The return of austerity

June 17, 2010

Lee Sustar explains why governments in Europe and the U.S. are replacing stimulus spending with cutbacks--and increasing the threat of a double-dip recession.

AUSTERITY IS in, stimulus is out--and the amount of sacrifice by working people has to go up.

That was the message of finance ministers at the recent Group of 20 meeting in South Korea. In their joint statement, these economic policymakers said that rising government debt worldwide--highlighted by the debt crisis that is rocking Greece--compelled them to abandon the huge stimulus measures of late 2008 and 2009 in favor of deep budget cuts.

"Those countries with serious fiscal challenges need to accelerate the pace of consolidation," the finance ministers stated. "We welcome the recent announcements by some countries to reduce their deficits in 2010 and strengthen their fiscal frameworks and institutions."

Translation: Governments are bowing to the big international banks--yes, the same banks that survived the financial crash only as the result of government bailouts. Now, bankers and other bondholders want repayment of debts to be the highest priority of governments--ahead of schools, hospitals, the pay and pensions of public employees, and everything else.

Public-sector workers and their supporters march in Barcelona during a one-day general strike to protest austerity
Public-sector workers and their supporters march in Barcelona during a one-day general strike to protest austerity (Josep Lago | AFP)

The U.S. is getting into the act as well. President Barack Obama's budget director Peter Orszag recently instructed government departments to carry out a 5 percent spending cut. These reductions follow hundreds of billions of dollars in budget cuts at the state and local level, which weakened Obama's already underpowered $787 billion stimulus package from early 2009.

According to the Center on Budget and Policy Priorities, state and local governments have eliminated 212,000 jobs since August 2008. Moreover, the limited federal stimulus money will leave states with a combined $260 billion shortfall in 2011 and 2012.

The most intense austerity drive in the industrialized world is in Greece, where total government debt amounts to an estimated 120 percent of gross domestic product (GDP). In other words, the Greek government owes more money than its entire economy can produce in a single year.

Greece is also the heart of popular resistance to the new austerity. A general strike on May 5 was the largest yet in a series of strikes and protests. The struggle has spread to Spain, where public-sector workers mounted their own nationwide strike June 8 against cutbacks that include a 5 percent pay cut for public-sector workers, a freeze on pensions and reductions in public spending.

Unions are also preparing to fight austerity measures in a range of other countries, including Germany, where the government recently announced record cuts of $96 billion, targeted mainly at welfare spending. "Germany, as the biggest (European) economy, has the outstanding task of setting a good example," Chancellor Angela Merkel said.

Italy has also announced austerity measures, including a three-year wage freeze for public-sector workers and 10 percent cuts in spending by all government ministries in both 2011 and 2012.

In Greece, the government has imposed especially severe measures, with the aim of reducing its annual budget deficit of 13.6 percent of GDP to 3 percent in just four years.

The cutbacks include: a wage freeze for public-sector workers, elimination of annual bonus pay for higher-paid workers and a pay cap for lower-paid ones; elimination of thousands of contract worker government jobs; strict limits on early retirement; a reduction in pensions; a 10 percent increase on indirect consumption taxes and a rise in the value-added sales tax from 21 percent to 23 percent. Thousands more government jobs could be eliminated as the result of privatization of government enterprises and services.

Greece is the crucial test case of the new austerity drive. If Greece's social-democratic government--backed by the European Union (EU) governments and the International Monetary Fund (IMF)--can break the power of the most militant and best-organized working class in Europe, then it can be done everywhere else.

TO BUY time to carry out this program, the most powerful EU countries--Germany, France and Britain, along with the IMF--agreed to fund a $955 billion plan to aid debt-wracked EU countries. This aid is intended to be a blowout preventer--a measure to keep Greece and other "peripheral" European countries from defaulting on their debts and dragging down big French and German banks with them.

Like the $700 billion Troubled Asset Relief Program (TARP) in the U.S., the European rescue is based on a vast transfer of taxpayer dollars from the working class to the banks. For their part, the bankers will get relief by selling government bonds on their books to the European Central Bank (ECB). That's a U-turn for the ECB, which has until now refused to buy government bonds or otherwise rescue economically troubled countries.

This huge rescue might forestall a repeat of the financial panic of late 2008, when the collapse of the investment bank Lehman Brothers threatened to topple major financial institutions worldwide. But even the best outcome of the EU strategy would involve a long and deep recession in Greece, Spain and possibly other highly indebted European countries.

