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Political Economist Answers: What's So Dangerous About Austerity?

Sunday, 16 February 2014 00:00 By C.J. Polychroniou, Truthout | Interview

Austerity(Image: Oxford University Press)In this interview with Mark Blyth, author of "Austerity: The History of a Dangerous Idea," we learn that austerity policies are called "a class-specific put option" in finance and are dangerous because they don't achieve their purported goals and harm the least politically powerful.

Austerity: The History of a Dangerous Idea, a book written by Brown University Professor of International Political Economy Mark Blyth and published last year by Oxford University Press, is one of the most important works to have emerged in recent years on the religion of austerity, the new dogma in neoliberal economics that is so perniciously enforced today in the peripheral countries of the Eurozone (Greece, Italy, Ireland, Portugal, and Spain) and loved by Republicans and all sorts of right-wingers in the United States. In his book, Blyth exposes how dangerous the policy of austerity has been in the past and explains why it resurfaced in the aftermath of the 2008 global financial crisis. With his critical analysis of austerity, Professor Blythe also provides a damning critique of orthodox economics and shows that class politics is very much alive in the actions of today's governments and the rich.

Recently, Mark Blyth was interviewed by C. J. Polychroniou for Truthout (a shorter version of the interview appears simultaneously in Greek in today's edition of Eleftherotypia). They discussed why austerity is a dangerous idea and why it came to be seen as the only viable way out of the latest global financial crisis, with Professor Mark Blyth exposing the myth of Greece as a nation of lazy people and other propaganda, while showing who benefits from austerity.  

C. J. Polychroniou for Truthout: Your latest book deals with austerity, which you describe as a dangerous idea. Yet, austerity policies remain dominant in both Europe and the United States, with the economic elite and governments alike arguing that they represent, in fact, the only way out of the crisis. Why is austerity a dangerous idea?

Mark Blyth: Ideas gain power where the institutional context allows. In the US, austerity thinking has been dominant at the state level, where Republicans rule and budget cutting has become an end in and of itself. However, at the federal level, the now near-dead sequester apart, gridlock meant that the Democrats could block Republican attempts to cut, which stymied austerity. The result was that the US economy managed to grow since it didn't cut (much). In contrast, in Europe, especially in the Eurozone, the institutional context - where the Germans draft the orders, the commission implements, then and the ECB [European Central Bank] facilitates – [assured that] full-blown austerity took hold, with consequences that the Greek public know all too well. Austerity is then a dangerous idea when it becomes institutionalized. But is it most of all a dangerous idea because it doesn't work.

While it makes sense for any one country to reduce its debts in a time of growth, if many countries that are each other's major trading partners and share the same currency, that none of them print, all try to save at the same time, the result can only be a common shrinkage of GDP, a rise in debt as a smaller economy tries to pay back a reciprocally larger amount of debt and a prolonged recession. All of this was predictable and was predicted. But it continues because it is institutionalized.

Ireland's bailout ended, and European Union officials claim that Ireland's austerity is paying off dividends. Myth or reality?

Ireland may have exited their bailout agreements, but that has nothing to do with how much they cut their budgets. Ireland's debt has risen from 44 percent of GDP in 2009 to 117 [percent] in 2013, despite their cuts, partly from the cost of bailing out their entire financial system and partly from GDP shrinkage increasing the stock of debt. So if the pro-austerity argument is that we need to cut to control the debt and thus reduce the interest rates on government bonds, why then has exactly the opposite happened? Debt is bigger than ever despite the cuts, and yet rates fell dramatically. Why?

Because the ECB, starting in 2012, flooded the near-insolvent European banking system with nearly 5 trillion euro in "official support." That brought down rates; that allowed Ireland to go back to the markets, and for Greece to now pay 7 percent rather than 30 percent on its 10-year bonds. Central bank policy mattered. Austerity had nothing to do with it. Moreover, Ireland still has huge debts; it has lost 50,000 graduates a year to immigration since 2009 - which is its future tax base to pay those debts - and its unemployment rate is still above the already high European average of 12.1 percent. So two cheers for Ireland.

