November 21st 2015

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Articles from this issue:

COVER STORY Gender variety has no basis in science

CANBERRA OBSERVED PM's political capital may be tax-reform casualty

EDITORIAL IPCC and the media: Last Tango in Paris

FOREIGN AFFAIRS Poland's election sends shock waves through EU

THE ELECTRONICS REVOLUTION Create infrastructure to bridge coming robo gap

LIFE ISSUES Keeping a straight face with Andrew Denton on euthanasia

LIFE ISSUES With Nitschke out of death industry, Exit must go next

EUROPEAN AFFAIRS Euro banks were lending like there's no tomorrow

INTERNATIONAL AFFAIRS Polls show conservative resurgence at grassroots

RELIGION IN RUSSIA State control, Slavophiles prepare way for apostasy

CULTURE Mankind needs to work; and mankind needs work

PUBLIC POLICY Drug substitutes used as treatment are lethal

CINEMA The man who stands back up: Bridge of Spies

BOOK REVIEW We're getting better all the time


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Euro banks were lending like there's no tomorrow

by Colin Teese

News Weekly, November 21, 2015

The ongoing saga of Greece has, for the moment, been and gone through the headlines. That being so, it is appropriate to have a fresh look at things and introduce readers to further insights that might help make the whole mess more understandable.

Economist Ann Pettifor.

That is, to the extent that Europe’s problems are economic. For the purpose of this article the problems now raging in relation to immigration are not considered – though these cannot, in the final analysis, be regarded as unrelated to the problems of unity confronting the European Union (EU).

Europe burning, as it has been over the last four or five years, is not a pretty sight.

Informed comment on the crisis in the Eurozone involving Greece on one side and Germany, the International Monetary Fund and the EU bureaucracy on the other, has brought together much scratching of heads along with an insufficiency of understanding. For the record, this writer readily admits himself to be up there alongside the puzzled.

At least, that was, until recently.

The transformation came courtesy of a long article written by Ann Pettifor. Pettifor, a London-based economist unburdened with orthodox economic thinking, had forged a reputation as something of an expert on country indebtedness – especially for developing countries. (She was instrumental in having written off $US100 billion of third-world debt – mostly in Africa and Latin America – at the beginning of the 21st century.)

More recently she has become known as perhaps the only economist genuinely able to claim having anticipated the global financial crisis (GFC).

In 2006 – one year before the onset of the GFC – Pettifor recorded her views in a book entitled, The Coming First-World Debt Crisis. In her own words, the book bombed out on publication, but a year and a half later it became a bestseller.

Since then she has undertaken a thoroughgoing analysis of how Europe got itself into such a mess after the GFC, which thus far has pushed the so-called “Troika” – the EU’s Brussels-based bureaucracy, the European Central Bank (ECB), and the International Monetary Fund (IMF) – into a mutually destructive confrontation with Greece. That confrontation remains unresolved.

As Pettifor explains it, what lies behind the troubles is an outstanding debt owed by governments, businesses and peoples in southern Europe (most seriously Greece) to northern European banks that lent imprudently large sums to the southern European members of the Eurozone.

The reason the northern banks were so quick with irresponsibly large lending becomes clear when one reads the text of the Maastricht Treaty – the European Union’s policy instrument responsible for the creation of the currency union that includes most of the EU’s member countries.

Maastricht imposes on all member states of the EU – but more especially those who have adopted the common currency – severe constraints when it comes to financial management of their economies.

They are required to maintain spending in such a way that their annual budget deficits do not exceed 3 per cent of gross domestic product (GDP). Within that constraint Eurozone member governments are obliged to take responsibility for debts owed to foreign banks, regardless of who incurred the debts, the government or the private sector.

Maastricht taken as call to party, party, party

Taken together, these obligations effectively crippled the capacity of the Greek and other governments to manage their economies. With this advantage the northern banks (mainly in Germany, Austria, France and the Netherlands) saw a wonderful opportunity to embark upon a lending spree.

The Maastricht Treaty’s guarantee that governments of individual member states would, in the last resort, be responsible for any foreign bank loans within their borders, encouraged banks to lend without regard for the borrowers’ capacity to repay.

Likewise, borrowers could borrow without due regard for their capacity to repay.

Moreover, the northern banks were mostly financing the exports of their home-based manufacturers. In many cases importers were encouraged to import more than they or the economy could afford.

