2011-09-24 Eurozone endgame: all that is solid melts into air

With Greece on the verge of default, Italy sucked into the storm, and French banks drawing ever closer to collapse, the euro has finally reached its endgame.

All that is solid melts into air. What we are experiencing at present will define our era for centuries to come. Precisely twenty years after the final collapse of the Soviet Union and the demise of state communism, we are now approaching the endgame for the European Union and the potential demise of European capitalism. The train of economic integration has come grinding to a halt. These are tectonic shifts in world history. But our leaders seem largely oblivious to it.

In many ways, this year has already made its mark upon history: 2011 is the year of revolution, war and crisis; of terror, truth and disaster; of revenge, revolts and riots. But, as we predicted in an article back in December 2010, it might yet be remembered as the year of collapse. None of the underlying causes of the enduring global financial crisis have been addressed. Indeed, the chosen policy response — draconian austerity measures — has only made matters worse.

Tales of Financial Armageddon

And so we find ourselves reading the news, day after day, with the headlines only becoming grimmer. “Greece Nears the Precipice, Raising Fear“, “Italy downgrade adds to eurozone contagion fears“, “The Euro Endgame“, “Eurozone: A nightmare scenario“, ”Global economy: it could be autumn 2008 all over again — but worse“. These are just some indications from the past couple of days, but it’s been going on like this for over a month now.

Amidst these tales of economic Armageddon, it is sometimes hard to dissect the broader dynamics. Some analysts claim we are seeing financial contagion writ large. But this is a bad analogy. Contagion implies the infection of a healthy host, while the European single market was fundamentally unhealthy to begin with. Indeed, neoliberal Europe was sitting on a time bomb of its own making all along. This is not contagion — it’s the unfolding of the inevitable.

The Inevitable Greek Default

We’ve pointed it out many times before (here, here, here and here, for example): a Greek default was inevitable from the very start. With public debt at 142.8 percent of GDP (in 2010), and the economy rapidly contracting as a result of brutal budget cuts, the idea that Greece could ever pay off its debts was always akin to a bad case of political psychosis. As Simon Jenkins of the Guardian mildly puts it, “The unthinkable may [now] be unavoidable. The priests are suddenly talking of “when, not if,” Greece defaults.”

It might happen as early as mid-October, when the Greek government is projected to run out of money. European leaders are withholding an 8 billion euro tranche of the 2010 bailout until the first week of October, citing unhappiness about the “speed of reforms”. The crucial change, however, is that a number of leading German politicians, including the Vice-Chancellor, appear to have embraced a Greek default, which some experts now believe is only weeks or months away.

The Inevitable Italian Sequel

Where the Greeks go, the Romans follow. This August, Italy got sucked into the heart of the European financial storm. As markets observed Europe’s failure to deal decisively with the Greek crisis, attention turned to Italy’s anemic growth and 120 percent public debt/GDP ratio. Standard & Poor’s just downgraded Italy’s credit rating, pushing yields back towards the 6 percent “this-means-trouble” mark, and weighing heavily on the country’s own banks.

Two weeks ago, a humiliated Berlusconi managed to push a series of ECB-imposed austerity measures through Parliament by the narrowest of margins. But if the Greek experience is anything to go by, austerity in Italy is bound to be just as counterproductive. The scary part is that, “except for German bonds, Italian debt is more widely held by European banks than any other government obligation. A default there could devastate Europe’s financial system.”

The Overleveraged Central Bank

So Italy is too large to fail — but it is also too large to bail. Which is why the European Central Bank was called upon to do the firefighting: this August, it swooped into secondary markets to start aggressively buying up Italian and Spanish bonds, both to suppress the borrowing costs for these two crucial dominoes and to clear the “toxic assets” off the balance sheets of European banks. The Keynesians now call for a more activist ECB to help solve the crisis.

But, as David Harvey rightly observed, capitalism never really solves its own crises; it merely moves them around in space and time. In truth, the ECB never put out any fires; it just moved the burning piles of peripheral debt into its own vaults, buying a few more ticks on the time bomb. But in the process, the ECB has become acutely exposed, making it extremely vulnerable to a cascading series of sovereign defaults. The ECB itself could now be tipped into insolvency.

The Run on European Banks

But, however embarrassing an ECB bankruptcy would be for Europe’s neoliberal elite, the gravest threat to the real economy is still the private banking system. Unlike U.S. banks, European banks never really re-capitalized in the wake of the 2008 collapse. Instead, they remained severely overleveraged and overexposed to peripheral debt. Realizing this, American banks simply froze their credit lines to their eurozone counterparts: an “institutional run on the banks.”

As a result, it has become impossible for European banks to obtain dollars. Again, central banks had to jump to the rescue, pumping dollars into the system. But this also failed to restore confidence. Spanish banks remain a total mess, and in the past three months, French banks, which are most acutely exposed to Greek debt, lost over half their stock value. No wonder IMF Chief and former French finance minister Lagarde urges Europe to bail out its banks again.

