European Financial Crisis

There have been recessions before. Unemployment has risen, government revenues have dropped, but after a couple of years some combination of economic policy and new consumer demand has turned the tide and Western democracies have reverted to politics as usual, with parties of the left and right arguing over the distribution of social goods within their own countries. Why isn’t that happening again?

There are plenty of answers that speak to the immediate causes: the economic stimulus packages on both sides of the Atlantic have been too small to restart substantial growth; the European Union bureaucracy has been dysfunctionally slow to respond; the euro zone lacks a process for countries to give up the currency.

But as most people can sense by now, the changes we are experiencing go well beyond these headlines. In many countries, the fundamental political and economic bargain of postwar society is in the process of coming apart. The question, then, isn’t when will public life return to normal? It won’t. Nor should we be asking when will the crisis end. It won’t end for a very long time, perhaps decades. And it will change most people’s lives more profoundly than the end of the Cold War or 9/11 ever did.

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For two and a half decades after World War II, the West enjoyed a remarkably sustained period of economic expansion. Industry thrived, wages grew, there was something close to full employment and tens of millions of people entered the new middle class.  Modern consumer society was born. By the late 1960s, however, this expansion had begun to sputter out. This was not just an economic problem but a serious political one, because businesses had become accustomed to sustained growth and voters to plentiful jobs and steadily rising income. Deviation from this condition was seen as an aberration that the government was obliged to fix.

As Wolfgang Streeck, managing director of the Max Planck Institute for the Study of Societies, has recently argued, this problem of slower growth in the West from the 1970s onward — and the societal expectation that it be overcome — led to a series of crises in the capitalist system. The first was inflation. Faced with recession in the early ’70s, governments eased monetary policy, i.e., printed more money, to raise consumer demand and ward off unemployment. But by the end of the decade inflation had reached the point where investors no longer found it profitable to risk their capital in new ventures and unemployment began to rise. In the early 1980s, again faced with recession, most governments turned instead to large public deficit spending to boost consumption, and in the U.S. and Britain in particular, they aggressively took on unions in an effort to break their power to demand wage increases.

But by the beginning of the 1990s, the resulting national debt and annual budget shortfalls had begun to worry financial markets and they were turned into a major political issue. In trying to maintain economic growth while at the same time cutting the deficit, both Washington and London dramatically deregulated their financial industries, leading to what some economists call “privatized Keynesianism.” By allowing financiers to invent and market endless new forms of private debt, these governments in effect shifted the site of borrowing from sovereign states to companies and individuals who could now fund their own current consumption (and speculation) by borrowing from their own future.

What ensued were two asset bubbles, the first in Internet stocks in the late 1990s, and the second, far more devastatingly in American real estate and the financial instruments derived from it, so-called mortgage-backed securities, which brought down Lehman Brothers in 2008 and began the current crisis.

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Seen in historical context, then, what we are experiencing right now is not simply a particularly severe economic contraction in the ordinary business cycle which will eventually abate. It is the acceleration of an endemic crisis in Western economies that has been building for four decades as we have attempted to replicate the supposedly “normal” economic gains of what were in fact historically anomalous postwar years. This is not to say there hasn’t been substantial growth since the 1970s. There certainly has been. But unlike during the postwar period, its distribution has skewed steadily upward producing an ever-greater inequality of income, particularly in the U.S. While GDP has grown, more in some countries than others, real wages have stagnated over the course of the last 40 years. In addition, over the last 20 years, the deregulated financial industry has become so politically powerful it can effectively block any serious reform of its practices, particularly on a global scale where reforms are needed most, thus locking in the trend of the upward distribution of any overall economic gains.

One of the related effects of this dramatic rise of finance capitalism has been to steadily erode the general public’s ability to understand how the modern economy actually functions. Most people can understand what political forces are at play when a union demands higher wages and a company resists, citing foreign competition. We can choose which politician to vote for based on the position they take in such a conflict and have a reasonable sense of whose interests we are supporting by so doing.

But what happens when a politician says we must lend billions of dollars to undercapitalized banks or indebted countries in order to provide liquidity to the financial system, and if we don’t we will enter a depression or blow up the euro? The content, let alone the truth, of such a proposition is hard for most people to assess. More troubling still, their assessment doesn’t much matter anymore. Because the answer to the question is now considered technical and because the situation demands immediate action, the key decisions are made without democratic consultation by financial bureaucrats working with private bankers. The public is relegated to the role of bystander, reading reports of what the (supposedly neutral but in fact determinedly free-market) technocrats have decided in the name of saving the economy. Financial policy becomes more like foreign policy, conducted by an executive strong-arming a parliament or legislature under conditions of emergency.

