On the brink of a new downturn
“2012 will not be a walk in the park”, warns Christine Lagarde, head of the IMF. The world capitalist economy is on the brink of a new downturn, with a recession in Europe and a marked slowing of China, India and other semi-developed economies. The eurozone debt crisis is far from resolved and could trigger a new global banking and economic crisis at any time. LYNN WALSH reports.
AT THE BEGINNING of a new year, capitalist leaders like to promise better times ahead. Indeed, in the US, Barack Obama is once again talking of ‘green shoots of recovery’, pointing to the small fall in the official unemployment figures. In Europe, however, German chancellor, Angela Merkel, is predicting that 2012 will be more difficult for the eurozone than 2011. French president, Nicolas Sarkozy, is warning of a “year of all risks”. In India, Manmohan Singh, the prime minister, has warned Indians not to take rapid growth for granted – and this warning also applies to China, which has appeared as the locomotive of global growth in recent years.
These leaders have dropped all pretence that the financial crisis and economic downturn of 2007-09 was merely a cyclical crisis and that everything will soon be back to ‘normal’. In fact, Europe has already entered a recession, and it is too late for the major capitalist powers to take any action that would avoid this. The only question is whether it will be a shallow recession, to be reversed in another year or so, or a deep, more prolonged downturn.
Eurozone banks in crisis
EUROZONE BANKS ARE facing a new phase of crisis, with a severe credit squeeze (which is exacerbating the growing European recession). A number of major banks are once again being forced to seek government bailouts. Eurozone banks need to raise around €115 billion to meet the new capital reserves required under the Basel III agreement, which proscribes 9% reserves. This measure is intended to prevent the kind of reckless lending that led to the banking collapse in 2008/09. But in the current situation, the new regulations are actually aggravating the situation. The new capital requirements, together with the need to roll over loans used to finance current business, mean that eurozone banks will need to raise €500 billion by the end of this year. At the same time, European governments will have to raise €1.6 trillion to refinance existing loans and finance their spending. This is giving rise to what one banker describes as a ‘death spiral’ of competition for funds between the banks and governments.
At the same time, there is a breakdown of trust between the banks: rather than lend to one another through the interbank wholesale market (the normal channel for day-to-day business), they are depositing their cash with the European Central Bank (ECB), even though this produces a lower interest rate. Recently, bank overnight deposits with the ECB rose to a record €464 billion. The seizing up of the interbank market, though not yet as severe as after the collapse of Lehman Brothers in 2008, is a symptom of a renewed crisis.
Bank lending to businesses has declined sharply, not just within the eurozone but internationally. For instance, some Asian airlines have recently had difficulty in raising loans to purchase new aircraft.
In normal times, banks would raise new capital by issuing more shares. But this is increasingly difficult as bank shares have fallen sharply, reflecting the growing banking crisis. Instead, the banks have been selling-off assets, such as overseas subsidiaries (many of which are being snapped up at bargain prices by US banks, which were recapitalised at the taxpayers’ expense under the Tarp programme). It is estimated that eurozone banks will attempt to sell off around $3 trillion of assets over the next year or so in order to raise additional capital.
It was recently rumoured that the big German bank, Commerzbank (already 25% owned by the German government as a result of a rescue in 2009), would be forced to go back for a second rescue. Commerzbank’s problems arise partly from losses on its holdings of Greek government bonds. Earlier, the Belgian-French bank, Dexia, was forced in October to seek government help to prevent a collapse. A Belgian financial analyst commented: “The banking system is extremely fragile. Whether it will result in spectacular events like collapses or nationalisations is difficult to say. I would not rule anything out”.
Role of the ECB
MARIO DRAGHI, THE new head of the ECB, has proved to be more flexible than his predecessor, Jean-Claude Trichet. With an almost theological fervour, Trichet opposed the ECB acting as a ‘lender of last resort’ for eurozone governments. This is based on the belief that inflation – even hyper-inflation – is an imminent threat – rather than low growth and chronic stagnation. He believes, like Merkel, that the debt problem should be solved by austerity measures rather than bailouts. Even under Trichet, however, the ECB propped up the ‘peripheral’ governments (Greece, Portugal, etc) through buying their bonds in the secondary bond market. He was also forced to approve limited purchases of Italian and Spanish bonds to avert a major crisis in credit markets.
