What the EU summit means for debt
Overnight EU leaders minus David Cameron agreed to abolish government budget deficits. Given that government budget deficits did not cause the financial crisis, this is like shutting the wrong stable door after the horse has bolted.
Meanwhile, the UK refused to sign-up to the deal, not because of concerns over such rigid austerity, but because of a perceived threat to the interests of one-square mile in the centre of London.
Debts build-up between countries when one nation imports more than they export, and another state does the opposite. As Martin Wolf in the Financial Times showed earlier this week, it is trade deficits, not government deficits, that explain which European countries are at the forefront of the crisis.
Those Eurozone countries with the largest trade deficits prior to 2007 were Estonia, Portugal, Greece, Spain, Ireland and Italy: sounds a familiar list. However, the countries with the largest government deficits were Greece, Italy, France, Germany and Austria.
When a country imports more than it exports the difference is made-up by borrowing, creating a debt, whether owed by governments, private companies or both. Debt crises hit when the debt repayments get too big and there is a sudden shortage of lenders to that country.
The focus on cutting government spending and increasing taxes misses the original cause of the crisis – the imbalance in imports and exports. It serves to weaken the economy, making it even more difficult to meet debt repayments, sending countries into at best stagnation and at worst a tailspin decline. What it definitely does not do is reduce the debt.
The debt crisis in Europe now is not new. They have been happening regularly for thirty years: the original Third World Debt crisis which began with Mexico’s default in 1982, the following 20 year stagnation in Latin America and Africa, the Asian financial crisis in 1998, the Argentinian crisis at the turn of the millennium.
In all these crises, focussing on government budgets and austerity – usually enforced by the IMF - has made the situation worse, causing suffering and poverty for hundreds of millions of people. But they also point to different solutions. Argentina defaulted on its debt at the end of 2001. Coupled with devaluation of the currency and bringing in controls over money crossing its borders, the economy was soon recovering and has been growing ever since.
Iceland had one of the biggest trade deficits and booms prior to the financial crisis, and its economy consequently crashed by more than most when the credit crunch hit. But it then broke away from the failed economic orthodoxy and allowed banks to fail, especially on debts owed to the rest of the world. It brought in controls to prevent massive flows of money out of the country. It allowed its exchange rate to rapidly devalue. And it maintained government spending, with a switch of funding towards lower income households which has been claimed to have reduced inequality through the crisis. The Icelandic economy is now recovering.
This stands in stark contrast to the European recipe of protecting reckless lenders from any losses, creating mass unemployment to force an internal devaluation (ie, wage cuts) and austerity piled on-top of austerity.
Over thirty years ago, most countries stopped regulating the flow of money across borders. Such global capital flows – lending and borrowing – have boomed. Large trade deficits and surpluses, and the debt they bring with them, are created by these huge inflows and outflows of money.
Really getting to grips with the crisis means cutting the debt between countries – whether through defaults or more orderly debt cancellation. Earlier this year the EU finally began to recognise that Greece’s debt is too big, and proposed a small reduction in some of the debt. The EU summit has now decided the Greek write-down is “unique and exceptional”. The private lenders are to remain protected from the consequences of their reckless actions.
To prevent future crises, finance needs to be regulated so these debts and surpluses are not created again, and trade is much more balanced. This means actively regulating and controlling lending and borrowing across borders, especially by banks.
In the confusion that always follows any European ‘deal’ it has been suggested that one element of the latest plan is to regulate the financial markets which caused the crisis. The extent and effectiveness of any proposals are yet to be seen; I can see no reference to them in the statement by EU leaders. But whatever hint of regulation there is led British Prime Minister Cameron to refuse to sign-up; nothing can be done against the interests of the City of London.
The point of regulation is to make it more difficult for financial markets such as the City of London to cause turbulence with their wild flows of money into and out of countries. One specific idea is to bring back capital controls; policies which regulate and limit the amount of money flowing across borders, preventing huge debts building-up between countries.
For those who care about people rather than financial markets - whether in London or Lusaka, Birmingham or Buenos Aires – limiting flows of money across borders might seem a worthwhile thing to try.