Looking over the edge

Never mind another recession. What Europe (and the world) faces is something much more sinister and catastrophic.

Christine Lagarde, until recently the finance minister of France, took over as managing director of the International Monetary Fund (IMF) only on 5 July. But her IMF has wasted no time in sending out some blunt messages to both Europe and the United States. 

Speaking in Dublin last week (14 July), Ajai Chopra, one of Lagarde’s senior officials, called on eurozone leaders to stop dithering.

He called for “prompt implementation” of steps to head off the growing threat to Europe’s financial stability and the world economy. “What is critical now is for Europe to dispel the uncertainty being created by what is perceived by markets to be an insufficient response,” he said.

In Rome on the same day, Italy’s Finance Minister Guilio Tremonti, a little recklessly, but accurately, summoned up the sinking of the Titanic to describe the peril. “Just like on the Titanic, not even the first class passengers will be saved,” he told the Italian Parliament in what appeared to be a reference to the hard line being taken in the Greek bail-out talks by Germany, which was successfully fighting off efforts by its partners to call an emergency summit of eurozone leaders last weekend.

That global financial markets could drive Italy and/or Spain into the same parlous financial state as Greece, Ireland and Portugal scarcely bears thinking about. A senior economist at a top-ten eurozone bank admitted privately last week that his giant institution would “be swept away” if Italy became caught up in peripheral Europe’s debt meltdown. The European Banking Authority’s stress tests, released last Friday (15 July), did not directly address the liquidity risks that transatlantic banks would face if the looming disaster were not contained.

Lawrence Summers, until last year President Barack Obama’s top economic adviser, warned on Monday (18 July) that with the tumult in Italian markets, the European financial crisis had entered “a new and far more dangerous phase, threatening both European monetary integration and the global recovery”.

He should know. For what helps to make the current crisis so dangerous is that confrontational politics in the US have increased the chances that it too may slip towards its own, self-induced, sovereign-debt disaster. 

Last week two (US-owned) credit rating agencies, Moody’s and Standard and Poor’s, both warned that the US could default on its debts. They decided to put the US’s triple-A debt rating under review.

Congress is being asked to approve, by 2 August, an increase in the amount of debt the US government is allowed to borrow. If it does not, there is the risk of a “short-lived” default, Moody’s said.

Intermittent stand-offs between the White House and Republican and Democratic congressmen have, in the past, always been relatively painlessly resolved.

But what today’s confrontation is doing is reminding international investors that, as in Europe, a deep political/ideological divide is blocking efforts to reach a compromise on how to tackle the US’s huge government debt burden. This is far from reassuring in view of the US’s dependence on foreign investors to support its troubled economy.

With debt disasters looming on both sides of the Atlantic, it is little wonder that behind the scenes, finance ministers and central bank governors of the Group of Seven (G7), a body which some observers thought had been displaced by the wider Group of 20 (G20), have once again been hard at work. The G7 has already held at least one conference call on the Greek crisis – during the weekend of June 18.

In a report released last week, the IMF itself warned of the perils ahead, saying that “the window of opportunity to prepare the [global] financial system against potential systemic shocks could close unexpectedly”.

Even as these words were being discussed at a meeting of G20 deputy finance ministers in Paris on 9-10 July, the window of opportunity they referred to was starting to close.

Toxic debt disease

On Monday the yield on ten- year Italian bonds penetrated the 6% level again amid fears that it was now being infected by the contagious and toxic debt disease that had gripped Greece, Ireland and Portugal.

With a debt to gross domestic product ratio of 120% and €900 billion of debt having to be refinanced in the next five years, it required no imagination at all to conclude that, uncontained, Italy’s problems would present the transatlantic economies with another systemic financial threat. Tremonti’s success in driving his €48 billion austerity package through Italy’s parliament is an important step in the right direction – but only a small one.

As European Voice went to press, the financial markets were wondering whether eurozone leaders would, at their summit tomorrow (21 July), finally step back from the edge of the precipice.

Clear agreement on mechanisms through which private-sector lenders could be bailed in to a second Greek rescue package would be a start. Lorenzo Bini Smaghi, an executive board member of the European Central Bank (ECB), last weekend (16 July) indicated that an agreement is needed to allow the eurozone’s bail-out fund, the European Financial Stability Facility, to buy on public markets the bonds of troubled sovereign borrowers.

Graham Bishop, a financial expert, says that eurozone leaders must finally adopt the comprehensive economic governance agenda proposed by the European Commission, enhanced by the European Parliament and backed by the ECB. “It’s either political union of the eurozone, or disaster is at hand,” he says.

Such a disaster would be global, not just European. Given the weaknesses of the transatlantic economies and their tight integration, a second downward leg in, the so-called Great Recession” of 2007-09, would not be just a ‘double-dip’. It would turn into a catastrophic plunge reminiscent of the Great Depression of the 1930s.

Stewart Fleming is a freelance journalist based in London.