EDITORIAL: by Peter WestmoreNews Weekly
Europe's financial crisis: is there a way out?
, July 7, 2012
The formation of a new government in Greece committed to remaining in the eurozone was welcomed by people on both sides of the Atlantic; but the European financial crisis remains unresolved, due to the probable insolvency of both governments and many European banks.
The crisis has a number of different causes. The most obvious is that government debt in a number of eurozone countries is unsustainable, that is, it cannot be repaid by the governments which borrowed it.
Using 2011 figures, Greece leads the field here, with public debt at 165 per cent of GDP, followed by Italy, Ireland and Portugal, all above 100 per cent.
There are a number of other causes. After the global financial crisis of 2007/08, there was a financial crisis in banks across Europe, many of which were technically insolvent after the collapse of the stock markets and the property booms in many countries, including the United States, Britain and the countries of the eurozone.
To avert a financial meltdown, governments in many countries, including Australia, guaranteed deposits and, ultimately, the solvency of the private banks.
Ireland’s public debt is largely due to a government bail-out of private banks which went bankrupt due to the collapse of the Irish property bubble.
Government debt is owed to local banks, international banks and the European Central Bank. Where governments are unable to repay their debts on time, there is a sovereign default which can lead to an Argentina-style financial meltdown, or international intervention to rescue the insolvent government.
Sovereign defaults have already occurred in Europe, with the bailouts of Iceland (2008), Ireland (2010), Greece and Portugal (2011), and Spain (2012), while Italy is considered a likely future candidate.
Invariably, the trade-off for every multi-billion dollar rescue package is an internationally-imposed austerity program, designed to cut spending to bring a country’s economy back into the black. Typically, these involve cuts in public sector employment, pensions and other services, the sale of public utilities such as ports, electricity generating capacity and telecommunications, and other public assets.
The problem is that this solution exacerbates unemployment, reducing a country’s productive capacity and making more people dependent on government welfare.
As lenders suspect that governments are unable to service their debts, the interest rate on government bonds rises, pushing up the cost of debt-servicing, and encouraging bond-holders to off-load them and invest in more secure currencies.
Rising borrowing costs also put at risk the banks which lent money in the first place, and increase the risk of a credit-rating downgrade, deepening the financial crisis by increasing further the cost of borrowing.
All these factors have been at work in the troubled countries of the eurozone, and have prompted an almost unspoken run on the banks, particularly in Greece, where the political uncertainty of whether Greece will remain in the eurozone has led to billions of euros of savings being withdrawn from Greek banks, and deposited overseas, often in Swiss bank accounts. Significantly, deposits held with the Swiss National Bank rose significantly in the weeks before the latest Greek election.
The loss of money aggravates the crisis of confidence, making the situation even worse.
In addition to the European Central Bank (ECB)’s direct intervention to support the European banking system and the stronger economies in Europe, including Germany and France, the European Union has put in place a series of emergency measures to try to contain the contagion.
So far, these efforts have averted a complete collapse, but have failed to restore confidence in the eurozone or prevent further financial crises.
In 2010, the EU states agreed to establish the European Financial Stability Facility, which has been instrumental in setting up a financial safety net for troubled economies in the eurozone of €750 billion, a third of which comes from the International Monetary Fund (IMF).
This facility is designed to run until 2013; but in its place the Europeans have established the European Stability Mechanism, which will guarantee up to €500 billion to act as a firewall, to prevent a financial crisis in one country becoming a contagion across the region. Additionally, the IMF has committed hundreds of billions of dollars to prop up governments and banks in the eurozone.
What is uncertain is whether this money is sufficient to maintain financial stability, let alone provide the foundation for economic recovery which must be based on restoring confidence within Europe’s battered financial system.
Any real solution will depend on rebuilding a productive economy based on increasing the output of goods and services, not financial speculation which got the world into the present impasse.
Peter Westmore is national president of the National Civic Council.