03.11.2011

Referendum gamble plunges euro still deeper into crisis

European leaders are stumbling from one crisis to another, writes Eddie Ford

George Papandreou’s sudden announcement on November 1 that he is to hold a referendum on whether to accept the latest austerity measures demanded by the European Union, European Central Bank and International Monetary Fund troika has sent the euro zone spiralling into still deeper crisis. Stunned, the markets and European leaders let out a collective cry of anger over this ‘reckless’ and ‘irresponsible’ action that threatened to sabotage the deals arrived in Brussels in the early hours of October 27. Why can’t the Greeks just do as they are told?

The troika certainly wants its pound of flesh - and a lot more besides. In order for Greece to qualify for the next tranche of €8 billion in bailout loans - authorised by EU finance ministers on October 21, pending last-minute finalisation by the IMF - the Athens government has to impose on the masses a fresh round of savage cuts. Like further cuts in public-sector wages of between 20% and 30%; the scrapping of bonus and incentive schemes; the placing of some 30,000 public sector workers on 60% pay for one year pending their dismissal; the suspension of collective wage bargaining; the cutting of pensions and lump-sum retirement payments; the lowering of the tax-free income threshold from €12,000 to €5,000 a year; and on and on it goes.

If the Eurocrats were to get their way, then Greek workers would be reduced to a virtual slave class - a fate which the bourgeoisie would like to see extended to Portugal, Spain, Italy, etc. The Greek working class movement has other plans, of course - which is why Papandreou has deemed it necessary to try and pre-empt their resistance through a referendum, that favourite device of dictators and bureaucrats.

High risk

Papandreou said it was essential to win a “clear mandate” from the Greek people; otherwise the austerity measures might be considered illegitimate. More to the point, they would not stand a snowball’s chance in hell of succeeding. Greece is already wracked by an endless succession of strikes and demonstrations, and fears are rising amongst the euro establishment that the country is rapidly becoming ‘ungovernable’. Even worse, the ‘Greek disease’ of working class struggle and resistance has the danger of becoming a dreadful contagion.

Yet, crazily, it is the very medicine being dished out by the troika that is killing the patient. Under the impact of its vicious cuts regime the Greek economy is being further depressed, thereby increasing the deficit rather than decreasing it - which in turns adds to the pressure from the EU leaders for still further austerity plans and programmes. A vicious cycle. The budget deficit this year is likely to be higher than last year’s 10.5%, partly because interest charges are high and rising, and partly because the economy, which has contracted by 15% in the past three years, is still getting smaller. There is no ‘recovery plan’ for Greece - more like a death sentence.

Playing a high-risk game, Papandreou revealed that the referendum would also deliver a verdict on whether Greece should retain its membership of the euro. Obviously, as with all such referendums, the wording and timing is absolutely crucial. It is certainly not beyond the bounds of possibility that Papandreou could win. After all, whilst the majority of Greeks are implacably opposed to the austerity programme, about 70% also say they want to remain part of the euro zone. No matter how distressing this might be for ‘official communists’ and left reformists, there is no desire amongst the masses for the return of the drachma - rather, just to end the attacks on them, euro or no euro. Papandreou now faces a crucial, make-or-break confidence vote in parliament on November 4 and with only a two-seat majority - thanks to defections from his ruling Panhellenic Socialist Movement - his government could well fall and then snap elections would have to be held.

Either way - referendum or fresh elections - Greece stands to lose the bailout cash, meaning that within days the government will be unable to pay public-sector wages and pensions (those that remain), keep the trains running, collect rubbish, etc. As a direct consequence, the banking system would collapse and the country would default - either leaving the euro ‘voluntarily’ or being kicked out. That, of course, would not be the end of it - indeed, it would almost certainly be just be the beginning.

Alarmed, if not terrified, the French and German governments issued a stern statement, saying they wanted the “full implementation” of the Brussels agreement “in the quickest time frame” - oddly forgetting to request that the oceans be turned into pink lemonade as well. Nicolas Sarkozy and Angela Merkel held (yet more) emergency talks on November 2 with officials from the EU and IMF in Cannes, in a frantic attempt to hold the euro zone together and formulate a response to Papandreou’s referendum call.

This meeting was due to take place just hours before both leaders were to meet Barack Obama, who is flying to France for the G20 summit to be held over November 3-4 - the emergency summit, we are told, to end all emergency summits. Until the next one. Needless to say, the United States administration - as its own economy continues to stagnate - is in near despair about European developments. A collapsing euro zone would ensure that any US recession will be much deeper and longer-lasting than otherwise.

Looming

Inevitably, the European stock markets suffered sharp falls in the wake of Papandreou’s referendum call. The FTSE 100 fell 2.2% and the German market lost 5%, while France was down 5.4%. There followed substantial losses in Japan and Hong Kong.

Bank shares, naturally, were among the worst hit and among the biggest losers was the French bank, Société Générale, which already needs to find an extra €3.3 billion if the recent European-wide stress tests conducted by the European Banking Authority are anything to go by (probably not - just up the figure). So SocGen lost 17%, while Italy’s Intesta Saopaolo fell 15%. US banks were also hard hit, as the Dow Jones index dipped by as much as 300 points at one stage.

Of course, the stock market woes were fed by other problems apart from Greece. Thus we had the collapse of the US financial brokerage, MF Global, which is now filing for bankruptcy protection (which would postpone its obligations to creditors, giving it time in theory to ‘reorganise’ its debts or sell parts of the business). MF Global disclosed last week that it has a “net long position of $6.3 billion in a short-duration European sovereign portfolio, including Belgium, Italy, Spain, Portugal and Ireland” - which, to translate, means that it bought bonds last year thinking their price would rise and their yields fall, the opposite of what actually happened. Or, to put it another way, it had lent a sum (to governments whose ability to repay all they owe is moot) equivalent to five times the value of the equity capital it holds as protection against potential losses.

