Angry Fragile World

Facing the devil to avoid the deep blue sea. That is how many people felt about the 2008 bank bail-outs. Having to save those well-paid bankers from the “creative destruction” of the free market, after they had always pled for the free market regardless what, was not something that people liked to do. However, it was considered an inevitable price to pay in order to avoid a second Great Depression and in order to quickly catch up again with better times. Now, as the crisis appears to last longer than expected and as bankers are still awarding themselves bonuses, anger in Europe and the Unites States is growing. The anger fits in the long line of protest we saw in many other countries in 2011.

The first debt mountain

Why the forecast of a strong but short pain did not come through? The reason is that the debt bubble, created by consumers and bankers for many years, turned out to be so huge that it continues to threaten the system, even if these debts have partially been re-allocated to states. A situation which took many years to grow wrong, cannot be straightened out in a couple of years.

American citizens, using the rising prices of their houses as a guarantee, put aside so little savings and lent so much money, that they were in effect the world’s economic engine for years. As a kind of global vacuum cleaner they assured the purchasing power that “sucked up”  the stuff produced by the ever growing world economy ( China kept on building new plants!). The American housing prices increased, because many people bought a house, often on a credit which was clearly  too high to ever be reimbursed. Did you know that an irregular migrant-strawberry picker with an annual income of € 10,000 could get a loan of € 550,000? This was only possible because the financial sector derailed completely, in absence of any regulation. The ones who sold this sort of credits, took a percentage and sold them to investment banks, the mighty magicians of Wall Street. There they were repackaged and clustered with thousands of similar loans into so called mortgage bonds. Strangely enough, rating offices rated these bonds as triple A – the maximum reliability – thus making it easy to sell them worldwide. 

The gap

The debt mountain of bad mortgages and consumer credits did not just appear by itself. It was meant to bridge a social gap. Raghuram Rajan, professor in economics in Chicago and former chief economist of the IMF, was the first to put the finger on the link between the financial crisis and the tremendous income inequality in the US: 56% of all economic growth between 1976 and 2007 went to the richest 1% of the population. The credit system was the only way to include the growing numbers of poor Americans in the American dream. Only thanks to credits, they were able to afford houses, cars and other “stuff” to make them feel part of a materialistic society such as the US. Their income alone was not sufficient.

The income inequality did not only increase in the US. According to the Organisation for Economic Co-operation and Development (OECD), there has been an increase since 1985 in nearly all rich countries but France, Greece, Hungary and Belgium. It is true that income inequality in the US grew faster, because taxes are less redistributive and because employees didn’t succeed in protecting their income and their working conditions, given the poor social laws and weak labour unions. In the meantime, the reason for the growing inequality became clear as well. Even the IMF admits in its last edition of the World Economic Outlook that in the richest countries, middle class is losing territory as good industry jobs are being shifted to low income countries and replaced by less well-paid jobs with a low productivity growth in the service sector. Skilled labour nowadays offers a large renumeration premium. ‘…there has been  an adverse impact on a large class of workers in advanced economies, particularly in manufacturing, and prospects for this class are dim’, says the IMF. ‘Redistribution must be part of the policy response, the potential benefits include social cohesion and continued support for globalization.’

Thus, the financial crisis grew out of the rising income inequality, caused by the globalization, and the way in which the US reacted to it: with credit. Exactly this credit was the globalisation’s catalyst: without the blown up demand in the US, it became difficult for China to find a large enough market for their products. If that pent up demand from the US weakens,  there is a problem.

A second debt mountain

The bubble burst when the real estate prices in the US went down. The bankers who lured poor Americans into obscure mortgage formulas were threatened by bankruptcy. In the same situation were the Spanish and Irish construction companies and the banks who had provided them with credit. After having saved a few banks already, the American government decided to stand its free market ideology and let Lehman Brothers go bankrupt. It turned out to be a disaster. The money system froze immediately and a cataclysm of bank bankruptcies was imminent. The money system is the economy’s nerve system: when it collapses, the whole economy collapses. Therefore, the free market ideology was very quickly abandoned and governments took massive loans to protect the falling banks. They furthermore decided to do whatever it takes to play the role of the former ‘vacuum cleaner of the world’s stuff’ – the American consumer who had to start paying off debts. With large public spending projects, governments (especially in the US and China) kept the economy going. This happened of course through credit, which further inflated the public debt. The call by some to use these public spending programs to turn the economy and especially the energy production green  – in a so called Green New Deal – was only realized to a limited extent.

