Contagion spreads to the core

The escalating euro zone crisis and the possibility of the US defaulting on its deficit could trigger another global economic meltdown, writes Eddie Ford - and yet more attacks on the working class

In response to the global economic meltdown of 2007-08, governments around the world resorted to massive state intervention in order to prevent a total collapse of the capitalist system. Ideological shibboleths, or manifesto commitments, went out the window, as panic spread.

Following the Lehman’s disaster, which was allowed to go bankrupt whilst holding over $600 billion in assets - thus triggering the subprime-induced world economic crisis - the Bush administration became ‘socialist’ almost overnight and effectively nationalised large sectors of the banking and insurance industry. Additionally, Bush embarked on a $168 billion stimulus package, or spending spree - which included an extensive system of state-subsidised mortgages - so as to keep the show on the road.

Similar measures were taken in the UK. After some characteristic prevarication, Gordon Brown nationalised Northern Rock - in the teeth of virulent Tory opposition, of course, with the current chancellor (George ‘We’re all in this together’ Osborne) leading the laissez-faire pack. These emergency Keynesian measures temporarily shored up the creaking capitalism system and produced a few “green shoots” of recovery. But the fear was that the recovery, such as it was, could easily be thrown into reverse - whether due to short-term governmental policies on tax and spending or cyclical economic/financial instability. The abyss still beckoned.

The real nightmare scenario, of course, has been that the toxic debt of Greece, Ireland, Portugal and Spain would start to eat away at the major economies: the dreaded contagion. Alarmingly, but somewhat inevitably, this nightmare seems to be becoming a reality - evidenced over the last two weeks by Italy, the euro zone’s third largest economy, finding itself convulsed by a sovereign debt crisis. To date, Italy had escaped the tender mercies of the speculators - appearing to have its deficit under control.

But the chickens are now coming home to roost - that is, Italy’s accumulated budget deficit of 120% of national product. However, the country will have, as a minimum, €900 billion (£793 billion) of debt ‘maturing’ over the next five years. The line now being pushed by advocates of austerity is that such a sclerotic economy would always be extremely vulnerable - a crisis waiting to happen. And now Italy has to take its medicine - a €45 billion (£32 billion) package of deficit-cutting measures to “balance the budget” by 2014 - ie, swingeing cuts combined with a hike in taxes. By getting this budget through parliament, finance minister Giulio Tremonti had hoped to “send the markets a strong signal” and avoid joining the “pigs”[1] of Greece, Ireland, Portugal and Spain. Unfortunately for him, the Northern League - Silvio Berlusconi’s coalition partner - is deeply unhappy at the very idea of tax rises; what it really wants, like so many in the Republican Party in the United States, is tax cuts (for business) to encourage ‘enterprise’.

The problem is that, for whatever reason, investors (read speculators) suddenly took fright at the situation developing in Italy. Hence the markets plunged, the practical result being that the bond yields on Italian debt soared to a nine-year high - and, of course, the rise in yields means that the interest rate Italy must pay to borrow correspondingly goes up - the upshot being that Italy now has to run faster to stand still. Despairingly, Tremonti has likened the euro zone crisis to the Titanic - where “not even first-class passengers can save themselves”.

As for Greece, needless to say, its predicament is going from bad to worse to … even worse still. Currently, the country remains locked out of capital markets, leaving it unable to borrow in order to service its colossal €355 billion debt. Short of divine intervention, Greece is all but certain to default, something confirmed by the latest International Monetary Fund forecast that Greek debt is likely to rise to 172% or more of national income, while GDP would shrink by 3.8% this year. For Greece to come back from the brink of economic destruction, argues the IMF, it is “essential that the authorities implement their fiscal and privatisation agenda in a timely and determined manner” - given that that the “debt dynamics show little scope for deviation”. Which is another way of saying that the Greek government needs to mount yet more vicious attacks on the working class and further drive down living standards and conditions.

Now frantic plans are afoot to ‘reschedule’ or ‘restructure’ Greece’s debt, so as to put it on a “sustainable footing” - like the further lowering of interest rates on bail-out loans and/or a broad-based bond buy-back programme. In particular, Germany, which has spent vast amounts trying to prop up Greece and save the euro zone project, is keen that private bondholders should share some of the pain.

However, all these plans require that the banks take a ‘haircut’ - that is, a loss on their investments. Which in turn puts the actual banks in jeopardy, acting to fuel fears that governments will have to bail them out - again. A vicious circle, of course. And a highly undesirable set of circumstances, to put it mildly, for investors of various stripes - beginning to suspect that if things carry on in such a manner they might have to take a very substantial hit on Italian, Spanish, Irish and Portuguese debt. Suspicions that gained weight following a July 11 statement from the euro zone finance ministers, distinctly hinting at an agreement on “enhancing the flexibility and scope” of the European financial stability facility - the mechanism by which they lend to countries otherwise unable to access financial markets or credit. This was seen as a prelude to purchasing ‘distressed’ peripheral debt back at knock-down prices, thus forcing banks to take a loss. Losses, losses, everywhere - but where are the profits?

This was certainly the view of the credit-rating agency, Fitch, which downgraded Greece even further - this time by three points to CCC status from its previous rating of B-plus. It expressed concern that the €30 billion (£26 billion) Greece hopes to raise from its privatisation programme was based on “largely unquantifiable private sector participation”. While asset sales of €5 billion in 2011 “look attainable”, the “privatisation programme will become increasingly challenging” after that.[2] In other words, Fitch does not believe the hogwash about the private sector coming to the rescue. The Greek government claimed that the downgrade was “bewildering”, but bullishly maintained that Fitch’s rating action “does not affect the Greek banking system and this will become clear as soon as the new programme comes into effect”. Dream on.

