis, it is clear that the peoples of Europe remain convinced that it is bankers and politicians that should be held responsible, and not workers, whether in the private or public sectors.  But the present system of political representation is so deeply compromised that none of the major parties in any country can accept such a radical conclusion. Indeed, the replacement of Papandreou in Greece and Berlusconi in Italy by banker-economists shows that parliamentary democracy as such is effectively suspended, in favour of rule by the bond markets.  And behind the bond markets stands the global oligarchy of the super-rich.

In these circumstances, it is up to citizens to propose alternatives that will open up the political system and its culture.  To gain traction with the media and with fellow-citizens, these alternatives need to address specific social needs, and to offer concrete plans for implementation.  The recent Plan B prepared by the New Political Economy Network makes a good start on this in the UK.  Elsewhere in Europe, the ATTAC network and the EuroMemorandum group are doing excellent work also. 

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