No 238 Posted by fw, August 5, 2011
The title of this post is in fact Paul Jay’s opening question to Rob Johnson in a Real News Network interview on August 3, 2011. Johnson, an international investor and consultant to investment funds on issues of portfolio strategy, is a Senior Fellow of the Roosevelt Institute and also the Executive Director of INET (Institute for New Economic Thinking).
Watch Johnson’s answer to this and other questions in the following 12:56-minute video titled, Austerity and the destruction of democracy. My slightly edited transcript of the interview follows the video.
Two reasons why what happens in Europe matters to North Americans
Paul Jay – The crisis in Europe continues [with] various forms of proposals for bailouts. But one thing is constant. Everything seems to be predicated on the condition of whether banks are going to be repaid or not. Even though thousands of people, sometimes hundreds of thousands of people are hitting the streets in opposition to the policies of austerity, the policies continue down that path. Now joining us to unpack all of this is Rob Johnson. So why does what’s going on it Europe matter to North Americans?
Rob Johnson – It matters for two reasons. First of which is turbulence over there, in their financial system can propagate right back into this fragile recovery in the United States and send us down again. Just like our Lehman episode from the housing bubble took Europe and Latin America and Asia right off of its feet, something emanating from Europe could do the same to us.
The second reason is that Europe is this composite of many, many different countries and cultures. It’s a rather fragile, what I call “democratic system” as a whole. And it’s a work in progress. And breaking it up now, through the extremes of austerity in places like Ireland, Portugal, Spain, Italy, Greece obviously, could lead to what you might call hostilities. You know this isn’t like we all are Americans and just live in different states. These are completely different cultures.
Paul Jay – In an earlier interview we talked about how investors on Wall Street and other people sitting on a lot of money are using and going to use a municipal crisis, state budget crisis to start big campaigns of privatization. We’re already seeing models for that in Europe and particularly Greece. That this is the prescription they’re offering up. So how much do you envision what’s going on there could happen here, but let’s start with what’s happening there?
“Europe built a political bubble: everybody’s trading on the notion that Germany guarantees everything”
Rob Johnson – Let’s start with what’s happening in Europe in the large. They built a system that’s a political bubble. And what I mean by a political bubble is everybody’s trading on the notion that Germany guarantees everything. And the idea is Germany’s the strong hand. They guarantee everything. Everything’s priced as if it was the credit quality of Germany. And Germany, by playing along in that European system is essentially writing an insurance contract. And you know how insurers are. When they’re collecting your premiums they’re smiling, but when an accident happens they try to wiggle off the hook.
But in 2009 Merkel burst the bubble by saying “We’re not going to guarantee all the banks of Europe”
What happened beginning in 2009 was Angela Merkel stood up and she said “We’re not going to guarantee all the banks of Europe. Every country for themselves.” And she divided Europe .Where all of a sudden the Irish had been part of the European system, they had an enormous amount of bank liabilities relative to their GDP, and now they were left on their own to guarantee themselves.
Greece, Portugal, Ireland and potentially Spain were perceived as “too big to save” But were they really?
Well, as they say “too big to fail” well these were “too big to save”. The guarantees were not credible. So now, all of a sudden you had all these fault lines within Europe emerging again and in late 2009 early 2010 they could see that Greece, Portugal in a downturn, potentially Spain, and Ireland were all in jeopardy. And an ounce of prevention would have been a pound of cure at that time. But that would have been everybody banding together and the Germans providing guarantees to the others, and making good on that promise, which they didn’t do.
Paul Jay – And part of this guarantee wasn’t just that of the good-heartedness of the Germans. German exports were profiting enormously because of the way Europe was structured.
“Germans don’t get to choose now whether they join Europe”
Rob Johnson – Europe as a whole is largely in trade balance, with Germany the surplus country and the rest the deficit country. Now Germany in the current circumstance is actually reorienting their trade towards Eastern Europe and towards the Far East. And they have been growing strongly and may come out really vital. But Southern Europe now is struggling a great deal and the Germans are very reluctant – and this isn’t about logic. For instance Wolfgang Schäuble, the [German] finance minister, is very acutely aware of this and wants to provide those guarantees. But the internal politics of Germany, between the Free Democrats, the SPD [Social Democratic Party], and the Christian Democrats is a constant fight and right now it doesn’t look as if there’s a coalition that can rule the country that clearly wants to conserve and rebuild that common Europe that they embarked upon a few years ago. At this time when you might say the insurance that was given – the guarantees that were given – would have to be collected on. Germany is not showing itself to be the strong hand. That‘s why I called it a political bubble ‘cause they have to make good on the deal. They don’t get to choose now whether they join Europe. They chose that years ago. And now they have to pay the price and they’re reluctant to do so and they’re waffling.
