Reboot for a new economy

This is not a Greek crisis. It is a European crisis, in two parts. First, the financial crash of 2008 provoked a global recession of exceptional severity. Combined with bailouts for the banks, this led to sharply increased debts and deficits for most large economies – including those in the Eurozone.

As tax receipts fell and unemployment rose over 2008-9, government deficits widened. To plug the gap, governments borrowed, pushing up their debts. For countries in the Eurozone, much of this borrowing was taken from European banks. The banks were happy with this arrangement, as they assumed it was not possible for a Eurozone member to default and therefore the loans were low risk. The governments were happy, as they appeared to be getting cheap financing.

But there was a problem. For the decade of the euro’s existence, it effectively fixed exchange rates of member countries relative to each other. The option to revalue a currency inside the Eurozone was no longer available. Germany, with weak productivity growth, drove the wages and salaries of its workers downwards, with falling real average incomes for seven years. It became more competitive, relative to other euro members, as a result. Normally, this would lead to a rise in its exchange rate. But the euro itself prevented that.

Instead, German exports appeared very cheap for southern European countries. They began importing more from Germany (and northern Europe in general) than they sold. A trade gap opened: widening deficits in the south were matched by widening surpluses in the north, all inside the Eurozone. The deficits needed financing. This is the second, critical, part of the crisis. To finance the deficits, countries borrowed, exploiting Europe’s newly emboldened financial system. For Spain and Portugal this borrowing appeared as private debt, helping a finance an enormous property bubble as rising prices drove rising borrowing. For Greece, it led to high levels of public debt – Greek households saved, rather than borrowed, during the boom. But in all cases, the total amount of debt in the economy began to rise rapidly.

The financial crash, with its increased demands borrowing, ran straight into this existing imbalance. The spark for the crisis was revelation, in October 2009 by a new Pasok government, that Greece’s public debt was far larger than the previous administration had admitted.

It is not a crisis of public spending. Spain and Portugal ran consistent government surpluses, spending less than they received in taxes, until the crisis erupted – unlike Germany and France, which were continually in deficit. Greece spends less, as a share of GDP, on its public sector than do either Germany or France – although it suffers from chronic tax evasion by its wealthy.

This is a crisis of the financial system, and of the euro itself. Without resolving both sides of that unhappy pairing, it will not end.

Two years of failure

Successive attempts to solve the crisis by the major powers have graphically failed. They have followed a set pattern: alongside bailout funds, now amounting to €240bn, intended to enable the Greek state to meet its creditors’ demands, come the insistence on austerity measures of increasing severity. Overseen by the EU/ECB/IMF ‘Troika’, successive Greek governments have shovelled growing piles of cash at international creditors, while squeezing greater and greater sacrifices from the Greek people. The impact on society has been devastating. To pick just one example, Greece used to have the lowest suicide rate in Europe. Suicides have increased by 40% in the last year.

The Troika plans were never going to work. Austerity is self-defeating. Government spending cuts – and sharp tax rises – suck demand out of an economy. If the economy is weak – and Greece is seriously weak – it weakens further, as falling demand leads to fewer goods sold, fewer people employed, and falling wages. A vicious circle of decline sets in, just as it did when governments attempted the same course during the 1930s. The Greek economy has now shrunk by 16% in five years, while unemployment has skyrocketed. And the debt burden, far from shrinking, is ballooning as a result, having risen from 130% of GDP in late 2009, to around 160% today.

The only way to remove a debt is to repay it, or to cancel it. The bailouts do neither. They simply help maintain the flow of repayments, with interest, enabling Greece to meet its creditors’ demands. As the economy collapsed – the direct result of austerity – this mechanism has become increasingly obscene: a whole country starved by austerity, but then kept on a bailout drip for the benefit of its creditors. It should be no surprise that so many Greeks voted for anti-austerity parties. There is no reason at all for anyone in Greece to accept this miserable settlement.

Syriza, the Coalition of the Radical Left, have emerged as winners, rising to second place in the last elections and now polling around 27%, ahead of all other parties. Syriza won its support in urban, working class areas, supplanting Pasok. It has insisted on the suspension of debt payments and an end to austerity as the conditions for any future coalition government. If no coalition is formed, fresh elections will be held in mid-June.

