The US Financial Crisis and the „Decoupling“ Debate in Europe

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The serial bankruptcies on Wall Street are a reality shock for those in Europe who thought the American financial-economic crisis could be pushed under carpet during the US presidential election campaign. Now a debate is underway whether Europe can “decouple” from the crisis in America or not. Protecting Europe is doable, but it necessitates a lot more than financial crisis management.

By Michael Liebig


From August 8th till the first week of September, the European mainstream media dwelled on the Caucasus crisis. After the Sept. 1 European Union summit and French President Sarkozy’s trip to Moscow and Tbilisi (Tiflis) on Sept. 8-9 the hype over an alleged “new Cold War” fizzled out: The Neue Zuercher Zeitung’s article on the Sept. 13-14 annual conference of the International Institute for Strategic Studies (IISS) in Geneva had the title: “No new Cold War on the Horizon”.

During the hype over the Caucasus situation, the US-centered financial and economic crisis became almost a non-issue in the media. Moreover, during August, the US dollar appreciated vis-à-vis the euro and an alleged 3.3% GDP “growth” in the 2nd quarter seemed to indicate that the US economy was far from recession. At the same time, the international financial press carried a barrage of articles pronouncing that European Union economies were plunging into deep recession: Not only Britain, Spain, Ireland and the Baltic States, but the German economy in particular.

Reality Shock

On Sept. 7, reality was back. And for those who even then had missed it, the reality shock came on Sept.14.

The United States government nationalized Fannie Mae and Freddie Mac, with owing or guaranteeing $5300 billion mortgages, on Sept.7. Nouriel Roubini called it “the biggest and most socialist government intervention in economic affairs since the formation of the Soviet Union and Communist China.” Yet, reading the Frankfurter Allgemeine Zeitung, which had described the Caucasus crisis as a “turning point” of world history, one had to gain the impression that the nationalisation of Fannie Mae and Freddie Mac was something just slightly bigger than the insolvency of IKB in Germany. IKB had a balance sheet total amounting to less than 1% of the two US mortgage giants.

Then, on Sept. 15, came the bankruptcy of Lehman and the de facto bankruptcy of Merill Lynch after the US government refused to bail them out or to nationalize them. On top of this, the insurance giant AIG too was tumbling towards insolvency. My guess would be that US government could afford take legal responsibility for the liabilities of Lehman and Merill Lynch (or AIG) on top of the estimated $6000 billion from Fannie Mae and Freddie Mac. Lehman alone has liabilities of $600 billion dollar. One has to realize that the very credit worthiness of the United States of America is now at stake.

The annual US budget deficit is roughly $400 billion. The US current account deficit is arround $800 billion. About 50% of the US treasuries financing the the total US government debt of more than $9000 billion are held by foreigners. The decision for the nationalisation of Fannie Mae and Freddie Mac was already significantly influenced by foreign governments who feared for their investments in two GSEs. These foreign governments, notably in Asia, have demanded that the US government take action to protect their investments.

There is a nagging doubt that the United States government is sliding into a situation where it may be unable to service its foreign debt. Many things have been “unthinkable” until the past few months. Is an Argentina-style debt moratorium really unthinkable for the United States?

The US government, the Federal Reserve and the American financial “industry” have created the biggest debt bubble in world history. If there is any meaningful historical comparison, the United States today would be in a financial condition similar to that of Germany after World War I. Let there be no misunderstanding, only a morally and intellectually defect person could feel schadenfreude over the crisis in America. But the plain fact is: In real history, there is no “American exception”.

The “Decoupling” Debate

In a bloomberg interview on Sept. 15, the Swiss financial analyst Marc Faber said that the serial bankruptcies on Wall Street were not necessarily “a disaster for the rest of the world”. I think, this is a correct assessment. What is probably the worst financial crisis in American history does not mean the terminal breakdown of the world financial system. That nonwithstanding, the global financial system has already dramatically changed over the past twelve months, and it will further radically change. Even the Frankfurter Allgemeine Zeitung’s lead editorial had to acknowledge on Sept. 16 that the “fifth shock wave rolling over financial markets” since August 2007 means that the financial system “will never be the same”. And Roland Koch, the “pro-American” State Governor of Hesse, where the German banking center Frankfurt is located, said that the times of “imitating American standards” in finance are over.

