We avoided the apocalypse – but 2013 will be no picnic

The world hasn't ended, but global leaders will still have to work hard to manage economic trials and social tensions

• 
• • Ha-Joon Chang
  • The Guardian, Sunday 30 December 2012 19.00 GMT

‘The eurozone is entering a make or break year, with the social fabric of the periphery countries stretched to the limit.' Illustration: Andrzej Krauze

 

 

The world did not end this year, as some people thought it would following a Mayan prophecy (well, at least one interpretation of it), but it seems pretty certain that next year is going to be tougher than this one.

We are entering 2013 as the Republican hardliners in the United States Congress does its utmost to weaken the federal government, using an anachronistic law on federal debt ceiling. Until the Republicans started abusing it recently, the law had been defunct in all but name. Since its enactment in 1917, the ceiling has been raised nearly a hundred times, as a ceiling set in nominal monetary terms becomes quickly obsolete in an ever-growing economy with inflation. Had the US stuck to the original ceiling of $11.5bn, its federal debt today would have been equivalent not even to 0.1% of GDP (about $15tn) – the current debt, which is supposed to hit the $16.3tn ceiling today, is about 110% of GDP.

A compromise will be struck in due course (as it was in 2011), but the debt ceiling will keep coming back to haunt the country because it is the best weapon with which the extremists in the Republican party can advance their anti-state ideology. This ideology has such a hold on American politics because it taps into the anxiety of the majority of the white population. Being squeezed from the top by greedy corporate elite and from the bottom by new immigrants, they seek solace in an ideology that harks back to the lost golden age of (idealised) 18th-century America, made up of self-defending (with guns), free-contracting (white) individuals who are independent of the central government. Unless mainstream American politicians can offer these people an alternative vision, backed up by more secure jobs and a better welfare system, they will keep voting for the extremists.

Meanwhile, on the other side of the Atlantic, the eurozone is entering a make or break year, with the social fabric of the periphery countries stretched to the limit. With its GDP 20% lower than in 2008, with 25% unemployment rate and with the wages of most of those still in work down by 40% to 50%, it is a real touch and go whether the current Greek government can survive another round of austerity. Spain and Portugal are not yet where Greece is, but they are hurtling down that way. And even the infinitely patient Irish are beginning to vent their anger against the inequities of the austerity programme that has hit the poorest the hardest. Should any of these countries socially explode, the consequences could be dire, whether they technically stayed in the eurozone or not.

As for the UK, 2013 may become the year when it sets a dubious world record of having an unprecedented "triple-dip recession". Even if that is avoided, with high unemployment, real wages that are at best stagnant and swingeing welfare cuts, many people will struggle to make ends meet. In a letter to the Observer yesterday, the leaders of the city councils of Newcastle, Liverpool and Sheffield, have even warned of a "break-up of civil society", should the austerity programme continue.

European leaders need to work out new economic programmes with a more equitable sharing of the burden of adjustment, both within and between countries. Paradoxically, they can look towards Iceland, the canary that first died in the mine of toxic debt, for a lesson. The country has been recovering rather well, considering the scale of the banking crisis, while making spending cuts in a way that impose the least burden on the poorest: between 2008 and 2010, income of the poorest 10% fell by 9% while that of the richest 10% fell by 38%.

Things look brighter in the Asian countries, with their economies growing much faster and with even Japan ready to make a dash for growth through more relaxed monetary and fiscal policies. However, they – especially the two giants of China and India – have their own shares of social tension to manage.

Growth is slowing down in China. It is estimated to have grown by 7.5% in 2012, well below the usual rate of 9% to 10%. Some forecast that its growth rate will pick up again to above 8% in 2013, but others believe it will fall below 7%. Given the country's heavy reliance on exports to the US and the European Union, the more pessimistic scenario seems likely, as things don't look very good in those economies. With slower economic growth it will become more difficult to manage the social tension that has been bubbling up thanks to runaway inequality and high levels of corruption.