The Unfolding of the Inevitable

So what we are witnessing is not contagion, but the unfolding of the inevitable: the coming undone of an unsustainable Ponzi scheme of bad loans made to countries that simply weren’t competitive enough to grow their way out of debt. It is essentially a mirror image of the U.S. subprime mortgage crisis at the national level: with too much liquidity flushing around the system, the banks got carried away and started making ever riskier investments.

For a while, everyone seemed to benefit: the Greek people could live like real Europeans; their politicians could keep a restless population at bay; and the French and German banks could jot down fat profit margins. But just like the U.S. housing boom, all this prosperity was an illusion grounded in fictitious capital. At some point, somewhere, someone was going to prick that bubble. It turned out to be Greece. But the day of reckoning was forever a-comin’.

The Collapse of the Eurozone

Now, the response of our leaders hasn’t been particularly useful, to put it mildly. Beholden to a nationalist popular underbelly, a flawed free-market ideology, and a Germanic obsession with budgetary “rules”, Europe has quite literally driven Greece out of the euro. A year ago, a managed default and a sizable injection of productive investment could have allowed Greece to return to growth and pay off at least part of its debts, while looking after the needs of its people.

But today, after a year of disastrous austerity, the Greek economy is contracting faster than it could ever hope to grow — 7.3 percent last quarter. By now, the only way back to growth is by restoring competitiveness through exchange rate devaluation. That would mean an exit from the euro. But when Greece leaves, investors will panic and flee from the other peripheral economies too. A self-fulfilling prophecy could then see the entire South pushed towards the exit.

The Next Global Financial Crisis

Now that’s where it gets really serious. As Barry Eichengreen — the soft-spoken Berkeley economist, and a leading expert on the Great Depression — once wrote, a break-up of the eurozone would unleash the “mother of all financial crises“. Because the external debt of the seceding countries would still be denominated in euros, a euro exit and the consequent devaluation would make their real debt skyrocket — making a full-on disorderly default inevitable.

This, in turn, will make these country’s banking sectors collapse, requiring mass nationalization. If it’s just Greece that goes, the French and German banks might hold up with a minor bailout. But if Italy falls, which is not unlikely, many large European banks will be forced into bankruptcy, followed by instantaneous cascading failures in the U.S. The problem is that we have already spent most of our fiscal ammunition on the 2008-’09 bailouts and stimulus packages.

The Next Great Depression

But given the close ties between global finance and national governments, our leaders are unlikely to allow the banks to fail. Taking into account the precarious state of our public finances, their only option will be to put on the digital printing presses and start spewing out more artificial cash to pump into the system. In other words, we might go into inflation — and we all know what that means: unaffordable consumer products for everyone but the rich.

At the same time, the cost of bailing out the banks again will be reflected in further austerity measures, which in turn will further dampen demand. The IMF is now warning of another impending global recession. But by the time the global banking crisis hits, this recession risks becoming a depression. As credit dries up, demand will grind to a complete halt. If China doesn’t step up as a lender and consumer of last resort, history might very well repeat itself.

The Anatomy of Capitalist Collapse

And so we find ourselves in an extremely precarious situation. We stand on the eve of what could potentially become the most disastrous banking crisis in living memory — much worse than the near-collapse of the global economy in 2008, when the world was just 48 hours away from ATMs running out of money. Even mainstream economists now warn of another Great Depression — or worse. And remember that we did not emerge from the last one until we mobilized for war.

Whatever the future may hold, even right-wing, free-market publications like Forbes, Business Insider, the Financial Times, the Wall Street Journal, and the Harvard Business Review now admit it: Karl Marx might actually have been right about capitalism’s tendency to self-destruct. After all, it was Marx who first observed that the internal contradictions of the system, barring a number of countervailing factors, were simply unsustainable in the long run.

All That Is Solid Melts Into Air

It was also Marx, who, following the capitalist crisis of 1846-’47, and in the midst of the revolutionary wave sweeping across Europe in 1848, so presciently observed that “everything solid melts into air, all that is holy is profaned, and man is at last compelled to face with sober senses, his real conditions of life, and his relations with his kind.” As the global Ponzi scheme of fictitious finance capital comes undone, the real conditions of life are revealed at last.

While the soothing consumerist lifeline of cheap credit dries up, the real relations with our kind (in the form of stagnant wages, rapidly escalating inequality, regressive taxation and brutal austerity) will be brought back to the surface. What we are experiencing is not really a crisis — it is merely the crystallization of the system’s naked essence into a highly tangible reflection of its previously invisible self. The real exception is not today’s human suffering; the exception was the past twenty years of fake prosperity.

It Will End Where It Once Began

And so, what once seemed solid — our jobs, our homes, our studies, our pensions, our simple day-to-day existence in this world — will melt into thin air. At last, we might be faced with the realization that our democratic rights and economic well-being are nothing but privileges in the hands of the powerful, traded in the marketplace like commodities, discarded upon convenience. When that day arrives, violent confrontation will simply become inevitable.

So mark these words: it will end where it once began. In Athens. I hope I’m wrong. Because it certainly won’t be pretty.