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Kindle Notes & Highlights
by
Adam Tooze
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January 6 - January 10, 2019
In what was dubbed an “emergency budget” in June 2010, Chancellor Osborne slashed spending and raised VAT. The aim was to calm markets by committing to close the deficit by 2015.14 The argument in 2010 was “necessity.” But, as Neil Irwin later commented: “Britain . . . was embarking on something that has rarely been attempted . . . cutting spending and raising taxes in a preemptive strike against the risk of a future debt crisis.”
The ultimate goal, as David Cameron would put it in his speech to the Lord Mayor’s Banquet three years later, was “something more profound”: to make the state “leaner . . . not just now, but permanently.”17
Between 2010 and 2016 spending by local councils on everything from elderly day-care centers to bus services, public parks and library facilities fell by more than a third. Britain became a darker, dirtier, more dangerous and less civilized place. Hundreds of thousands of people who were barely coping on disability and unemployment benefits were tipped into true desperation.
It was the simplistic householder analogy that drove economists to despair.
Meanwhile, the alternative to debt alarmism was spelled out most cogently by Ben Bernanke, who had recently been reappointed as Fed chair. Bernanke did not deny the scale of the deficits or the serious implications in the long run of a much larger debt burden. But he cautioned against drastic austerity efforts. America’s nascent economic recovery might not withstand a sharp fiscal shock.
“[O]ther EU members, and the US administration, have urged Germany to spend more to maintain the current economic recovery, and reduce its export surplus.”34 But that was not how Germany saw its role. The crisis, so the prevalent German interpretation went, was a result of excessive debt. What the world needed to guide its recovery was for Germany not to act as an expansionary counterweight but to lead the way in offering a model of austerity.
After the worst economic crisis since the 1930s, at a time when, according to the OECD, 47 million people were unemployed across the rich world, and the total figure for underemployed and discouraged workers was closer to 80 million, the members of the G20 committed themselves to simultaneously halving their deficits over the next three years.43 It was the householder fallacy expanded to the global scale. It was a recipe for an agonizingly protracted and incomplete recovery.
When Keynesians worried about domestic demand, the German answer was exports. An aging continent should be exporting to the world and building up a nest egg of financial claims on the fast-growing emerging markets.
By the summer it was already clear that the fix devised to contain the Greek crisis in May 2010 was not sustainable. The worst fears of the more pessimistic IMF analysts were rapidly being confirmed. Not only was the PASOK government slow to push through the changes the troika demanded, but when it did, the results were counterproductive. In a classic Keynesian downward spiral, demand fell and unemployment surged further, reducing incomes. In 2010 Greek GDP would fall by 4.5 percent. Worse would follow in 2011.47 The tax revenues flowing to Athens, which even at the best of times were hardly
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As always, the most serious risks were concentrated in the balance sheets of a few dangerous banks. Dexia and Fortis were at the top of the list, as was Germany’s troubled Hypo Real Estate. According to the OECD, Hypo’s capitalization was so inadequate that a sovereign debt crisis in any one of Italy, Spain, Ireland or Greece would put its survival in question.
On September 30 the Irish government announced that, given its obligation to backstop the banks, in 2010 Ireland’s public borrowing requirement would surge from 14 percent to a jaw-dropping 32 percent of GDP. This would take Ireland’s public debt from a modest 25 percent of GDP in 2007 to 98.6 percent in 2010. The Irish government, once a paragon of austere public finance, was forced to withdraw from the bond market.
Merkel and Sarkozy agreed that as of 2013, in any future crisis, creditors would be bailed in. It would not just be taxpayers who put up new funds. Haircutting the creditors would help to bring debts down. It was equitable. And it would serve a useful disciplining function. Creditors would take their responsibilities more seriously if they knew that they had skin in the game. The package was announced without forewarning in a press release late in the afternoon of October 18, 2010.
Advocates of extend-and-pretend would insist forever after that it was Merkel and Sarkozy who tipped Ireland over the edge, that Trichet was right, that this was Europe’s “Lehman moment”: an unforced, politically motivated error. But, as in the case of Lehman, political and technical judgments were mingled. Given its gigantic budget deficit and the expiry of the 2008 guarantee for its banks, Ireland was heading into rough waters in any case, with or without Deauville.
There is the shame of it all. Having obtained our political independence from Britain to be the masters of our own affairs, we have now surrendered our sovereignty to the European Commission, the European Central Bank, and the International Monetary Fund.” But rather than lapsing into self-pity, the Irish Times went on: “The true ignominy of our current situation is not that our sovereignty has been taken away from us, it is that we ourselves have squandered it. Let us not seek to assuage our sense of shame in the comforting illusion that powerful nations in Europe are conspiring to become our
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With the IMF heretics silenced, the Irish were left with no alternative. Prime Minister Lenihan admitted resignedly: “I can’t go against the whole of the G7.” For Ireland to haircut unilaterally would be “politically, internationally, politically inconceivable.”72 On November 28 Ireland agreed to accept 85 billion euros in emergency loans: 63.5 billion euros from the troika; the rest came in the form of bilateral support from other EU members, notably the UK, whose own financial markets had contributed so much to the debacle.