That's because they're among the 16 nations that share the euro as a common currency, which makes it impossible to use traditional economic policies to fight a recession. For example, when a country finds itself unable to repay debt owed on government bonds, it typically devalues its currency in relation to other currencies. As a result, the real (after inflation) amount of the debt owed is reduced. Moreover, a devalued currency makes exports cheaper, providing a boost to the economy.

Today, however, Greece, Spain, Portugal and Italy don't have that option. As members of the eurozone, they have no control over their own monetary policy. And now, with the EU and IMF dictating the terms for receiving aid, they're losing control of their fiscal policy, too. Government spending priorities must get the approval of EU bureaucrats, foreign politicians and bankers.

Another complication is the nature of the ECB itself. Unlike the U.S. Federal Reserve, the ECB has no central government standing behind it. Where the Fed can rely on the U.S. Treasury to support its operations, the ECB is subject to the squabbling between its dominant backers, France and Germany, as well as other eurozone governments.

The result was months of indecision during a growing crisis, during which the bond traders not only punished Greece, but began demanding higher interest rates on bonds issued by other European countries as well. Only when the crisis threatened to overwhelm the entire eurozone in May did the EU and ECB come up with its unprecedented bailout. But in exchange for putting up much of the money for these measures, Germany demanded strict austerity measures for Greece and other countries that may need the funding.

CAN THIS harsh medicine lead to a recovery in Greece and the other peripheral European economies? The power players in the EU hope that a deep cut in working-class living standards in those countries will not only free up money to repay government debt, but also lower labor costs so much that capital will invest once again and spark economic growth.

But such views were disproved 70 years ago. "This is a return to the policies of Herbert Hoover and Andrew Mellon," said Joel Geier, associate editor for the International Socialist Review, referring to the U.S. president and treasury secretary in the early years of the Great Depression.

Hoover and Mellon believed that market forces would spontaneously emerge to revive the economy once prices and wages went low enough. Instead, the downward spiral set off by the 1929 stock market crash continued, dragging wider sections of the economy downward for years.

It was amid this catastrophe that the ideas of economist John Maynard Keynes emerged as an alternative. Keynes contended that government spending--economic stimulus, in today's terms--was at times necessary to prop up demand in a complex industrial economy. That doctrine became the conventional wisdom during the long boom that followed the Second World War.

Over the last three decades, however, free-market economists have claimed that Keynes was wrong or irrelevant. The economic recovery of the 1990s, they argued, took place because government deregulated finance and other parts of the economy.

But with the crash of 2008, even the champions of deregulation went running to governments to prevent the collapse of the financial system. By investing, lending or guaranteeing trillions of dollars to bail out the banks, governments effectively assumed the banks' debts--with taxpayer money.

Now, however, governments have concluded that they can no longer afford Keynesian solutions. That's because bankers and bondholders, worried about governments' ability to repay their debts, have jacked up interest rates to punishing levels, particularly for Greece. As a result, governments across Europe have for the past few weeks raced one another to announce austerity programs. Goodbye Keynesianism--hello 19th century free-market economics.

Economist and New York Times columnist Paul Krugman summed up the turn to austerity this way:

So wise policy, as defined by the G20 and like-minded others, consists of destroying economic recovery in order to satisfy hypothetical irrational demands from the markets---demands that economies suffer pointless pain to show their determination, demands that markets aren't actually making, but which serious people, in their wisdom, believe that the markets will make one of these days.

Krugman argues that the Greek case is exceptional, pointing out that other highly indebted countries like Britain the U.S. can still borrow at low interest rates. But Krugman fails to see how Greece is part of an international "sovereign debt crisis"--the diminished capacity of a growing number of countries to repay the holders of national, or sovereign, government bonds.

Indeed, the great fear in European capitals is that if Greece and other highly indebted countries like Italy and Hungary fail to make their debt payments in full, they could trigger a banking crisis across the eurozone of the 16 countries that use the common currency. (In Spain, the big debts are mostly in the hands of private banks, but investors assume that the Spanish government will ultimately be on the hook for that money. Sure enough, the Spanish government bailed out a savings bank that went under in June.)

The nervousness among European bankers is evidenced by a recent sharp rise in the interest rates they charge one another for short-term loans to the highest level in a year. European banks have also had trouble getting access to dollars, a reflection of U.S. banks' growing reluctance to do business with their counterparts across the Atlantic.