And so people get angry: They get angry at bankers, at politicians, at entire countries for not budgeting more carefully, and at the press for failing to explain what’s going on in such a way that they can understand where their interests actually lie.

Which brings us to our current moment. In the United States the bleak economy and the increasingly oligarchic division of wealth have led to protests on a scale not seen since the 1960s. In Europe, the euro is in danger of collapse and the entire postwar project of integration could conceivably begin to run in reverse, far more quickly than most people imagine.

Under intense pressure from the bond markets, Greece and Italy have essentially suspended their democracies and agreed to the installation of European bureaucrats (and former Goldman Sachs advisors) as their prime ministers. Their assignment is to impose steep cuts in public spending, raise taxes and privatize state-run enterprises at a time when their economies are either stagnant or already shrinking. This operation will be painful, the authorities in Brussels and Berlin say, but they will save the patient.

There are sound and, in fact, quite conventional economic arguments about why this will not work. Take the example of Ireland. It accepted these same conditions in order to escape having to pay such high interest on its sovereign debt. In return, it got a European bailout. For a time, the interest rate it had to pay to borrow money declined. But once investors examined how deeply the Dublin government was cutting spending, they decided the Irish economy was unlikely to recover any time soon, there being so little demand for goods. Thus, precisely because of its austerity, Ireland’s bonds now have a higher interest rate than before the bailout, setting the stage for further disaster.

But there is another — and in many ways deeper — reason why the technocrats put in charge in Greece and Italy are likely to fail, and it is related to the larger story of where Western capitalism has been heading for the last 30 years. The decisions the technocrats make will lack legitimacy with the populations they govern. In Europe, this is made clear by the imposition of the leaders by external forces. In the U.S., the imposition of the market’s sovereignty is felt through the now unlimited corporate campaign contributions that effectively circumvent the public preference for a more equitable distribution of income by bribing the Congress. In both places, the demands of the financial elite run against the popular will, and in both places the popular will is being ignored. There is no reason to believe that these abrogations of popular sovereignty cannot be sustained for a very long time with the tactical application of force. But if they do persist they will lead us into a condition we would no longer recognize as democratic. Capitalist, yes. Democratic, no.

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I write this article from Berlin where I have been living for the last three months. I’ve had occasion while I’ve been here to talk to a lot of people from the worlds of business and finance as well as ordinary Germans. And most all of them have held Germany up as the counter-example of what I’ve been describing thus far. The economy has done quite well over the last several years; unemployment continues to decline; there has long been greater cooperation between capital and labor. And here the popular will is being followed. Most Germans don’t want to send more of their tax money south to bail out countries they see as profligate and poorly managed. And their government’s policies more or less reflect that preference. If the crisis leads more countries to be more like Germany — living within their budget, enforcing their tax laws — than so much the better, they say.

As an American, I hail from a country whose banking sector and previous government are more responsible than any other for virtually all the trends toward instability and inequality I have been discussing, so I say what follows with all due humility. German prosperity relies on exports. As global confidence in the euro zone has declined so has the value of the euro, making German goods more affordable all over the globe. Indeed, for several years now, the worse the crisis gets for Europe’s southern rim, the better the German economy does. This is not entirely the German government’s fault, and it’s certainly not the German people’s fault. But it has created a perverse dynamic in which the very instrument that was meant to bind Europe even closer together — a common currency — now threatens to tear it apart.

And this is a tension that cannot be sustained. If enough members of the euro zone are driven into recession by German demands for austerity, and if major, basically solvent trading partners like Italy are pushed toward sovereign default, then Germany’s fortunes will decline. Moral bromides about countries having to live within their means like ordinary families will do no more good for Germany and Europe than they do for alleviating unemployment in the U.S. The structure of global finance is fiendishly more complex than a family checking account and politicians who suggest otherwise, including Barack Obama of late, are doing the public a disservice.

The prospects for even a short-term solution of the European crisis seem dimmer than ever as the interests of different nations within the euro zone are increasingly set against each other in the popular press. Comity seems a long way off and the democratic legitimacy of any resolution even further afield.

It is little comfort to be able to step back and see that this crisis is part of a much broader and endemic instability in Western capitalism that continues to redistribute wealth upward, weaken democratic institutions, and concentrate power in the hands of the few. But it is this larger force, not the daily ups and downs of the current troubles, that will continue to shape our lives for decades. Even if we cannot at present see a path to reversing this force, we can at least endeavor to understand it more clearly.