The economic crisis is back with a vengeance, argues James Supple
CHAOS ON global stockmarkets in recent weeks has revived fears that the world economy is heading back into meltdown. Around $4 trillion dollars was wiped off the world’s stock markets in the first two weeks of August. Financial analysts worldwide described the feeling as similar to the days after the collapse of merchant bank Lehmann Brothers in 2008, the event which triggered the global financial crisis.
There were two reasons for the immediate panic. One was the fear that government debt in Italy and Spain might be unsustainable. The “sovereign debt crisis” in Europe, which has led to massive bailouts to stop weaker European governments including Greece, Ireland and Portugal from defaulting on their debts, has put bigger economies at risk.
The renewed panic shows the hollowness of the talk of “recovery” and the predictions that the worst of the global economic crisis was over.
Governments in both Europe and the US have amassed large debts as a result of the stimulus spending that was needed to avoid a catastrophic economic collapse after the economic meltdown of 2008.
They also spent billions of dollars to bail out banks that were effectively bankrupt as a result of bad debts. Those bad debts are now held by governments.
The stimulus programs did provide some modest economic growth. But as they have run out, many economies are again on the slide.
Figures show the US economy grew by just 0.4 per cent in the first six months of this year, equal to less than a 1 per cent annual growth rate. This compares to an average rate since WWII of 3 per cent.
Reuters’ August poll of economists revealed expectations that growth across the European Union was also slowing, with an average expected growth for next year of 1.6 per cent. This is even the case in the stronger economies of France and Germany. France recorded a growth rate of zero in the April to June quarter and industrial production fell in Germany by 0.8 per cent.
Falling growth makes it harder for governments to repay debt, since it results in falling tax revenue. This is fuelling the fears about governments defaulting on their debts in the Eurozone and that the sovereign risk will spread to the bigger European economies.
A second bailout for Greece was stitched up by the French and German governments in July. In exchange the Greek government has promised further privatisation and increases in income tax, on top of austerity measures, like shutting hospitals. Public sector wages have been cut by 20 per cent and unemployment driven up to 16.5 per cent.
While the bailout will allow Greece to keep paying its debts for now, most believe that it will eventually default. Rating agency Moody’s believes the likelihood of a Greek default is “virtually 100 per cent”.
This risks spreading “contagion” across the European banking sector, threatening banks in countries like France and Germany with huge losses and even bankruptcy due to their holdings of Greek debt.
Greece is a small economy, its size estimated at between 1 and 2 per cent of the European Union as a whole. This has made it possible for the European Central Bank (ECB) to buy up Greek debts and stave off the immediate threat of default.
But there are now also fears about government debt in Spain and Italy, after markets pushed their costs of borrowing money to over 6 per cent. When interest rates on government debt get beyond this level, it becomes harder and harder to repay the debt.
In early August the ECB was forced to step in, spending two days buying up Spanish and Italian debt in order to stabilise the situation. This has worked in the short term to drive down their costs of borrowing.
But Spain is the Euro’s fourth largest economy, double the size of the economies of Greece, Portugal and Ireland combined. Italy is bigger still. The ECB is unlikely to be able to raise the funds necessary to bail out either government if it faced default.
A huge question mark hangs the European economies. On the one hand the size of Italy or Spain mean they are “too big to fail”. But, on the other, as many have pointed out they are also “too big to bail”.
If their interest rates remain stable, both Italy and Spain may be able to repay their debts by resorting to austerity measures. The Italian government has announced spending cuts of $62 billion aimed at repaying debts by 2013.
But this locks them into a vicious circle, since government spending cuts take money out of the economy. Both the government and companies sack workers which in turn, means less money in the economy. That means lower economic growth and falling tax income, leaving the government with even less money to repay debts.
This is the cycle that the Greek economy has fallen into. The economy has contracted by 6.9 per cent over the year to the end of June, in the third year of recession.
US debt crisis
The US political system was mired in paralysis throughout July as politicians tried to stitch up an agreement to lift the country’s “debt ceiling”.
For a while it looked like the US may default on its debts. This could have triggered a major crisis across the banking sector, as world markets have viewed US government debt as “a safe option”. Due to the size and strength of the US economy, its government has been seen as the one body that would always be able to repay debts.
Republicans in the US Congress eventually agreed to a deal with Democratic President Barack Obama to launch a savage austerity program in exchange for raising the debt ceiling. As a result there will be at least $2.1 trillion in cuts over the next decade—$900 billion through an immediate cap on spending and the rest to be decided on by a “bipartisan committee” later this year.
But the uncertainty was enough for Standard & Poors to downgrade its rating on US debt to AA+. This is the first time in history the US’s credit rating has slipped below AAA.
Economist Paul Krugman concluded in The New York Times, “what we’re witnessing here is a catastrophe on multiple levels”. Like the austerity policies in the EU, the cuts in the US are coming just as government stimulus spending runs out. Emergency unemployment benefits, which allowed 3.8 million jobless Americans to continue receiving benefits, will expire at the end of the year. After this, there will be no unemployment benefits for anyone out of work for over 26 weeks—when ordinary benefits for the unemployed expire in the US.
The cuts will make it harder for an already struggling US economy to keep growing.
What is even more bizarre about the turn to austerity in the US is that it does not face any real debt crisis. US government debt is large, at over $14 trillion dollars. But unlike Spain, Greece or Italy, the US has the benefit of extremely low rates on interest on its debt.
This means it does not face huge problems repaying its debt. In fact, as jitters spread on the stockmarket, there was a rush of investors trying to put their money into US government debt.
Is there a solution?
Things are much more serious for the global economy now than in 2008. Then, the state stepped in with huge government stimulus programs to rescue the world economy from the abyss. Interest rates were slashed in an effort to encourage businesses to borrow money.
But such measures are no longer an option if another serious recession hits. There are now such high government debt levels that even the US will find it harder to afford another major round of stimulus. Interest rates in the US can’t be cut much further. They are already at just 0.25 per cent, and the US Federal Reserve has promised to keep them at that “exceptionally low” level for the next two years.
What does all this mean for us? Julia Gillard has commented that, “Australia is in a very different position with a strong economy that is the envy of the world.” Treasurer Wayne Swan believes that Australia can “ride out” any economic storm in Europe and the US because of possible growth in China.
Despite lower growth in thew world economy, China has grew by 9.5 per cent over the last year.
It’s true that 25.3 per cent of our exports now go to China, as opposed to only 12 per cent to the US and EU combined. But the US and the EU, which together make up half the size of the world economy, are two of China’s major export markets. Economic stagnation there will inevitably hurt the Chinese economy.
Wayne Swan’s hope is that, “China [could] fire up its domestic engines of growth if external conditions fall sharply” by launching another huge stimulus program. It is a forlorn hope. Inflation in China is already a problem (6.5 per cent in July) and it is doubtful that it would boost domestic spending on the same scale as in 2008.
As the global stock markets crashed, $40 billion dollars was wiped off the value of Australian stock markets. Tens of thousands of jobs are already being cut as the Australian economy slows. If China is affected by the economic problems in Europe and the US, the effect will be even more dramatic. Australia won’t be immune—more jobs will go.