You didn’t really think the global financial crisis was over, did you? While no one officially declared victory, it has become commonplace, in Australia at least, to talk of the GFC as an episode passed. But, unfortunately, the GFC is one case where the parrot really isn’t dead, just sleeping – and a rather troubled slumber at that, which threatens at any moment to give way to much squawking and flapping of wings.
Governments around the world have had some success soaking up the bad debts of greedy banks and pump-priming their economies with stimulus spending, thereby averting the onset of another Great Depression. But in doing so, the debt problem has simply passed from private to public hands. And as governments bow to pressure to slash spending to restore damaged balance sheets, economic growth in the US and Europe remains anaemic, at best, with jobless rates hovering near double digits in many countries.
Fears over the future of debt-laden nations intensified this week. Ratings agency Moody’s warned it would downgrade the US’s AAA credit rating if Congress does not pass legislation to increase its already indecent $US14.3 trillion ($13.4 trillion) debt ceiling. That the opinions of credit ratings agencies such as Moody’s – who helped cause the GFC by assigning their vaunted AAA credit ratings to junk assets – continue to hold sway is only further evidence of how much further financial markets have to go before emerging from their current mess.
Across the pond, the rip tide of the global recession has revealed the extent to which a handful of Mediterranean nations (plus the pasty-skinned Irish) spent the past decade swimming naked and pissing in the pool of good budget and economic management. The Greeks lied about their debts. Portugal, Spain, Ireland and now Italy – the world’s seventh biggest economy – have also been exposed for various degrees of lazy budgeting and failure to pursue economic reforms to drive anything but the most sluggish of economic growth.
What spooks investors most about Italy is not whether it is too big to fail – it is – but whether, as home to the second biggest public debt in the European Union, it is too big to save. But despite this week’s jitters, the budget position in Rome is recoverable. While its stock of public debt is large, its yearly budget deficits are more modest than most, and are forecast to return to surplus in 2014. If anything, market tremors have fired the warning shot the Prime Minister, Silvio Berlusconi, and his coalition partners needed to push ahead with planned austerity measures.
As for the US, it must be hoped that legislators there realise the potential fallout from failure to increase the debt ceiling is simply too big to ignore.
The Greeks are a different story. No one seriously believes the Greeks have any near-term, or even medium-term, prospect of paying their bills without help. Despite this, European leaders have pushed ahead with two separate bailout packages to stave off a messy default by the Greek government on its debts to foreign banks, mostly French and German. For 20 months now, European leaders have forced an increasingly downtrodden and violent Greek nation to accept euro loans so it can continue to finance existing debts. The hope is to keep Greece on oxygen until 2013 when a new bailout fund, the European Financial Stability Facility, comes online.
But, increasingly, analysts think it is only a matter of time before the Greek government defaults on its debts. Austerity and spending cuts can get you only so far. By sucking demand out of the economy, such cuts, while cutting the deficit in the short term, will cripple any hopes of a recovery fast enough to achieve the revenue growth needed to get on top of debt payments.
The worst-case scenario, of course, is if Greece unexpectedly falls short on its regular repayments, defaults and sparks a seizure of the entire global credit system on fears other countries could do the same. Alternatively, a decision by Greece or any other member nation to abandon the European Union and break with the single currency could also set off waves of instability.
European leaders will hold an emergency summit tonight to advance efforts to avoid such outcomes. While many leaders favour continued bailouts, markets are hoping for a plan that recognises the failure of the current approach. One way forward would be a negotiated agreement with private creditors – largely French and German banks – for an orderly write-down of some Greek government debts or a rescheduling of interest payments. Of course, no single creditor will voluntarily agree to write off debts if they think their debtor has a sugar daddy – the EU – waiting in the wings to pay the bills. Arguably, however, European banks should be forced to wear some of the losses. They bought Greek bonds in the first place, and every investment carries risk.
The only real policy question is what level of losses the European banking system could withstand before it seized and banks became unwilling, or unable, to continue making new loans. Such a strategy, of limited but forced losses, could be the equivalent of radical surgery to amputate a leg to stop an infection spreading to other parts of the body.
No one has the answers here. But Euro leaders would do well to recall the definition of insanity offered by Albert Einstein: that state of “doing the same thing over and over again and expecting different results”.