The verdict on the G-20 meeting is in. It wasn’t delivered by the spinmeisters of the global leaders hailing their bosses’ groundbreaking accomplishments. It wasn’t delivered by the clueless journalists gravely assessing whether the summit was a win for Merkel’s message of austerity or Obama’s message of spending. The verdict was delivered by the world’s financial markets and it can best be summed up by the Edvard Munch painting: “The Scream.”
At first glance, the G-20 looked harmless. As predicted, it cost much and accomplished nothing. No decisions were taken, no minds were changed. Politicians had their pictures taken; the press hailed mushy communiques as breakthroughs and delusional protesters played silly ‘revolutionary’ games.
That would be fine under normal circumstances; wasting taxpayer money on pointless pageantry is one of the least harmful things the world’s political leaders ever do.
But this is actually one of those times when the world needs leadership. The European financial crisis, like a metastasizing cancer, is infecting new targets. It is no longer a question of sovereign debt in a handful of fringe countries. We are now looking at real threats to the financial architecture of the EU’s richest and most powerful members.
Obama and Sarkozy in Canada at the G8 meeting, before attending the recent G20 summit (White House).
With the adoption of the euro, southern European countries (and a few northern ones like Ireland) enjoyed a cheap credit bonanza. Historically, interest rates in countries like Italy, Spain and Greece reflected the belief by investors that those countries would constantly depreciate their currencies in response to high deficits and the inflationary bias of their policy makers. When those countries entered the euro, interest rates fell to near-German levels as currency and inflation risk disappeared overnight. Those low interest rates inflated two bubbles. In the public sector, countries with low borrowing costs started handing out cash to government workers and other well connected interest groups, pumping up economic demand overall and increasing the national debt. In the private sector, countries like Spain saw huge real estate bubbles develop as home buyers rushed to take advantage of cheap mortgages — and developers enjoyed cheap financing as well.
Central banks are supposed to be the chaperons at parties like this, locking up the liquor cabinet when the guests start getting too happy, but the European Central Bank wasn’t paying attention. That wasn’t a mistake; it was on purpose. The ECB is supposed to think about the European economy as a whole, so it was watching economic conditions in the biggest economies like Germany and France. The ECB sat in the living room, watching Mom and Dad stay sober even while the kids were whooping it up in the basement. Mom and Dad were pretty well behaved so the bankers left the punch bowl alone — but things got a little out of hand down below and now the whole house is on fire.
As the Europeans scramble to deal with the problem, they’ve tried three things. First, they tried to build a firewall to stop the crisis from spreading, opening up the liquidity pumps at the central bank and putting together a fund to stabilize Greece’s short term financial situation and reassure investors worried about Spain and Italy. Second, they canceled the kids’ credit cards — Spain and Greece have both passed strict austerity programs to bring their deficits down over the next few years. Third, they have started one of those complex, multi-stage European talking processes aimed at economic reforms to make labor markets more flexible plus the creation of new fiscal rules and procedures to provide the kind of unified economic governance that Europe needs to operate a single currency zone.
The trouble is that none of these steps seems to be working very well. More and more investors believe that Greece will never be able to repay its debts and that sooner or later it will have to go through the international equivalence of bankruptcy proceedings. This also means that the Greek banking system, which holds many Greek government bonds, is probably also insolvent. If it isn’t already, it certainly will be by the time the Greek economy goes through a massive contraction as the government austerity bites — and the Greek government then declares that it cannot pay its debts in full.
This isn’t just a Greek problem. German and French banks don’t just own a lot of Greek government debt; they have complicated relationships with the Greek banks and private sector as well. Much of this debt may turn out to be worthless, and perhaps almost all of it is going to have to be written down. Throwing in the problems of the Spanish banking system (and Spain’s credit problems result more from the housing bubble than from the public sector deficits), makes the problem worse. It’s possible that some of the major European banks (especially the badly managed, politically connected Landesbanks in Germany) are also insolvent. Reflecting these concerns, lending between banks in Europe has seized up; if the ECB stopped providing loans to banks unable to finance themselves elsewhere, a full blown financial crisis would take the European economies down overnight.
Meanwhile the political signals are flashing red. A recent poll in Germany showed that 51 percent of Germans want to ditch the euro and go back to the deutsche mark. It is very hard to see Germany paying billions and billions more euros on into the indefinite future to keep an unpopular currency alive. Meanwhile Germany and France, the two countries on whose close and strategic cooperation the entire EU system depends, have opposite views about how the current crisis should be addressed. The French think the Germans should pay through the nose to keep the euro going while increasing the German government deficit to bolster the European economy. The Germans think the French should shut up.
Both sides have a point. The French are right that Germany has benefited hugely from the euro. Those Greeks, Spaniards and Italians who were wildly overspending were spending a lot of their money on German goods. Under the old system, the franc, peseta, lira and drachma kept losing value against the deutsche mark; that limited Germany’s ability to sell products in the EU market. From this point of view, the cost of bailing out the weak euro economies is the cost of keeping Germany’s export markets in good shape — and, at the same time, the bailouts of weak European governments and banking systems are chiefly bailing out Germany’s own banks.
On the other hand, from a German point of view it now seems clear that no matter what rules are agreed, the Mediterranean countries won’t keep them. The Greeks systematically lied and cheated their way into the euro and continued to lie and cheat and steal until the books could no longer be cooked. “Fool me once, shame on you” say German taxpayers. “Fool me twice, shame on me.” A monetary union doesn’t just need rules of the road; it needs some basic consensus about values and methods. Lacking these, the euro area must sooner or later break down, many Germans feel. Why not let it break down before spending billions and billions in a doomed effort to save it? German politicians cannot avoid dealing with this popular feeling; this is a pocketbook question of vital interest to everyone in the country. The loss of export markets in Greece and even Spain is a small matter compared to the value of your money in the bank.
In my lifetime the Europeans have solved or at least fudged many intractable problems. Given the enormous stakes and the tremendous talent of European financiers and banking authorities, I would not advise underestimating the chances that they will figure out some ingenious way to manage the current crisis. But they have been trying and failing to manage their euro crisis since last December and in many respects things have only gotten worse.
If this were just Europe’s problem, the rest of the world could commiserate or gloat depending on its state of mind. But economically speaking, we live in adjoining row houses. The fire in Europe’s basement will burn us all out of house and home if it isn’t put out. Without a healthy European economy it is hard to see the world returning to an era of stable growth anytime soon. President Obama’s plan to double US exports has always been a long shot and one suspects that the White House now wishes that a target this ambitious and this public had never been set. A prolonged slowdown in Europe puts that goal totally out of reach and could even derail the US economic recovery — if the latest fall in consumer confidence doesn’t accomplish that on its own. A full blown European banking crisis would almost certainly plunge us back into the deepest depths of recession.
China must also worry about Europe. The EU is the largest consumer market in the world, and Chinese exports to the EU are now larger than its exports to the US. Slow growth or recession in Europe will create more problems for a Chinese leadership already struggling to cope with labor unrest and housing bubbles. Throw in the effects of a European crisis on Japan and the rest of Asia, and it is clear that the world’s economic leaders have plenty to think about — and they need to act fast.
Acting fast was exactly what the world’s leaders did not do in Toronto. The stately, pointless procession of photo ops and staged conversations sent out a strong signal that the world’s leaders take after the old Mad magazine mascot Alfred E. Newman: “What, Me Worry?” was the motto du jour in Toronto.
Pointless posturing is all very well in normal times. But these times aren’t normal and the world’s leaders don’t seem to have grasped that. This was the message from Toronto and it is hard to think of anything more alarming.