Since the banking crash, Europe has been engaged in a long drawn out process of trying to shove a problem under the carpet, pat down the lumps and hope no one notices. This is the settlement that is being tested this autumn. What we are seeing at the moment are the first tremors, notably spiralling borrowing costs for Athens. But the worry is that these tremors will get stronger and combine in a toxic way with other problems. The outlook for the US and the UK is now cloudier than it has been at any time in the past three years, yet the US central bank is said to be about to end its quantitative easing regime of flooding banks with cheap money. That may be postponed, but an end must come sooner or later. China’s economy is slowing down, Japan’s is immobile. The Bank of England’s chief economist, Andy Haldane, said this week: “Put in plain English, I am gloomier... This implies interest rates could remain lower for longer, certainly than I had expected three months ago, without endangering the inflation target.”
It is worth recalling that the roots of this crisis lie in a German squeeze on wages, intended to maintain German competitiveness in the global economy, which led to southern Europe becoming uncompetitive in comparison. The difference was largely made up by banks in France and Germany and northern Europe then lending to the south so that the Spanish and the Greeks could keep buying their BMWs and Mieles. When southern European governments could no longer borrow from world markets, the big banks of northern Europe stood to go bust.
The reaction of Angela Merkel and Nicolas Sarkozy was not to force their banks to face up to their bad loans, but primarily to impose a drastic austerity programme on southern Europe. Meanwhile the European Central Bank flooded the banking system with money. The intention was to create the illusion that the banks were still solvent, that the bad debtors were learning their lesson and so on. In the meantime, the banks could sort themselves out.
The consequences of these imperfect solutions are now becoming manifest. Markets are falling and the cost of borrowing is rising, especially in Greece, the place where the Euro-crisis began two years ago. The Greeks have certainly not helped by announcing a plan to dispense with EU and IMF aid, which led swiftly to a flight out of Greek bonds. European leaders strove to look cheerful, but that is not an easy stance when France, Italy and the European Central Bank find themselves confronting a still-adamant Chancellor Angela Merkel over the best way of restoring growth in a flat lining eurozone economy.
France presented its annual budget to Brussels on Wednesday, after refusing to introduce additional cuts the EU had suggested. That will displease Brussels without placating critics of austerity in France. The Italian government’s budget falls just short of such defiance, but will also be problematic for Germany. But the dispute at the heart of the eurozone over the next steps is clearly going to mire the largest economic market in the world in several more years of stagnation. Even if France and Italy find a way to bypass the rule limiting budget deficits to 3%, they cannot embark on the Marshall Plan each believes is needed to turn their economies around. As for the banks, the ECB is due to report soon on which banks are in good heart, which need more capital and which should be closed as beyond rescue. It is an exercise designed to restore confidence in the banking system, but it could have the opposite effect.
Occasionally the idea that things may never get better crosses peoples’ minds, but the reassuring orthodoxy of an inevitable, if much postponed, recovery is a principle upon which much else hangs. If we lose it, Europe will be in deep political trouble. This particular flurry will probably pass, if only because the sheer wall of money in international financial markets needs to find a home. Safe havens, like German and US bonds, pay a negative effective interest rate. Meanwhile, the confrontation between Germany and most of the rest of the EU will probably be patched up. But all this is a reminder that we are skating on very thin ice indeed.