Paul Jay – If you’re sitting in German seats and you look around at the countries they call the periphery and they’re trying to push Italy into that now, the periphery, these policies of austerity one would think are going to lead to a decade or more of deeper recession, Which also, you would think, would hurt Germany because these were such important markets for German products –
Who benefits by pushing countries over the edge into punishing austerity? – People who have money
Rob Johnson – Well, it could hurt German banks because they have a lot of credit extended to places that are now going to deflate and default. And it could hurt German commerce because it was a source of demand as you had suggested. And at the other side it could actually make – if you pushed these places down far enough in austerity – acquisitions on the cheap.
Paul Jay – That’s what I was about to ask you. Who benefits from this is what I’m asking?
Rob Johnson – Well, the people who have money for potential acquisitions in the future. . . . When people get in distress they sell assets at distressed prices.
Paul Jay – And is the other part of it that the banks are just absolutely fixated that they need to get repaid . . . Pay us today and we’ll figure out a way to make money out of the disaster that comes tomorrow.
There is an alternative to driving people into years of punishing austerity – Bankruptcy and restructuring
Rob Johnson – Well there’s part of that. There’s also a fear right now that concerns me a great deal. At the one level we’re told to treat the rating agencies and the banks like they’re the wise men, they’re like the prudent, they’re the ones that understand discipline, etc. Why we think that after 2008 is beyond my imagination. But that is the ritual. At the same time, we’re being told that you cannot restructure. You know when a corporation goes bust – like an airline or whatever – you just do a restructuring — the debt and the equities wiped out – this is almost like engineering. It’s pretty mechanical.
Two arguments against restructuring
But we’re being told you can’t do that to Greece because it creates contagion, contagion of two forms. One, what you do for Greece sets a precedent for what happens to Portugal, Spain, Italy and it gets bigger and bigger.
The second thing is they have these derivatives, credit default swaps are the most notorious, and they’re intertwined through the entire system and nobody knows how much they are because there’s no law or rule that says they can only be as large as the insurable risk, meaning the size of the outstanding Greek debt. So people like Jean-Claude Trichet have no idea if they restructure Greece what they are unleashing – not only within Europe but in the world financial system.
But will grinding austerity rip apart the democracies in Europe’s fragile, debt-ridden economies?
And so we’re at a place where something of the size of Rhode Island or Nevada is holding the world hostage. And what’s happening is when it’s holding the world hostage the world says well we can’t adjust these things financially, we can’t do the restructuring so we have to grind down the people of say Portugal even further. And then you run into the question, can these democracies withstand that much austerity? Or will they rupture? Will they become like a – there’s an old saying in engineering, the elastic limit of a material. You pull it, it springs back. You pull it too far, it deforms.
Bankruptcies and restructuring have worked for hundreds of years. Why not now?
Will we deform the democracies of Portugal and Greece and Spain and potentially Ireland, because we have to put them through the wringer too hard when, for hundreds of years when you get people into that much debt you do restructuring. You have bankruptcies.
In the 1931 banking crisis “the politics could not produce the result”
When you saw the banking crisis of 1931, which emanated from Austria and Germany, there were plenty of things that a logical financier could step back and say systemically you could do this, but the politics couldn’t produce the result. And the result — the politics produced enraged people, and it enraged people to the point where they didn’t trust in government, the government became more dysfunctional, the trust further deteriorated and as you know the system degenerated and it ended up in a world war.
Here we are again — In 2009-2010 the politicians and powerful banking interests could not produce the results
People are beginning to fear that if Greece and Portugal and Ireland have problems it can propagate up if the Germans don’t step in and the French and the Dutch to provide the guarantees then the Euro system can break up and the Italians and Spanish can become individual countries, own currencies and risky again. But it’s a terribly complicated problem to take a common currency unit and take it back apart. So I still think it’s better than a 50 percent chance that won’t happen.
Those are the real stakes. That’s the long term stakes of something becoming dysfunctional, which could have in February of 2010 been solved. But when I say solved — somebody had to pay a small amount of money in the scheme of things. A much smaller amount of money than we will ultimately have to pay even now. But you couldn’t decide who paid at that time. And the banks were disproportionately powerful so they were saying even if those losses occur on our balance sheet we’re not paying.
“The banks own the place”
Paul Jay – Rather than the US playing some role pushing in the other direction, this administration and this whole Congress is going down the same path [as Europe].
Rob Johnson – Well, they are structurally deferential to the financial sector. As Dick Durbin says, senator from Illinois, “The banks own the place.”