Sunday, 17 July 2011


The public debt of the US and EU periphery (Greece, Ireland, Spain, Portugal and Italy - perhaps Belgium) is the most serious issue facing the global economy today. This is not because it need be, but because the banks' bailouts absorbed so much capital between 2008 and 2011 that the credit economy is at its weakest amid a slow growth period and the possibility of another global recession after the US presidential election in 2012. The manner that governments have handled the public debt issue in the last 10-12 months is a reflection of how the state in the EU and US has been guided purely by one rule only, namely, saving finance capitalism without reforming it.

On 30 September 2010, one day after the strikes and demonstrations across Europe with Brussels at the center, Moody’s Investor Service downgraded Spain’s debt, making it more difficult and costly for the government to borrow. The IMF immediately joined EU to criticize S & P, Fitch and Moody’s for the damage they have inflicted on government financial stability ever since the Greek crisis erupted.
On the same day, the Irish Central Bank announced that an additional 14 billion euros ($19 billion) will be needed to save the Irish banks, bringing the total bill to 50 billion euros ($68 billion at current exchange rate). 
This at a time that the Irish economy contracted by 1.2% instead of growing by 0.4% as had been expected. The IMF immediately cautioned investors not to draw comparisons between Ireland and Greece, but Ireland was the first EU country to help its banks, yet, it remains at the heart of financial/economic trouble among the PIIGS (Portugal, Ireland, Italy, Greece and Spain). As a result of a budget stalemate in Portugal, bond yields are the highest in 13 years and the center-left government of Jose Socrates introduced higher indirect taxes, pay cuts for public employees, a freeze in public investment and it is about to launch Greek-style austerity measures to achieve fiscal discipline. 
Like Greece and all the other debtor countries in Europe, Portugal found itself under immense pressure from the EU to undertake austerity measures. On 1 October 2010, the European Commission decided to focus on Ireland, Portugal and Spain in order to contain the damage, primarily by announcing that EU approves of their policies. Italy is also in trouble despite Berlusconi presenting rosy scenarios, as it is projecting lower GDP growth for next year and higher debt. 
In autumn 2010, Berlusconi received a vote of confidence in autumn 2010, thereby postponing the inevitable political instability that would have necessarily translated into further financial and economic instability. However, the Italian public debt issue is back as number one topic for EU leaders, especially after it has become clear that Japanese banks are heavily invested in the Italian economy. While Italy has the second highest public debt-to-GDP ratio after Greece, the Eurozone as a whole has a lower debt-toGDP ratio than the UK, US, and Japan. Why then is there talk about the possible breakup of the EU?
Eastern Europe and the Balkans on the periphery of the EU, more as dependencies than equal partners to northwest Europe, are feeling the squeeze of the global crisis, as they are tightening budgets and experiencing economic contraction. At the center of the EU financial and economic troubles remains Greece as the poster child of debtor nations that manages to combine endemic public and private sector corruption, and all this with a Socialist regime that is more neo-liberal and pro-free enterprise as the IMF would have it than any conservative government in Europe. 
While Greece has managed to avoid default for now, there is the fundamental question of how and if it will be able to service a debt that amounted to 113% of GDP in 2009, rising to 165% of GDP today (July 2011)  and expected to go above 200% by 2014; during which years the economy is expected to contract. In the absence of some type of default, some type of rescue plan that involves another EU-IMF bailout package, some type of major cut in the bonds' nominal value (haircut), some type of massive foreign assistance/investment, how will the Greek government be able to service its debt that could rise to half of its GDP? 
The government is hoping to avoid default by following the IMF-EU austerity measures. Yet, it is off its target to reduce the deficit because revenue is off by 13% owing to the fact that the economy is shrinking at about 4% and unlikely to grow given that unemployment hovering around 10% will probably rise by at least another 5% in 2011. The government is slashing the reputedly unproductive public sector which will result in higher unemployment and increased poverty, currently at 20%. The result will be lower fiscal revenues and lower private consumption. 
Greek government is counting on foreign investment to stimulate growth and it has struck some deals with Arab countries and China. However, foreign investment is hard to come by these days of financial retrenchment, and besides, neighboring Turkey along with Eastern Europe and every Balkan country is competing to attract foreign investment and in many cases they are offering more attractive terms than Greece. 
The Greek government is counting on integrating a portion of the underground economy into the mainstream so that it contributes to the fiscal system. Integration of the “informal economy” into the mainstream is a long-term proposition and unlikely to succeed to the level the authorities are hoping. Meanwhile, every day more and more small businesses are closing, largely owing to the economic contraction which favors large enterprises. 
At the same time, banks are approving one to two out of ten loan applications, as business growth, especially construction, have come to a standstill. The Greek government is counting on the EU for help. Most analysts expect Greece to default within the next two years or so, and that would mean at least 10% drop in the euro, and a scramble by the EU commission to prevent a domino effect from taking place, that is, Portugal, Ireland, and Spain defaulting as well. The worst case scenario would be the end of the Eurozone as Greece would drag down the periphery countries and they would drag down northwest Europe that supplies the credit.
My own view is that much will depend on the political will of the EU to keep the eurozone and focus on GDP growth of the core (creditor) economies. It is early to predict 'contagion defaults', though some type of restructuring may have to take place for the periphery, in which case the euro would have to be devalued. 
Meanwhile, the European Commission is becoming tougher with debtor countries and proposing: a) members must not exceed the 3% budgetary deficit as % of GDP debt limit; b) public spending cannot exceed GDP growth; sanctions against members that surpass the EU’s debt ceiling of 60% of GDP; c) chronic violators would pay penalty of 0.1% of GDP. The EU/IMF Rescue Plan, capitalized at one trillion dollars, is intended not to protect the weaker states like Greece, but the euro as a reserve currency and the stronger members as creditors. 
As I have written in previous postings, the EU creditor nations are determined to create a two-tiered union of some type even if the eurozone remains as it has been; especially now that it is expanding and Eastern Europe is integrated or about to join full membership. The German concept of integration is based on a patron-client model where the core remains strong within the bloc in order to compete with other regional bloc dominated by US, Japan, and China. 
The German political and economic elites remain loyal to the 19th-century Deutscher Zollverein concept that ran its course and died out as nationalism polarized the members. For now, the EU has strong interests beyond economic to stay unified. However, if a series of crises hit the weaker members, the stronger creditor EU countries are establishing mechanisms now to make certain that their national interests are protected in the future.

So far, the EU and IMF have been throwing money at Greece and the periphery and they are prepared to keep on doing the same thing, without considering that the formula has not worked and will not work except to create a poorer middle class and labor force owing to absence of economic growth. Economic growth cannot come by recycling money from the pockets to taxpayers to the pockets of bondholders.The EU and to a lesser degree the US will drive the economy into the ground by following monetarist policies. The only solution is heavy investment in the 'real economy', especially in labor-intensive enterprises to absorb the surplus labor force and raise consumption. Otherwise, we are headed for a double-dip recession after the 2012 US elections.

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