In the wake of the Greek and Irish crises last year, analysts predicted that the collapse of the eurozone might become the big story of 2011. But while our neighbors in North Africa and the Middle East have burst into full-blown revolution, all appears to be quiet on the Western front. Or does it?
Last Thursday, Moody’s downgraded Spain’s credit rating, sending shock waves through the global financial system and once again leading to a fall in the euro. Foreign investors are also becoming increasingly antsy about Portugal, which some fear might need a bailout within weeks, while the looming threat of a Greek default has led to a downgrading of its credit rating to below junk status.
In the meantime, Spain is under increasing pressure to recapitalize its debt-laden banks and Germany continues to refuse a thorough shock test of its own. While Chancellor Merkel has jumbled together her best advisors and envoys, she remains plagued by the misguided idea that strict deficit targets will reduce the fundamental imbalances that lie at the heart of the crisis.
Increasingly, Merkel’s once pro-European stance is being undermined by the isolationist tendencies of her conservative constituency back home. As a result, the only idea that could possibly save the eurozone from its own self-destruction – a European economic government – has been stalled in its tracks by an increasingly inward-looking Germany.
The chimerical Franco-German competitiveness pact – which is nothing short of an attempt to place the periphery in a tight budgetary straitjacket – merely maintains the illusion that Germany can continue to practice its own trade surplus mercantilism unabated, and will therefore do absolutely nothing to stem the more fundamental causes of the crisis.
Clearly the essence of the problem does not lie in Greek profligacy, Italian bookkeeping or Spanish mañana mañana culture. Rather, we have to look for the roots of the crisis in the dynamics of the eurozone as a whole. Germany is increasingly acting like the China of Europe, quietly benefiting from a massively undervalued currency and systematically repressed wages, out-competing everyone on the continent.
The periphery, in the meantime, has found itself on the flip-side of the second German Wirtschaftswunder. Accession to the eurozone gave these countries temporary respite by opening up vast amounts of cheap credit, but as sovereign and private debt piled up to unsustainable levels, the so-called ‘PIGS’ suddenly became aware of the bad hand they had been dealt from the start.
Troubled by a permanently overvalued currency, the peripheral economies found themselves increasingly unable to compete with Germany’s high-tech, low-wage model. To maintain living standards (and demand for German exports), Southern Europeans were essentially forced to keep buying into the global Ponzi scheme that first began to unravel on the US housing market in 2007.
But this Ponzi scheme has still far from fully unfolded. Everyone knows that the regional Spanish savings banks, the cajas, are sitting on billions of euros worth in toxic assets. But even German and French banks, which are exposed to Spanish debt to the tune of nearly $450bn, have all but cleared their accounts. A Spanish default, if not cushioned by another EU bailout, would spell disaster for Germany and France.
In the meantime, while the banks are making record profits and dosing out mega-bonuses all over again, they still refuse to lend to individuals and small businesses. Combine this lack of credit availability with the austerity measures being forced upon the lower and middle classes, and what you get is a serious liquidity trap. After the major flood of the boom years, money is now suddenly drying up everywhere.
The consequent shortfall in demand will only worsen the Great Recession. At that point, all that needs to happen is for enough people, firms or local banks to go bust and the entire European financial system will be tipped towards insolvency. This time around, government finances and taxpayer consent will be so far stretched as to make another round of banker bailouts politically and fiscally impossible.
The only fair and effective way to prevent this crisis from spinning out of control is for the Germans (and bondholders!), who have benefited so enormously from the introduction of the common currency, to realize that they must now pay their dues and compensate their brothers and sisters in the South for what amounts to twenty years of involuntary currency manipulation and trade surplus mercantilism.
An ambitious redistributive project, overlooked by a democratically-elected EU economic government, would be the only truly transnational solution for this European crisis. The longer we postpone its enactment, the closer to collapse we will get.