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A protester waves the tricolour at a protest against the Troika bailout of Ireland in 2010
by Admin

Some euros are more equal than others: trade imbalances and debt crises

WHY WERE leaders of European Union countries so determined to establish a monetary union among member states despite the setbacks and shocks experienced in the first decades of such an attempt at creating a common currency? In part it was a response to the collapse of Bretton Woods, and in part it was viewed by committed European federalists as a way to push the pace of political integration. There was a widespread belief stretching back to the Gold Exchange Standard that a common currency would ensure price stability and predictability, eliminate the risk of changes in exchange rates and therefore boost trade. For the European deficit states, the susceptibility of their currencies to repeated devaluations against the Deutschmark was viewed as an economic and political vulnerability, which caused inflation that reduced the purchasing power of both rich and poor. Meanwhile, from the mid-1980s the expanding US deficit had allowed both Germany and the EEC as a whole to generate a trade surplus. For the technocrats that had already set up shop in the limited European community administrative bodies, the creation of the euro would speed up the process of political integration and movement towards a European federation.

A shared currency with different motivations

Successive French governments had repeated the call for a European monetary union since Giscard d’Estaing first proposed it in 1964, with a view to reining in German power – and to make it easier to impose wage restraint on French workers, by comparing their wages with those of German workers. French national expertise in constructing political institutions would also be able to shine in a European administration. Germany had dragged its heels on such a union for decades, largely because of a fear that a fixed exchange rate between the franc and the Deutschmark would require the Bundesbank to print more money to prop up the franc, causing inflation that had been regarded with profound dread by Germans since their experience of the hyper-inflation of the 1920s, a dread that continues to define German monetary policy today.

The typical explanation regarding the creation of the Economic and Monetary Union (EMU) found in history books is that Germany finally agreed to the long-standing French call for a monetary union after the fall of the Berlin Wall in exchange for French acceptance of Germany’s reunification. But it was also created to accommodate Germany’s export-led economic strategy. The Deutschmark’s sky-high value in the wake of the collapse of Bretton Woods was a reminder to Germany that if the Deutschmark’s exchange rate was to float freely its value could rise indefinitely, making its exports too expensive and destroying its trade surplus strategy. Competitive currency devaluations were successfully reducing Germany’s trade surpluses with the countries that used them during the 1980s. Germany needed some way of locking its exchange rate to other currencies after the demise of the dollar zone. The ERM was viewed as a partial solution to these problems by German political leaders and the Bundesbank. But the speculative attacks on the currency fluctuations possible within the ERM that caused its collapse in 1992 led Germany to finally accept the creation of a common currency – on the condition that the deflationary debt and deficit rules of the Maastricht convergence criteria were accepted by its neighbours, of course.

Germany’s biggest export – stagnation

The question of how to deal with chronic, persistent trade imbalances within a common currency area was resolved to a large degree under the Bretton Woods system by the American commitment to spend its surplus internationally – its direct injection of capital into the economies of its capitalist allies during the duration of the system through aid and then investment. In this way, the US exported its goods but it also exported demand. The German model, on the contrary, aims to export its goods and import demand from other countries. In this way, the biggest German export can said to be stagnation. Instead of playing a role of recycling surplus profits, generating growth and stabilising the international economic system, the persistent German surplus plays a destabilising and deflationary role in the monetary union.

China has faced much criticism internationally in recent years for consistently running a large trade (or current account) surplus, but Germany’s trade surpluses have been almost twice as high as China’s in recent years as a percentage of GDP. China has made a conscious effort to reduce its economic dependence on exports, while Germany recorded a record surplus in the first half of 2017. Large and persistent trade surpluses are a problem because the sum of all surpluses has to equal the sum of all deficits. As discussed above, in stable economic periods, the banks in surplus countries can lend to borrowers in deficit countries, maintaining a semblance of balance, but in a crisis this surplus recycling measure comes to a sudden stop. But chronic surpluses also cause an overall decline in demand. The surplus countries are exporting goods but they are spending less than they are making in income.

Keynes called this the paradox of thrift – the phenomenon where when a country’s population saves their money during a downturn this actually causes a fall in aggregate demand, while total savings are not actually increased. Savings must equal investment, so if the level of investment remains the same, the level of savings must also remain the same. People might save a higher proportion of their income, but the only way the level of savings can change is if there is a reduction in the level of income. Stiglitz argues that the global economy today “is in this precise position, with a deficiency of aggregate demand leading to slow growth and 200 million unemployed. This deficiency of demand is the cause of what many call global secular stagnation” (secular meaning long-term stagnation as opposed to cyclical stagnation).

