No such thing as a free lunch
With Madrid refusing to take a bailout and Athens still facing the possibility of default, the euro crisis is far from over, writes Eddie Ford
By late July the euro crisis seemed to be spiralling out of control yet again. Borrowing costs on 10-year government bonds in Spain and Italy had reached 7.6% and 6.6% respectively - totally unsustainable levels. Both countries are just too big to fail, as far as the euro zone project is concerned - yet too big to bail out either, given that the European Financial Stability Facility/European Stability Mechanism rescue fund only came to about €700 billion (using the most generous estimate). Nowhere near enough. In response, Mario Draghi, president of the European Central Bank, told an investment conference in London that he was prepared to do “whatever it takes” to preserve the euro - just wait and see.
Then on September 6 Draghi unveiled some concrete details about the plan. If necessary, the ECB would buy “unlimited” quantities of sovereign debt to ensure euro zone governments retained access to funding. Or, to put it another way, guarantee that states struggling to raise funds from financial markets will be helped out by the central bank - rest easy. This new type of financial intervention was instantly dubbed ‘outright monetary transactions’ (or OMT). Rather than buying new issues of government bonds, the proposed scheme will see the ECB buy existing bonds that are already held by pension funds and banks. The aim, naturally, is to provide sufficient demand to drive up the prices of these bonds and so reduce the interest rate on them. And to a certain extent the ECB has already had a measure of success - as of September 12, bond yields stood at 5.7% in Madrid and 5.1% in Rome. Manageable for now.
Predictably, there was fierce opposition to Draghi’s plans from Germany’s central bank, the Bundesbank - attacking it on the grounds that it comes close to breaking European Union treaty provisions preventing the ECB from bailing out governments. Indeed, the Bundesbank views Draghi’s “unlimited” purchase of bonds as seriously increasing the risk of the ECB itself going bust and also enhancing ‘moral hazard’ - ie, the creation of a licentious situation where borrowers think they will always be bailed out and so renege on their fiscal commitments. With the German taxpayer always there to dutifully dole out the cash or, alternatively, “consigned to economic serfdom” in order to save the euro.1
Expressing such anxieties, Peter Gauweiler, a backbench Christian Social Union MP, made a formal request to the German Constitutional Court to postpone its decision on the legitimacy or otherwise of the ESM until the ECB has altered its unlimited bond-buying programme. Gauweiler argued that the programme had “created a completely new situation” regarding the ESM, making the impact on Germany’s taxpayers “completely incalculable”. But the court on September 11 rejected his complaint and the next day ruled that the ESM was legal vis-à-vis the German constitution. However, it attached two main conditions: namely, that German liability to the ESM must not exceed €190 billion without “prior approval” by the Bundestag lower house of parliament; and that both houses must be kept “informed” about how the ESM funds are deployed.
So you could say that the new ECB plan looks like the sort of intervention required. Maybe the euro, as Draghi and others have insisted, is “irreversible” and the crisis is finally drawing to a close?
However, in reality, the crisis is far from over. There are limitations - indeed potentially fatal flaws - to the ECB’s seemingly ambitious rescue plan. Most importantly, the ECB will only buy a country’s bonds if its government formally signs up to a euro zone bailout programme and sticks to the “strict and effective” conditions inevitably attached to such a deal - there is no such thing as a free lunch, especially when dished up by the ECB, European Commission and the International Monetary Fund. Spain, of course, has already secured European rescue funds up to the sum of €100 billion for its distressed banks.
A very bitter pill to swallow - perhaps too bitter. That seems to the case for the increasingly beleaguered Mariano Rajoy, the Spanish prime minister. In a TV interview on September 12, he belligerently stated that he had no intention of applying for a bailout - possibly putting him on a collision course with the ECB and Brussels. He declared that his overriding priority was “creating employment”, not taking up “what people like to call a bailout”. In fact, Rajoy “couldn’t accept anyone else telling us what our policies should be” or “where we have to make cuts”. National pride would not tolerate it.