Another deal was sewed up. Debts would be honored. The population of Ireland paid the price. A “Lehman moment” was avoided. But the result was not to restore confidence to the markets. The European financial crisis could not be contained by transferring the costs to taxpayers on a nation-by-nation basis. The resulting bailouts preserved the form of stability, but were not credible in their substance.
thus justify his interference in Greek and Irish affairs and more to come. What the ECB did not have was a mandate to concern itself with the economic welfare of the eurozone or its member states in any broader sense. It was a willfully simplistic and conservative interpretation.73 It was ruinous for the eurozone. The crisis would begin to be overcome only when the ECB began to step beyond it.
How exactly quantitative easing works remains a subject of controversy.74 Large-scale purchasing of mainly short-term bonds drives up bond prices and thus reduces yields. Reduced short-term rates may help to lever down long-term rates and thus to stimulate investment. But that depends on there being businesses willing to
invest, which cannot be taken for granted at a time of crisis. The most direct effect of QE comes via financial markets. As the central bank hoovers up bonds, it drives down yields, forcing asset managers to go in search of yields in other classes of assets. Switching out of bonds into stocks inflates the stock market, increasing the wealth of those with stock portfolios, tending to make them more willing to both invest and consume. This, to say the least, is an uncertain and indirect method of stimulating the economy. By boosting the wealth of already wealthy households, it is predestined to
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Beyond the Fed’s walls the reactions were more intemperate. In the superheated political climate of the Republican election triumph of November 2010, what hogged the headlines was the news that the Fed was embarking on a plan to “print” tens of billions of dollars every month.
This was predictable, but it was not necessary. The two agenda-setting innovations of October and November of 2010—the Merkozy PSI agenda of Deauville and Bernanke’s QE2—could have been complementary. As Chopra of the IMF had laid out, the ideal accompaniment for aggressive debt restructuring in Ireland would have been an ECB bond-purchasing program designed to insulate the other fragile members of the eurozone from the fallout.
show.” The Brazilians, as the putative leaders of the left wing of the emerging markets, inveighed against the risks of hot money and accused Bernanke of a beggar-thy-neighbor devaluation of the dollar. They warned of a “currency war.”80 For the Chinese, the Fed’s action was a sign that “[t]he United States does not recognize . . . its obligation to stabilize capital markets,” as Zhu Guangyao, China’s vice finance minister, put it. “Nor does it take into consideration the impact of this excessive fluidity on the financial markets of emerging countries.”81 Wolfgang Schäuble went furthest. Once
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The Americans did not go down without a fight. Tim Geithner countered that the real source of imbalances in the world economy was not US monetary policy but the mercantilist trade policies of China and Germany. The Fed was not deliberately depreciating the dollar. It was targeting domestic conditions, not the exchange rate.84 If others wanted to prevent their currencies from appreciating, all they had to do was to match the Fed’s low interest rate policy with an expansion of their own. What the critics dubbed a “currency war” could thus have been turned into a comprehensive program of monetary
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Germany would never admit that its trade surplus was anything other than a reward for its competitiveness and productive virtue.
While Berlin denounced QE as a source of instability, Europe’s banks took a very different view. For every billion dollars’ worth of securities the Fed purchased, it credited an account with a corresponding amount of dollars. But who was it that held those dollar accounts with the Fed and thus “funded” QE? As the Fed’s statistics show, it was not America’s banks that took advantage of QE to unload large portfolios of bonds or to hold cash, though some American pension funds and mutual funds did sell bonds to the Fed. The banks most actively involved in QE2 were not American but European,
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They shifted money out of Europe, shrank their US operations, deleveraged their balance sheets and built up a huge pile of cash. Thanks to QE2 they held that liquidity reserve not with the ECB but with the ultimate guarantor of the global financial system, the Fed. It was not a recipe for economic expansion. But in the absence of any solution to the eurozone crisis, it did at least promise a cushion of stability.
The commitment to austerity in 2010 drove critical economists to impatient fury. Why was the world embarked on a course that was so self-evidently counterproductive and so damaging to the prospects of tens of millions of unemployed around the world? Whose interests were being served by preserving this reserve army? Paul Krugman asked in the New York Times.1 Whose interests were served by a lopsided deficit debate in which minor tax increases were traded for huge cuts in entitlements?
“The fact is,” Krugman insisted, “the Great Depression ended largely thanks to a guy named Adolf Hitler.