The price of banking without regulations

The bank rescues and the increased public spending stopped the free fall. In 2009, most rich countries’ economies shrunk, but afterwards the economy bounced back, at least for a while. China even reported a growth of 8% in 2009. The country had ordered its national banks to invest massively in buildings and infrastructure. As a consequence, China now consumes on average 40% of the world’s natural resources (except for oil), resulting in increased commodity prices, which stimulated economic growth in commodity exporting countries.

Over all, the crisis was less severe in the developing countries, as their financial sector was not liberalized – despite pressure of the IMF and the US. In India, 70 percent of the banks are owned by the state, in China even 85%. Furthermore, these are “traditional” banks, investing citizens’ savings in loans to companies. Banking activities were also more regulated and thus protected against the ‘toxic’ financial products. Hence, banks in emerging countries could continue to play their key role and did not burden the states with debt. In 2009, the growth difference between North and South amounted to 6%: minus 3.7 versus plus 2.8 percent. Also in 2011, developing countries see their economy grow (6.4%), while the traditional rich countries are facing sluggish growth (1.6%) or loss. The crisis strengthened an already ongoing process: developing countries grow faster than rich countries.

Vulnerability quickly returns

The public debt of the rich countries varies, according to the latest IMF annual report on global financial stability, from 67% (Spain) and 85% (Germany, France, UK) to 95% (Belgium), 100% (US), 120% (Italy) and 162% (Greece). First on the list is Japan with a debt of 233% of its GDP, although the Japanese debt is mainly domestic. As soon as the states took over a share of the bank debts, some of them were attacked by the same money markets which they had just saved from a collapse. These attacks happened selectively: Spain, with a lower public debt and budget deficit than the US, is paying much high rates on its loans than the US. During the G20 in Cannes, director-general of the IMF Christine Lagarde suggested that the markets are irrational. ‘Is it normal that Italy is only considered slightly safer than Egypt or Pakistan?’

Capriciousness is in the nature of the financial markets. Reckless at first, they are now suspecting danger everywhere, thus provoking the situations they feared. By charging Italy high interest rates, they make their fear come through that Rome will not be able to reimburse its loans. And there are more examples of this kind of vicious circles. If the solvency of the European states is being affected, the European banks too will face problems again. The crisis also exposes the construction mistakes of the euro. There are tremendous differences in productivity between

Capriciousness is in the nature of the markets. Reckless at first, they are now suspecting danger everywhere, thus provoking the very situations they feared.

th and Southern Europe, and mechanisms to overcome these differences are lacking. In the past a devaluation could be used to erase differences. By the current “German approach”, however, the weight of the measures to solve productivity differences is entirely with the Southern European countries, who are forced to reduce their wages and government expenditure in order to regain their competitiveness. This risks becoming a downward spiral, leading to a long depression in southern Europe. A positive sign is that the party of chancellor Angela Merkel is now pleading for the introduction of minimum wages: more purchasing power in Germany will make the balancing effort in the south of Europe a bit easier.  

But not only banks are vulnerable. People and societies are suffering too. Unemployment in the EU today amounts to 10.2% and is higher than ever. In Spain, an astonishing 44% of young people does not have a job. The US today counts officially 9% of unemployed people, but in reality around 17% of the population has no or insufficient work. It is yet uncertain how the situation in Greece will evolve, but the society is under huge pressure, led by a government that implements European “orders” conflicting with the people’s will. The situation in Southern Europe risks to open the door for extremist parties. And apparently, there is more to come. In 2012, the US will cut its public spending. And the EU is already reducing government expenditure under pressure of the international markets. If everybody spends less, this will influence growth and job creation, which again will scare off the markets: a vicious circle all over again. Who is going to be the victim of the consecutive budget cuts is an open question. Public expenditure generally reduces inequality. It is therefore likely that cuts in public expenditure will further increase inequality. It can be questionable whether executing the “diktats” of the unpredictable markets is the right approach.

2009, a “green” year

‘Each advantage has its disadvantage’, said the well-known Dutch philosopher Johan Cruijff. Because the economies of the richest countries shrunk in 2009, the greenhouse gas emissions dropped by 6.5%, according to the International Energy Agency (IEA). This was unprecedented. As the developing countries kept on growing, their emissions increased by 3.3%. Globally, the CO2 emission rate dropped by 1.5%. So there is still a direct link between economic growth and the emission of CO2. In 2010, when the economies did well again, emissions grew by 5.3%, a new record. The IEA now expects the temperature to rise 3.5°C in the best case scenario and recommends large-scale investments in low carbon energy and energy-efficiency. In fact, climate change is a large scale demonstration of market failure. Mankind, always rationally maximizing its own interest according to the neo-liberal theory, disregards long term interests. Adjustments by governments are absolutely necessary, but appear to be difficult, especially when they have to be agreed on a global level.

