Rescuing Greece or the banks?

THE EUROPEAN Union has launched a financial bailout, American-style: Flood the banks with government money and make workers pay the price through lower wages, increased unemployment, reduced social spending and higher taxes.

"The €750 billion [$955 billion] plan's success will rest to a great extent on the ability of governments to persuade citizens that painful austerity programs and economic reforms are not only the price of eurozone membership but the surest long-term guarantee of prosperity," wrote Tony Barber of the Financial Times.

In other words, workers are supposed to accept deep cuts in their standard of living now in the hope of better days to come...someday.

It was the Greek debt crisis that forced the leaders of the key EU countries to take the plunge. Despite the passage of a severe austerity program in exchange for a $146 billion bailout, speculation was growing that the Greek government would default on its debts and trigger a run on the euro, the currency shared by 16 member nations of the EU.

With Portugal, Spain and Italy also swamped by major debt, the worsening Greek crisis--and the big general strike and protests in that country--threatened to set off an international financial panic. Stock markets dived worldwide and credit tightened up during the first week of May.

It appeared as if the world was about to experience a repeat of the financial crash of September 2008--a development that almost certainly would have choked off the weak signs of an international economic recovery.

That's why German Chancellor Angela Merkel, who was previously reluctant to bankroll a bailout with German taxpayer dollars, finally lined up with French President Nicolas Sarkozy to engineer the $955 billion bailout. President Barack Obama applied added pressure--and the Federal Reserve chipped in with an offer to supply European banks with short-term loans to provide access to dollars.

THE EU plan proved big enough to turn financial market fears into euphoria when markets opened the following the May 9 announcement. The core of the bailout is a $640 billion "European Financial Stabilization Mechanism." The International Monetary Fund (IMF) will provide another $330 billion--as well as the big stick to force countries to implement unpopular austerity measures.

A less publicized but crucial part of the deal is the move by the European Central Bank to start buying not only government bonds of hard-pressed countries like Greece, but private assets as well.

This move--a total reversal of longstanding policy--mirrors the action of the U.S. Federal Reserve. Since the crash of 2008, the Fed has purchased more than $1 trillion in mortgage-backed securities--aka: toxic assets--as part of its endless transfusion of cash to U.S. banks. Now the European Central Bank is doing the same to keep European banks afloat. (And not just European banks: U.S. banks are deeply tied to their European counterparts).

The EU plan followed the example of the former Bush administration in the U.S., which created the $700 billion Troubled Asset Relief Program (TARP) to bail out the banks. The U.S. used the money to inject capital into the U.S.'s biggest banks in a kind of nationalization lite.

The message was that the U.S. government was prepared to stand behind its banks, no matter what, in order to reassure that financial institutions would keep doing business with one another. Essentially, the conservative Republican Bush administration embarked on a policy of financial state capitalism that right-wing critics derided as "socialism."

The Europeans had their own bailouts, too. But these were carried out by national governments for national banks. There was no European-wide solution, since Germany, the economic powerhouse of the EU, didn't want to pay the cost of cleaning up the economies of peripheral countries like Greece.

The EU powers expected to muddle through the crisis with the help of the IMF, which was brought in to restructure the economies of Eastern Europe that are not part of the euro zone. But in recent weeks, it became clear that Greece's crisis could blow up the euro itself and create chaos across Europe's economic heartland.

Still, Germany's Merkel held back--and since the EU has a central bank, but no central government, policymakers were paralyzed. It was only the threat of a meltdown that compelled Merkel to line up with France's Sarkozy and get EU leaders to act in concert with a sweeping rescue

AS IN the U.S. TARP plan and the various lending programs devised by the Federal Reserve, money is no object in the EU bailout. Except when it comes to workers.

While the bailout creates a pipeline of money to indebted EU countries--and the banks that finance their debts--any government that taps those funds must agree to impose harsh austerity measures. So if, for example, Spain is forced to seek a rescue, it will have to carry out the kind of cutbacks that have driven Greek workers to mass strikes and street protests. The IMF, which has long imposed such measures on Third World countries, will now become the enforcer in Europe as well.

But even if the EU bailout money materializes when and where it is needed, and even if workers are bludgeoned into accepting the cuts--which is no foregone conclusion, as Greek workers have shown--the plan may not solve Europe's debt crisis. As the New York Times pointed out:

By definition, if Spain came to a point where it could no longer finance itself, interest rates would be on the rise. The several hundred billion euros for the fund would not only come at a high cost, but would bring additional pain to already indebted countries like Portugal, France, Italy and the United Kingdom...thus compounding the region's debt woes.

In other words, Europe's slow growth and high debt will continue to plague the EU's strongest economies as well as its weakest ones.

The euro, as a common currency, compounds the problem by preventing eurozone members from the typical response to recession: a devaluation of the currency to make exports more competitive, boost economic growth and relieve the pressure of debt by allowing inflation to rise.

By contrast, the EU's economic medicine for Greece is a throwback to the Herbert Hoover administration's response to the Great Depression: slashing government spending and wages, which will only cause the economy to shrink even further. "It's monetary stimulus combined with fiscal austerity," said Joel Geier, associate editor and economics writer for the International Socialist Review.

That extreme contradiction--an unprecedented injection of money into the financial system by the U.S. and European governments even as they cut government spending--is the inevitable outcome of the strategy that Western nations used to overcome the crisis. By essentially guaranteeing their respective financial systems, governments are now themselves being subjected to the same market pressures that nearly broke the world's biggest banks in 2008.

While the U.S. and Germany, for example, may be able to overcome those challenges, smaller nations like Greece--and even bigger ones like Spain and Italy--may not be. And allowing even one country to default on its debt--which could still happen in Greece, despite the bailout--threatens major financial institutions internationally that remain on government life support.

Moreover, the EU (and the U.S.) solution to the government debt problem--cuts in government spending--could cut short the economic stimulus that's behind the still-weak economic expansion.

As economists Barry Eichengreen and Kevin O'Rourke note, world industrial production remains 6 percent below its previous peak, and world trade is 8 percent lower than its previous high--and there's still excess capacity in many industries worldwide. A turn to austerity in Western countries and Japan could snuff out the recovery, despite the renewed boom in China.

For now, the European Union and the world economy may have avoided the consequences of a chaotic unraveling of the euro. But there's little to cheer for working people in Europe, who will soon find themselves the target of Greek-style austerity measures.

Fortunately, Greek workers have provided Europe and the world with a fighting example--and that struggle is far from over.