Questions Surround the Crisis
Published in Interia
(Poland ) on 17 October 2011
by Witold Gadomski (link to original)
The Occupy Wall Street protests began in the early days of September. Protests have been raging in Spain since May and for over a year in Greece. The protesters are different in every way — in age, political leanings and education, etc. One thing, however, does connect all of these movements: They all believe that the culprits behind the crisis are the elites and greedy bankers. The people of Poland also subscribe to this view.
The Wall Street protests began in September. At first, only a few people showed up; then, dozens of people came, then a couple of hundred, until there was more than 1,000 protesters. The police intervened; arrests followed. Signs read, “Down with Greed” and “Down with the 1 Percent.” The crowds are politically diverse. There are progressives and anarchists, but also members of the conservative populist tea party. They are united in their belief that the people responsible for the global crisis are the rich and greedy bankers.
Since May, Spanish streets have been filled with protesters. This is a rebellion of young people against the political establishment, which has been inept in its handling of the financial crisis. Much more dramatic are the protests occurring in Greece, which have continued nonstop since last year. The government there has admitted that it will not be able to pay off the huge debt and has announced drastic savings measures. On Oct. 15, in a gesture of solidarity, demonstrations in Warsaw took place aimed at highlighting the inadequacies of the political system, social injustice and income disparity.
The protesters are united in their belief that the crisis took place because of the rich and that the burden of recovery is unfairly placed on the shoulders of the masses. However, the truth is much more complicated.
The Guilty Are Among Us
When average Americans were living beyond their means, spending more than they earned, no one raised their voice in protest. This state of affairs took place during the decade preceding the crisis. No one complained when the price of homes jumped by 15 percent annually and when the interest on mortgages did not keep up with inflation. No one protested when the governments in the U.S., Spain or Ireland subsidized the housing industry, creating a speculative bubble.
Greek society had no objections when the government subsidized the welfare state with abandon, financed by the now-hated speculators. It is true that banks and other institutions let things get out of control. CEOs in the financial sector had exorbitant salaries while risking other people’s money.
We should remember, however, that it wasn’t just the banks and CEOs who profited from the credit mania, but also the average client. The savings measures that are being protested in New York, Madrid and Athens come after a long period of states living beyond their means.
The culpability of politicians and central bank officials is evident. They should have warned the public and attempted to halt the growth of government spending, and tried to eliminate deficits. Had they been more honest and braver, they should have told their constituents that the free lunch was over. They should have told their citizens to start saving instead of spending themselves into extreme debt. These protesters had nothing against the accommodating behavior of politicians when the times were good, but now have a problem with the consequences.
Deadly Debt
Three years after the collapse of Lehman Brothers, we are starting to get a clearer list of reasons why the crisis began. Bankers’ greed, the carelessness of ordinary citizens, the foolishness of politicians — this all had something to do with it. The root cause of the crisis, however, is sovereign debt in America and Europe. For years, these economies developed through lines of credit, which expanded three times faster than the GDP. For every dollar produced in the U.S. or Europe, $3 or $4 were added to the debt. This not only pertains to the national budgets, but to the average household budgets of ordinary citizens, businesses and banks. These banks loaned money to others while they financed themselves through ever-increasing lines of credit. When the market did well, investors were confident that the debts would be eventually paid off. The situation could be equated to sailing in a bay filled with reefs and sandbars at high tide. When the tides subsided, the reefs appeared.
Global Village, Global Problem
When the real estate market in the U.S. finally collapsed in 2007, the first to feel the effects were the banks, which issued the loans for homes. Because they themselves were in debt, the crisis spread quickly to the entire financial market, not just in the U.S., but in Europe as well. American banks invested heavily in their European counterparts. In order to save the banks, the governments took the debt on themselves, which spread the crisis to the public sector. The hardest hit in Europe was the heavily indebted Greece, but also those with small amounts of debt, such as Spain, Latvia, Estonia and Ireland. The governments of these countries did not borrow heavily, but their domestic banks were deep in debt.
The Euro Effect
Did the euro exacerbate the problem? Probably yes, but it is impossible to tell what the situation would have been if European nations had retained their sovereign currencies. A currency war would probably have taken place. Each country would have tried to devalue their currency in order to boost exports. The result would have been chaos and possibly the dissolution of the EU. The common currency forces all the nations involved to act in solidarity. However, the lack of sovereign currencies causes other problems.