The weeks ahead

Two years of ignominious failure by the Troika are finally grinding to a halt. The situation is complex. Subject to significant uncertainty, the pattern over the next few months looks like this. The table below shows the amount Greece is expected to pay to meet its creditors over the rest of the year.

Schedule of Greek debt payments, 2012 (million euros)

Source: Bloomberg

Major individual repayments include the €3.1bn due for the ECB on 20 August. But any single missed payment before that date would trigger a default.

It is not now possible for the Greek state to both meet those repayments, and pay its own employees. If payments are made, it must continue to receive bailout funding from the EU. The EU has, until now, insisted that receiving bailouts requires Greece to honour the Memorandum of Understanding, signed last year, that commits it to strict austerity measures. If these measures are not adhered to, funding will be cut off, forcing a default. It is possible, but not certain, that the EU is now wavering on this, with Jean-Claude Juncker, Prime Minister of Luxemburg and head of the Euro Group, hinting on Monday that some leniency may be permitted.

Once in default, there is little point Greece remaining inside the Eurozone. International banks have spent the last year ditching their Greek bonds, with official sources (like the ECB), Greek banks, and risk-addicted hedge funds being the only remaining buyers. A default will not hit banks outside of Greece too hard, and the ECB can withstand the losses. But those inside Greece will be wiped out. They will need recapitalising – stocking up with fresh funds - most likely under tight government control. Recapitalising banks in euros will not be possible without access to a ready supply of euros – and the ECB and others will not be keen to supply them. Recapitalisation in a new currency, however, is a possibility, the central bank effectively printing money to cope. A Greek banking collapse could quickly lead to a euro exit.

The most likely date for elections is the 10 or 17 June. Germany has insisted that if Greece has no government after this, it will not receive the next tranche of EU assistance, due in June. This, too, would lead rapidly to a default, and so drive Greece towards the euro door.

But a government that honours its debt commitments – if, somehow, one can be formed – would be in an extremely vulnerable state. Its dependency on further EU subventions would be terminal. Greece’s primary deficit – the difference between the state’s taxes brought in, and expenditure made, minus interest payments – is 1% of GDP. This is not huge, but still needs covering. If it is not covered, for whatever reason, the state would run out of money to pay its employees pretty shortly, perhaps by July. It may be forced to issue promissory notes – offers to pay in euros at a later date – and these, in turn, would start to take on some of the functions of money, being accepted in shops and so on. Euros would disappear from circulation, becoming too valuable to use in either exchange or entrust to Greek banks. A de facto, almost accidental euro exit would occur.

The chances of all sides negotiating their way through the next few months, and Greece remaining a euro member, are low. Although the outcome is uncertain, and dependent on political processes, even if Greece gets through the next few months and out of the election period as a euro member, the crisis will not be resolved. The public debt will overwhelm every other consideration, and, with no realistic hope of repayment and a collapsing economy, the issue of its euro membership will merely reappear.

Contagion and collapse

In theory, Greece can be contained. The EU and ECB, between them, have spent two years constructing a series of “firewalls” to block the spread of the crisis beyond its borders, with €750bn theoretically available. Its former private creditors have been ditching their holdings of Greek debt, reducing their exposure to a minimum. In theory, the crisis in Greece can be held there.

But this is not a Greek crisis. Spain, Portugal and Italy are all part of the same debt-creation mechanism, driven by the euro’s imbalances. During the euro’s boom years, Spain and Portugal ran up immense private sector debts. A property boom drove borrowing for property, which in turn drove rising prices – until at one point more than 20% of the Spanish workforce was employed in construction. Private debts ballooned. When the crash came, those debts became unpayable. Spanish banks are threatening to collapse, with the third-largest, Bankia, quietly nationalised by the government last week. Italy, meanwhile, suffers from permanently low growth and a €1.3tr public sector debt. It, too, is caught in the trap.