2009 was a good year for the climate, but that was a consolation to few. The fear for the impact of the crisis to society and politics was too high. The crisis learned that economic growth is necessary for countries with a high public debt. And that there is a strong link between growth and job creation, as demonstrated in Spain and Greece.

Creating green jobs can be a solution. There is in fact a need for new growth sectors: even the Bank for International Settlements (BIS) – the bank of the central banks – stated in its annual report that the building sector and the financial sector have become too large and that growth should in fact take place in other sectors. However, the BIS did not link this necessity to climate change and the desperate need for green technologies. As if central bankers were living on a different planet.

Mighty magicians

Saying that there was something fundamentally wrong with the financial sector, is to state the obvious. Banks had become “too big to fail” and could therefore take risks at the expense of the tax payers. And this has not changed a bit, judging by the second episode in the Dexia-drama. The “super-banks” are so complex that they are also difficult to supervise. Unlike during the crisis of the 1930’s, regular banking has as of yet not been separated from the much riskier investment banking. The bank lobby blocked this. Even though tax payers saved their jobs, bankers still think they can continue awarding bonuses to themselves. According to the principles of the Basel III Accords, concluded by the Basel committee for bank supervision composed of bank supervision authorities from over twenty countries, banks should hold more capital as of 2019. The EU supports this principle, the US are hesitating. The American professor Simon Johnson, also former chief economist of the IMF, describes very clearly to what extent the financial sector controls politics in the US, not only financially but even intellectually. Washington became convinced that what is good for Wall Street is good for the US. Since 1980,  most US ministers of finance came straight from an investment bank and went back to the financial sector after their term at the helm of the Treasury. Those banker-ministers have forced the deregulation, a line more or less followed by the EU afterwards. Also president Barack Obama did not really break with Wall Street. The crisis did not change the submissiveness of politics. Governments which had paid through the nose to save banks, preferred to restrict the nationalizations and their influence in the banks they saved as much as possible.

Opposition against this system can possible come from developing countries, who always looked skeptical at the Anglo-American model with its bloated financial sector. ‘The developing countries do not believe in an unregulated financial sector and high debts, but go for industry, growth and redistribution’, says Gregory Chin of the Canadian Center for International Governance Innovation, who spent much of his time in Asia the past years.

This does not mean that the developing countries are invulnerable. Since 2008, many of them faced a credit boom which is not without risks. The vulnerability of the South lies also in its export dependency. This could be felt at the G20 in Cannes in early November, where everyone was concerned about the situation in Europe, the world’s largest market. The growth of countries such as Malaysia and China depends for at least 50% on the export. And this is not likely to change soon, says the IMF. Sure, countries like China do raise the wages, but this is a slow process. ‘The developing economies do not compensate the lower consumption of the rich countries’, according to the IMF. If this is indeed the case, one can wonder where the ‘stuff’ will be sold in the coming years.

#ows

Globalisation somewhat reduces the income inequality between states, but it increases the income inequality within states, in most cases. The latter proved to be a politically very sensitive issue in 2011. The Arab countries, especially the North-African ones, have been world leaders in unemployment since years. An (educated) youth deprived of opportunities is certainly one of the main factors which led to the Arab Spring. And Israel is one of the OECD countries in which income inequality rose fastest. Is it any wonder that protests against unaffordable houses were so successful over there? In Chili, another OECD country with high income inequality, student protests were directed against the government’s refusal to ease access to higher education for poor students. Also in India and China, increasing inequality is a very sensitive issue.

But in the traditional rich countries, protests are arising as well. Street protests in Greece have lasted already a whole year and in Spain the indignados movement was born. In the US, Occupy Wall Street –on Twitter known as #ows– gained some support and rapidly initiatives like Occupy Ghent or Occupy Ypres emerged. Wolf, a twenty-year old unemployed man, explains why he joined the “Occupy” protests: ‘I agree with their slogan: one percent indeed fucks it up for the rest of us. The bankers caused this crisis, and now we have trouble finding a job.’

Social inequality is not only a disturbing fact, it is at the very basis of the crisis. Countering the inequality will have to be part of the solution for the crisis. Governments will have to take measures that neutralize the forces of the globalization and to redistribute the national and international purchasing power, preferably in a coordinated way. Exactly therein lies one of the main challenges: whether its dealing with the lack of financial regulation, climate change or inequality, action should be coordinated at global level. And this is not evident.