The calls for austerity seem to be based on the premise that the latest crisis facing the advanced capitalist world emerged as a result of too much government spending. Isn't it true, however, that the global financial crisis of 2008 originated in the private sector, not in the public sector? So, what's really going on here?

In my book I call this "the greatest bait-and-switch in human history" when the debts of the private sector were dumped on the public sector balance sheet and christened "excessive spending." The real story goes like this. Back in the 1990s, European banks made a lot of cash as European national bond rates converged on the expectation that the Euro would take inflation and devaluation off the table as policy options. To make money on a declining spread, they levered up their balance sheets (took on debt) and became, in many cases, bigger than the underlying economies that house them. Once the Euro arrived, excess northern savings flooded bank funding circuits in the south, giving the south money to buy northern products and making the banks' balance sheets bigger still.

Now here's the trick. How do you get your hands on funding sufficient to become bigger than a state? Your grandmother's deposits are not going to do it. You go to short term "repo" markets, where huge amounts of money are borrowed and renewed overnight by banks. To get this cash, you need to pledge collateral in case you can't pay back the money. The collateral of choice after 2001 was, yes, Euro-denominated government bonds. So when the crisis hit and the ECB in May 2009 said that "it was not at all doing quantitative easing" and the German government said a few months later that there was no backstop for Eurobonds apart from the sovereign issuer, spreads began to move apart as the markets priced in the risk of break-up leaving them with worthless bits of paper. This led rating agencies to downgrade the bonds, which made it harder for the sovereigns to service their debts and much harder for banks to maintain these elaborate and hugely levered funding structures. Liquidity drained from the system and lending dried up, worsening the recession. Bank failures and bailouts added to public debt problems and the recession made deficits and debts bigger still. Eventually, in 2012, the ECB flooded the market to stabilize the situation, thus bailing out the whole system. But the costs were now on the state's balance sheet in the form of debt, and the story they told wasn't that we bailed out the banks and the folks with assets in those banks. They instead made up nonsense about lazy Greeks and state spending when there was no orgy of state spending. The rise in debt was a consequence of the lending crisis, not a spending crisis. And still there is no recognition of this fact since those that got bailed matter politically and those paying the costs in cuts don't. In the language of finance this is called a class-specific put option.

How instrumental has the role of the banking and finance sector been in compelling governments to pursue austerity measures in the midst of an economic recession?

Actually, not much. Banks don't care about how much Spanish teachers earn or even the size of the Greek debt so long as the central bank commits to stand behind the bonds of these countries. I interviewed many bond market people for the book and they were quite clear about this. The yields went up as a reaction to the perceived risk of Euro break-up. Once that was taken off the table in 2012, yields went down. Sure, some politically more conservative than average bankers can be found talking about the need to cut the welfare state, but most could not care less. So long as the debt they use to fund their operations was AAA, states could spend what they want.

For many, Greece seems to be a "special case," in the sense that the crisis there starts off as a public debt crisis. Do you agree with this assessment of the origins of the Greek crisis, and therefore with the idea that austerity was inevitable at least in the case of Greece?

Greece is only a special case in terms of how much nonsense is talked about it. Greeks work on average 600 hours more than Germans. Check OECD stats hours worked. Greece did not actually go on an orgy of goverment spending either. On a five-year average between 2002 and 2007, Greek spending rises no greater than the European average. Compare it with Germany over the same period and see. The rise in spending comes once the crisis hits as the deficit grows and taxes fall after 2010. As for the supposed surplus of pubic sector jobs, Greece had the same proportion of people employed in central government and public corporations as a percentage of the population in 2009 as the USA (14.1 percent), which is much less than the likes of the UK or France - and half of that of Sweden.

Greece was only important as the proverbial "canary in the coal mine" for the markets, already jittery after the ECB and the German government passed the buck on who backstops the bond markets. Greece mistakenly told the truth about its deficit, and it started a panic that lead to spikes everywhere over the next year. If Greece actually defaulted, which is paradoxically what the spikes were both reading the probability of and causing as the spread widened, then it would have led to a contagion panic through Portugal and Ireland to Spain and had to be stopped. So Greece had to remain in at all costs to stop the rot. The real story on Greece is far from the official version.