MF Global’s ignoble demise closely follows that of the French-Belgium bank, Dexia. Though both these financial institutions are not big enough to cause an immediate domino effect throughout the system, they might be acting like canaries in a coal mine. An ill-omen of what is to come.

More seriously still, there is the looming catastrophe that is Italy. At the beginning of the week the yield (interest rate) on Italian government bonds reached a new euro-era high of 6.33%, a potentially calamitous situation in a country which already has a debt mountain of close to €2 trillion. Normally, anything above 6% means the warning signs are flashing wildly; and 7% - now a distinct possibility - would surely see Italy join Greece, Ireland and Portugal in the bailout club. At this rate, if nothing dramatic is done, bankruptcy stares Italy in the face. In which case, Greece would be the least of the euro zone’s worries.

Just to complete the happy picture, Portugal and Spain seem to be going down the plug-hole too. The financial press has been full of reports that monetary contraction in Portugal has intensified at an alarming pace and is mimicking the general pattern seen in Greece before its economy spiralled out of control. In the words of Simon Ward from Henderson Global Investors, Portugal “appears to have entered a Grecian vortex”, registering a decline of 8.4%, and Spain is not far behind. A mix of fiscal austerity and monetary tightening by the ECB earlier this year appears to have tipped the Iberian region into a downward slide.

But everywhere you look the news is grim, with no respite in sight. The German government has slashed its growth outlook by nearly a half. Belgium’s central bank said the country’s economy “stalled” in the third quarter, growing by the slowest pace over a quarter since 2009. The news adds pressure on the Belgian ‘government’ (after over 500 days of failed negotiations the country still has no agreed coalition cabinet) to accelerate fiscal consolidation in order to cover budget gaps.

Overall, and most critically, financial analysts have noted that the cost of borrowing for Germany had been falling sharply - hitting its lowest point in six weeks at 1.736% - as jittery investors hastily dumped risky assets and flocked to those perceived as the safest in the euro zone, which perhaps is not saying much these days. The spread, or difference, between the 10-year bond yields of Italy, Belgium and France as against Germany has hit record highs.

Post-Brussels

The Brussels summit of October 26 now seems like a long time ago - the dim light that appeared to have flickered at the end of the tunnel has now darkened to the point of occlusion. Of course, even before Papandreou’s unwanted announcement, the markets had crashed back to earth. Utterly predictably, it soon became apparent that the European leaders had once again kicked the can down the road. But you cannot buck reality forever.

Instead of real cash backed up by a coherent and viable strategy, the rescue plan for the euro zone seems more based on the never-never. The much lauded €1 trillion capacity of the enhanced European Financial Stability Facility, four times its remaining €250 billion lending capacity, depends almost entirely on relatively “favourable” market conditions - and the willingness, more importantly, of various overseas investors such as sovereign wealth funds to commit more capital: eg, China. From some of the hype surrounding the Brussels deal, you might be lulled into believing that China is about to come to the rescue of the euro zone - if not the world. European leaders met with Chinese officials immediately after the Brussels summit. They hoped that their agreement for a €106 billion recapitalisation programme for European banks and a 50% ‘haircut’ (write-down) on private bondholders would persuade the Chinese the time was right to buy up European sovereign debt - maybe make a small contribution of around $100 billion from its foreign currency reserves of $3.2 trillion to the EFSF (or any new fund set up in collaboration with the IMF).

Forget it. Hardly surprisingly, the Chinese government is not exactly enthused by the idea of bailing out heavily indebted euro zone countries - too big a risk, Greek referendum or not. Soberly, the official Xinhua news agency stated that Europe must address its own financial woes, as China cannot take up the role as the “saviour” of the euro zone.

Recession is beginning to look unavoidable. The Organisation for Economic Cooperation and Development has slashed its growth forecasts for some of the world’s biggest economies and said that “without decisive action the outlook is gloomy” - warning of a “marked slowdown” in the euro zone area, with “patches of mild negative growth” likely in 2012. Hence growth is projected at 0.3% next year and will remain weak in the US too - while emerging markets will see slower growth than before the financial crisis began. Overall, the G20 states will slow to 3.8% in 2012, compared to 3.9% this year - and a repeat of the financial crisis of 2007-09, the OECD added, could wipe at least 5% off the major economies’ GDP by the first half of 2013. Furthermore, official figures showed that unemployment in the euro zone had climbed to a 15-year-high of 10.2%. Young people are being hardest hit by the lack of jobs, with youth unemployment at 29% in Italy, 43% in Greece and 48% in Spain.

Things are no better in the UK. Yes, GDP expanded by 0.5% from July to September. But a separate report released at the same time indicated that activity in the manufacturing sector shrank at the fastest pace for two years in October, suggesting the UK could fall back into negative growth before the end of the year. The headline reading on the Markit/CIPS UK Manufacturing Purchasing Managers’ Index dropped to 47.4, well below the 50-mark that divides contraction from expansion and much lower than 50.8 the month before. Leading Jonathan Loynes of Capital Economics to conclude that there is a “good chance” that the economy will contract in the fourth quarter. Against a background of high inflation, the ongoing fiscal squeeze and the escalating euro zone crisis, he thinks the UK economy at best will be “stagnating” by 2012.

To put it another way, the UK is now officially stuck on a slower recovery path than after the great depression of the 1930s, its economy now 4% smaller than it was at its peak in the first three months of 2008 - having recovered 3.1% from its lowest point in the third quarter of 2009. But with no Plan B the UK, like the US, stands on the brink of a double-dip recession.