First it was the US Federal Reserve. Now it is the turn of the Bank of England. Yesterday in London’s Threadneedle Street, Bank governor Mervyn King announced a new phase in British monetary policy: "quantitative easing".
QE, as it is also known, is economist jargon for printing money. In the British case, an initial £75 billion (AU$165.5 billion) of additional reserves will be generated and spent to buy up corporate debts and government bonds. The hope — there are no guarantees — is that increasing the flow of cash will encourage banks to start lending again and kickstart Britain’s flailing economy. With interest rates almost at zero (the cash rate has been reduced to 0.5 per cent), this nuclear option is just about all that is left.
Across the channel on the continent, things aren’t looking any better. The European Central Bank (ECB) also cut interest rates by half a point yesterday to 1.5 per cent in response to a rapidly deteriorating Eurozone economy. Spring may be approaching in Europe, but everyone is bracing for a deepening economic winter.
How quickly events have unfolded. Last December German finance minister Peer Steinbrück dismissed British Government efforts to stimulate the UK economy as "crass Keynesianism". In the eyes of some Germans at least, any financial crisis and economic downturn would be confined to the profligate, credit-obsessed economies of Britain and the US.
Herr Steinbrück was tempting fate. It is avoiding a full-blown depression, not crass Keynesianism, that European policymakers are now most worried about.
Not even Germany has been immune. Just over two weeks ago, the German parliament approved a €50 billion (AU$97.9 billion) stimulus package — the biggest such injection in the history of the German federal republic. The German economy, the largest in the EU, is expected to shrink by 2 per cent this year as its exports plunge with falling global demand.
But Steinbrück’s earlier indifference — some would say schadenfreude — tells the sorry story of the European response to the global financial and economic crisis. Denial, timidity, inertia: these have been the successive stages of European policy since the credit crunch transformed into a financial meltdown. There was never going to be any EU decoupling from the crisis, and it was hubris to think otherwise.
Not all the blame lies, of course, with Germany.
The French president of the ECB, Jean-Claude Trichet, has consistently argued eurozone members should adhere to the EU stability and growth pact (which restricts government borrowing to 3 per cent of GDP). While the rest of the world began slashing interest rates, the ECB was still hawkish about inflation, waiting until November to make its first cuts to the euro cash rate. As recently as last Thursday, Trichet was urging governments to "pursue courageous policies of spending restraint".
More generally, European leaders have failed to offer a coordinated regional policy response, something even senior figures in the EU have conceded. The last five months have certainly involved something like a comedy of errors. French President Nicolas Sarkozy has done little to ease the rancour that exists between himself and German Chancellor Angela Merkel. While some say that British Prime Minister Gordon Brown has adopted a unilateral approach to policy in offering a substantial fiscal stimulus and slashing the UK’s value added tax, without consulting his European counterparts.
Yet many observers believe Germany has a special responsibility, as a trade surplus economy, to help stimulate global demand during a recession. When the gold standard collapsed in the Great Depression of the 1930s, it was because the surplus economies of the time — the United States and France — pursued beggar-thy-neighbour deflationary policies. Deficit countries were made to bear the cost of adjustment, with dire consequences. Germany may naturally worry about having its taxpayers financing its neighbours, but there is much more at stake.
Any adequate European response indeed requires German leadership in coordinating policies across national borders. For all that it has achieved in creating a common market, with a common currency, the European Union is not yet a political union. It may have a central bank, but it does not have a central treasury. International cooperation remains the political currency underwriting the euro.
At one level, policymakers are still coming to grips with what Martin Wolf has called the "global failure" of the world economy: "the malign interaction between some countries’ propensity towards chronic excess supply and other countries’ opposite propensity towards excess demand".
Today’s crisis illustrates, along with the systemic failure of risk management within banks, the consequences of a world economy that rests on severe global imbalances in trade and income. Global growth depended on surplus countries exporting their savings to fund credit-fuelled household borrowing in deficit countries. For global demand now to re-inflate, surplus countries will have to expand domestic demand. It is a 21st century lesson in the interdependence of a global economy.
The lesson will be easier to grasp now that much of Europe has been sent into a dramatic economic spiral. The International Monetary Fund has already offered emergency loans to Hungary, Latvia and Ukraine. France last week reported the sharpest increase in jobless numbers on record: a 15 per cent spike over the last 12 months. In Britain, the number of unemployed has soared to almost 2 million, with another 1 million job losses expected in the next year. Financial markets continue to speculate on whether Greece and Ireland are on the verge of defaulting on their national debts.
It is central and eastern Europe, however, which present the gravest threat to European stability. Last week, banks east of the Danube were given a €24.5 billion (AU$48 billion) rescue package to save them from insolvency. At an EU leaders’ summit on Sunday, the Hungarian Government called for a €180 billion (AU$352.4 billion) stabilisation package for the region, with Prime Minister Ferenc Gyurcsány warning about a "new iron curtain" dividing East and West, yet again.
The realisation has hit, however belatedly, that Europe could become the epicentre of global economic and social turmoil. At a summit last weekend, EU leaders agreed to push for tighter regulation of financial markets; this was followed up with a series of legislative measures announced in Brussels on Wednesday. Even the previously hardline Steinbrück has signalled Berlin will not hesitate to participate in a eurozone bailout.
Some observers believe this will not be enough: the EU needs to act to address some of its longstanding structural weaknesses. Figures including Romano Prodi, the former Italian prime minister and european commissioner, and George Soros, the billionaire hedge fund investor, have proposed the creation of a eurozone sovereign bond market. Such a development, it is argued, would offer better protection to smaller and vulnerable EU nations, as well as become a financing mechanism for coordinated fiscal policies.
There remains as well the danger that resurgent protectionism may scuttle any renewed urgency about cooperation. Last month, Nicolas Sarkozy angered his eastern European counterparts when he suggested that Peugeot close down a car-making plant in the Czech Republic and relocate to France. Spain has recently launched a "Buy Spanish" campaign. Recent wildcat strikes in Britain against foreign workers appropriated Gordon Brown’s once-used slogan of "British jobs for British workers".
The problem is not confined to Europe. Closer to home, a protectionist surge has arrived on Australian shores. Earlier this week the ACTU launched a campaign for a "Buy Australian" clause to be applied to government spending decisions, emulating the "Buy American" clause inserted into the recent US$737 billion (AU$1.1 trillion) stimulus package passed by the US congress.
We can expect debates about protection to escalate as the global recession worsens. But to raise walls of protection will do little to ease the current economic situation; it would only make matters worse.
Even Gordon Brown has mended his ways. In an impassioned speech to a joint sitting of the US Congress on Wednesday, praised by some British observers as his finest ever, Brown warned against succumbing to a protectionism "that history tells us … protects no one". Calling upon America to join with Europe to share the burden of economic and financial recovery, he said: "We should seize the moment — never before have I seen a world so willing to come together."
Carpe diem? Coming together? Such idealistic ambition is sure to be put to the test in Europe, and elsewhere.
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