Any eruption in Greece could spread rapidly to these three – Spain, in particular. A run on the banks could begin, as panicked depositors believe their governments to be incapable of supporting failing banks, and begin withdrawing their cash – sparking a real bank run. Or bond market traders, believing that heavily-indebted economies will see major bank failures that governments will not be able to rescue – driving up interest rates, and forcing governments to seek bailouts. Or private investors and speculators, believing that these countries cannot support their banks, begin withdrawing capital elsewhere, provoking capital flight and the collapse of banks.

Or, indeed, some combination of all three. Interest rates for Spanish and Italian government bonds have already started rising sharply, as traders start to fear the risks of a widespread collapse. Credit ratings agency Fitch have announced they will downgrade euro members in the event of a Greek exit. The EU’s firewalls, the temporary European Financial Stability Facility and the permanent European Stability Mechanism, appear to be able to cope – on paper. In practice, they rely not on actual funds, but on promises by signatory members to pay if needed. And a promise to pay is not the same as having the cash to hand – especially if those promising to pay, like Spain, are also those requiring bailouts. Both could soon be overwhelmed by a general conflagration. The risks of a second, severe recession are significant.

Next steps

There are two main routes out of a crash. One is to try as far as possible to cling to the old ways of working. This is the Troika’s preferred route. It has not worked so far, and it will not work in the future.

The other is to impose a sharp break with a failed past. Syriza have been absolutely correct to insist on refusing to make debt repayments, and vowing to end austerity. Neither are for the benefit of ordinary Greeks, or European society in general. They are right, too, to raise the use of unorthodox financing, like forced domestic borrowing – compulsory loans, with those who can afford them as creditors, set at low rates of interest. Preventing the spread of contagion, and the containment of financial crisis, will require capital controls – restrictions on the free movement of capital, either directly or indirectly, to prevent panic spreading. Even the IMF now admits the efficacy of such measures in a crisis. The wealthy must be taxed effectively to cover costs, and banks run in the interests of society, not private profit.

What is needed, in other words, are the first steps away from a failed economic system. The movement against austerity in Europe is growing. Greece could be about to take those first steps out of the wreckage. If a new, anti-austerity government is formed there, the pressure on them to break will be immense. Our solidarity will be crucial.

Official figures, released today, show the UK has slipped back into recession. This is technically defined as six months (two consecutive quarters) of negative growth.

The whole economy shrunk by 0.2% in the first three months of this year. This is worse than many (including me) would have expected: most forecasts predicted that the economy would wobble slightly upwards, with no real recovery in evidence.

The blame for the UK’s worsening slump can be laid – in the first instance - squarely at the door of Number 11 Downing Street. George Osborne’s obsessive commitment to austerity is driving the whole economy backwards – with the partial exception of the super-rich.

The explanation is simple. At present, indebted households and panicked firms are cutting their spending. This drags down demand, meaning firms sell less. As firms sell less, they cut wages and make redundancies. A vicious circle of falling demand is set in train.

The worst possible course of action for government is for it to also cut its expenditure. Precisely the opposite is required. But by focusing only on the headline numbers we ignore fundamental problems. Whatever the figures do over this year, there are no realistic prospects of a convincing recovery in the UK.

The private sector in Britain has been historically poor at creating jobs.  Research from the University of Manchester found that the 4m manufacturing jobs lost since 1979 were not replaced by the private sector – public sector employment took up the slack. And the public sector is now contracting.

Our economy remains excessively exposed to the financial sector, with financial corporations' debt amounting to over 600% of GDP. Bloated finance is a continual threat to stability. The danger of a serious financial crash in Europe is growing, and our freewheeling, overexposed financial system will take a major hit. No recovery is possible with this overhang of bad debt and high risks.

The first steps to recovery look like this:

1. End austerity – government should be stimulating the economy. Use cheap public borrowing now to create sustainable, decent jobs for the future, through spending on green infrastructure like public transport and offshore wind, and overhauling the UK housing stock.
2. Transfrom the UK’s dysfunctional financial system, introducing capital controls, using the nationalised banks to drive investment, and writing off bad debts.
3. Reform the tax system so that the rich are taxed effectively, and the tax burden focuses on wealth, high incomes, and pollution.