Trade imbalances cause debt crises

Trade imbalances do not only contribute to stagnation. Countries who run deficits must borrow the gap between what they export and what they import, meaning they have to take on more debt and become exposed to the risk of a debt crisis. If the country’s exchange rate can be devalued, then the external imbalance can be gradually reduced as the deficit country’s exports become more competitive on the global market. But inside a currency union, the option of exchange rate adjustment disappears. The main alternative way for a deficit country inside a currency union to regain trade balance is by an ‘internal devaluation’. This is when the nominal exchange rate remains fixed, but the real exchange rate falls as local prices in the deficit country drop, which makes its exports more competitive. (The nominal exchange rate sets the amount of foreign currency that can exchanged for a unit of the domestic currency, while the real exchange rate takes into account local prices and indicates how much goods in the domestic economy can be exchanged for goods in a foreign country.)

In a currency peg system, participating countries are not only prone to experiencing high or long-term unemployment, as they lack the ability to change their exchange rates and interest rates after a shock; they are also very susceptible to debt crises. In the absence of successful internal devaluation, deficit countries with a misaligned exchange rate seeking to finance the gap between their imports and exports rely on capital inflows. If foreign direct investment is not forthcoming then the only option is debt. But if the misalignment in the exchange rate is persistent, then the debt mountain grows until creditors fear it will not be repaid, usually resulting in a sudden stop of credit.

The Irish economy, Spain, Greece and others received huge capital flows after the creation of the euro in 1999, as a result of the elimination of exchange-rate risk. These countries were able to run deficits but also maintain employment and experience growth as a result of the low interest rates they were allowed to borrow at, and the small risk premium on government bonds (the extra amount that was added to the government bonds to compensate for the perceived extra risk associated with lending to that country). Both Ireland and Spain experienced massive housing bubbles based on speculative inflows of capital throughout the 2000s, while neither country imposed any effective measures to cool the heat.

Economist and writer Martin Wolf comments in his book on the financial crisis, The Shifts and the Shocks, that the belief among the Eurozone’s founders was that the problem of trade imbalances would no longer matter in a currency union, “as exchange-rate risks would vanish and payment disequilibria within the area would be smoothly offset by private capital flows”. But “these expectations proved delusional; the sovereign debt crisis in the Eurozone in 2010-12 started as a fully-fledged balance-of-payments crisis… prompted by the accumulation of large payment imbalances between its members and reflecting persistent underlying divergences in prices and costs”. These countries that were running trade deficits based on private and government debt due to the misalignment of their exchange rates then experienced the sudden stop of credit brought about by the global financial crisis, causing creditors to doubt their debts would be repaid. The common currency meant that these countries were forced to turn to the so-called Troika of the European Commission, the ECB and the IMF to be bailed out.

The euro, in this way, is somehow both a domestic and a foreign currency for its members. It is less risky for people, firms and governments to borrow in local currency markets than to borrow in foreign currency. To prevent a debt crisis developing, the government can print more of the local currency to repay creditors. But for Eurozone members, they were borrowing in a supposedly “local” currency that they could not then control. The nature of the Eurozone changed as soon as some members of the monetary union owed other members, Stiglitz argues. “Rather than a partnership of equals striving to adopt policies that benefit each other, the ECB and Eurozone authorities have become credit collection agencies for the lender nations, with Germany particularly influential”. The deficit countries dependent on creditor countries and the ECB are then vulnerable to any and all political and economic demands made by the creditors.

In their study of financial crises over eight centuries, Carmen Reinhart and Kenneth Rogoff identify several key features as having strong correlations with banking crises, all of which applied in the Eurozone. They note that in an analysis of banking crises after 1970, in 18 out of 26 of those studied the financial sector had been liberalised within the previous five years. They also identify a major correlation between removing restrictions on capital mobility and the incidence of banking crises over centuries. “Periods of high international capital mobility have repeatedly produced international banking crises, not only famously as they did in the 1990s, but historically”.

A further common feature they identify is that in the lead-up to banking crises there is often what they call a “capital flow bonanza” – a surge of capital inflows of roughly a few per cent of GDP on a multiyear basis, and the tendency to run a large current account deficit. While the liberalisation of the financial sector is by no means limited to the Eurozone, the free movement of capital and persistent trade imbalance problems inherent in the Eurozone, due to its design, make the common currency area prone to crises.