Greece would not have been able to run up the huge debt that it now has, which is 150 percent of GDP, since the drachma would not have the same confidence among investors. The euro fell victim to a self-fulfilling prophecy. Eurozone countries had access to cheap credit, and therefore spent themselves into huge deficits. When confidence in the euro declined, the crisis began. The greatest weakness of the euro is that it gives individual countries limited flexibility in dealing with crisis.
Economists Are Not Fortune Tellers
The euro was designed not for crisis, but for a world without crisis. As Prof. Paul Dembinski describes it, “Countries are like pedestrians on a crowded street. Each of them walks in their own direction, pursuing what is best for them. However, if a siren turns on and creates panic, the pedestrians adopt a herd mentality and create a dangerous situation.”
Financial markets were a stage for uncoordinated movements of many indicators. Economists were able to estimate risk and reduce it. However, when the crisis began, it turned out that all the elements are tied together. The models put together by economic experts were rendered useless.
Is There a Solution?
The crisis that we are currently experiencing has been the most painful since the ‘80s, but is still nowhere near the scope of the Great Depression. That crisis led to a fundamental change in economic policy and to drastic political change. It was one of the reasons for World War II, but it eventually came to an end. If we look back at history, there is no reason to suppose that the crisis will last forever. Prof. Stanisław Gomułka thinks that the world will have to adjust to a lower rate of growth. “For several years, the American economy grew faster than it was able to, which was a cause of lax fiscal and monetary policies. This led to crisis, which then ushered in budgetary problems. Now, the governments must find a way to reduce their deficits, which inevitably leads to an economic slowdown.”
Gomułka adds that while the international community pays off its debts, the economy will be sluggish. After the debts are paid off, the economy will return back to normal.
Life After Crisis
This opinion is not shared by all economists. Many think that the crisis will bring about change. The financial markets have been criticized for their substantial influence on the economy. The crisis has shown that there is no such thing as a safe haven or a safe currency. Some have suggested a new Breton Woods conference, where the international community could hammer out a new set of rules for the global economy. However, there no longer is a single world power that could take charge of this movement and shoulder the costs of adopting this new system. That is what the U.S. did in 1944, offering Europe millions of dollars, which were guaranteed with gold. That guarantee has long been gone, and the dollar’s strength is as brittle as the euro’s.
The Wall Street protests began in September. At first, only a few people showed up; then, dozens of people came, then a couple of hundred, until there was more than 1,000 protesters. The police intervened; arrests followed. Signs read, “Down with Greed” and “Down with the 1 Percent.” The crowds are politically diverse. There are progressives and anarchists, but also members of the conservative populist tea party. They are united in their belief that the people responsible for the global crisis are the rich and greedy bankers.
Since May, Spanish streets have been filled with protesters. This is a rebellion of young people against the political establishment, which has been inept in its handling of the financial crisis. Much more dramatic are the protests occurring in Greece, which have continued nonstop since last year. The government there has admitted that it will not be able to pay off the huge debt and has announced drastic savings measures. On Oct. 15, in a gesture of solidarity, demonstrations in Warsaw took place aimed at highlighting the inadequacies of the political system, social injustice and income disparity.
The protesters are united in their belief that the crisis took place because of the rich and that the burden of recovery is unfairly placed on the shoulders of the masses. However, the truth is much more complicated.
The Guilty Are Among Us
When average Americans were living beyond their means, spending more than they earned, no one raised their voice in protest. This state of affairs took place during the decade preceding the crisis. No one complained when the price of homes jumped by 15 percent annually and when the interest on mortgages did not keep up with inflation. No one protested when the governments in the U.S., Spain or Ireland subsidized the housing industry, creating a speculative bubble.
Greek society had no objections when the government subsidized the welfare state with abandon, financed by the now-hated speculators. It is true that banks and other institutions let things get out of control. CEOs in the financial sector had exorbitant salaries while risking other people’s money.
We should remember, however, that it wasn’t just the banks and CEOs who profited from the credit mania, but also the average client. The savings measures that are being protested in New York, Madrid and Athens come after a long period of states living beyond their means.