Even a restructuring that resulted in a reduction of Greek debt payments--what's known as a "haircut" for the banks and other bondholders--could lead to losses large enough to drag down big French and German banks. No one knows for certain, since the bankers refuse to divulge their exposure to such a default. But the losses could be catastrophic, according to Bloomberg:

Writedowns stemming from a Greek default would total almost $200 billion, estimates Jon Peace, an analyst at Nomura Holdings Inc. in London. Banks globally could lose as much as $900 billion in a worst-case scenario where Greece, Ireland, Italy, Portugal and Spain all have to restructure their debt.

As Gary Jenkins, head of credit research at Evolution Securities Ltd. in London, wrote: "If Greece defaulted in the near future, the ramifications wouldn't just be banks holding Greek debt, but also Spain and Portugal and Italian bonds--and how do you value Armageddon? The idea is to postpone reality. If it had happened in a disorderly manner in May, it would've been such a quick event that it would have been very difficult for authorities to control the reactions on Portugal and Spain."

With the rescue money in place, the banks and the dominant EU countries that look out for their interests hope that debt restructuring--a euphemism for default--can take place in a controlled manner. Meanwhile, they're compelling governments to transfer as much wealth from the working class into the bank coffers as possible, by means of austerity and higher taxes.

AS A small economy, Greece is especially vulnerable to these dictates from the banks and their enforcers in the EU and IMF. If Greece doesn't implement those harsh measures, the bankers will force it to pay extortionate interest rates.

Yet other, much larger, economies face similar pressures. Britain, for example, has a budget deficit of 11 percent of GDP. While the far larger British economy doesn't face as severe a crisis as Greece--it controls its own currency, for one thing--the new Conservative-Liberal coalition government is preparing to cut $87 billion from the country's annual budget.

Japan, too, is turning to austerity. The new prime minister, Naoto Kan, has abandoned his predecessors' big public works projects and proposed tax increases. "As we have seen with the financial confusion in the European Community stemming from Greece, our finances could collapse if trust in national bonds is lost and growing national debt is left alone," Kan said. Japan has $9.7 trillion in public debt, nearly twice its GDP.

The U.S. is also shifting from stimulus towards austerity. The projected $1.4 trillion U.S. budget deficit has sapped the Obama administration's political will to spend money on jobs programs and other stimulus measures. Federal Reserve Chair Ben Bernanke recently told the House Budget Committee that while the U.S. shouldn't cut the budget too deeply or too soon because of the fragile economic recovery, without a fiscal "exit strategy," even the U.S. might, "in the worst case," experience a Greek-style financial crash.

Since Barack Obama refuses to countenance big cuts in military spending or major tax increases on the wealthy, we're getting cuts in the federal government's discretionary spending precisely when the economy needs another boost to bring down the unemployment rate.

Furthermore, the growing crisis in the EU--the world's biggest economic entity--threatens to derail the world economic recovery, and the U.S. is particularly vulnerable. As the New York Times DealBook blog noted, "American banks ended 2009 with $1.2 trillion worth of total European debt. That is about par with the amount of subprime residential mortgage debt outstanding in 2008. It would be foolhardy to assume this problem is far away."

Even if the U.S. financial system were to survive the shock of a Europe-wide banking crisis, the U.S. economy would be hard-hit by a weakening European market for U.S. exports.

The same is true for China, by far the fastest growing economy among the major countries. Despite a major push to develop its domestic economy, the Chinese economy remains overwhelmingly dependent on exports to Europe and the U.S.

Moreover, China's resurgent growth has only added to the persistent problem of overcapacity--both in China and worldwide--in a range of industries. The problem of overproduction--too many goods to be sold at an adequate profit--was a central factor in the 2008 financial crash. As companies became unprofitable or went bust, they could no longer repay loans to the banks.

In the U.S., manufacturing has been slowly expanding for the last 10 months. But according to the Federal Reserve, U.S. manufacturing capacity utilization in April was still only 70.8 percent, well below the 1972-2009 average of 79.2 percent. Austerity measures in markets for U.S. exports worldwide could snuff out those modest gains and lead to more job losses.

What comes next is hard to predict--a second financial crash, a milder double-dip recession or a continued weak recovery with painfully slow job creation in the U.S. But what's clear is that a strategy is emerging among the capitalists and politicians of most of the world's major economies: Accelerate efforts to make workers pay the cost of the crisis.

Whether or not they succeed is up to workers, their unions and their allies.

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