Being a bankrupt member state of the Eurozone, did Greece have the luxury of pursuing any other policies other than those dictated by its international lenders?

It could have played chicken against the ECB and demanded that the proportion of its debt subject to rollover risk (that needed to be refinanced - about E50 billion) be taken off the market and put on the balance sheet of the ECB in exchange for cash of the same amount. This is what the Federal Reserve did with their banks, and it stopped the crisis in a matter of months. It would have cost less than the useless "covered bond" program the ECB announced around the same time and could have halted the rise in spreads before it started. However, the ECB under Trichet didn't think that's what the ECB was for, and the Germans agreed, so it was never tried. Instead we were told about the swimming pool tax and the taxi drivers' monopoly and how no one works in Greece and other such nonsense, and the Greek government capitulated. Bankrupts are not devoid of options. They can always push back on their creditors. Greece forgot that.

Are you optimistic about the future of the Eurozone?

I am optimistic that the citizens of the Eurozone will tire of austerity and demand leaders that say no to this policy consensus. Last week, European Commissioner Oli Rehn said that it would take 10 years to solve the Spanish crisis. They have already been in crisis for five years. That would be a 15-year recession. I find it hard to imagine people voting for that. And the core problems are not so difficult to fix.

First, just stop doing austerity. Bond yields and debts are inversely correlated, so there is no point in fettishizing debt and deficit levels. Just stop self-harming. Second, triage the $1.2-$1.5 trillion of bad assets and nonperforming loans in the European banking system, close down the insolvent and restart lending to the real economy. Third, stop signing up to sadomasochistic fiscal treaties where governments can have 6 percent surpluses and only 3 percent deficits. Everything in the global economy sums to zero. That minus three has to show up somewhere, and it will show up in a periphery perma-recession. The private sector that caused the crisis is still free to do whatever it wants with free public money. The public sector that solved the crisis is more constrained then ever in what it can do. This would be funny if it wasn't so serious.

A final thing to consider is why austerity has lasted as long as it has. After all, it benefits no one. Right? Not quite. Think of it this way. We hear a lot about the top 1% owning 30% of everything. It's true. But the top 30 percent of rich countries own about 90 percent of everything. So when you bail out the banks, their assets are your liabilities if you have assets in the bank, which you do the moment your paycheck goes into it (a deposit is best thought of as a loan to a bank). So their assets are your liabilities and vice versa. If you have assets of any kind, a mortgage, a pension, savings, then when "they" got bailed out, you got bailed out too.

So imagine a country like Greece or Ireland or Spain divided up into income quintiles from the top 20th percentile to the 40th to the 100th. Now imagine a set of hugely expensive bank bailouts that crash the economy and create a ton of debt. In a way those bailouts are asset insurance for the top 30, maybe 40, percent of the income distribution. Now, best of all, the folks that just got bailed out don't have to pay for the costs of the insurance. Those costs will be paid for by those lower down the income distribution that rely on government spending: the bottom 20 percent and the next 20 up being the most affected. They don't vote much. They don't earn much, if anything. They don't matter in elections. So the top 30 percent are doing fine under austerity. After all, someone else is paying the costs. And best of all, it's someone that they don't know. That's why austerity continues. And that's the definition of a class-specific put option.

Copyright, Truthout. May not be reprinted without permission.

C.J. Polychroniou

C.J. Polychroniou is a research associate and policy fellow at the Levy Economics Institute of Bard College and a columnist for a Greek daily national newspaper. His main research interests are in European economic integration, globalization, the political economy of the United States and the deconstruction of neoliberalism’s politico-economic project. He has taught for many years at universities in the United States and Europe and is a regular contributor to Truthout as well as a member of Truthout’s Public Intellectual Project. He has published several books and his articles have appeared in a variety of journals and magazines. Many of his publications have been translated into several foreign languages, including Greek, Spanish, Portuguese and Italian.

The views expressed in this article do not necessarily represent those of the Levy Economics Institute or those of its board members.


