It is now five years since the longest slump in the global economy since World War II was triggered by a financial crisis in the US in August 2007. And there is little sign of a letup, with a number of indications that September 2012 is shaping up to be a crunch month. Although Europe’s sovereign debt crisis is at the eye of the storm, the effects are increasingly being felt in many other parts of the world.
Five years on and still no sign of relief
August 29th, 2012
The building blocks of the crisis had been moving into place for some time, but the world became acutely aware of it on 9 August 2007. On that day the European Central Bank (ECB) released €95 billion on the markets when the exposure of European banks to the American housing debt crisis became clear.
Less than two weeks later, on 21 August US treasury bills crashed from 3.76% to just 2.55% in two hours. It was even more dramatic than the crash of 1929.
And it was not only in the US that a real estate financing bubble had been building for some time. In Spain 800 000 homes were built in 2007 for a market of only 250 000. In Britain 5% of GDP was extracted per year in home equity.
The so-called “sub-prime” crisis in the US was not the problem in itself, but rather just a symptom of a much wider structural problem in the global economy.
It was but the first “bubble” to pop. Already in December 2007, a Swiss Central Bank commissioner, Thomas Jordan, warned that the crisis could make 1929 look like a “walk in the park”. The sub-prime mortgage crisis "hit a vital nerve of the international financial system," he said.
Five years later the global economy is still at a point where industrial output is well below previous levels: Germany (-2), US (-3), Canada (-8) France (-9), Sweden (-10), Britain (-11), Belgium (-12), Japan (-15), Hungary (-15) Italy (-17), Spain (-22), Greece (-27). Judging by these figures, the crisis is proving to be more intractable than the “Great Depression” of the 1930s.
Seeds of the crisis
The seeds of the present crisis have been sown over a long period. In the developed world, debt ratios rose from 167% of GDP to 314% over the preceding 30 years. Along the way a situation developed where far too much liquidity, on the back of far too low interest rates, was chasing too little consumption and too few assets.
In the process, among others, the world saw the development of complicated financial “products” chasing profits in areas like the so-called derivative market, which are totally divorced from the real economy where tangible goods and assets are produced.
In the words of Nouriel Roubini, the New York University economics professor who first predicted the financial crisis, a “perfect storm” was globally in the making.
By January 2008 it was clear that the trouble, first noticed in the US, was morphing into a full-blown crisis in Europe, risking the collapse of the European Monetary Union (EMU), commonly known as the eurozone.
The sovereign debt crisis in Europe, which among others, has Greece teetering on the brink of bankruptcy, led to controversial and socially destabilising austerity programmes and a proliferation of bailout plans for the weaker eurozone members followed.
Where do we stand?
As the crisis enters its sixth year the eurozone looks more vulnerable than ever. Banks, large corporations and even some euro zone governments are preparing for the possibility of its breakup. Cross-border lending within the eurozone is steadily declining, with banks and companies financing their operations locally, reducing risks.
Not only are banks and other financial institutions scaling back on loans in other countries but in some instances are even cutting links to their own subsidiaries there.
Banks are also parking excess capital reserves at central banks rather than risking devaluation, especially if countries in southern Europe reintroduce national currencies.
Oil giant Shell surprised the markets recently by declaring that, rather than taking credit risks in Europe, cash reserves are being moved into US government bonds or deposits in US banks.
The amount of open financial betting against the eurozone in the form of so-called “short positioning” has sharply risen over the past twelve months.
Finland’s minister of foreign affairs, Erkki Tuomioja, said recently: “We have to face openly the possibility of a euro breakup. It is not something that anybody ... is advocating in Finland, let alone the government. But we have to be prepared.”
Similar sentiments were expressed by influential political circles in Austria.
Those who want to save the EMU pin much of their hope on the ECB's upcoming bond-buying programme, which is intended to drive down sovereign yields and buy time for countries to reform and for the eurozone to integrate financial and fiscal policies.
But to get private investors, crucial to recovery, to start buying bonds again and for banks across the zone to resume lending to each other, it is crucial that confidence in the zone is restored. At this point, however, markets remain highly skeptical.
The European Commission will also, next month, propose European Central Bank supervision over all of the eurozone's major banks.
But Europe’s main instrument to prop up weaker eurozone members, the European Stability Mechanism (ESM) could be under threat. Germany’s Constitutional Court will decide in September whether the ESM is compatible with the country’s constitution.
At the same time it is increasingly becoming clear that austerity -- German chancellor Angela Merkel’s preferred policy option -- alone will not be enough to restore the health of the eurozone. Ten days ago this policy saw a revival of protests amongst civil servant in Spain and drastic austerity programmes did not do the trick for Greece.
In September “troika officials” of the ECB, European Commission and the International Monetary Fund (IMF), overseeing the Greek programme, will visit that country to check on progress. It is unlikely that all of the €130 billion European bailout package will ever be paid out. Even if it is, it is unlikely to save Greece while it stays in the eurozone without the option of devaluation as a mechanism to write down some of its debt.
There was also, recently, a clear indication of how the eurozone crisis is adversely affecting countries outside Europe.
Morocco in north Africa, long a model of relative prosperity, had to seek help to the tune of $6.2 billion from the IMF. The IMF says it offered the loan to help Morocco cope with fluctuating energy prices and the effects of Europe's economic troubles. Some austerity demands came with the loan.
The latest economic figures indicate that Europe is edging closer to recession, dragged down by the crippling sovereign debt problems. Europe's stumbling economy is making it harder for other economies around the world to recover.
Figures presently coming out of China and the US which, with Europe, are the global economic super powers, do not look very promising either. China’s economy seems to be heading for a “harder landing” than hoped for and the US for another recession.
Too much globally accumulated debt, not just in Europe, is at the heart of the crisis. And, in the words of Abrose Evans-Pritchard, international business editor of Britain’s Daily Telegraph: “Much of the debt will have to be written off. Whether this is done by inflation (1945-1952) or default (1930-1934) will be the great political battle of this decade. Pick your side. Pick your history.”
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