The reality was that member states of the Eurozone – not only Greece – were powerless to prevent private borrowers from undertaking debt obligations beyond their capacity, and for which the governments had ultimate responsibility.

Eurozone member states were tied into a currency structure geared to the northern euro countries that rendered the export industries of the south uncompetitive. Tied to the common currency of the Eurozone, they could not devalue to make the debt more sustainable.

Greece was the hardest hit. For the so-called Greek Oligarchs – a rich elite that effectively controlled the media and the Parliament for their own benefit, and whose vast fortunes are beyond the reach of tax collectors – the new arrangements were incredibly attractive. They, together with those controlling EU economic policy, created havoc for the Greek economy and left it with an unmanageable debt.

Ann Pettifor tells us how this happened and what prevents it being fixed. She points out that the Eurozone is founded on a belief in the idea of a fixed price for all currencies measured against gold. The so-called “gold standard”.

This idea has dominated European economic policy formation since the 19th century. Banking and financial interests have been the prevailing policy influence and their concerns have been to ensure the safe mobility of capital across national borders. “Safe” meaning that the value of international loans is fully protected. In a gold-standard system, all currencies are of the same value; nations with a debt problem cannot gain relief by devaluing their currency, and thus the value of their debt.

This was the case in the 19th and earlier part of the 20th centuries in Europe, Britain and the U.S. Each country’s spending was limited by its gold holdings. Eventually the system broke down so completely that by 1920 it had totally destabilised the world economy.

What followed were 25 years of chaos. This prevailed until economic order was restored by the negotiation of the Bretton Woods Agreement in 1946. That agreement, itself a gold-standard mechanism, created the U.S. dollar as effectively the currency of international trade. The U.S. government guaranteed to pay, on demand, in gold, a fixed price for every dollar held by a foreign government.

The system differed from the gold standard in one important respect; and by this means, unlike its predecessor, created a stabilising mechanism for the conduct of international trade. The change was that, in return for fixed-currency relationships, strict controls were put in place to control capital flows over borders.

The Bretton Woods agreement collapsed in 1971 when the US could no longer guarantee to exchange gold for US dollars at a fixed price. Without Bretton Woods the world of fixed exchange rates was no longer possible. What replaced it was a deregulationist system with effectively no government agreement about currency relation­ships and free movement of capital flows.

Poison mix of fixed currencies and free capital flows

The emerging European integ­ration movement (then known as the European Economic Community) never wanted Bretton Woods and even before its collapse was busy trying to bring the EEC member states into some kind of fixed-currency relationship, though without much success.

Europe’s finance sector was once more gaining control. Twenty-five years later the Maastricht Treaty represented the resurgence of an influence that had drawn Europe into the arms of fascism and World War II. An influence that, ironically, the creation of European integration was intended to suppress.

Ann Pettifor points out that some dedicated European integrationists who were firmly behind Maastricht now recognise that current monetary policy is undermining the real economy.

The combination of monetary influences behind the Maastricht Treaty are the “Troika” I referred to earlier: the Brussels bureaucracy guiding the European Union and the Eurozone, the IMF, and the misleadingly named European Central Bank. The Troika have become the enforcers of the policy of fixed currency and free capital flows. This has once before brought Europe to its knees and is in the process of doing so again.

The strange thing about all this is an attitude that seems an essential part of modern political life. The protagonists seem willing to advance propositions they well know cannot succeed, yet they pretend otherwise to advance the claims of special interests.

For example, in the case of Greece, simple arithmetic demonstrates that it can never repay its debts, but that fact cannot be acknowledged because a treaty exists that has specified otherwise, and that treaty must be enforced even though that its aims cannot be fulfilled. More than that, the treaty’s integrity must be defended even to the extent that that defence will subvert economic and political fundamentals.

If the basics of a treaty cannot be fulfilled, then the instrument itself must be flawed.

There is, however, nothing in all this to suggest that economics has been captured by politics. More likely we might conclude that Europe attaches greater importance to making money than to making things, when common sense suggests that the opposite should be true.

Perhaps also, those charting the course of European integration have lost sight of the original objective – to make the continent safer and better for all Europeans. European leadership seems to believe that economic growth can be achieved on the basis of lending money to make money.

We seem to be observing a Europe in thrall to financial interests on the basis that those can best serve wider European interests. If nothing else, evidence of the past and the present should give Europeans pause to question the wisdom of that belief. At least that seems to be Ann Pettifor’s message.

Colin Teese is a former deputy secretary of the Department of Trade.

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