FacebookTwitterGoogle+RedditEmail

Wrecking the World Economy

by DEAN BAKER

The world is eagerly waiting to see if the European Central Bank (ECB) will take the steps needed to save the euro. Specifically, is the ECB prepared to act as a central bank and guarantee the sovereign debt of the countries in the eurozone as the lender of last resort ordinarily does in a crisis?

If not, there is little doubt what the outcome will be. The austerity being imposed on country after country will slow GDP growth and throw workers out of jobs. Higher unemployment will worsen deficits, since it means less tax revenue coming in and more unemployment benefits and other transfers being paid out. Higher deficits will cause investors to worry about the solvency of the government, leading interest rates to rise.

This gives us the famous downward spiral that already sank Greece’s economy and government. It will soon sink Italy and Spain if the ECB doesn’t start acting like a central bank. The fallout from disorderly defaults from these two countries will cause banks throughout the eurozone to become insolvent, leading to another Lehman-type freeze-up of the financial system.

The end result will be a second recession and another sharp spike in unemployment, not just in the eurozone, but almost certainly across the globe. The finances and the economies of the eurozone are too intertwined with the rest of the world to envision a meltdown that doesn’t also push the rest of the world into recession. At the end of this story, the euro itself is likely to be placed in the dustbin of history, another failed monetary experiment.

This story is especially painful since this crisis is the outcome of one set of failed policies layered on top of another set of failed policies. The original downturn came about because the ECB, like the Fed and the Bank of England, chose to ignore the buildup of enormous housing bubbles and the resulting economic imbalances.

It was 100 percent predictable that the collapse of these bubbles would lead to a serious recession. The financial crises that accompanied this collapse was also a predictable outcome of the rapid disappearance of trillions of dollars of wealth. Yet the central bankers at ECB and elsewhere were completely caught by surprise.

At least the Fed and Bank of England have been reasonably aggressive in trying to correct the damage they caused. They have both pushed their overnight lending rates to near zero and have engaged in large-scale purchases of long-term debt to try to directly lower long-term interest rates.

By contrast, the ECB never lowered its short-term rate below 1.0 percent and actually raised it to 1.5 percent last spring in order to dampen inflation. While other central banks were trying to boost their economies, the ECB was actually trying to reduce growth in the eurozone.

The question at the moment is whether the ECB will be allowed to continue this course to disaster or whether it will be persuaded by a combination of internal and external forces to change course. The joint action last week by the Fed and five other major central banks is encouraging in this respect. Their plan to extend lines of credit to eurozone banks in other currencies in effect meant that these central banks would supply the necessary liquidity to keep the eurozone economy moving forward if the ECB failed in this task.

While the immediate effect of this measure is limited, it was nonetheless important for two reasons. First, it is an acknowledgement that other central banks can fill the role of the ECB if it fails in its responsibilities to the eurozone economies. There are other deep pockets in the world that can provide the guarantees of eurozone sovereign debt that will be needed to prevent disorderly defaults and the resulting freeze-up of credit.

The second reason that the move was important is that it suggested that the other central banks, most importantly the Fed, would act to fill this role if it becomes necessary. This is not a question of being altruistic. The collapse of the eurozone would be a disaster for economies that are still reeling from the collapse of the housing bubbles in the United States and elsewhere.

In the case of the Federal Reserve Board, a purchase of a few hundred billion dollars of sovereign debt, coupled with guarantees on the debt of Italy, Spain, and possibly other indebted countries, will have far more impact in supporting growth than any other policy that it is currently contemplating. And, as the promoters of the TARP and other bank bailouts endlessly repeat, we will make money on the deal.

Once it is known that Fed is standing behind these countries debt, their interest rates will fall, causing bond prices to rise. This will allow the Fed to resell its holdings at a profit. (This is still a subsidy to the indebted countries, or in the case of the TARP, to the banks.)

