Trends by Martin Khor
Monday 21 May 2012
in Europe affects all of us
economic crisis in Europe is deepening and may get worse, with worrisome
effects on the rest of the world.
economic situation in Europe has worsened considerably in the past
week, giving rise to a very worrisome situation. The ramifications
of a full-blown crisis are serious not only for Europe but also the
rest of the world.
The recent Greek elections saw the citizens proclaiming their anger
towards the austerity policies tied to the European-IMF bail-out package,
by repudiating the two major parties and giving the small anti-austerity
Syriza party second place.
The elections came in the midst of a greatly deteriorating condition.
Greece has 22% unemployment, 50% youth unemployment, GNP is falling
steeply, and public debt will remain high at 160% of GDP next year
despite the recent bailout and debt-restructuring measures.
The leader of Syriza, Alexis Tsipras, who swept to the forefront of
Greek politics on the wind of protest against the austerity measures
imposed by creditors, wants to re-negotiate the terms of the bailout.
He thinks his insistence on this will eventually force the creditors
to change the terms, with Greece remaining in the Eurozone.
But many analysts think that the response to this demand from the
EU and IMF would be to stop further loans and force Greece to exit
the euro. In a second election in mid-June, Syriza is expected to
do even better and a messy Greek loan default and euro exit are now
seen as more than just possible.
In a Eurozone exit, Greece would re-introduce a local currency, and
after Greeks change from their euros, a depreciation of the new currency
is expected to happen. News report indicate that some capital flight
from Greece is already taking place, as Greeks fear that their present
euro-denominated assets would lose value after conversion to the local
A continuation or worsening of capital flight would of course compound
the cash-strapped Greek crisis, which could accelerate at speed in
a few weeks. If so, a disaster may happen even before the second
Meanwhile, Spain was last week desperately trying to avoid a run on
banks after the government was forced to partly nationalise Bankia,
the second largest bank, followed by rumours of such a run. The value
of bad loans held by the banking sector rose one third in the past
year to 148 billion euro and Moody’s downgraded the credit rating
of many Spanish banks.
Friday, government denial of a bank run and reassurances on bank safety
reversed the one-day 30% plunge on Bankia shares, but this could be
a brief respite. Spanish and Italian government bond yields have
risen sharply, indicating the governments will have to pay higher
interest on future loans, and they are near the threshold level (around
6-plus per cent) that is considered unsustainable (for repayment).
The Spanish finance minister Luis de Guindos said the battle for the
euro is going to be waged in Spain, implying his country is now in
front in trying to prevent the Greek crisis from infecting other European
countries and bringing down the euro.
The spreading crisis throws into doubt the policies in most European
countries that have in recent years focused on drastically cutting
government spending to reduce the budget deficit in an attempt to
pacify investors and enable a continued flow of loans.
This reversed the coordinated policy of fiscal reflation that the
G20 leaders agreed on in 2009 to counter the global crisis. It contributed
to the rapid recovery.|
Since then economists and politicians alike have been debating the
merits of Keynesian reflationary policies versus a resumption of IMF-type
The movement towards recession in Europe as a whole and deep falls
in GNP in bail-out countries like Greece has boosted the arguments
of the Keynesians. But key leaders such as Angela Merkel of Germany
and David Cameron of the United Kingdom are still convinced of the
need to stick to austerity.
The victory of the new French President Francois Hollande and the
stunning polls performance of the Syriza party in Greece indicate
that the public wind has shifted radically against austerity, and
that a change may be on the cards.
However, has this come too late to avert a full-blown crisis? A Greek
exit from the euro risks creating a Eurozone upheaval which in turn
would cause a global crisis, according to Martin Wolf’s article in
the Financial Times of 18 May.
The stopping of loans to Greece would lead to an economic collapse,
with government debt default, bank runs, re-denomination of local
contracts to local currency and default on external contracts denominated
in euro, in a scenario painted by Wolf.
A Greek exit could trigger bank runs and capital flight in Portugal,
Ireland, Italy and Spain and beyond, causing collapse in asset prices
and large GNP falls. A decisive European response is needed, such
as the European Central Bank providing unlimited loans to replace
money taken out in bank runs, capping of interest rates on sovereign
debt, Eurobonds and abandoning austerity-centred policies.
But if these policies are not taken, the Eurozone may disintegrate,
with one study suggesting GNP falls on 7 to 13 per cent in various
countries, and if a full Eurozone
up takes place there could be a freeze in the financial system, a
collapse in spending and trade, many lawsuits and Europe facing a
situation of political limbo.
The impact on the world would be worse than the Lehman collapse.
Though the implication is that this should not be allowed, a Greek
exit would greatly increase the likelihood of these dangers.
If Greece leaves, the Eurozone will have to change fundamentally but
if that is impossible, large crises will be repeated in a nightmare.
There would have to be a choice between a stronger union of European
countries (which many do not like) or endless crises in future, or
a break-up now. No good choices exist, concludes Wolf.
The scenarios and predictions detailed above in the Wolf article are
pessimistic, but may also be realistic not only because of the current
economic situation, but also the apparent lack of conditions for a
Watching from the side-lines, with no ability to influence developments,
many in the developing countries are disturbed by the turn of events.
It will likely lead to a weakening of the global economy at best and
a full blown crisis at worst, with the developing countries at the
receiving end in terms of trade downturn, financial reverberations,
and declining incomes and jobs.
It is apparent, once again, that a global forum should exist where
all countries can discuss developments in the global economy and contribute
their views on what needs to be done. In the inter-connected world,
policies and events in one part (especially in the core countries)
affect all others.