Criticism of austerity has reached ferocious levels in Europe. Increasingly, it carries a moral tone, portraying the stronger north, especially Germany, as forcing harsh policies on to weaker nations. Opponents of austerity argue that the north is demanding fiscal tightening and labour market reforms from these stricken states in exchange for vital lending from entities such as the European Central Bank. They see it as kicking economies when they’re down.
This is an important debate, but critics are forgetting a key point. It was not Angela Merkel, chancellor of Germany, or other political leaders who pushed austerity on to Italy, Spain, Greece and the others. It was private lenders, beginning in the autumn of 2011, who declined to finance further borrowing by those countries. Then they stopped financing portions of their banking systems. In other words, markets triggered the Eurozone crisis, not politicians. The fiscal and banking restructuring that followed was the price of rebuilding market confidence.
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In fact, 21st-century markets are much more powerful than any government leader. We have repeatedly seen their power over the past 25 years, from the Asian financial crisis of the late 1990s to the collapses in Mexico, Russia, Argentina and elsewhere. Indeed, the seismic market events of 2008 in America and 2011-2 in Europe transcended political agendas. For example, had Ms Merkel opposed austerity, it would have had little effect on the course of events.
This is because a sovereign or banking system that loses access to financing is functionally insolvent. Its indispensable borrowing programme is halted, and its liquidity can evaporate. Payrolls and social welfare obligations are in peril. An immediate restructuring of its finances is required to avoid collapse and regain credibility with private lenders. Yes, authorities such as the Federal Reserve or European Financial Stability Facility can provide temporary financing. In a full-scale crisis, however, even their firepower is limited. Therefore, elected officials, whether in Berlin or Madrid, did not have a choice on austerity under these dire circumstances. There was no other path to renewed borrowing.
In 2010, and continuing through mid-2012, the yield on Irish bonds reached 12 per cent, those on Greek and Portuguese bonds hit 48 per cent and 17 per cent, respectively, and Spanish and Italian yields exceeded 7 per cent. These stratospheric levels signify loss of access to usable financing. Both official statements and press accounts at the time were clear on this. The Spanish government, for example, openly admitted it. And, the markets closed to these countries on their own, not in reaction to political criticism.
Each of these countries required emergency lending assistance from a combination of the European Commission, European Central Bank and International Monetary Fund – and each was required to tighten its budget in exchange. This is the same condition that the IMF has always required for rescue financing. Yes, Germany wanted the IMF involved in these bailouts. It has market credibility in such situations. But its conditionality was no harsher than markets themselves would demand in order to reopen financing. If anything, it was the opposite.
The same conditionality also applied to the rescues in Europe and the US. When many US banks lost the ability to finance themselves in 2008 and became insolvent, taxpayers rescued them to avoid a bigger economic crisis. But the price charged by Congress for this help was high – including shareholder losses, board and management changes, broad asset sales and far tighter regulations.
Today, the question is whether the rescued European borrowers, and the Eurozone itself, have regained sufficient market confidence to permit an easing of the fiscal tightening that took effect a year ago. This is more a market question than a political one. Italian and Spanish bond yields, among others, have nearly returned to normal levels. We do not know how solid this investor confidence is, but this fall in borrowing costs suggests that some easing can be done, provided that it proceeds carefully and does not trigger another market boycott.
History is not likely to view these austerity trends in political or moral terms. Rather, the context will probably be a financial one. Capital markets turned against the financial practices of certain Eurozone states over the 2010-12 period, which forced a restructuring of their finances. It is as basic as that.
The writer is executive chairman of Evercore Partners and was US deputy treasury secretary in 1993-94