Other credit rating agencies have taken similar steps, naturally. They hunt in packs. Moody’s on July 12 downgraded Ireland’s debt to junk status, citing the “increasing possibility that private sector creditor participation will be required as a precondition for additional support”. A week earlier it had slashed Portugal’s status to junk, calling it the “new Greece”. Stung by the development, the Irish government complained that the regrading was “unfair” - whilst Richard Bruton, the inappropriately titled minister for ‘jobs, enterprise and innovation’, said Ireland had become “caught up” in the problems of “other weaker members” of the euro zone. More than unconvincingly, Bruton maintained that the country was “on track” to hit the targets agreed - or dictated - by the IMF. But Moody’s reclassification of Ireland, he bitterly claimed, threatened “the recovery”.

The behaviour of the credit ratings agencies so infuriated the commissioner in charge of the EU’s single market, Michel Barnier, that he threatened to declare “war” on the three big agencies who dominate 90% of the ratings industry: Standard & Poor, Moody and Fitch. His remarks followed a broadside from fellow commissioner Viviane Reding, who said the ratings agencies’ “cartel” should be “smashed up”, as they were seeking to “determine the fate” of Europe and its single currency. Barnier even suggested that the agencies be “banned” from delivering ratings decisions on the euro zone countries being bailed out: Greece, Portugal and Ireland - but “it’s just an idea”, he quickly added. Of course, the unceasing search for surplus value and the system of market speculation itself are entirely free from blame.

US showdown

When one looks at events on the other side of the Atlantic - with the US teetering on the edge of the precipice - it is evident that things could get even worse. We now have high noon between the Obama administration and the Republican-led House of Representatives over the ‘debt ceiling’, which has reached its $14.3 trillion legally permitted maximum.

In order to persuade Republicans to agree to increase this as a matter of urgency Obama has put forward a “compromise package”, proposing $4 trillion in savings over 10 years - signalling the definitive end of the neo-Keynesianism of 2008-09. However, part of this involves a $1 trillion component that would come from increased taxes on the very wealthy. White House budget director Jack Lew said it would “not be fair to ask senior citizens to pay a price”, while leaving “the most privileged out of the equation”. Whether overconfidently or not, Lew said that the “debt will be extended” by the “responsible” members of Congress - as opposed to the “voices of a few who are willing to play with Armageddon”.

But the Tea Party-influenced tax-cutting, budget-balancing fundamentalists in the Republican Party show no signs yet of backing down - either that or they are taking brinkmanship to new heights. One of those “voices of a few” include the Republican presidential candidate, Michele Bachmann - who makes Sarah Palin look like a paragon of progressive liberalism. For instance, Bachmann argues that global warming is a “hoax” and has expressed the opinion that Obama, and other unnamed members of Congress, have “anti-American views”.[3] She asserted last week that she would vote against raising the debt ceiling, whatever the outcome of the negotiations. Not much room for manoeuvre then, it seems.

The US treasury has until August 2 to raise the limit on its debt or risk running out of federal money immediately - which in theory could see it effectively shutting down all ‘non-essential’ areas of government (so that teachers, etc will not get paid, and so on) Analysts say that in order to give Congress time to prepare the necessary legislative paperwork needed to raise the ceiling, a deal would have to be close to fruition by as early as July 22 - leaving the US just days away from a potentially catastrophic default.

Therefore, as the deadline approaches like the grim reaper, the very financial credibility - and credit-worthiness - of the US government is at stake. Incredibly, this conjures up the possibility that the US itself might be downgraded by the credit agencies, wielding their apparently god-like powers. Not that that long ago, this would have seemed like economic science fiction. But Priya Misra of Bank of America Merrill Lynch has warned that the market reaction to any sort of default - even if it was only a temporary one - would be “drastic”; indeed, that the US “may also lose one of its most valuable assets, the safe haven nature of US treasuries, which could structurally pressure bond rates higher”. The risk, however small, of a default pushed Moody’s on July 13 to downgrade the outlook on its triple-A rating of US sovereign debt to “negative”. Standard & Poor followed the next day, declaring that it was so “unimpressed” by the longer-term budget negotiations that there was a “50-50 chance” of the US losing its triple-A status over the next three months.

The downward spiral of the dual debt crisis in both the euro zone and the US has the potential to reproduce the 2007-08 crisis, but at an even higher level: ruination stares us in the face. Some imagine, or dream, that China - with its 9.5% annual growth for the second quarter - will come to the rescue of capitalism like Superman - or at least act as a “circuit breaker”. More like a pipe-dream.

Of course, if the US and the euro zone slip further into crisis - and a double-dip recession - then George Osborne’s plans for recovery, sick joke that they are, become junk as well. Meaning he needs a plan B, but of course he has not got one - rather, just more of plan A; more austerity, more cuts, more job losses, more attacks on the working class. Meanwhile, City bonuses totalled £14 billion last year and there were base salary rises for high-earners in City - who are doing very nicely, thank you very much.

The developing crisis on both sides of the Atlantic shows the political class has no real idea as to how to repair the chronically malfunctioning system which they serve.


  1. PIGS or PIIGS is an unflattering acronym used mainly by international bond analysts, academics and sections of the economic press when referring to the economies - and debts - of Portugal, Ireland (originally Italy), Greece, and Spain (tinyurl.com/ykbexpk).
  2. The Daily Telegraph July 13.
  3. www.msnbc.msn.com/id/27297028