Socialist Worker

European economies are headed for crash

by Alex Callinicos
Issue No. 2725

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European economies are in trouble


The political disarray the pandemic is causing in Britain and the United States has made the European Union (EU) look good by comparison.

But the EU’s relative political stability is largely a consequence of its fundamentally undemocratic character. 

This was summed up by the former German finance minister and architect of austerity, Wolfgang Schauble. During the Greek debt crisis in 2015 he said, “Elections cannot be allowed to change economic policy.”

Discontent may rise at a national level in electoral successes for the far right or the radical left. But impenetrable and unaccountable EU decision-making processes limit their impact across Europe. 

Behind this political facade the European economy is rotting away. 

The German export powerhouse continues to drive the eurozone, but its core industries are vulnerable to global technological competition.

Established car firms such as Volkswagen are struggling to keep up with the development of electric cars, where outsiders such as Tesla are making the running. And Europe lacks anything comparable to the US and Chinese IT giants. 

But there’s a more immediate problem. The eurozone is slipping into deflation—prices are falling. This reflects the impact of the economic depression precipitated by the pandemic. Goldman Sachs now predicts that the eurozone will contract by 7.9 percent this year.

Consumer price inflation was -0.3 percent in September, down from -0.2 percent in August.

Deflation was worst in some highly-indebted member states that were the target of austerity policies during the eurozone crisis of the 2010s. It was running at -2.3 percent in Greece, -1.1 percent in Ireland, -0.9 percent in Italy and -0.6 percent in Spain. 

This represents a serious problem for the European Central Bank (ECB).

It’s been a long time since it met its target of inflation below or close to 2 percent. “The European Central Bank has completely lost control of the inflation process,” says Ashoka Mody, the International Monetary Fund’s former European deputy director. 

Inflation

From the perspective of neoliberalism, which emerged in response to the combined rise in inflation and mass unemployment in the 1970s, falling prices might seem like a good thing. But this isn’t so, because falling prices make debt harder to service.

Back in the 1930s the American economist Irving Fischer developed what he called the “debt-deflation theory of great depressions”. 

He argued that economic crises begin with high levels of debt. Economic actors try to cut their debt by reducing spending and in some cases go bankrupt.

This leads to falling prices, which increases the value of the debt. There follows a vicious downward spiral of more bankruptcies and falling output, pushing prices further down and debt up. 

As Fischer put it, “Each dollar of debt still unpaid becomes a bigger dollar, and if the over-indebtedness with which we started was great enough, the liquidation of debts cannot keep up with the fall of prices which it causes. In that case, the liquidation defeats itself. 

“While it diminishes the number of dollars owed, it may not do so as fast as it increases the value of each dollar owed. Then, the very effort of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate in swelling each dollar owed.”

The OECD group of leading economies’ worst-case scenario predicts debt-to-GDP ratios next year reaching 229 percent in Greece, 192 percent in Italy and 158 percent in Portugal.

The ECB and other central banks reacted to the pandemic by stepping up their policy of pumping cheap money into the economy.

ECB president Christine Lagarde advocates allowing inflation to overshoot its target to compensate for the current deflation. But cheap credit is keeping alive many unprofitable “zombie firms” highly vulnerable if the economic situation worsens.

The EU agreed on a highly-touted “Recovery Fund” to help the worst hit economies, but this looks set to be too little too late. Europe won’t continue to look good.


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