Capital defies gravity

After the signing of the Maastricht Treaty in 1992, the interest rates across the euro area converged towards the low level predominant in Germany. At the same time, in taking steps to lower inflation to the 3 per cent limit required for entry into the common currency, governments implemented deflationary measures that compressed wages. These low interest rates, lower real wages and the removal of all restrictions on capital flows as well as financial deregulation in the euro area combined to cause massive influxes of capital into the peripheral economies, and a massive expansion of both private and government debt in these countries. These trends reached new heights in the years leading up to the crisis, causing worsening trade imbalances and divergence.

From 2003 to 2007, net capital outflows from Germany were on average 45 per cent of its GDP. By comparison, the net capital inflows into Greece over the same period was 37.5 per cent of GDP; in Portugal the net inflow was 36.6 per cent of GDP and in Spain it was 29.1 per cent. A large majority of these inflows came in the form of credit. In the Irish state, house prices doubled in real terms between 1995 and 2005, and then continued to rise. From 2003 until 2007 lending to households in the Irish state expanded at one of the highest rates in the Eurozone, with the exposure by German banks reaching more than US$200 billion.

The once-popular view outlined by Wolf above and expounded by free-market fundamentalists – that trade imbalances would be offset and rectified by private capital flows – proved to be completely false. Instead of playing a balancing and stabilising role in the Eurozone economy, the completely free movement of capital generated massive speculative bubbles, and the abrupt reversal of capital flows from 2008 shows that these capital flows have operated in a pro-cyclical instead of counter-cyclical way. (Pro-cyclical policies exacerbate economic and financial fluctuations, while counter-cyclical policies aim to decrease fluctuations.) If the free movement of capital operated in a counter-cyclical way, as was claimed, then it would flow to weak countries when they were in trouble, instead of doing precisely the opposite.

While there is a single interest rate across the Eurozone, set by the ECB, the risk premium on government bonds and bank debt in different countries means the actual interest rate differs significantly across the common currency area. The perceived risk in lending to a weaker country is reflected in the spread of interest rates. Where economies are viewed as strong (and governments viewed as being capable of bailing out their banks), their banks will benefit from lower interest rates. Weaker countries and their companies have to pay a higher interest rate. During a crisis, capital flees to the ‘safe’ countries’ banks. Since 2008 capital has flowed dramatically from the poorer countries to the rich – not only in the Eurozone but across the global economy – with a large proportion of global capital fleeing to the US as a result of the US government’s perceived ability (and political commitment) to bail out the banks. Inside the Eurozone, the trend has been for capital flight from banks in the periphery to the core, particularly Germany. Stiglitz notes: “Standard economics is based on the gravity principle: money moves from capital-rich countries with low returns to countries with capital shortage. But in Europe under the Euro, capital and labor defy gravity. Money flowed upward”.

The proposed European Deposit Insurance Scheme, the so-called third pillar of the EU’s Banking Union following a single rulebook and single supervision, was dreamt up as a way to reduce this tendency. It is one of the few proposals emanating from the Commission and the leaders of the EU that would could actually effectively reduce divergence in the Eurozone, and reduce the incentive for capital flight from the weak to the strong countries. It could work as a form of institutionalised surplus recycling during a downturn or a period of crisis for the periphery – and for that reason it is being resisted by Germany and has been put on the legislative back-burner. The lack of a common deposit insurance scheme makes the Eurozone “structurally vulnerable” to bank runs according to Wolf.

Betting on default

The so-called sovereign debt crisis saw the global financial crisis shift to inside the euro area, where it still remains, due to the structural flaws in the architecture of the Eurozone. The ‘foreign currency’ nature of the euro – the fact that countries couldn’t create the money they were borrowing in – meant that the belief by investors in the years following the creation of the common currency that all Eurozone government bonds were equal was short-lived. From 2007-2009 the spreads between government bonds in Greece and government bonds in Germany (‘bunds’) increased tenfold up to 2.8 percentage points, with the market giving its ‘verdict’ on the creditworthiness of the Eurozone’s deficit countries. This increased again to a differential of almost 4 percentage points by April 2010, when the Greek government found itself unable to keep funding itself from international money markets. After the Greek default, the markets turned to train their sights on Ireland.

Former Greek Finance Minister Yanis Varoufakis describes this ‘market verdict’ of risk strikingly: “Suddenly [in 2009-2010] hedge funds and banks alike had an epiphany. Why not use some of the public money they had been given [in the mass bank bailouts] to bet that, sooner or later, the strain on public finances (caused by the recession on one hand, which depressed the governments’ tax take, and the huge increase in public debt on the other, for which the banks were themselves responsible) would cause one or more of the Eurozone’s states to default?” The most common way to place these bets was through credit default swaps, which are basically insurance policies that pay out in the case of a default by a third party. As the CDS casino on sovereign debt in the Eurozone grew – instead of this capital being directed towards productive investment or economic recovery – the rising value of CDSs in Greece, Ireland and the other peripheral economies caused the interest rates these countries were forced to pay to rise, pushing them towards the cliff.