Here and across Europe, the tide is turning against austerity. The case for the alternative is there to be made, if you want to help us make it, sign-up to nef today.

The crisis continues. As Spain’s borrowing costs rise above 6 percent, European Commissioner Jose Manuel Barroso claimed this morning to be “absolutely confident” Spain can meet its new austerity programme, before – as one tweeter saw it – riding off on his unicorn.

There’s more chance of King Juan Carlos turning vegan than of Spain meeting its targets for spending cuts, and the financial markets know it. Spain’s austerity programme amounts to one of the harshest ever attempted by any major developed economy, aiming to reduce its budget deficit to 5.3 percent of GDP this year from 8.7 percent last. Not so much a cut as an amputation.

But this won’t be achieved for two reasons. The first is political: the victims of the axe will be many and varied, and they will make their feelings known – as they should, and as they are in growing numbers. No government can survive creating too many enemies, and fear of the mob concentrates political minds wonderfully. It will be no great surprise if Spain’s new PM Mariano Rajoy attempts once more to ease off on spending curbs – or is removed from office by someone who will.

The second reason is economic. If the Rajoy government survives impoverishing its own people, it will fall victim to the same trap Greece has run so spectacularly into. Cuts in government spending shrink demand in the economy. As demand shrinks, firms sell less. Firms that sell less cut wages and make redundancies. Demand falls still further, and a vicious circle of decline is established. Cutting spending to reduce a deficit leads to bigger deficits as unemployment rises and taxes fall. Austerity is self-defeating.

The impossible demands now placed on Spain are causing market panic. That panic is leading to a drying up of credit, which in turn causes interest rates to rise.  When a similar panic started before Christmas last year, the European Central Bank (ECB), under its new President, Mario Draghi, broke its own rules and authorised the flooding of European financial markets with cheap credit – the so-called “Long Term Refinancing Operation” (LTRO). The plan was to stuff banks so full of cheap cash that their borrowing and lending would continue, reducing the pressure on interest rates.

It worked – for a while. Banks used much of the cheap cash in turn to buy up their own government debt. That, in turn, helped reduce borrowing costs for those governments, briefly easing the crisis. It now, however, has the potential to produce a powerful rebound effect.

The European crisis is one of both states, and banks. The faults in both make the whole system weaker. The crash of 2008 broke the back of the European financial system, and burdened its states with heavy debts and deficits. Euro members once assumed to be at no risk of default suddenly looked rocky. (One – Greece – has to all intents and purposes already defaulted, although not sufficiently to break its own economic malaise.) But those ropey debts are held inside the European financial system. Default by a euro member state threatens European banks. By increasing the amount of Spanish debt held by banks, LTRO increased the exposure of banks to this risk. “Systemic risk” – the risk of the whole system failing – has most likely increased as a result.

This is the rebound. Every attempt by the ECB to solve the crisis they face today worsens the crisis they will face tomorrow. And with austerity crippling the chances of economic recovery, the alternation of crisis and half-cocked response will continue.

Breaking that loop will require two things: first and most pressingly, an immediate end to austerity. Second, the cancellation of bad and unpayable debts, across the continent – both public, and private, as appropriate. This will require the nationalisation of banks, preferably under public, democratic management, and the imposition of controls on the movement of cash and capital to prevent speculation. Nothing less is likely to work: certainly not the grim combination of endless austerity for the public backed up by (almost) free cash for bankers. Failing that, expect a bailout for Spain shortly.

The eurocrisis is back, as expected. Greece is contained – at least for the moment – and attention has shifted to Spain. Twenty per cent unemployment, a shrinking economy, rising government deficits, and public and private debts totalling more than four times its national income have conspired to panic the financial markets. Spain has failed to hit the stringent borrowing targets set by the EU. Costs of borrowing for the Spanish government have shot up in the few days since Easter.

With weary predictability, the solution offered by the European powers is more austerity: sharp spending cuts now to reduce Spain’s deficit, and bring its public debt under control. Equally predictably, this is grossly misguided. Spain, up to 2008, ran consistent budget surpluses – unlike Germany. It was the financial crash of that year and the subsequent, very sharp, recession that provoked the deficits. As unemployment rose, and tax revenues fell, the gap between what the government spent and what it earned opened wider. The deficit exploded and the national debt rose.

