Debt Crisis in Europe: What to expect in 2012?

6 February 2012 by Daniel Munevar

The first weeks of January have served to dispel any illusions about the ability of European governments to deal effectively with the debt crisis that is sweeping the continent. On January 13th, in an unprecedented move, the rating agency Rating agency
Rating agencies
Rating agencies, or credit-rating agencies, evaluate creditworthiness. This includes the creditworthiness of corporations, nonprofit organizations and governments, as well as ‘securitized assets’ – which are assets that are bundled together and sold, to investors, as security. Rating agencies assign a letter grade to each bond, which represents an opinion as to the likelihood that the organization will be able to repay both the principal and interest as they become due. Ratings are made on a descending scale: AAA is the highest, then AA, A, BBB, BB, B, etc. A rating of BB or below is considered a ‘junk bond’ because it is likely to default. Many factors go into the assignment of ratings, including the profitability of the organization and its total indebtedness. The three largest credit rating agencies are Moody’s, Standard & Poor’s and Fitch Ratings (FT).

Moody’s :
Standard & Poors, downgraded the sovereign debt Sovereign debt Government debts or debts guaranteed by the government. rating of 9 European countries. The main countries affected by the downgrade were France, who lost its AAA rating, and Portugal, whose debt is now rated as junk in international markets. Just three days after the rating of the European Financial Stability Facility (EFSF), the common fund created in order to support countries facing problems to finance themselves in the markets, was likewise reduced. In a way these events encapsulate the difficulties and serious problems that the common currency will face to survive intact, that is with all of its original members, for another year.

Despite the announcements made after the extraordinary summit of the European Union in December 2011, the spiral derived from weak or no economic growth, deteriorating public finances and the implementation of new austerity measures that exacerbate the initial problem of growth, continues to strengthen every month. The central commitment made by countries in the Euro area during that summit was the promise to include in all national constitutions a balanced budget law. This type of law requires the enactment of spending cuts and tax increases required to maintain a structural fiscal surplus. The balanced budget law was introduced as the solution to all problems of Europe based on two premises. A first premise is that the difficult situation being experienced by the European periphery is the result of excessive public spending and a social welfare system that is fiscally unsustainable. The second premise is that by virtue of being included in national constitutions and having the potential of being enforced by the european community in case of non-compliance, balanced budget laws could now force fiscally ¨irresponsible¨ countries to observe the rules of common coexistence.

The issue with those arguments is that neither premise is true. Regarding the first, a quick look at the evolution of the fiscal and public debt in the euro area shows that in all cases, with the possible exception of Greece, there was a tendency towards the stabilization or decrease of those indicators before the crisis of 2008. The current recessionary cycle that led to the increase of public deficits and debt came as a result of tightening credit standards and the collapse of private sector spending. This means that the current public debt problems faced by European countries came as a direct result of the unsustainable growth of private sector debt during the early years of the euro area.

This argument opens the door to question the second premise, that is the actual capacity of balanced budget laws to contain the deficit and return Europe to a path of growth and prosperity. The growth of the deficit in the period after the crisis is the natural result of the collapse of credit and private spending. Without a recovery in spending power and stabilization of the balance Balance End of year statement of a company’s assets (what the company possesses) and liabilities (what it owes). In other words, the assets provide information about how the funds collected by the company have been used; and the liabilities, about the origins of those funds. sheets of households, a significant improvement in public balance sheets is out of question. As the process of de-leveraging in the private sector will take some years, it is not possible to expect for households and corporations to play an important role in the process of economic recovery. To insist on the implementation of austerity significantly increases the difficulties faced by european economies given that in the present context public spending is the only stable source of aggregate demand. More austerity implies slower growth and thus less income to pay the debt. This sequence has little or nothing to do with the european supreme court’s ability to impose fines on European governments unable to meet fiscal targets that ignore the effects of austerity on the evolution of sectoral financial balances. In fact, the penalties included in the new fiscal pact only aggravate the overall picture as they would weaken even more the insufficient spending capacity of countries in the european periphery.

In this regard, the recent downgrades granted even more power to the country that has relentlessly insisted on the importance of the implementation of balanced budget laws: Germany. By downgrading France but retaining the highest credit rating for Germany, S & P has validated the rhetoric of fiscal virtue preached by leading German authorities. According to their discourse, if all countries in the European periphery would follow the German example of fiscal rectitude, wage restrictions and high international competitiveness, the euro zone would not be facing its current travails. However, as in the case of the premises this is a completely empty argument. The growing external surpluses and improvement in the international investment position of Germany over the decade are simply the other side of the coin of the external deficits and debt accumulation of the European periphery: the virtues that Germany preaches would not be possible without the vices that it now attributes in an arrogant way to its European counterparts.

The main danger facing Europe in the current year is then derived from the emphasis on a rhetoric that insists on dividing the old continent divided along certain imaginary lines of virtue that ignore the most basic political and economic principles. As it was warned less than a century ago by Keynes in his book ¨The Economic Consequences of Peace¨ to force nations to pay debts beyond their economic capacity while being denied the minimum means of subsistence to their population is a direct recipe for the intensification of nationalist sentiments, rearmament and ultimately, war. Although it is clear that Europe has come a long way since the dark days of the Great Depression and World War II, it is also evident that is not possible to expect for entire nations to remain immutable as their living standards collapse in the name of fiscal rectitude. The intensification and internationalization of the protests originated in Spain and Greece, which is expected to grow even more in 2012, are a clear example of this.

In this sense not all bad news in Europe. While policymakers insist on dragging the continent into an economic disaster, social movements have increased their coordination to find alternatives in order to put an end to the crisis. Over the last six months public debt audit committees have been formed, or are in process of being so, in Greece, France, Portugal, Spain, Italy, Ireland and Belgium. The immediate objective of these initiatives is to open a public debate about the legitimacy of the current European economic agenda that preaches on the need of government budget cuts in the order of billions of euros while at the same time delivers, without any public control, similar amounts to the banks which are in the first instance responsible for the crisis. But the real goal of these initiatives is to achieve a clear and transparent management of public finances in the euro area, that allows to cancel those debts of illegal or illegitimate character that have been taken by European governments in recent years. On the capacity of social movements to promote an exit to the current crisis of a social and progressive character hinges the possibility to avoid a crisis similar to that experienced in 2008.

Daniel Munevar, economist, is from CADTM Colombia and member of the coordination of CADTM AYNA network.

Daniel Munevar

is a post-Keynesian economist from Bogotá, Colombia. From March to July 2015, he worked as an assistant to former Greek Finance Minister Yanis Varoufakis, advising him on fiscal policy and debt sustainability.
Previously, he was an advisor to the Colombian Ministry of Finance. He has also worked at UNCTAD.
He is one of the leading figures in the study of public debt at the international level. He is a researcher at Eurodad.



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