Under Draghi, the purchase of Italian and Spanish bonds by the ECB has increased significantly. However, Draghi’s main measure has been to enormously increase lending to European banks. This is a backdoor way of propping up debtor-governments. Banks are able to borrow from the ECB almost unlimited quantities for three years, at 1% interest, on the basis of a wide range of collateral (including government bonds of Greece, Italy, Spain, etc).
This has provided an attractive incentive for banks to purchase government bonds in order to use them as collateral for ECB loans. In some cases, the banks have used this cheap cash to invest in more government bonds, giving a return of 5-7%. This is clearly a risky strategy, both for the ECB (which is piling up an accumulation of dodgy government bonds) and for the banks concerned. A wave of defaults by several eurozone governments would trigger a new banking crisis, almost certainly deeper than the 2008/09 crisis. That is why some banks and financial institutions are following a much more cautious policy, for instance, buying German government bonds – even when, for the first time, they are yielding a negative interest rate!
Another summit
WITH A NEW summit approaching (30 January), Merkel is claiming that ‘progress’ has been made since the last summit. But this is far from clear. The January summit is meant to concretise the ‘treaty’ (in reality, a series of headings and broad commitments) between the 26 EU governments that endorsed it (with David Cameron exercising a British veto). However, a treaty that imposes a constitutional obligation on EU governments to balance their budgets (an economic absurdity) will provoke massive opposition throughout the EU. Moreover, it is hard to believe that EU governments will be able to agree on the terms of the new conditions, particularly when it comes to the role of the European Court of Justice in enforcing the rules and the question of penalties. There has already been conflict between Merkel and Sarkozy on this issue (Sarkozy favours a much more flexible regime than Merkel).
Merkel is also urging that EU governments should accelerate the implementation of the eurozone’s permanent €500 billion rescue fund, the European Stability Mechanism. But there is, as yet, no agreement on the exact contributions to be made by the eurozone governments. At the same time, the temporary EFSF (European Financial Stability Fund) appears to have been more or less abandoned. It has only €450 billion left, nothing like enough to bail out major eurozone governments such as Spain or Italy. But it has been unable to borrow additional capital in order to increase its power of intervention.
Instead, the EU has turned to the IMF. This currently has around $290 billion, and it is proposed that EU governments should contribute a further $200 billion and non-European governments an extra $200 billion. Again, it is far from certain that governments will be forthcoming. For instance, Cameron will have enormous difficulties with eurosceptic opponents in the Tory party if he were to propose that Britain makes an additional contribution to the IMF – which would be seen as an indirect way of supporting eurozone governments.
The US and Asian governments have also indicated their reluctance to support such an augmentation of IMF funds. They have understandably asked why the stronger European economies, like Germany and Netherlands, should not make more of a contribution. German capitalist leaders continually demand that the weaker economies reduce their deficits, but these deficits are the counterpart of the surpluses in countries like Germany, and cannot be removed without Germany, Netherlands, etc, absorbing more imports from the weaker countries.
At best, the January euro summit will be another muddle-through meeting, with some patch-up measures to deal with immediate problems but no resolution of the underlying problems.
The eurozone debt problem is being aggravated by the decline in growth. The austerity measures imposed by the eurozone regime and the straitjacket of the euro are getting worse. Recent data indicate that the eurozone slipped back into recession in the last quarter of 2011, and it is now too late for eurozone governments to prevent a downturn in the first half of this year. The only question is, how severe will it be?
Merkel and Sarkozy claim that they will be putting forward a policy for growth at the summit. But how can they stimulate growth and reduce unemployment within the framework of severe austerity measures, ultimately designed to satisfy financial markets? Stimulating growth would require fiscal stimulus packages on a big scale – anathema to finance capital. As a Deutschbank analyst wrote in a recent report: “In the current market environment, there is no room for using a Keynesian-type expansionary fiscal policy to boost demand in countries with low growth – the markets will simply not accept such a strategy”. (Crunch Time for Euro Is Not Far Off, International Herald Tribune, 10 January)
The Greek time bomb
EUROPEAN LEADERS HAVE certainly not solved the crisis of Greek capitalism, which will explode in the next period. Savage austerity measures have, apart from imposing barbarous conditions on the working class and sections of the middle class, induced a four-year long slump, with the economy sliding 5% during 2011. On the basis of passing a further austerity budget for 2012 and imposing further cuts, such as a rise in electricity charges, the interim government under Lucas Papademos was rewarded with another €8 billion payment from the first bail-out package.