Ireland defaulted in December 2010, followed by Portugal and Cyprus. Portugal hadn’t gone through a bubble bursting like Ireland but had experienced a long period of stagnation as a consequence of joining the euro at a very uncompetitive exchange rate that it was then locked into. Cyprus imposed capital controls on euros leaving the country between 2013 and 2015 in fear its partial ‘bail-in’ of deposits would prompt massive capital flight. Iceland had done the same in 2008 but this was the first time capital controls had ever been used in the Eurozone. The Treaty on the Functioning of the EU states that capital controls can only be “justified on grounds of public policy or public security” and that such measures should “not constitute a means of arbitrary discrimination or a disguised restriction on the free movement of capital and payments” (Articles 63 and 65), prompting threats of legal action.

The existential crisis of the Eurozone began in 2011 when the CDS bets on Spain and Italy defaulting caused the spreads in the government bonds of these two countries to diverge from bunds by between three and six percentage points, yield rates that had pushed Greece, Ireland and Portugal over the edge. Spain received a recapitalisation package for its banks but it was not a fully-fledged bailout. Italy’s public debt was around four times the amount of the Eurozone rescue fund.

The European Financial Stability Fund (EFSF) was created in 2010 as a temporary vehicle to finance bailouts, and was made permanent in 2013, becoming the European Financial Stability Mechanism (EFSM). The EFSF and EFSM were created to bail out banks, not states. Varoufakis likens the Eurobonds issued by the EFSF to the toxic collateralised debt obligations (CDOs) peddled by Wall Street in the lead-up to the crisis. CDOs were instruments that included ‘slices’ of different bank loans, each with a different level of risk and a different interest rate. The rationale behind CDOs was that by pooling together risky loans with less risky assets, the overall risk profile would be lowered – the CDO would be able to gain a higher credit rating – and they would be more profitable for investors. The “mix was toxic because if one slice within a CDO went bad, that increased the risk of a default by the next slice”. Unbelievably, the same structure and rationale that underpinned the disastrous CDO was used by the EFSF when issuing Eurobonds for lending to the Irish state, and later other countries subject to Troika intervention. Each Eurozone state was required to make a guarantee according to the size of their GDP, and these guarantee from states with wildly diverse credit ratings were then bundled together as bonds. Weaker countries were charged higher interest rates, increasing the pressure on the next weakest state to fall. The EFSM is now a permanent body called the European Stability Mechanism (ESM).

This is an excerpt from the economic discussion document launched by MEP Matt Carthy on October 27, entitled The Future of the Eurozone. Download the full document for a referenced version of Chapter Three, above.

by Admin

From Bretton-Woods to Maastricht: the creation of the Eurozone

This is an excerpt from the economic discussion document launched by MEP Matt Carthy on October 27, entitled The Future of the Eurozone. Download the full document for a referenced version of Chapter Two, below.

WHEN AN economic downturn affects a country, for whatever reason, a government usually has three key tools to stimulate the economy and restore full employment – lowering interest rates, devaluing the country’s currency (or allowing it to depreciate), or using macroeconomic policy (eg, lowering taxes and boosting public spending). In a currency union, the first two options are dependent on the policy choices imposed by the union’s supranational institutions instead of national bodies.

If all of the economies within the currency union are sufficiently similar in nature, this should theoretically not be a problem. But the economies of the 19 member states of the Eurozone vary widely in their characteristics. At any given moment, the value of the euro vis-à-vis other currencies may be beneficial for some states’ economies but damaging for others. Likewise, the Eurozone-wide interest rates set by the ECB may boost some economies but depress others.

An economic crisis that affects a monetary union comprised of diverse economies will affect different countries in different ways. The designers of the Eurozone were aware of this possibility of “asymmetric shocks” having a different impact on different member states, motivating their development of the so-called convergence criteria. However, for ideological reasons, they chose to focus only on the issue of budgetary divergence, controlling member states’ national debt and deficits. This singular focus on controlling fiscal policy – despite overwhelming evidence that public spending cuts have a contractionary impact during downturns, and with no corresponding focus on the external current account (trade) balance of member states – has caused an increase in inequality and contributed to divergence instead of convergence among the Eurozone’s economies since the introduction of the currency peg.

