As the Greek financial system lurches from one brink of collapse to the next, it’s worth trying to identify what we know about the current state of the Atlantic financial crisis that broke in 2008. In summary, I think it is this: the present approaches to dealing with debt will fail until the banks take losses as well. And that needs financial and social innovation.
So, to summarise what we probably know so far:
- The crisis is a long way from over; we may not even be at the beginning of the end. As I have written elsewhere, with Hardin Tibbs, there are deep structural reasons for believing that the crisis has some way to go yet. These are exacerbated because most of the ‘solutions’ have so far avoided addressing the power and interests of the banking classes, which are a core part of the problem.
- So far responses to the crisis have – broadly – been to play a a version of ‘pass the parcel’ with debt, rolling it on to someone else at each point. But – as we have seen in Greece and Spain – each time the parcel moves on, it lands somewhere where the resistance to its effects is greater than it was previously. It becomes more political, and more politicised, each time it goes round the room.
- This is a crisis of representation as much as economics and finance. Ruling parties have repeatedly been punished for their association with austerity proposals and policies, but the beneficiaries so far have been parties who would have done much the same thing if they had been in power, but just happenend to be out of office at the right time. Nonetheless, a whole generation of politicians have wrecked their credibility by being too close to finance. A new generation has not yet come through who are not so tainted.
Constrained policy options
Because of the stranglehold that the banks still have on public policy, the policy options tend to be constrained quite tightly. It is either more cuts, cuts plus some loans, or printing money and keeping your fingers crossed. The cuts option tends not to reduce the level of debt, as the UK has discovered, because it reduces the overall level of activity in the economy; the loans option simply loads under-performing economies with interest payments they can’t afford; the printing money (QE) option seems to reflate the balance sheets of the banks while having a minimal impact on the rest of the economy.
In a recent article in the New York Review of Books Paul Krugman and Robin Wells observe that the recent bailouts in Europe have followed the same pattern as those in Latin America in the early 1980s.
The program for Latin America in the 1980s bore a strong family resemblance to what is happening to Europe’s peripheral economies now. Large official loans were provided to debtor nations, not to help them recover economically, but to help them repay their private-sector creditors. In effect, it looked like a country bailout, but it was really an indirect bank bailout.
One of the results, so far, has been a continuing growth in top incomes and an increase in inequality, as Forbes has documented.
Creating ‘Generation U’
But the problem with all of this is that it has consequences. Trends bend. Debt-laden economies create fear, both of high levels of personal debt and of unemployment. One of the surest ways of creating political instability is to create a generation of unemployed young people, and we’re seeing this so-called “Generation U” across Europe and the United States. As Krugman and Wells say,
All the evidence suggests that the United States is on track to spending the better part of a decade experiencing high unemployment and sub-par growth blighting millions of lives—particularly the old, the young, and the economically vulnerable. Yet even now we don’t seem to have learned the lesson that unregulated greed, especially in the financial sector, is destructive.
Cuts have other costs as well. Since they typically go hand in hand with asset sales, they also tend to enclose commons and sell off public resources. Of course, these are exactly the resources which are needed to mitigate the effects of austerity measures, and asset sales tend to inflame public opinion and galvanise activists.
Dancing towards defaults
There are alternatives, although they are messy, precisely because they require the banks to take their share of the losses which they have imposed on us through the financial crisis. So the banks are going to have to be pushed. After all, if you are a banker, you might as well keep dancing for as long as the DJ is showering you with money. Politicians, however, do have some incentives to change course: if they keep pushing the people to take losses on behalf of the banks (no matter how this is dressed up), they risk their own political oblivion.(Just ask Fianna Fail).
Defaulting on debt does involve economic pain in the short-to-medium term, as we know from Argentina’s experience, and pushes up interest rates for a generation. It cuts off access to international bond markets. But it also gets the monkey of the international financial establishment off your back. It has the merit of breaking the cycle of cuts and privatisations which are the preferred solution of the IMF. But it is an unsystemic response to a systemic problem. A ‘debt jubilee’ would work better, in which creditors and debtors cancel mutual obligations, taking debt out of the whole system.
Building a debt jubilee
As it happens, a relatively large proportion of Europe’s debt is held between the different states, as research (opens pdf) by the ESCP Europe Business School has demonstrated. A debt jubilee – cancelling out these mutually held debts – would reduce European debt levels from 41% of GDP to 15%, shifting it from a recurring crisis to a modest economic problem. The banks would take losses, which would be politically popular with almost everyone, although bankers and their fellow travellers in the credit rating agencies would complain. The benefits, though, would far outweigh the losses.
If this seems too radical, there are some simpler options which are still an improvement on where we are today.
The first is that if governments are going to print money, they should link it directly to socially useful investment, for example in sustainable infrastructure (opens pdf), that means the benefits are more widely distributed, and also help to build skills in new so-called “green-collar” jobs.
Beyond the Euro (or the dollar)
The second is that large scale single currency areas such as the Euro (or the US dollar) work better when there are local currencies as well. Otherwise all economic disparities within them end up being managed by a combination of migration and shifts in relative wages. In the US, this works because Americans are astonishingly willing to move for work, and because they speak a common language and have a shared system of educational qualifications. None of this is true in Europe, and it’s also the case that the Euro has real value only for “tradeable” goods and services – those which are imported or exported across national boundaries.
Digital technology means that it is increasingly easy to manage multiple currencies and the return of national currencies (and the introduction of regional or local ones) alongside the Euro would make it possible for economies within the Eurozone (or even within the UK’s sterling area) to adjust to changes in relative economic performance.
The alternative is to continue to pursue policies which are plainly not working – while watching our political systems stretching to breaking point.
The picture at the top of this post was found at EconomicsNewspaper.com and is used with thanks.