During the interview he also admitted that he had reneged on election promises not to raise income tax and VAT. Mea culpa. His unconvincing excuse though was that “no one told me” the deficit was €90 billion and not the €60 billion he had been led to expect when first taking office last December - if only he had that ‘extra’ €30 billion then things “would have been different”. Methinks the man doth protest too much. Rajoy also reiterated that he would not adopt any measures that would “harm” pensioners, whilst completely dodging the question of how he is going to ‘reform’ (ie, cut) the pension system without further reducing living standards.
It is hardly surprising that neither Rajoy nor, for that matter, Italy’s Mario Monti is exactly rushing to take advantage of the ECB scheme. If Madrid accepts tough new conditions, it will be seen as prostrating itself before the ‘men in black’ - inspectors from the EC, ECB and IMF troika - and that may spark more trouble on the streets. Rajoy is already deeply unpopular, if not hated, for the July budget which contained sweeping austerity measures. That €65 billion package included raising VAT from 18% to 21%, which, for example, saw the rate on public transport, hotels and processed foods rise from 8% to 10%; cuts to benefits (reduced unemployment benefit after six months out of work) and public sector pay, like removing Christmas payments; a new fuel tax; raising the retirement rate; and cutting billions off local government spending.
Vicious and painful measures that are being made at a time when the Spanish jobless rate is close to 25% - with youth unemployment now standing at a staggering 53% - and an economy that is mired in recession. The IMF, to name one organisation, expects that the recession will last until at least 2014. Extra austerity measures on top of that, even if it were a so-called ‘bailout-lite’, could amount to political suicide.
Given the intense pressure Rajoy is under, both from the Brussels bureaucracy and a combative Spanish working class, he could twist either way - towards capitulation or defiance. However, the Rajoy administration is being ‘encouraged’ to make a bailout application before the EU summit at the end of October and before Spain has huge bond redemptions (repayments) to make at the end of that month. Playing for time, Rajoy has stated that he wants to “see what emerges” from the next Council of Europe meeting on October 18-19. This has been widely interpreted to mean that no bailout will be announced before the regional elections, which are due on October 21 in his native Galicia and in the Basque country (just to make Rajoy’s life even harder, nationalist/separatist sentiment has been steeply rising in Catalonia and elsewhere).
Madrid and Rome face other problems as well. Draghi’s plan, as things stand now, is for the ECB to focus its purchases on bonds with a maturity of one to three years - ie, short-term debt. Therefore both countries still have to find some other way of dealing with long-term debt, which accounts for around two-thirds of what is owed. No easy task. Meanwhile the spread between Spanish/Italian and, for example, German/Dutch/Finnish bond yields is reaching dangerous proportions. For the latter countries, two-year yields have entered negative territory in recent months (meaning, at least in theory, that investors could end up losing money if they hold the bonds to maturity). Such extreme divergence - as opposed to convergence, supposedly the euro’s raison d’être - could split the euro apart.
Yes, investors at the moment are currently relatively bullish about Spain and Italy. But we know that they are notoriously fickle. After all, the good mood engineered at the start of the year by the ECB’s €1 trillion of cheap long-term loans to the zone’s banks had vanished by the spring. With economies shrinking, and the prospect of tougher political challenges and looming elections, both Rajoy and Monti are in a precarious position. Draghi’s bond-buying scheme may have bought them both a little bit of time, bailout ‘lite’ or not, but if they drag their heels for too long the markets may well lose patience and snuff them out.
The euro zone has other headaches. Troublesome noises are coming from Athens, for instance. Greek prime minister Antonis Samaras has reportedly asked the ECB to hold over bonds due to mature between 2013 and 2015 until 2020. Obviously, by holding Greek bonds longer, the ECB would be extending the terms of repayment and effectively admitting to losses. Certainly not something Berlin would be too happy with.
Showing the stress upon Greek society, the country’s ‘non-political’ president, Karolos Papoulias, broke with diplomatic protocol whilst visiting Canada on September 11 when he said that “up until now we’ve been receiving a merciless lashing”, but “we have paid enough for our mistakes and Europe must realise that it needs to help Greece”. Papoulias made these scathing remarks as the ‘men in black’ (some of whom are actually women) want labour minister Yiannis Vroutsis to sanction further cuts to an already traumatised country. The economy contracted by 6.2% in the second quarter compared to a year earlier and since the April-June quarter of 2008 has shrunk by a total of almost 18% - the unemployment rate is now 23.1% (among youth it has almost reached 55%). Troika officials want to see the government in Athens force through €11.7 billion in extra spending cuts if it is to receive the next tranche of bailout money - or go bankrupt.