While left-wing political movements and parties in Europe have focused on campaigning against the policy choices enacted by the EU institutions since the crisis, particularly the imposition of fiscal austerity, there is an urgent need to also examine – and explain – how the very structure of the Eurozone has contributed to inequality and divergence, prolonged and deepened the financial crisis and sovereign debt crisis, and makes future sovereign debt crises inevitable.

The gold standard currency peg

The euro is a currency peg system, which lacks the institutions that have allowed a common currency to work in other parts of the world – ie, in federal states such as the United States, Canada and Australia. Under a peg system, a currency’s value is fixed relative to a commodity, or to another currency.

Before the 20th century the global monetary system was characterised by the gold standard, where the value of different countries’ currencies were pegged to the value of gold, and to each other. The reason there was widespread support for fixing a state’s currency relative to gold was so that governments would not be able to print more money in response to economic conditions to their short-term political benefit. It was intended to deliver price stability. If there was more money pumped into the economy, it would cause prices to rise – causing inflation, reducing the purchasing power of working people, and making it harder for businesses to export their goods. Governments fixed their currencies at a set exchange rate, fixed the rate for exchange of these currencies with gold, and fixed the amount of money they could print with the small and reliable amount of gold entering the economy each year due to new discoveries of the precious metal.

For many decades during the 18th and 19th centuries, the US used a fixed gold standard and at other times relied on fiat money (money backed by a government guarantee instead of being backed by gold) – at times floating, and at times fixed to gold. The scarcity of gold in the late 19th century led to falling prices, deflation and depression in the US; debt became more difficult to repay. During the First World War the Gold Exchange Standard was temporarily suspended. But in spite of these problems and temporary suspensions, the Gold Exchange Standard was still being used by the capitalist countries when the Wall Street stock market crashed in 1929.

This currency peg worsened the Great Depression for the countries that clung to it because it prevented their governments from printing more money to stop banks and businesses failing, and generally to stop a deflationary spiral developing; those who exited the currency peg earlier recovered quicker. The two central lessons of 1929 and governments’ response to it, almost universally accepted by economists today, are that both inflexible exchange rates and austerity measures in response to a sharp downturn will deepen and prolong the crisis.

When a state’s money is flexible it works as a form of shock absorber, but fixed exchange rates remove a key way that economies can adjust to shocks or trade imbalances. Instead of abandoning the gold standard in response to the Great Depression, US President Hoover raised trade tariffs, contributing to a rise in protectionism and a decline in global trade. Some countries who had walked away from the gold standard retaliated by engaging in competitive devaluations of their currencies, in an example of ‘beggar-thy-neighbour’ economic policies. These ‘currency wars’, as they were known, saw countries cause the exchange rate of their currency to fall in relation to other currencies in order to gain a trade advantage – i.e., in order to boost their exports at the expense of other economies. When Franklin Delano Roosevelt won the US presidential elections in 1932, he promptly took the US out of the gold standard, largely ending the common currency system of the era. But the damage had been done, and the slump in the global economy continued until the massive public investment into the “industrial scale carnage” brought about by the Second World War.

The golden era of Bretton-Woods, 1944-1967

The decision to create the euro in 1992 was based on different motivations among its proponents in different countries. But one of the key goals shared by all of the participants was to create a replacement for the Bretton-Woods system that had underpinned the global economy since the end of the Second World War. Bretton-Woods disintegrated in August 1971 with the ‘Nixon Shock’, the announcement by then-US President Richard Nixon that the US was abandoning its commitment to propping up the global economy with the dollar.

The post-war global financial and monetary system was devised and agreed at a three-week conference attended by representatives of 44 Allied countries in the town of Bretton-Woods, New Hampshire, in the US in July 1944 as the Second World War neared its end. It aimed to bring an end to the inter-war global financial volatility that had led to the Great Depression and the collapse of the gold standard, as well as the post-Depression rise of protectionism and competitive currency devaluations.

Bretton Woods

Delegates Mikhail Stepanovich Stepanov (USSR), John Maynard Keynes (Britain) and Vladimir Rybar (Yugoslavia) at the Bretton Woods conference in 1944

The leading figures formulating the agreement were John Maynard Keynes on behalf of the British Treasury, and his more powerful counterpart from the US, Harry Dexter White, representing President Roosevelt. In addition to creating the International Monetary Fund and the International Bank for Reconstruction and Development (which later became known as the World Bank), the agreement also included a commitment to a global fixed-exchange rate system, underpinned by the American dollar, in turn backed by gold. Restrictions were placed on international capital flows in order to prevent currency speculation. The IBRD was to act as an international investment bank with the goal of promoting economic recovery from the war.