If you look at the German, Swiss or British financial media, you see that there is a heated debate whether Europe will be pulled down by the crisis in America or not? Those who claim that “decoupling” is impossible are the same who, literally until yesterday, were pushing the line that Europe must imitate the American example: Financial deregulation plus “innovation” and public and private debt expansion. What supposedly assured a dynamically growing economy, led the USA into a giant debt bubble which is so painfully bursting now.

I would think that Europe will be affected by the US crisis, but it won’t be overwhelmed by it. My perception is that a new type of “protectionism” is emerging in Europe, albeit a problematic one. While the bankruptcies at Wall Street were about to be announced, the Eurozone finance ministers met in Nice, France. Little was announced afterwards except that Luxembourg’s Jean-Claude Juncker will remain chairman of the Ecofin group and that Eurozone governments would not go for US-style “reflationary” policies. In parallel, the European Central Bank acts very differently from the Fed: Interest rates in the Eurozone are at 4.25% compared to the 2% in the USA, meaning at least 3% negative interest rates in America and a moderate 1% interest rate in Europe. Economic statistics are faked everywhere, but in Europe, different from the USA, prices for food, energy and gasoline are not excluded from calculating the inflation rate.

A quiet consensus in Europe seems to have emerged that the past years’, US-driven financial asset price inflation must be reversed – precisely by avoiding interference into the ongoing deflation dynamic of financial assets. 12.000 billion dollars have “evaporated” alone on world stock markets since October 2007 (other estimates go as high as 17.000 billion dollars). This gigantic financial asset price deflation is the result of market-driven financial deleveraging — not the result of far-sighted regulation, which, of course, is indispensable and urgently required.

The “hard core” in the ECB, centered around the Bundesbank, wants this financial deleveraging to proceed “naturally,” while avoiding an uncontrolled, chain-reaction collapse in the financial system.

One must not forget that American-style “reflationary” policies leading to debt bubbles, albeit with certain European peculiarities, have been applied in quite a few European countries. The disastrous results of this approach, we can now witness in Britain, Spain, Ireland, and, in particular, in the Baltic states.

Investment in the Real Economy

What is dangerously missing in this European approach of “financial traditionalism,” is the protection of Europe’s real economy from the consequences of the US-centered crisis. The danger of a recession in Europe next year is real. The German export industries have been profiteurs of the US debt bubble and the “bubble economies” in Europe. German exports into these markets will shrink. They will have to be compensated by other markets. That may be difficult, because China, Russia and other emerging economies too will pass through a difficult adjustment phase, refocusing on internal economic development.

Therefore, the stimulation of the domestic real economy will be vital for Germany (and other EU countries), but not by US-style “reflationary” policies, stimulating financial profits, real estate bubbles and debt-driven consumption.

German economists like Wilhelm Hankel and the late Claus Noe have rightly emphasized that the first and foremost task is a new economic policy which encourages and promotes the redirection of vast amounts of private savings out of the financial sector and into productive investments in the real economy. Germany has a very high savings rate of 11% GDP and a vast capital stock has accumulated in private pension funds. This capital has to be directed into education, infrastructure, advanced technologies on a national scale as well as transnational infrastructure projects. Italy’s finance minister Gulio Tremonti has proposed to use the European Investment Bank (EIB) for such investments in the real economy. Bonds issued by the EIB may have low yields, but, different from “innovative” financial investments, they are safe! If such a economic strategy is being pursued in Germany and Europe, the decoupling from the US-centered financial crisis is doable.

If such a policy is not implemented, Germany may be in a real recession in one year from now. And in September 2009 there are Bundestag elections. The Chancellor candidates are Angela Merkel for the Christian Democrats and Foreign Minister Frank-Walter Steinmeier for the Social Democrats. Neither has yet spoken up on how to avert a recession. This will be the dominating issue next year. Without a new economic strategy on a national and European level, one thing seems certain: The newly formed “Left Party” will make big gains in the Bundestag elections.

But first, there are elections in the United States on Nov. 4th. The next US Preseident will face a Gargantuan task trying to sort out the financial and economic mess in America. The natural impulse of the main economic and political actors on the world scene will be protecting their economies from the fallout of the American financial-economic crisis. Once the dust has settled in the United States – financially, economically and politically — the task will be building a new multipolar financial architecture. In China, Russia, the European Union, India and Brazil the active design work for a new world economic order must commence without delay.

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