However, the Greek government urgently needs the second bail-out package of €130 billion in order to finance the proposed bond exchange with private bondholders. This is now based on a 50% haircut for private holders of Greek bonds (totalling around €200bn), on the basis of making €30 billion upfront payments to these bondholders. However, the deal has not yet been agreed. There are reports of the government demanding an even bigger haircut, while even on the basis of a 50% haircut there are bondholders who are refusing to agree on the exchange.
This is a crucial question for the euro summit on 30 January. Without an agreement on the exchange of Greek bonds, there would be the imminent prospect of a default, with Greece being forced out of the eurozone. Even with a deal, however, it would not resolve Greece’s debt problems. It would be another temporary fix that would give way to a further crisis in a relatively short time. The growing burden of debt is economically unsustainable and intolerable to the workers and middle class.
The recession in Greece, with a reduced demand for imports from the European economies, will affect economies all around the world. However, the eurozone debt crisis is a time bomb: an explosion could trigger another worldwide banking and economic crisis, perhaps even worse than 2008/09.
Bleak prospects
AS A RESULT of bailing out banks and other financial institutions and piling up fiscal deficits (due to slow growth and a decline in tax revenues) the major economies are weighed down by a colossal burden of debt. The OECD recently estimated that the advanced capitalist countries will have to raise over $10.5 trillion in new loans during 2012, almost twice as much as in 2005. Government defaults on sovereign debt and/or the collapse of major banks would unavoidably trigger a new banking crisis, which in turn would induce a major downturn.
Many commentators hope that a recovery in the US will help pull the rest of the world out of recession. A marginal fall in the official unemployment rate (down from 8.7% to 8.5% in December) raised hopes of a recovery. But much of this ‘improvement’ is actually due to workers dropping out of the labour force. In 2011, the US economy gained 1.64 million jobs, the best annual improvement since 2006, but still far short of the almost nine million jobs lost during the recession.
At the same time, US exports are being hit by the developing recession in Europe. Fourteen percent of the sales of the S&P 500 companies go to Europe. Exports have also been hit by the rising value of the dollar, as capital moved to the US in search of a ‘safe haven’. These trends have hit the profits of the big corporations (in the fourth quarter profits of the S&P 500 fell from 17.5% to 7.9%). This will most likely result in a decline in investment, with further knock-on effects in the economy.
Serious commentators have begun to comment on the ‘Japanisation’ of the US economy, raising the prospect of a prolonged period of very slow growth with a very weak business cycle. The 2% growth predicted for the US this year now appears optimistic.
At the same time, there is clearly a significant slowing of growth in China, which could be reduced to 8% or even 7%. Undoubtedly, the Chinese regime will intervene in an attempt to prevent a sharp downturn. But whether it can restore a growth rate of 9-10%, as it did during the last downturn, is somewhat doubtful. Reduced demand for industrial commodities, food and energy from China, moreover, will have a knock-on effect on Brazil, Australia, and other economies that have grown on the basis of trade with China.
Another factor is the price of oil. It has hovered around $100 a barrel, but a closing of the Straits of Hormuz by Iran, or even severe tension between Iran and the US, could produce a sharp increase of around $50 – which would also have an effect on global growth.
A recent ‘2012 Outlook’, from the investment bank Morgan Stanley (Global Economic Outlook, 15 December), makes sombre reading. Its baseline projection for global growth in 2012 is 3.5% (compared to an average of nearly 5% before the downturn at the end of 2007). This is based on a prediction of a shallow recession in Europe, weak but positive growth in the US, and slower growth in the ‘emerging markets’ (China, Brazil, India, etc). It half-heartedly argues for a ‘reasonable’ bull case, which would lift global GDP to 4.2% during 2012.
Its ‘bear case’ is for a full-blown global recession, with a slowdown in the US as well as a recession in Europe. This would reduce global growth to 1.9% during 2012. However, Morgan Stanley also puts forward a ‘super-bear case’: “You don’t really want to know”.
“Even our bear case may still be too optimistic”, it warns. If the eurozone governments fail to agree on decisive steps to resolve the eurozone crisis, and if the ECB refuses to increase its support for floundering governments, “a super-bear scenario including serial private and public-sector defaults and euro breakup may well materialise”. Morgan Stanley views this scenario as the least likely event but, nevertheless, warns that it has recently become more likely. “Putting numbers for GDP and other economic indicators to such a scenario is extremely difficult. Yet, the Great Recession that followed the Lehman bankruptcy would probably pale in comparison to a scenario involving a euro breakup and widespread bank and government failures”.
2012 will undoubtedly be a year of great events and massive working-class struggles.
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