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Political Economist Answers: What's So Dangerous About Austerity?

Sunday, 16 February 2014 00:00 By C.J. Polychroniou, Truthout | Interview

Austerity(Image: Oxford University Press)In this interview with Mark Blyth, author of "Austerity: The History of a Dangerous Idea," we learn that austerity policies are called "a class-specific put option" in finance and are dangerous because they don't achieve their purported goals and harm the least politically powerful.

Austerity: The History of a Dangerous Idea, a book written by Brown University Professor of International Political Economy Mark Blyth and published last year by Oxford University Press, is one of the most important works to have emerged in recent years on the religion of austerity, the new dogma in neoliberal economics that is so perniciously enforced today in the peripheral countries of the Eurozone (Greece, Italy, Ireland, Portugal, and Spain) and loved by Republicans and all sorts of right-wingers in the United States. In his book, Blyth exposes how dangerous the policy of austerity has been in the past and explains why it resurfaced in the aftermath of the 2008 global financial crisis. With his critical analysis of austerity, Professor Blythe also provides a damning critique of orthodox economics and shows that class politics is very much alive in the actions of today's governments and the rich.

Recently, Mark Blyth was interviewed by C. J. Polychroniou for Truthout (a shorter version of the interview appears simultaneously in Greek in today's edition of Eleftherotypia). They discussed why austerity is a dangerous idea and why it came to be seen as the only viable way out of the latest global financial crisis, with Professor Mark Blyth exposing the myth of Greece as a nation of lazy people and other propaganda, while showing who benefits from austerity.  

C. J. Polychroniou for Truthout: Your latest book deals with austerity, which you describe as a dangerous idea. Yet, austerity policies remain dominant in both Europe and the United States, with the economic elite and governments alike arguing that they represent, in fact, the only way out of the crisis. Why is austerity a dangerous idea?

Mark Blyth: Ideas gain power where the institutional context allows. In the US, austerity thinking has been dominant at the state level, where Republicans rule and budget cutting has become an end in and of itself. However, at the federal level, the now near-dead sequester apart, gridlock meant that the Democrats could block Republican attempts to cut, which stymied austerity. The result was that the US economy managed to grow since it didn't cut (much). In contrast, in Europe, especially in the Eurozone, the institutional context - where the Germans draft the orders, the commission implements, then and the ECB [European Central Bank] facilitates – [assured that] full-blown austerity took hold, with consequences that the Greek public know all too well. Austerity is then a dangerous idea when it becomes institutionalized. But is it most of all a dangerous idea because it doesn't work.

While it makes sense for any one country to reduce its debts in a time of growth, if many countries that are each other's major trading partners and share the same currency, that none of them print, all try to save at the same time, the result can only be a common shrinkage of GDP, a rise in debt as a smaller economy tries to pay back a reciprocally larger amount of debt and a prolonged recession. All of this was predictable and was predicted. But it continues because it is institutionalized.

Ireland's bailout ended, and European Union officials claim that Ireland's austerity is paying off dividends. Myth or reality?

Ireland may have exited their bailout agreements, but that has nothing to do with how much they cut their budgets. Ireland's debt has risen from 44 percent of GDP in 2009 to 117 [percent] in 2013, despite their cuts, partly from the cost of bailing out their entire financial system and partly from GDP shrinkage increasing the stock of debt. So if the pro-austerity argument is that we need to cut to control the debt and thus reduce the interest rates on government bonds, why then has exactly the opposite happened? Debt is bigger than ever despite the cuts, and yet rates fell dramatically. Why?

Because the ECB, starting in 2012, flooded the near-insolvent European banking system with nearly 5 trillion euro in "official support." That brought down rates; that allowed Ireland to go back to the markets, and for Greece to now pay 7 percent rather than 30 percent on its 10-year bonds. Central bank policy mattered. Austerity had nothing to do with it. Moreover, Ireland still has huge debts; it has lost 50,000 graduates a year to immigration since 2009 - which is its future tax base to pay those debts - and its unemployment rate is still above the already high European average of 12.1 percent. So two cheers for Ireland.