Management of social tension will be an even bigger challenge for India. Its economic growth has significantly slowed down since 2010, and few predict a major reversal of the trend in 2013. Add to this economic difficulty deepening economic, religious and cultural divisions, and you have a heady mixture, as we see in the social unrest following the recent gang rape and death of a young medical student.

If the political leaders of the major economies do not manage these social tensions well, 2013 could be a year in which the world takes a turn for the worse. It is a huge challenge, as it is like trying to fix a car while driving it. However, without fixing the malfunctioning car, we will not get out of the woods, however much extra fuel, like quantitative easing, we pour into the car.

Eurozone needs a pre-nuptial

By Reuven Brenner

French President Francois Hollande has announced that he will be pushing for mutualizing European debt, which Germany, the Netherlands and Finland oppose. [1]

While there are historical precedents for mutualizing debts - Alexander Hamilton 1790 assumption of states' debts - there are significant differences between that situation and the one Europe is facing now. While the US eventually managed to shape an "American tribe" - though 70 years after Hamilton, a civil war was fought that shaped eventual features of this new tribe - the notion of a European "tribe" is not on the horizon.

The Balkan tribes are as divided as they have ever been; the Scots want to separate from the rest of the United Kingdom; Italy seems to be almost as divided between south and north as it was in Garibaldi's time; and the chances of Greeks, Italians, Spanish, French intermingling with Germans to shape a European tribe do not seem much closer today than they were in preceding centuries.

The above does not imply that crisis might not make for strange bedfellows, resulting in mutualizing some debts. If that happens, the problems raised with the demutualizing of the national debt during the 1995 referendum when Quebec almost separated from Canada (there was just 1% difference in the votes which prevented it) suggest what certain clauses should appear in the potential Eurozone debt offerings and prevent crises that lack of such anticipatory clauses would bring about.

Paragraphs in the draft bill of the Quebec government tabled on December 7, 1994, in the National Assembly, indicated ways in which constitutional, territorial issues, as well as those linked with currency, debts would be settled in case of separation. The document though never addressed the question how an independent Quebec would assume responsibility for its share of Canada's public debt. Yet these were questions raised then:

How do you credibly transfer responsibility for the debt in case of demutualization? What will Canada's creditors say about the transfer? What will be the price paid for it? Quebec had the following options: 1. The Quebec government convinces Canada's creditors to release Canada from their fraction of the debt, exchanging it for bonds issued by Quebec's government (or equities in enterprises); 2. Quebec issues bonds and deposits them with the Canadian government. The Canadian government continues then to bear responsibility for payments. In the European case, the countries that would not implement the policies agreed upon when the bonds are issued would also be facing these two options. If the eurozone bonds are issued, clauses in the bond contracts would have to deal with these two questions. Answers to them would indicate creditworthiness in case of mutualization, and potential demutualization. Let examine these answers. A public debt is backed by the government's right and ability to tax. The proposed euro-bonds would be backed by expectations that European Community's citizens can create sufficient taxable wealth. I highlight "taxable" because both Greece and Italy create wealth, just much of it does not pay taxes. Assume then that with the potential euro-bonds issue, Greece, Spain and Italy ("Club Med") would agree to a clause that in case of secession due to lack of performance, the bonds would be exchanged for those of the three national governments. Would creditors buy these new issues at lower interest rates that the Club Med countries are now trading? The answer is no. After all, the new paper would be backed by exactly the same thing that any governments' outstanding debt is backed by: governments' right and ability to tax. What happens with such clauses in place is that the European Community gives up the right to enforce payment on the seceding members, and that right is transferred to the seceding national governments. This is the core of the issue: Under what political umbrella can the debt be serviced more credibly? Is it under the European community umbrella, with its ability to speed up changes in fiscal, regulatory, monetary and immigration policies? Or are the Club Med countries separately, outside the European umbrella, more creditworthy in changing their fiscal, regulatory, monetary and immigration policies so as the service the debt? With these clauses in the proposed Eurozone bond, it is not clear that the issue would fly. The price buyers would pay would reflect the option that the Club Med countries would not change their policies, end up seceding, in which case the eventual national governments would be standing behind the debt. Now what happens if Germany, the Netherlands and Finland agree that the new public debt remains an obligation of the European countries, with some separate side agreements between the countries? In 1995, the assumption was that Quebec would remit to Canada the funds necessary to service the interest and the principal on the negotiated portion of its debt with a "Promise to Pay Agreement" for every issue, whatever the interest rate or the maturity. Could this work for Europe today and lower interest rates for the Club Med countries? The answers is again no. If Quebec was unable to convince lenders of its ability to service the debt under the federal umbrella, why wouldn't the rest of Canada have not the same doubts? After all, we are talking about the same amounts of money exactly. If Club Med countries are unable to raise funds now, why would the solvent European countries believe that if they back the Eurobonds now, the Club Med countries would pay them back in timely fashion? And if they do not, what are their options? To send in tax collectors, backed by armies? Thus we are back at the point where we started. Creditors know that government bonds are backed by governments' recognized rights and abilities to tax. If all Europe is held responsible for the additional debt, a credible promise that the debt will be serviced without interruptions or without imposing more taxes on Europe's solvent members, would mean that the stronger European countries would have sufficient influence on the weaker countries' fiscal and regulatory policies so that they would be changed in time and prevent default on payments. If solvent Europe does not have the stomach and ability to do this, its creditworthiness diminishes with the proposed euro-zone bonds. Briefly: no matter which of the two options is chosen, creditors must know that the entity who is responsible and held accountable for the debt is also the entity who has the right to tax and regulate. If the two are not the same, the eurozone bonds idea loses credibility. Either clauses in bond covenants or the side political agreements - if enforceable - are ways to increase such credibility. The above analyses is similar to "pre-nuptials" adapted to national levels. Such agreements are by now a common feature of marriage contracts in the United States. In France, they have a longer history. French novelist Honore de Balzac's classic Marriage Contract (1835) is dedicated to them, with perfect insight into human behavior and with broad implications relevant to today's Europe. The story is about Paul de Manerville, a wealthy gentleman who decides, against the advice of his friends, to get married at the age of 27. He marries the Spanish Natalie Evangelista, whose financial assets have been declining since the death of her father - the banker who nature furnished her with at birth. He does not see either that Natalie's loyalty is to her "tribe" - her mother, that is - and that outsiders, her husband among them, are way down the pecking order; that Natalie's mother is desperate to assure for her daughter the lavish lifestyle she believes to be her "right"; or that the various marriage intermediaries negotiating the marriage contract are trapping him. Paul ends up in an unhappy and childless marriage - with his wife happily playing the field. Reads like a good allegory for today's childless Europe; brought into a union by politicians blinded by a non-existent European "democratic ideal," misleadingly traced back to Greece (whose present population has nothing to do with Ancient Greece, except occupying the same real estate); and whose politicians sold every possible rights to their constituents - without requesting obligations. Although Germans and Dutch - not French - pay the bills, and the International Monetary Fund (IMF) and central banks play the roles of the intermediaries, reminding one of Balzac's self-interested negotiators, whom he despises, and whose wile he describes with devastating perfection. If Paul's friends had only managed to convince him to put some enforceable clauses in his marriage contract, linking "secession" to measures of future "productivity" - children, in his case (after all, that's the only source of future productivity) - perhaps Balzac's story would have had a happier ending. Perhaps German, Dutch and Finnish leaders could distribute the book before the next Group of Eight gathering, instead of dealing with IMF intermediaries' Keynesian nonsense and mindless statistics. Then they could discuss the aforementioned clauses in the mutualized debts contracts, and debate if they have the guts to enforce them, knowing that some Club Med countries would sure raise the specter of "Occupation". Note 1. Mutualizing debt involves guarantees whereby each member state not only pays for itself but also meet the obligations of any other country unable to meet its liabilities. Reuven Brenner holds the Repap Chair at McGill University's Desautels Faculty of Management, and serves on the Board and the Investment Committee of McGill's Pension Fund. He was appointed to be one of a seven member commission dealing with consequences of the 1995 potential secession of Quebec. The article draws on his Financial Options for Countries Wanting a Divorce (1995) and his Force of Finance (2002). (Copyright 2012 Reuven Brenner)

