Weekend Economists Merry Little Christmas December 23-26, 2011

[Demeter]

9. Dean Baker: The eurozone crisis is not about market discipline

http://www.aljazeera.com/indepth/opinion/2011/12/2011121874651469307.html

The crisis should be recognised for what it really is: a class war waged on workers in Europe. The people who gave us the eurozone crisis are working around the clock to redefine it in order to profit politically. Their editorials - run as news stories in media outlets everywhere - claim that the euro crisis is a story of profligate governments being reined in by the bond market. This is what is known in economics as a "lie". The eurozone crisis is most definitely not a story of countries with out of control spending getting their comeuppance in the bond market. Prior to the economic collapse in 2008, the only country that had a serious deficit problem was Greece. In the other countries now having trouble financing their debt, the debt to GDP ratio was stable or falling prior: Spain and Ireland were actually running budget surpluses and had debt to GDP ratios that were among the lowest in the OECD...The crisis changed everything. It threw the whole continent into severe recession. This had the effect of causing deficits to explode since tax revenues plummet when the economy contracts and payments for unemployment benefits and other transfer programmes soar. Spain was hit especially hard by this contraction because it had a huge housing bubble. This bubble fuelled an enormous construction boom that went bust after the crash...Ireland saw its debt explode because it got stuck with a huge bill from bailing out its free-wheeling bankers. It is possible that its financial system could have been kept intact at a lower cost to taxpayers by forcing creditors to take losses.

............................................

The story here is of the incredible failure of the European Central Bank (ECB) to take any steps to rein in the housing bubbles across Europe before they grew so large that their inevitable collapse would lead to economic wreckage across the continent. This failure might make a good argument for punishing the ECB (maybe the pensions of their senior staff should be slashed), but this is absolutely not a story of government profligacy...Even after the collapse, the ECB has exacerbated the debt problem with its wrong-headed policies. The ECB could end the debt crisis at any time by acting as a lender of last resort, as central banks are supposed to do in a crisis. This would mean making a commitment to guarantee the bonds of the heavily indebted countries. That would immediately end the runs that Spain and Italy and now other countries are seeing on their debt. Expecting positive actions from the ECB to end the crisis might be asking too much from this institution, but at least it should not be taking measures that actively make the crisis worse. For example, in the spring, it raised its overnight lending rate from 1 to 1.5 per cent, ostensibly to counter concerns about inflation.

While the US Federal Reserve has kept the overnight lending rate at zero since the early days of the crisis, the ECB has never allowed the rate to go below 1 per cent. To lower long-term interest rates, the Fed has bought up close to $3tn worth of government bonds. The ECB bond purchases have been an order of magnitude lower. The dampening impact of the ECB's policies on growth worsens the debt situation of governments across Europe....Furthermore, the ECB's commitment to capping eurozone inflation at 2 per cent makes it almost impossible for the southern European countries to regain competitiveness. They would have to see years of deflation for their economies to again be able to compete with Germany and other northern European countries.

Again, the crisis of Italy, Spain and other heavily indebted countries is absolutely not a story of the market disciplining profligate countries; it is a story of countries victimised by the mismanagement of the ECB. To claim that it is just a case of the bond market exerting its discipline would be like saying that a sailor who died of thirst and starvation after pirates tore up his sail, smashed his motor and stole his lifeboat was just a victim of the sea. It is only because the ECB pirates have wrecked these nations' economies that they are now so vulnerable to the vicissitudes of the bond market. People should recognise this process for what it is: class war. The wealthy are using their control of the ECB to dismantle welfare state protections that enjoy enormous public support. This applies not only to government programs like public pensions and healthcare, but also to labour market regulations that protect workers against dismissal without cause. And of course, the longstanding foes of Social Security and Medicare in the US are anxious to twist the facts to use the eurozone crisis to help their class war agenda here. The claim that the countries in Europe are just coming to grips with the reality of modern financial markets is covering up for the class war being waged on workers across the globe. The assertion that this crisis is about market discipline should not appear in a serious newspaper, except on the right side of the opinion page.

Dean Baker is co-director of the Centre for Economic and Policy Research, based in Washington DC. He is the author of several books, including Plunder & Blunder: The Rise and Fall of the Bubble Economy, The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich, Get Richer, The United States Since 1980 and The End of Loser Liberalism: Making Markets Progressive.