Spain already had heavy debts. But they were not, in the main, owed by its government. They were owed by its citizens. By 2008, Spanish public debt was just 30 per cent of GDP. It has risen now to 79 per cent and continues to increase. But just as in Greece before it, by choking off economic activity, austerity actually increases the burden of the debt. In Greece’s case, its debt to GDP ratio was 130 per cent at the start of this round of crisis, in late 2009. By late 2011, after nearly two years of severe austerity, it stood at over 160 per cent. Spain, Ireland and Portugal have all suffered the same way.

Austerity is not just the wrong medicine for the wrong diagnosis. It is actively harmful. By insisting on austerity, the EU and major European powers are – in effect – placing the immediate needs of finance above any other consideration. It is hopelessly short-term at best and it is driving the whole continent into stagnation.

The imbalances behind the crisis

This is not a Greek crisis. It is not a Spanish crisis. This is a crisis of the European system. It is the direct product of deregulated finance and a dysfunctional single currency. During the boom years, easy credit masked real underlying weaknesses. Greater and greater injections of debt kept the European system moving. In particular, with different economies locked inside the single currency, effectively operating fixed exchange rates against each other, chronic balance of payments imbalances built up. In the north, countries began to run huge surpluses on their current accounts. In the south, these were matched by huge trade deficits, funded by debt. With currency adjustments ruled out, the imbalances became permanent. Spain ran annual current account deficits that reached 10 per cent of GDP or more, year on year. 

When boom turned to bust, these deep weaknesses were exposed: and, worse yet, the debt overhang is immense. Spain is an acute example: a property boom, which at one point saw 12 per cent of the workforce employed in construction, was funded by cheap credit sloshing through the euro-backed financial system. Rising property prices helped drive greater borrowing. By 2007, average household debt had risen to 130 per cent of average household earnings, up from just 68 per cent in 2000. So government borrowing remained low, but private borrowing exploded. As the financial crisis broke, ending the property boom, those private debts turned bad. Spain, like the rest of Europe, now suffers from an immense debt overhang.

The problem of debt

Until that overhang is removed, the crisis will not end. The mechanism works like this. European banks, stuffed full of loans threatening to default, know they are weak. And they know all the other banks are weak. They fear collapse. This fear makes them reign in on further lending. As lending dries up, the risk of default and subsequent collapse increases. It makes perfect sense for each bank to tighten up its lending – they don’t want any more exposure to risk. But it undermines the whole system. This is the irrationality of private finance at work.

By the second half of 2011, this fear had begun to turn into a serious financial freeze. Spain and Portugal in particular were suffering enormously as capital retreated. Inflows of private funds, necessary to keep their economies moving, were drying up. In response to this, the new – unelected, note – head of the European Central Bank, Mario Draghi, authorised the flooding of financial markets with liquidity – hard cash. Tearing up the ECB’s own rulebook, over €1tr of new cash has been released electronically into European banks since December, through the so-called “Long-Term Refinancing Operation”

There’s nothing greatly “long-term” about this. The bulk of the new cash went straight back into the ECB’s own deposit accounts, European banks preferring the safety of the official institution to anything else out there. Very little went to businesses – the credit crunch did not end. But some went into buying up European government bonds, which, in the case of Italy and Spain helped reduce their costs of borrowing for a while.

These purchases, in turn, increased the banks’ exposure to those countries. With no recovery in sight, that debt threatens to default. That threat is now worse than it was before Draghi’s “rescue operation”. And the debt doesn’t need to actually default to allow fear and panic to spread disastrously throughout the financial system. The increased possibility of default is enough. Like an epidemic diseases, financial contagion can spread rapidly through the system, dragging country after country behind it. Spain is a big economy with substantial debts. But bigger still is Italy, with its €1.3tr public debt burden. It is also now back in the bond markets’ firing line.