The calls for austerity seem to be based on the premise that the latest crisis facing the advanced capitalist world emerged as a result of too much government spending. Isn't it true, however, that the global financial crisis of 2008 originated in the private sector, not in the public sector? So, what's really going on here?

In my book I call this "the greatest bait-and-switch in human history" when the debts of the private sector were dumped on the public sector balance sheet and christened "excessive spending." The real story goes like this. Back in the 1990s, European banks made a lot of cash as European national bond rates converged on the expectation that the Euro would take inflation and devaluation off the table as policy options. To make money on a declining spread, they levered up their balance sheets (took on debt) and became, in many cases, bigger than the underlying economies that house them. Once the Euro arrived, excess northern savings flooded bank funding circuits in the south, giving the south money to buy northern products and making the banks' balance sheets bigger still.

Now here's the trick. How do you get your hands on funding sufficient to become bigger than a state? Your grandmother's deposits are not going to do it. You go to short term "repo" markets, where huge amounts of money are borrowed and renewed overnight by banks. To get this cash, you need to pledge collateral in case you can't pay back the money. The collateral of choice after 2001 was, yes, Euro-denominated government bonds. So when the crisis hit and the ECB in May 2009 said that "it was not at all doing quantitative easing" and the German government said a few months later that there was no backstop for Eurobonds apart from the sovereign issuer, spreads began to move apart as the markets priced in the risk of break-up leaving them with worthless bits of paper. This led rating agencies to downgrade the bonds, which made it harder for the sovereigns to service their debts and much harder for banks to maintain these elaborate and hugely levered funding structures. Liquidity drained from the system and lending dried up, worsening the recession. Bank failures and bailouts added to public debt problems and the recession made deficits and debts bigger still. Eventually, in 2012, the ECB flooded the market to stabilize the situation, thus bailing out the whole system. But the costs were now on the state's balance sheet in the form of debt, and the story they told wasn't that we bailed out the banks and the folks with assets in those banks. They instead made up nonsense about lazy Greeks and state spending when there was no orgy of state spending. The rise in debt was a consequence of the lending crisis, not a spending crisis. And still there is no recognition of this fact since those that got bailed matter politically and those paying the costs in cuts don't. In the language of finance this is called a class-specific put option.

How instrumental has the role of the banking and finance sector been in compelling governments to pursue austerity measures in the midst of an economic recession?

Actually, not much. Banks don't care about how much Spanish teachers earn or even the size of the Greek debt so long as the central bank commits to stand behind the bonds of these countries. I interviewed many bond market people for the book and they were quite clear about this. The yields went up as a reaction to the perceived risk of Euro break-up. Once that was taken off the table in 2012, yields went down. Sure, some politically more conservative than average bankers can be found talking about the need to cut the welfare state, but most could not care less. So long as the debt they use to fund their operations was AAA, states could spend what they want.

For many, Greece seems to be a "special case," in the sense that the crisis there starts off as a public debt crisis. Do you agree with this assessment of the origins of the Greek crisis, and therefore with the idea that austerity was inevitable at least in the case of Greece?

Greece is only a special case in terms of how much nonsense is talked about it. Greeks work on average 600 hours more than Germans. Check OECD stats hours worked. Greece did not actually go on an orgy of goverment spending either. On a five-year average between 2002 and 2007, Greek spending rises no greater than the European average. Compare it with Germany over the same period and see. The rise in spending comes once the crisis hits as the deficit grows and taxes fall after 2010. As for the supposed surplus of pubic sector jobs, Greece had the same proportion of people employed in central government and public corporations as a percentage of the population in 2009 as the USA (14.1 percent), which is much less than the likes of the UK or France - and half of that of Sweden.

Greece was only important as the proverbial "canary in the coal mine" for the markets, already jittery after the ECB and the German government passed the buck on who backstops the bond markets. Greece mistakenly told the truth about its deficit, and it started a panic that lead to spikes everywhere over the next year. If Greece actually defaulted, which is paradoxically what the spikes were both reading the probability of and causing as the spread widened, then it would have led to a contagion panic through Portugal and Ireland to Spain and had to be stopped. So Greece had to remain in at all costs to stop the rot. The real story on Greece is far from the official version.