The key point is that if the ECB still lacks the competence to manage the eurozone economy then the Fed and other central banks will have to step in. The eurozone is too important to the world economy to allow it be destroyed by incompetent central bankers.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of False Profits: Recovering from the Bubble Economy.

This article originally appeared in The Guardian

Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.

More articles by:
Weekend Edition
June 24, 2016
Friday - Sunday
John Pilger
A Blow for Peace and Democracy: Why the British Said No to Europe
Pepe Escobar
Goodbye to All That: Why the UK Left the EU
Michael Hudson
Revolts of the Debtors: From Socrates to Ibn Khaldun
Andrew Levine
Summer Spectaculars: Prelude to a Tea Party?
Kshama Sawant
Beyond Bernie: Still Not With Her
Mike Whitney
¡Basta Ya, Brussels! British Voters Reject EU Corporate Slavestate
Tariq Ali
Panic in the House: Brexit as Revolt Against the Political Establishment
Paul Street
Miranda, Obama, and Hamilton: an Orwellian Ménage à Trois for the Neoliberal Age
Ellen Brown
The War on Weed is Winding Down, But Will Monsanto Emerge the Winner?
Gary Leupp
Why God Created the Two-Party System
Conn Hallinan
Brexit Vote: a Very British Affair (But Spain May Rock the Continent)
Ruth Fowler
England, My England
Jeffrey St. Clair
Lines Written on the Occasion of Bernie Sanders’ Announcement of His Intention to Vote for Hillary Clinton
Norman Pollack
Fissures in World Capitalism: the British Vote
Paul Bentley
Mercenary Logic: 12 Dead in Kabul
Binoy Kampmark
Parting Is Such Sweet Joy: Brexit Prevails!
Elliot Sperber
Show Me Your Papers: Supreme Court Legalizes Arbitrary Searches
Jan Oberg
The Brexit Shock: Now It’s All Up in the Air
Nauman Sadiq
Brexit: a Victory for Britain’s Working Class
Brian Cloughley
Murder by Drone: Killing Taxi Drivers in the Name of Freedom
Ramzy Baroud
How Israel Uses Water as a Weapon of War
Brad Evans – Henry Giroux
The Violence of Forgetting
Ben Debney
Homophobia and the Conservative Victim Complex
Margaret Kimberley
The Orlando Massacre and US Foreign Policy
David Rosen
Americans Work Too Long for Too Little
Murray Dobbin
Do We Really Want a War With Russia?
Kathy Kelly
What’s at Stake
Louis Yako
I Have Nothing “Newsworthy” to Report this Week
Pete Dolack
Killing Ourselves With Technology
David Krieger
The 10 Worst Acts of the Nuclear Age
Lamont Lilly
Movement for Black Lives Yields New Targets of the State
Martha Rosenberg
A Hated Industry Fights Back
Robert Fantina
Hillary, Gloria and Jill: a Brief Look at Alternatives
Chris Doyle
No Fireworks: Bicentennial Summer and the Decline of American Ideals
Michael Doliner
Beyond Dangerous: the Politics of Climate
Colin Todhunter
Modi, Monsanto, Bayer and Cargill: Doing Business or Corporate Imperialism?
Steve Church
Brexit: a Rush for the Exits!
Matthew Koehler
Mega Corporation Gobbles Up Slightly Less-Mega Corporation; Chops Jobs to Increase Profits; Blames Enviros. Film at 11.
David Green
Rape Culture, The Hunting Ground, and Amy Goodman: a Critical Perspective
Ed Kemmick
Truckin’: Pro Driver Dispenses Wisdom, Rules of the Road
Alessandro Bianchi
“China Will React if Provoked Again: You Risk the War”: Interview with Andre Vltchek
Christy Rodgers
Biophilia as Extreme Sport
Missy Comley Beattie
At Liberty
Ron Jacobs
Is Everything Permitted?
Cesar Chelala
The Sad Truth About Messi
FacebookTwitterGoogle+RedditEmail