As part of the agreement, the US committed to guaranteeing this fixed exchange rate and the convertibility between the dollar and the gold it held, at the price of $35 per ounce of gold. There was a limited option for a country’s exchange rate to be renegotiated if it was clearly impossible to maintain. Within the fixed exchange rate, governments would be required to keep fluctuations within a band of plus or minus one per cent, by buying or selling their own dollar reserves.

The main reason the pre-war gold standard had collapsed was that it was unsustainable for countries to continue to keep such a high value for their currencies when their current account, or trade account, was in a deep deficit. Then, as now, there are balance-of-payment creditor economies with a trade surplus, meaning they export more than they import, and debtor economies with a trade deficit, meaning they import more than they export. A surplus in one country must equal a deficit in another, and every deficit must be financed, usually by borrowing. Economies with a trade surplus find themselves holding large quantities of money in their banks, who lend it to the deficit countries which need to finance their imports. As money is scarce in deficit countries, the interest rate will be higher, meaning it is more profitable for banks to lend to borrowers in these debtor nations. This lending by banks recycles the surpluses – but during a downturn such lending dries up.

The role of the IMF, according to the Bretton-Woods agreement, was to (partially) address this problem for debtor countries by acting as a lender of last resort. White, representing the world’s largest creditor country, scuttled Keynes’s proposals for measures to be taken to adjust trade imbalances on the part of creditor nations, and for a new global currency, the bancor, to be created to underpin an international balance-of-payments clearing mechanism.

However, White and Roosevelt did understand that such a global fixed exchange rate would remove a shock absorber for the global economy and would have the potential to turn a future downturn in the value of the dollar into a global recession. They aimed to establish a mechanism to avoid this. They believed strong regional currencies, backed by heavy industry, needed to be developed in both Europe and Asia. Very quickly after the war was over the US turned to its former foes to act as these strong regional currencies to support the dollar. In March 1947 then-President Harry Truman made a speech calling on the US Congress to intervene in Greece’s civil war by plugging the gap left by the British in providing financial support to pro-monarchist forces fighting Greek communists. The speech marked the arrival of the Truman Doctrine, opening the Cold War era, and it also marked the beginning of a US-backed industrial revival in its former enemies-turned-protégés, West Germany and Japan.

The Marshall Plan, officially known as the European Recovery Program, was launched shortly after the Truman Doctrine was announced and saw the US pump in more than 2 per cent of its national income in aid to western European economies to assist in recovering from the war, but also to ensure their dollarisation. The final factor that ensured Germany’s revival was the role of the US at the London Debt conference of 1953, in which it pressured other European countries to write down, or even write off, Germany’s pre-war debts.

In his book on the changing role of the US in the global economy throughout the 20th century, former Greek finance minister Yanis Varoufakis writes that Keynes’s proposal for an International Currency Union was overruled by Roosevelt’s New Dealers because they had an alternative plan: “The dollar would effectively become the world currency and the US would export goods and capital to Europe and Japan in return for direct investment and political patronage”. The US would run a massive trade surplus with the rest of the world, but it would also use this surplus to directly finance its protégés through aid and investment – meaning that demand for US products would be sustained in these countries. It would also support its key regional currency partners, West Germany and Japan, in their development of trade surpluses with their neighbours at a regional level.

In other words, the US was committed to ensuring it benefited from its position of a strong trade surplus, but made a simultaneous commitment to recycle a large part of its own surplus – in order to bolster other capitalist countries during the Cold War, and to ensure the stability of the new monetary system. The Bretton Woods structure “plainly recognized the asymmetry of the world as it was”, according to US economist and former Federal Reserve chair Paul Volcker, speaking in 1978. “The US, in effect, held an umbrella over the system.”

Nixon Shock: ‘It’s our currency but it’s your problem’

The Bretton Woods era saw two decades of post-war growth and relative stability. But the US had designed this global architecture in the mistaken belief that it would always be in the position of being a trade surplus country. The growth in the industrial capacity of West Germany and Japan in the following decades, combined with a massive rise in US government debt as a result of the costs to the US Treasury of the Vietnam War, started to shake the system by the mid-to-late 1960s. The global trade balance experienced an inversion and the US entered a deficit. Only the US was allowed to print more dollars under the Bretton Woods system, but the fixed exchange rate meant that other currencies pegged to the dollar started to suffer the consequences of US monetary policies. The rising amount of dollars was causing inflation in Europe and elsewhere, and in order to keep the fixed exchange rate in place, European governments had to increase the volume of their own currencies. Currency speculators predicted that the price of gold could not be maintained at $35, and frenetically purchased stocks of gold, worsening the situation.

