Can the Euro Avert Collapse?

Can the Euro Avert Collapse?

As politicians dither, the threat of default spreads from Greece to Spain and Italy.


Supporters of the newly-elected French President Francois Hollande celebrate during a victory rally at Place de la Bastille in Paris early May 7, 2012. Reuters/Pascal Rossignol


Socialist François Hollande’s victory in the French presidential elections and an impressive showing by the leftist Syriza (Coalition of the Radical Left) in the Greek polls on the same day may prove to be a watershed moment in Europe’s battle for survival against global bond markets. Or it may not. For while the backlash against austerity has now reached the European core, the eurozone is still trapped by its own monetary union and lacks the tools to implement an alternative to the depression economics of a crumbling Berlin consensus.

Hollande sent shudders through the European orthodoxy and was branded “a rather dangerous man” by The Economist when he pledged to renegotiate the fiscal compact pushed through by German Chancellor Angela Merkel and the defeated Nicolas Sarkozy in March in an attempt to lock permanent austerity into the European Constitution. “Austerity should no longer be Europe’s fate,” Hollande said in his victory speech in Paris, echoing a perception gaining ground even in Brussels that an obsession with deficits is driving the region into a double-dip recession and an ever deeper debt trap. “‘Merkozy’ is gone. We’re now going to have an open debate in Europe on austerity—not just lip service to growth but real measures, starting with the renegotiation of the fiscal compact,” said Pervenche Berès, the French Socialist Member of the European Parliament (MEP) who heads the committee on employment and social affairs, speaking the week before the elections after a conference in Rome with the slogan “Beyond Austerity.”

Even as the mainstream media warned that Hollande’s populism would be punished by the bond markets, the IMF’s chief economist, Frenchman Olivier Blanchard—who is closer to Hollande’s heterodoxy than might be expected—confessed that “schizophrenic” investors are now as scared by the impact of austerity on growth as they are of fiscal largesse. Even in Germany the austerity paradigm may be under review. Merkel’s office ruled out any renegotiation of the fiscal compact, but Berlin does not oppose adding new commitments to growth. “Hollande will demand that the fiscal pact be supplemented by a robust growth initiative, and the SPD [Social Democratic Party] in Germany will support him,” said Alfred Gusenbauer, former Austrian chancellor, at the Rome conference. This will force Merkel, weakened after local election setbacks, to introduce some pro-growth measures, he predicted.

French Socialist MEPs said their new growth plan will include doubling the European Investment Bank’s capital base to 60 billion euros, which allows it to provide more cheap loans to credit-starved businesses, and issuing bonds for infrastructure development; fast-tracking structural cohesion funds to finance development projects in poorer regions; and adopting a financial transactions tax to curb speculation in the markets. The revamping of the EIB—which unlike the European Central Bank (ECB) can issue debt for investment—now has the support of EU commissioner Olli Rehn, and Berlin seems likely to follow. “We need far more loans disbursed to small business to compensate private credit contraction and fiscal adjustment, and we have seen how effective public development banks can be, from Brazil to China and even in Germany,” said Britain-based development economist Stephany Griffith-Jones, one of the organizers of the Rome conference. She calculates that the EIB could provide more than 30 billion euros’ worth of investment loans a year, a welcome (though barely sufficient) resource for Europe’s credit-starved southern rim, where a spate of suicides of Italian small businessmen in recent months has highlighted the drama of this crisis.

Hollande’s commitment to wealth redistribution by way of a 75 percent income tax on France’s highest earners could also set an example for Europe’s debt-constrained periphery, said Nobel Prize–winning economist Joseph Stiglitz. Despite market constraints on their ability to implement fiscal expansion to combat recession, countries like Italy and Spain could kick-start growth by redistributing income to the less well off, who consume more and save less of their income. In countries like Germany, meanwhile, there should be an immediate end to “deficit fetishism,” Stiglitz added.

Yet even Hollande’s longstanding economic advisers recognize that these measures by themselves will do little to halt Europe’s slide into another recession or avert the real possibility of catastrophic defaults on Spanish and Italian debt. Not even the newly created European stability mechanism, with some 800 billion euros of emergency funds bolstered by the IMF’s replenished crisis-prevention resources, will be enough to save Spain or Italy if, as some economists believe, their debt-servicing costs pass a point of no return in markets gripped by a self-fulfilling fear of default. “We need new instruments: eurobonds and a central bank that can buy sovereign debt and bring interest payments down,” said Jean-Paul Fitoussi, one of Hollande’s economic advisers, in an interview in Rome. The French president-elect supports both measures, Fitoussi added, and has daringly supported changes in the ECB’s mission that would allow it to set a ceiling on interest payments by buying sovereign bonds whenever markets pushed interest rates beyond sustainable levels. Hollande would like to see the ECB play the role of lender of last resort, which could assuage market fears of defaults in Spain and Italy. In Rome Stiglitz sketched out a “holistic” alternative to austerity, in which a looser fiscal policy in the euro-core plus pan-European investment would be followed by the introduction of European debt.

But while Germany will make concessions on new growth measures, few expect the Bundesbank or the German taxpayer to back eurobonds or a more active ECB, at least in the short run. “You need a paradigm shift in Germany, and, frankly, that is further away than ever,” said Peter Bofinger, a rare Keynesian among austerity lovers in the country’s influential nongovernment Council of Economic Experts. Meanwhile, after a short period of calm following the ECB’s injection of half a trillion euros into the banking system late last year, the cost of financing Spanish and Italian debt has returned to the giddy heights of 2011. “With zero growth and rising interest costs in Spain and Italy, no debt is sustainable,” Fitoussi said. “Even France will be challenged if it goes into recession.”

For the Italian center left—partners in Mario Monti’s national unity government—the demise of “Merkozy” creates the potential for a new, progressive Mediterranean response to the crisis from Italy and France with the support of Spain and Portugal, which, despite their recently elected conservative governments, are aware that only pan-European investment, eurobonds and the full support of the ECB can save the eurozone. Even Monti’s conservative government partner, the People of Liberty Party, has used Hollande’s victory to call for a more flexible approach to the fiscal compact. While Monti, a former European Commissioner, has obediently implemented spending cuts and a reform that will weaken Italian labor unions, he seemed keen to show some support for Hollande’s and Stiglitz’s Keynesian alternative. “I agree with most of what Professor Stiglitz says,” he told a packed audience in Rome’s Chamber of Commerce as center-left leader and former Prime Minister Massimo D’Alema looked on. The devastating protest vote in Greece, meanwhile, makes a second default on that country’s debt appear almost inevitable, and withdrawal from the eurozone an ever more likely endgame.

The stakes are terrifyingly high. If economic slump, mass unemployment and uncontrollable debt are beginning to evoke the interwar years in Europe, so is Marine Le Pen’s bid to replace Sarkozy as the leader of the French right—to say nothing of the success of Greece’s violently racist Golden Dawn. “The fiscal compact is folly for two reasons: it will do nothing to solve the debt problem, and it is hollowing out national democracy, creating conditions for the rise of extremism,” said Fitoussi. In the street outside his office at LUISS University in central Rome, the billboards had been plastered with electoral posters for Italy’s Right Party (La Destra). They showed a radiant Le Pen under the slogan: “In Italy, just as in France, we need coherence.”

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