By the spring of 2011 austerity was biting deep into the social fabric of Europe. Spending cuts and tax increases were slashing demand and squeezing economic activity. Across the eurozone, 10 percent of the workforce were unemployed.
The sense that Europe’s welfare state was being subjected to a relentless program of rollback driven by the demands of bankers and bond markets provoked outrage. Stéphane Hessel, former French resistance fighter and ecological activist, survivor of Buchenwald, Dora and Bergen-Belsen, became an unlikely bestselling author with his well-timed manifesto Indignez-Vous! (Time for Outrage!).
A resurgent nationalism, defending sovereignty against the impositions of the crisis, would be one of the most powerful political responses to the crisis.
What forced a change in policy was not protest, however passionate and imaginative, but the inescapable realization that extend-and-pretend, the “fix” cobbled together in 2010, simply did not work.
Cutting government expenditure did not have the energizing effect on private business activity that the advocates of expansionary austerity imagined, but rather the reverse.24 Consumer spending and investment plummeted.
This was the basic inconsistency in the German position. Berlin was not just the relentless advocate of austerity. It was also the most consistent and clearheaded on restructuring and PSI. But when it came to its necessary concomitants, starting with backstopping the rest of the bond market, Berlin was inconsistent and incoherent.
As the eurozone crisis heated up again in April and July 2011, the ECB, in one of the most misguided decisions in the history of monetary policy, raised rates.
The ECB was asserting its independence. It was putting Europe’s governments on notice. It would be up to them to take responsibility for the debt markets.29 Nor were interest rates the only way to send the message. Without fanfare, indeed, without public announcement of any kind, in mid-March the European Central Bank stopped purchases of eurozone sovereign bonds and introduced differentiated haircuts on repos for lower-rated bonds.30 It took a few weeks for the markets to register the serious tightening of credit conditions. Then they sold off. The yield spread between the safest and riskiest
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Nor was it only American money that was signaling its lack of confidence. A huge internal movement of funds within the eurozone was afoot. This was registered in a previously obscure but soon to be notorious appendage of the Eurosystem known as the TARGET2 balances.
Suddenly, in the spring of 2011, thanks largely to the journalistic entrepreneurship of the economist professor Hans-Werner Sinn, the German public was alerted to the shocking and quite misleading news that they were secretly providing a huge “credit” to the periphery.
This alarmist interpretation of the accounting data should be seen less as a piece of economic analysis than as a symptom of the increasing loss of legitimacy on the part of the euro system. What the TARGET2 balances registered was not a “loan” by Germany to the rest of the system. The TARGET2 balances were the offsetting official counterpart to an enormous movement of private funds into German bank accounts from the eurozone periphery.
What Germany was benefiting from was something akin to the exorbitant privilege enjoyed by the United States in the global economy. At times of stress, global money moved into dollars. In the eurozone, money moved to Germany.35 It was a privilege measured by the yield spread.
By May 2011 the effort to defend the indefensible, to uphold extend-and-pretend, had resulted in a complete breakdown of credible and coherent communication about the eurozone’s economic policy. Juncker was unusual only for feeling that he didn’t need to dress it up, which, as far as a tiny bourgeois tax haven like Luxembourg was concerned, might have been true.
In France those who did not blame the Americans blamed Sarkozy, who was widely suspected of plotting to eliminate Strauss-Kahn as a rival for the presidency.
The priority of systemic stability and preventing contagion reasserted itself. This was no time for dangerous talk about debt restructuring or bank recapitalization. What mattered was containing the crisis and preventing uncertainty spreading from Europe.
In exchange for further austerity from Greece, there would be another aid package. Private sector involvement, i.e., debt restructuring, would be part of the bargain, as Germany had wanted from the start.
It would take not only austerity and privatization but a truly heavy bondholder haircut to get Greece to sustainability.
Whereas in 2007 eurozone bond investors had regarded Greek debt as equivalent to that offered by Germany, by September 2011 the CDS spreads on Italy and Spain were higher than those of Egypt in the throes of revolution.
The three countries in the world judged most likely to default were all in the eurozone—Greece, Ireland and Portugal—well ahead of Belarus, Venezuela and Pakistan.
As one Goldman Sachs analyst commented: “This tendency to ‘under-size’ otherwise good policy initiatives has been a recurrent feature of European policies.”
Earlier in the year Rome had had the temerity to suggest that any joint European bailout fund ought to be funded in proportion not to GDP but to the size of bank claims that were being rescued. Not surprisingly, this was not a popular idea in Berlin.
On August 3 China’s Dagong ratings agency was the first to draw the obvious conclusion. It downgraded the United States from A+ to A. As Dagong remarked: “[A]t this crucial juncture, neither the Democratic Party nor Republican Party has shown any consideration for the general interest in order to argue for their own partisan interest; they had a hard time making the correct choice in a timely manner leaving the world in terror, which highlights the negative role of the US political system on an economic basis.”