Ending the crisis – the first steps

To break the crisis, two things need to happen. First, austerity must end. It is counterproductive, but it is followed because finance holds the upper hand. That means ending the swingeing spending cuts and looking to public investment to create sustainable jobs. Second, debts will need to be written off. They are the product of a bloated, crippled financial system and the rest of European society should not be expected to bear their burden. Nor can they: for as long as the debts demand repayment, prospects for any recovery are grim. For Greece, this will mean cancelling all of its outstanding public debt. For Spain, where private debt is the concern, this will require writing off household debts: a general amnesty being declared, perhaps along the lines recently implemented by Iceland. Of course, this will damage the banks; they will need nationalising and – unlike our own dear RBS, where public servants ape private greed – run democratically in the public interest. Capital and exchange controls, to prevent financial markets spreading contagion, will also be required. Countries like Spain and Greece will need to exit the euro to be in with a chance of achieving any recovery.

Until a serious break is made with the errors of the past, the continent will remain trapped. As things stand, there are no realistic prospects for recovery – although those who believe in magic free-market fairies may want to offer unrealistic ones. The pattern is familiar: each attempt to stave off the last crisis prepares the way for the next, worse, round of panic. That vicious circle must be broken, and broken in the interests of the people of Europe. The protests against austerity, from the occupations of the squares to the strikes, show the way forward.

This morning at 9am, a 77 year old pensioner shot himself dead on Syntagma (Constitution) square in Athens, Greece.

Arguably this tragic event is only the tip of the iceberg; suicides have dramatically increased in Greece since 2010, but the note the 77 year old left illustrates the dramatic conditions of both the Greek social economy and the remnants of Greek democracy. This symbolic act is reminiscent of the self-immolation of Jan Palach after the Prague Spring in 1968 and other democratic protests. There have been some reports of the man’s death in the media but few mentions of the contents of his suicide note. I have translated it into English below:

“The occupation government literally annihilated any possibility for me to survive given that my revenue was entirely based on a pension which I, without any support from anyone nor the State, financed during 35 years.

Because my age impedes me to take radical action (without excluding that, if a citizen decided to struggle with a Kalashnikov, I would be the next to follow) I have no solution left but to put a decent end to my life before having to start looking for food in garbage bins to survive, and being a weight to my child.

I believe that the futureless youth will soon uprise [he literally says: “take the arms”] and hang all national traitors upside down, like Italians did to Mussolini in 1945 (Piazza Porretto in Milan)”      

Meanwhile, the EU and IMF consortium continue to impose extreme austerity measures, thus shrinking the Greek economy even further, imposed by an unelected and unconstitutional government.

The current regime’s refusal to shift the burden of adjustment from the people of Greece to the banks and financial institutions means that Greece will mourn many more dead - as a direct consequence of political choices.

Originally posted at New Statesman.

If George Osborne does one thing today he should use the Green Investment Bank to create jobs and transform the economy. The collapse in private sector investment is the biggest single factor behind the UK's stagnation, with investment by firms down some £48bn from its 2008 peak.

And Britain's infrastructure is clapped out - Professor Dieter Helm has estimated that £500bn will be needed, over the next decade, to bring it up to international standards. Investment now in green infrastructure - from improved public transport to renewables - means new jobs and a future-proofed economy.

Bribes for the super-rich, like the expected reduction in the 50p tax rate, won't even begin to deliver this. Corporate profits have risen over the last year, but this hasn't led to greater investment - quite the opposite, with retained earnings by large companies at record levels. To meet the challenges, government has to take a lead. A fearful private sector won't do it alone.

Yet the government's flagship initiative, the Green Investment Bank, is a pathetic, stunted creature. It's not a bank - it has no powers to borrow. It has a £3bn cash pot - a tiny sum when set against the scale of the tasks ahead. It can only invest on strictly commercial terms. Granting the GIB the power lend and borrow, letting it invest in long-term projects, and beefing up its capital stock - perhaps through a part-merger with RBS - would turn it into a serious proposition, able to take a lead in major infrastructure projects and develop an expertise.

On current showing, the Chancellor's economic record is poor. His entire fiscal strategy boils down to an economically illogical and socially damaging commitment to austerity. If he can manage one valuable step, creating a Green Investment Bank worthy of the name should be it.