Germany, France and Britain in particular began to signal their displeasure at the rising quantity of dollars in global markets. From the early 1960s, the Bundesbank resisted printing more Deutschmarks to defend the currency peg. In 1967, the British government under Labour Prime Minister Harold Wilson made an extreme deviation from the one-per-cent fluctuation limit set by Bretton Woods and devalued the pound sterling by 14 per cent. And most dramatically of all, France sent a warship filled with US dollars to New York harbour in early August 1971 with instructions to claim its gold held in the US Federal Reserve and Fort Knox. Britain immediately followed suit – minus the warship – and requested that $3 billion it held in US dollars be redeemed for gold.

Within days, US President Richard Nixon announced the end of gold convertibility on 15 August 1971, in a move that became known as the Nixon Shock and which marked an abrupt collapse of the Bretton Woods system. The US was cutting the rest of the world loose from the dollar zone. The regions that had benefited most from the system, Europe and Japan, would suffer the most from this unceremonious ejection. The US Treasury Secretary, John Connally, famously told a group of European finance ministers that the dollar “is our currency, but it’s your problem”.

Richard Nixon at a news conference

Former US President Richard Nixon

The idea of suspending gold convertibility was proposed to Nixon by Paul Volcker as a kind of ‘Plan B’ in May 1971; Nixon had appointed him as undersecretary of treasury in 1970. At a speech Volcker made in 1978, he reflected: “In the end, the inherent contradictions in the system were too great. With the benefit of hindsight, it would seem that an erosion of the US competitive position was implicit in the post-war arrangements. Europe and later Japan brought its industrial capacity close to US. It took some twenty years, but eventually the US payments position was irreparably undermined.” In the same speech he also said that US policymakers in 1971 believed that “controlled disintegration” of the global economy was a “legitimate goal”. The price of gold and commodities rose drastically and the 1970s were marked by a period of so-called ‘stagflation’ where high unemployment combined with high levels of inflation.

Varoufakis offers a convincing analysis and description of the reversal in global capital flows that followed the Nixon Shock. The US now had both a government deficit and a trade deficit, which policymakers resolved to find ways of making the rest of the world finance. The surpluses generated by the former US beneficiaries, Germany and Japan, needed to be redistributed towards the US somehow. Varoufakis argues that there were “two prerequisites for the reversal of global capital flows, which would see the world’s capital stream into Wall Street for the purpose of financing the expanding US twin deficits” – a rise in the competitiveness of US firms against their competitors in Europe and Japan, and a steep rise in interest rates in the US that would attract capital flows to the US by increasing profitability, but damage other countries’ economies and its own population.

This motivation underpinned the tight constraint of average real wages in the US since the 1970s – which to this day have not regained the real purchasing power they had in 1973 – and unleashed the wave of financial deregulation that was then implemented with enthusiasm by President Ronald Reagan. Capital gravitated towards the dollar in the aftermath of the Nixon Shock, purchasing US Treasury bills and investing in Wall Street. As net capital flows reversed – flowing into the US rather than out of it – the surplus capital of other countries was recycled as the US government and consumers then bought the exports of these same countries. The US played the complete reverse role it had during Bretton Woods but its leading role in recycling trade surpluses in order to maintain a semblance of balance continued. An expansion in the access to credit as a result of capital flows into Wall Street meant working people in the US increasingly went into debt to compensate for their stagnating wages, a pattern that was soon to be replicated in Europe.

The Union is born – as a price-fixing cartel

Understanding the Bretton Woods system, and the reversal in global capital flows that followed its collapse, is crucial to understanding the structures and beliefs underpinning the Eurozone – because the creation of the Eurozone was largely an attempt to recreate the Bretton Woods system.

The European Coal and Steel Community (ECSC), created in 1951, was the first step towards a European Union (EU). In 1950, French foreign minister Robert Schuman proposed that “Franco-German production of coal and steel as a whole be placed under a common High Authority, within the framework of an organisation open to the participation of the other countries of Europe”, which later became the ECSC with the Treaty of Paris in 1951, signed by West Germany, France, Italy, Belgium, the Netherlands and Luxembourg. This “High Authority” of 1951 became known as the European Commission.

Although the leaders of the ECSC participant countries of 1951, and the EU leaders of today, would express horror at such a characterisation, the reality is that the EU began life as a US-devised price-fixing cartel, which “openly and legally controlled prices and output by means of a multinational bureaucracy vested with legal and political powers superseding national parliaments and democratic processes”, according to Varoufakis in his book on the history of the Eurozone and the crisis. France and other countries also aimed to ensure the post-war scarcity of coal and steel did not work to Germany’s advantage. The ECSC fixed the price of coal and steel, and later moved to remove tariffs on coal and steel between members, and then on all goods.