Vroutsis is thus being urged to raise the retirement age, adopt a minimum wage freeze, make more cuts to overtime and severance pay and introduce a six-day working week as part of the draconian terms for the country’s second bailout. The demand is found in a leaked letter from the troika sent last week to the Greek finance and labour ministries. The relevant section reads: “Measures: increase flexibility of work schedules; increase the number of maximum workdays to six days per week for all sectors. Increase flexibility of work schedules; set the minimum daily rest to 11 hours; delink the working hours of employees from the opening hours of the establishment; eliminate restrictions on minimum/maximum time between morning and afternoon shifts; allow the consecutive two-week leave to be taken any time during the year in seasonal sectors.”2
On the same day that Papoulias lashed out at the troika, Panos Kammenos - leader of the rightwing Independent Greeks - described, not inaccurately, the savage cuts/austerity (‘internal deflation’) being inflicted on the country as a “death recipe that is killing the Greek people”. The country, he declared, could only be saved from recessionary policies if the loan agreement it had signed with its creditors was “abandoned once and for all”. Communists find themselves in agreement with Kammenos over that matter, if nothing else. Similarly, Pasok leader Evangelos Venizelos and Fotis Kouvelis of the Democratic Left - both part of the coalition government - have stepped up criticism of the measures demanded by the troika, saying they will “unfairly” hit the most vulnerable sections, particularly pensioners and low-income workers. Nothing more wretched than panicking opportunists.
Samaras is digging in, however. Opening the country’s international trade fair in Thessaloniki at the weekend, he insisted that the cuts - which were originally meant to have been implemented in June - had to be carried through. There is no alternative. It will all be worth it in the end though, Samaras added, as the €31.5 billion cash injection Greece stands to receive in return for the cuts will “instantly improve” the liquidity of the country’s cash-starved market. Doubtlessly that will be a great comfort to Greek workers who have had their unemployment benefits cut off or been made homeless by the government’s ruthless austerity regime.
Meanwhile, the world economy remains in the doldrums. Data published last week by China’s National Bureau of Statistics showed that industrial output increased 8.9% in August from a year earlier, compared with a 9.2% gain in July. August’s rise undershot market forecasts for a 9.1% rise and is the weakest since May 2009. China’s factory sector has been hit by slowing new orders from Europe, needless to say. Overall, the economy expanded by 7.6% in the second quarter, the worst performance in three years and the sixth straight quarter of slower growth. Beijing will not be coming to the rescue of capitalism some time soon - or ever, if truth be told.
What about that mighty powerhouse, the United States - surely the capitalist knight in shining armour? No, its economy is merely bumping along the bottom at 1.7% in the second quarter of 2012. US manufacturing growth remained sluggish in August too, according to two influential surveys. The Markit Manufacturing Purchasing Managers’ Index was 51.5 last month, a notch higher than 51.4 in July. A similar index by the Institute for Supply Management showed a small contraction, with a score of just under 50 (indicating contraction). Looking at the gloomy surveys, the Federal Reserve has cut its forecast for economic growth in 2012 from 2.9% to 2.4%.
More worrying still, at least for Barack Obama’s re-election chances, are the unemployment figures. Although they showed a drop from 8.3% to 8.1%, the fall was mainly attributed to people just giving up the search for work - then god knows what happens to them. Call it economic eugenics. Only 96,000 new jobs were created in August, compared with 141,000 in July - well below the rate of population growth. The US economy needs a growth rate of at least 2.0%-2.5% if it is to keep the employment rate stable, never mind whittling it down.
Furthermore, as if things were not bad enough, the US is on the edge of what IMF director Christine Lagarde referred to as a “fiscal cliff” - an economy-rattling set of across-the-board spending cuts and higher taxes caused by the expiration of Bush-era tax cuts in January 2013. The Senate remains deadlocked over the question - a year ago Moody’s cut its outlook on US debt to “negative” precisely due to the ceaseless partisan wrangling over raising the government debt limit.
1. Gunnar Beck, The Guardian (September 9)