The European Crisis

By Pepe Escobar

History will register his plane struck by lightning on the way to Berlin, no fancy kisses, and asparagus with veal schnitzel on the menu. This is the way the eurozone ends (or begins again); not with a bang, but a ... lightning strike. Merkollande - the new European power couple drama interpreted by French Socialist President Francois Hollande and German Christian Democrat Chancellor Angela Merkel - is a go.

Trillions of bytes already speculate whether former President Nicolas Sarkozy spilled the full beans about "Onshela" to Hollande - apart from the fact she fancies her glass of Bordeaux. King Sarko also had a knack for making stiff "Onshela" laugh. That may be a tall order, at least for now, for the sober and pragmatic Hollande.

The good omen may be that both do not eschew irony. In the middle of such a eurozone storm, that's a mighty redeeming quality. Then there's that lightning strike on the way to Berlin. Was it Zeus sending a message that his Greeks would have to be protected - or else? Not to mention that Europe is a Greek myth (Zeus made Europa, the beautiful daughter of a Phoenician king, his lover…)

About that German miracle

So now Merkollande has to show results. There's not much they're bound to agree on - apart from the possibility of a financial transaction tax (FTT) which could yield up to 57 billion euros (US$72.5 billion) a year to battered trans-European economies, according to the European Commission (EC).

Berlin is not exactly against it. But Britain, for obvious reasons, is - seeing it as curbing the City of London. The EC, applying some fancy models, has already concluded that a FTT would not be a burden on economic growth; that would represent only 0.2% in total by 2050.

Two members of the troika - the EC and the International Monetary Fund (but not yet the European Central Bank) - along most governments in the EU, now at least admit that some countries, such as Spain, will need more time to reduce their deficits. An FTT in this case would come out handy.

At home, "Onshela" is secure her austerity mantra is popular (61%, according to the latest polls). Yet she lost another regional election last weekend, in heavily urbanized Nordrheim-Westfalen, the fourth largest urban concentration in Europe after London, Paris and Moscow - now suffering from deindustrialization and high unemployment. And this after losing in rural Schlewig-Holstein, near the Danish border.

What's fascinating is that all this had nothing to do with Europe - and the messy fate of the eurozone with the strong possibility of Greece leaving the euro. German voters couldn't give a damn. They are first and foremost worried about their own eroding purchasing power.

So for the first time the Supreme Taliban of austerity, German Finance Minister Wolfgang Schauble, has admitted in public that a general wage freeze - one of the pillars of the new, neo-liberal "German miracle" - should be revised. Even the Financial Times has admitted that consumption in Germany is "anemic". Schauble now says that wage increases might help.

The heart of the matter is that whatever "German miracle" is good for Germany's robust banking and financial system, is not good for a vast majority of its workers. Plus this neo-liberal miracle simply can't be sold anywhere else in the world.

German weekly Der Spiegel did its best to show why [1].

The heart of the "miracle" is - predictably - the deregulation of the jobs market, always against the interests of workers. That implies a tsunami of part time jobs, "non traditional contracts" and sub-contracting. This means masses of workers not eligible for bonuses or participation in profits - coupled with a reduction in retirement payments and pensions. The graphic consequence has been Germany as the current European champion of rising inequality.

Who's in charge here?

It's wishful thinking to imagine some German politician seeing the light, Blues Brothers-style, and suddenly preaching a true European political integration. German regional politics is directly linked to the banking industry - the same banks which had a ball speculating on securities all across Europe, especially in the Club Med countries.