Being a bankrupt member state of the Eurozone, did Greece have the luxury of pursuing any other policies other than those dictated by its international lenders?

It could have played chicken against the ECB and demanded that the proportion of its debt subject to rollover risk (that needed to be refinanced - about E50 billion) be taken off the market and put on the balance sheet of the ECB in exchange for cash of the same amount. This is what the Federal Reserve did with their banks, and it stopped the crisis in a matter of months. It would have cost less than the useless "covered bond" program the ECB announced around the same time and could have halted the rise in spreads before it started. However, the ECB under Trichet didn't think that's what the ECB was for, and the Germans agreed, so it was never tried. Instead we were told about the swimming pool tax and the taxi drivers' monopoly and how no one works in Greece and other such nonsense, and the Greek government capitulated. Bankrupts are not devoid of options. They can always push back on their creditors. Greece forgot that.

Are you optimistic about the future of the Eurozone?

I am optimistic that the citizens of the Eurozone will tire of austerity and demand leaders that say no to this policy consensus. Last week, European Commissioner Oli Rehn said that it would take 10 years to solve the Spanish crisis. They have already been in crisis for five years. That would be a 15-year recession. I find it hard to imagine people voting for that. And the core problems are not so difficult to fix.

First, just stop doing austerity. Bond yields and debts are inversely correlated, so there is no point in fettishizing debt and deficit levels. Just stop self-harming. Second, triage the $1.2-$1.5 trillion of bad assets and nonperforming loans in the European banking system, close down the insolvent and restart lending to the real economy. Third, stop signing up to sadomasochistic fiscal treaties where governments can have 6 percent surpluses and only 3 percent deficits. Everything in the global economy sums to zero. That minus three has to show up somewhere, and it will show up in a periphery perma-recession. The private sector that caused the crisis is still free to do whatever it wants with free public money. The public sector that solved the crisis is more constrained then ever in what it can do. This would be funny if it wasn't so serious.

A final thing to consider is why austerity has lasted as long as it has. After all, it benefits no one. Right? Not quite. Think of it this way. We hear a lot about the top 1% owning 30% of everything. It's true. But the top 30 percent of rich countries own about 90 percent of everything. So when you bail out the banks, their assets are your liabilities if you have assets in the bank, which you do the moment your paycheck goes into it (a deposit is best thought of as a loan to a bank). So their assets are your liabilities and vice versa. If you have assets of any kind, a mortgage, a pension, savings, then when "they" got bailed out, you got bailed out too.

So imagine a country like Greece or Ireland or Spain divided up into income quintiles from the top 20th percentile to the 40th to the 100th. Now imagine a set of hugely expensive bank bailouts that crash the economy and create a ton of debt. In a way those bailouts are asset insurance for the top 30, maybe 40, percent of the income distribution. Now, best of all, the folks that just got bailed out don't have to pay for the costs of the insurance. Those costs will be paid for by those lower down the income distribution that rely on government spending: the bottom 20 percent and the next 20 up being the most affected. They don't vote much. They don't earn much, if anything. They don't matter in elections. So the top 30 percent are doing fine under austerity. After all, someone else is paying the costs. And best of all, it's someone that they don't know. That's why austerity continues. And that's the definition of a class-specific put option.

Copyright, Truthout. May not be reprinted without permission.

C.J. Polychroniou

C.J. Polychroniou is a research associate and policy fellow at the Levy Economics Institute of Bard College and a columnist for a Greek daily national newspaper. His main research interests are in European economic integration, globalization, the political economy of the United States and the deconstruction of neoliberalism’s politico-economic project. He has taught for many years at universities in the United States and Europe and is a regular contributor to Truthout as well as a member of Truthout’s Public Intellectual Project. He has published several books and his articles have appeared in a variety of journals and magazines. Many of his publications have been translated into several foreign languages, including Greek, Spanish, Portuguese and Italian.

The views expressed in this article do not necessarily represent those of the Levy Economics Institute or those of its board members.


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