The culpability of politicians and central bank officials is evident. They should have warned the public and attempted to halt the growth of government spending, and tried to eliminate deficits. Had they been more honest and braver, they should have told their constituents that the free lunch was over. They should have told their citizens to start saving instead of spending themselves into extreme debt. These protesters had nothing against the accommodating behavior of politicians when the times were good, but now have a problem with the consequences.
Deadly Debt
Three years after the collapse of Lehman Brothers, we are starting to get a clearer list of reasons why the crisis began. Bankers’ greed, the carelessness of ordinary citizens, the foolishness of politicians — this all had something to do with it. The root cause of the crisis, however, is sovereign debt in America and Europe. For years, these economies developed through lines of credit, which expanded three times faster than the GDP. For every dollar produced in the U.S. or Europe, $3 or $4 were added to the debt. This not only pertains to the national budgets, but to the average household budgets of ordinary citizens, businesses and banks. These banks loaned money to others while they financed themselves through ever-increasing lines of credit. When the market did well, investors were confident that the debts would be eventually paid off. The situation could be equated to sailing in a bay filled with reefs and sandbars at high tide. When the tides subsided, the reefs appeared.
Global Village, Global Problem
When the real estate market in the U.S. finally collapsed in 2007, the first to feel the effects were the banks, which issued the loans for homes. Because they themselves were in debt, the crisis spread quickly to the entire financial market, not just in the U.S., but in Europe as well. American banks invested heavily in their European counterparts. In order to save the banks, the governments took the debt on themselves, which spread the crisis to the public sector. The hardest hit in Europe was the heavily indebted Greece, but also those with small amounts of debt, such as Spain, Latvia, Estonia and Ireland. The governments of these countries did not borrow heavily, but their domestic banks were deep in debt.
The Euro Effect
Did the euro exacerbate the problem? Probably yes, but it is impossible to tell what the situation would have been if European nations had retained their sovereign currencies. A currency war would probably have taken place. Each country would have tried to devalue their currency in order to boost exports. The result would have been chaos and possibly the dissolution of the EU. The common currency forces all the nations involved to act in solidarity. However, the lack of sovereign currencies causes other problems.
Greece would not have been able to run up the huge debt that it now has, which is 150 percent of GDP, since the drachma would not have the same confidence among investors. The euro fell victim to a self-fulfilling prophecy. Eurozone countries had access to cheap credit, and therefore spent themselves into huge deficits. When confidence in the euro declined, the crisis began. The greatest weakness of the euro is that it gives individual countries limited flexibility in dealing with crisis.
Economists Are Not Fortune Tellers
The euro was designed not for crisis, but for a world without crisis. As Prof. Paul Dembinski describes it, “Countries are like pedestrians on a crowded street. Each of them walks in their own direction, pursuing what is best for them. However, if a siren turns on and creates panic, the pedestrians adopt a herd mentality and create a dangerous situation.”
Financial markets were a stage for uncoordinated movements of many indicators. Economists were able to estimate risk and reduce it. However, when the crisis began, it turned out that all the elements are tied together. The models put together by economic experts were rendered useless.
Is There a Solution?
The crisis that we are currently experiencing has been the most painful since the ‘80s, but is still nowhere near the scope of the Great Depression. That crisis led to a fundamental change in economic policy and to drastic political change. It was one of the reasons for World War II, but it eventually came to an end. If we look back at history, there is no reason to suppose that the crisis will last forever. Prof. Stanisław Gomułka thinks that the world will have to adjust to a lower rate of growth. “For several years, the American economy grew faster than it was able to, which was a cause of lax fiscal and monetary policies. This led to crisis, which then ushered in budgetary problems. Now, the governments must find a way to reduce their deficits, which inevitably leads to an economic slowdown.”
Gomułka adds that while the international community pays off its debts, the economy will be sluggish. After the debts are paid off, the economy will return back to normal.
Life After Crisis
This opinion is not shared by all economists. Many think that the crisis will bring about change. The financial markets have been criticized for their substantial influence on the economy. The crisis has shown that there is no such thing as a safe haven or a safe currency. Some have suggested a new Breton Woods conference, where the international community could hammer out a new set of rules for the global economy. However, there no longer is a single world power that could take charge of this movement and shoulder the costs of adopting this new system. That is what the U.S. did in 1944, offering Europe millions of dollars, which were guaranteed with gold. That guarantee has long been gone, and the dollar’s strength is as brittle as the euro’s.