Blaming the eurozone abyss on the irresponsible acts of selected European nations, on their mounting public debt, and even their pensioners, is perverse. The real cause is the ferocious deregulation of the financial system and the worshipping of the God of monetarism. The absolute majority of European political leaders do not have a clue about basic economics. They have been at the mercy of technocrats who could not give a damn about the social and political consequences of their actions.

But now the technocrats are finally freaking out because if Greece, for instance, nationalizes its banks, the Spanish and French financial systems will go bust, and Germany's will be in deep trouble. Once more this is a graphic illustration of how countries across Europe are - in the public as well as the private sector - totally dependent on the financial system of other countries.

The Masters of the Universe in Europe are actually the Institute of International Finance (IIF) [2] a lobby representing the 450 largest world banks. They get a privileged seat on every significant euro-summit. The proverbial EU and IMF "officials" actually ask the Masters how much a country - as in Greece - should pay to get itself out of trouble. Europe's commissioner for economic affairs, Olli Rehn, is a certified servant of the Masters. Obviously the EU leadership will never admit it is in fact controlled by a cartel of bankers.

One currency, 17 debts

It's hard to believe Merkollande can find a way out of this financial labyrinth. We are facing the uber-surrealist situation of a single currency with 17 different public debts - over which the frenzied "markets" can merrily speculate while individual states cannot fight back, for instance by devaluing their currency. It's this set up that has plunged Greece into the abyss - and may do the same with the euro.

Thomas Piketty, a professor of the Paris School of Economics, dreams that Hollande might become the European Roosevelt. That may be as unlikely as Prometheus getting rid of his burden. But at least Piketty identifies the problem; imagine if the Fed everyday had to choose between Texas debt or Wyoming debt - it would never be able to conduct a sound monetary policy (not that it actually does…)

That explains why the European Central Bank cannot possibly be a factor of financial stability. Meanwhile, Europe is left wallowing in the mire of loaning buckets of euros to banks, hoping they will loan them back to individual states; or loaning the money to the IMF, hoping they will do the same.

Into this quagmire comes Hollande with an economic Hellfire missile; he says that instead of loaning at 1% so the banks make a killing loaning to individual states at a much higher rate, the ECB should deal directly with European nations. He wants the FTT - now. And the wants the European Investment Bank to extend credit to companies. And he wants euro-bonuses to finance infrastructure works.

"Onshela" is bound to give him a firm "nein" on all this - except, maybe, the FTT. Because this all implies that these debts are part of a common European debt. That would be, according to Hollande's vision, a conception of Europe true to its construction - less technocratic, less hostage of the God of the market, less constrained by the dogmas of the financial system. Will Merkollande pull it off? Ask "Onshela".

Note:
1. See The High Cost of Germany's Economic Success, Der Spiegel, May 4, 2012.
2. - See here

Pepe Escobar is the author of Globalistan: How the Globalized World is Dissolving into Liquid War (Nimble Books, 2007) and Red Zone Blues: a snapshot of Baghdad during the surge. His new book, just out, is Obama does Globalistan (Nimble Books, 2009).

Don't blame the ratings agencies for the eurozone turmoil

Europe and the eurozone are strangling themselves with a toxic mixture of austerity and a structurally flawed financial system

• 
• • Ha-Joon Chang
  • guardian.co.uk, Sunday 15 January 2012 21.16 GMT

Standard & Poor's has decided to downgrade France's top-notch credit rating. Photograph: Philippe Huguen/AFP/Getty Images

 

Even the most rational Europeans must now feel that Friday the 13th is an unlucky day after all. On that day last week, the Greek debt restructuring negotiation broke down, with many bondholders refusing to join the voluntary 50% "haircut" – that is, debt write-off – scheme, agreed last summer. While the negotiation may resume, this has dramatically increased the chance of disorderly Greek default.

Later in the day, Standard & Poor's, one of the big three credit ratings agencies, downgraded nine of the 17 eurozone economies. As a result, Portugal pulled off the hat-trick of getting a "junk" rating by all of the big three, while France was deprived of its coveted AAA rating. With Germany left as the only AAA-rated large economy backing the eurozone rescue fund (the Dutch economy, the second biggest AAA economy left, is much smaller than the French economy) the eurozone crisis looks that much more difficult to handle.

The eurozone countries criticise S&P, and other ratings agencies, for unjustly downgrading their economies. France is particularly upset that it was downgraded while Britain has kept its AAA status, hinting at an Anglo-American conspiracy against France. But this does not wash, as one of the big three, Fitch, is 80% owned by a French company.

Nevertheless, France has some grounds to be aggrieved, as it is doing better on many economic indicators, including budget deficit, than Britain. And given the incompetence and cynicism of the big three exposed by the 1997 Asian financial crisis and more dramatically by the 2008 global financial crisis, there are good grounds for doubting their judgments.

However, the eurozone countries need to realise that its Friday-the-13th misfortune was in no small part their own doing.

First of all, the downgrading owes a lot to the austerity-driven downward adjustments that the core eurozone countries, especially Germany, have imposed upon the periphery economies. As the ratings agencies themselves have often – albeit inconsistently – pointed out, austerity reduces economic growth, which then diminishes the growth of tax revenue, making the budget deficit problem more intractable. The resulting financial turmoil drags even the healthier economies down, which is what we have just seen.

Even the breakdown in the Greek debt negotiation is partly due to past eurozone policy action. In the euro crisis talks last autumn, France took the lead in shooting down the German proposal that the holders of sovereign debts be forced to accept haircuts in a crisis. Having thus delegitimised the very idea of compulsory debt restructuring, the eurozone countries should not be surprised that many holders of Greek government papers are refusing to join a voluntary one.

On top of that, the eurozone countries need to understand why the ratings agencies keep returning to haunt them. Last autumn's EU proposal to strengthen regulation on the ratings industry shows that the eurozone policymakers think the main problem with the ratings industry is lack of competition and transparency. However, the undue influence of the agencies owes a lot more to the very nature of the financial system that the European (and other) policymakers have let evolve in the last couple of decades.

First, over this period they have installed a financial regulatory structure that is highly dependent on the credit ratings agencies. So we measure the capital bases of financial institutions, which determine their abilities to lend, by weighting the assets they own by their respective credit ratings. We also demand that certain financial institutions (eg pension funds, insurance companies) cannot own assets with below a certain minimum credit rating. All well intentioned, but it is no big surprise that such regulatory structure makes the ratings agencies highly influential.

The Americans have actually cottoned on this problem and made the regulatory system less dependent on credit ratings in the Dodd-Frank Act, but the European regulators have failed to do the same. It is no good complaining that ratings agencies are too powerful while keeping in place all those regulations that make them so.

Most fundamentally, and this is what the Americans as well as the Europeans fail to see, the increasingly long-distance and complex nature of our financial system has increased our dependence on ratings agencies.

In the old days, few bothered to engage a credit ratings agency because they dealt with what they knew. Banks lent to companies that they knew or to local households, whose behaviours they could easily understand, even if they did not know them individually. Most people bought financial products from companies and governments of their own countries in their own currencies. However, with greater deregulation of finance, people are increasingly buying and selling financial products issued by companies and countries that they do not really understand. To make it worse, those products are often complex, composite ones created through financial engineering. As a result, we have become increasingly dependent on someone else – that is, the ratings agencies – to tell us how risky our financial actions are.

This means that, unless we simplify the system and structurally reduce the need for the ratings agencies, our dependence on them will persist – if somewhat reduced – even if we make financial regulation less dependent on credit ratings.

The eurozone, and more broadly Europe, is slowly strangling itself with a toxic mixture of austerity and a structurally flawed financial system. Without a radical rethink on the issues of budget deficit, sovereign bankruptcy and financial reform, the continent is doomed to a prolonged period of turmoil and stagnation.

• © 2012 Guardian News and Media Limited or its affiliated companies. All rights reserved.