The Treaty of Rome created the European Economic Community (EEC) in 1957. The objections of farmers, particularly in France, to the lowering or elimination of tariffs led to the creation of the Common Agricultural Policy from 1962 onwards, where part of the profits made by the heavy industry cartel were distributed to farmers as subsidies in order to gain their compliance with further economic integration and a customs union. A monetary union was first raised in the Marjolin Memorandum in 1962, authored by the European Commission. This memorandum initiated the first discussion on monetary integration in the EEC and proposed that the customs union should lead to fixed exchange rates between the currencies of its members. But as the Bretton Woods system was working reasonably well at the time to ensure exchange rate stability, there was little follow-up on the proposal in the short term. The first call for a common currency from a political leader came in 1964 – from then-French finance minister (and later President) Valéry Giscard d’Estaing.

A defining moment in the development of a common currency was the publication in 1970 of the Werner Report (to the Council and Commission of the European Communities) “on the realization by stages of economic and monetary union in the Community”. This report, produced against the backdrop of an increasingly strained, and soon to be destroyed, Bretton Woods system, proposed the main elements necessary for monetary union: full and irreversible convertibility of the currencies of the union; elimination of fluctuations in exchange rates; complete freedom of movement of capital; and the centralisation of monetary policy. National currencies could be maintained under the system, the report stated, or a single Community currency could be created, “but psychological and political factors weigh the scale in favour of adopting a single currency that would demonstrate the irreversible nature of the undertaking” (my emphasis).

A snake in a tunnel

The first practical attempt at creating a European currency peg, known as the ‘snake in the tunnel’, began in 1972. The metaphor was grim but apt – the snake was a currency’s exchange rate, and the tunnel was the narrow band in which the rate could fluctuate. Several members of the EEC, plus Britain, Ireland, Denmark and Norway, agreed to limit the margin of fluctuation between their currencies to a difference of no more than 2.25 per cent. It was a clear and open attempt to replicate the Bretton Woods fixed exchange rate regime in order to regain price stability between the European currencies after the collapse of the dollar-backed system the year before.

The Nixon Shock had caused the value of the dollar to fall but the Deutschmark to rise significantly, meaning the price of West Germany’s exports were becoming increasingly expensive. The Deutschmark’s soaring value strained the attempts to manage (or fix) the prices of Europe’s heavy industry and agricultural sectors, the raison dêtre of the EEC. The oil shock – a huge and sudden rise in energy costs – of 1973 forced the deficit countries to emerge from the tunnel. France, Italy, Britain and Ireland could not maintain these fixed exchange rates with the Deutschmark. The only way these deficit countries could maintain such an exchange rate was to increase their interest rates to attract foreign capital and to cut public spending to increase ‘confidence’ that government debt could be repaid, both of which would have significant negative effects on their own populations. By the late 1970s, only the Deutschmark, the Danish Krona and the Benelux countries’ currencies – Belgium, Luxembourg and the Netherlands – were still members of the snake in the tunnel system.

The road to Maastricht

As is the case with all major developments in the history of the EU, the creation of the European Monetary System (EMS) enacted in 1979 was the product of a political compromise between Germany and France. The German and French leaders had announced the creation of the EMS in September 1978. The EMS set a European Currency Unit (ECU) as a “basket” of currencies, and it established an Exchange Rate Mechanism (ERM), which was based on fixed exchange rate margins – but with a degree of variation possible within those margins. There was no official “anchor” currency of the EMS, which lasted for two decades until 1999. But indisputably the Deutschmark was the anchor, and the policies and approach of the system were heavily influenced by the Bundesbank’s phobia of inflation.

There were four key phases of the EMS according to an expert report carried out for the European Commission. The first phase, 1979-1985, included the retention of capital controls by several member countries. The inflation differentials, combined with fixed nominal exchange rates, required “frequent adjustment of the official parities”. The Irish state joined the EMS in 1979, and was required to break the punt’s parity with sterling in order to do so, as sterling – not in the ERM – was appreciating against the ERM currencies. Parity with sterling would have taken the punt outside of the agreed band, so it had to be broken as a condition for Irish entry into the ERM.

During the second phase, 1986-1992, the EMS was referred to by many as the “Deutschmark Area” because members of the system were forced to give up their own monetary policies in order to implement the anti-inflation policies of the Bundesbank and reduce their inflation levels to “German” levels. The so-called Mundell–Fleming trilemma (developed by Robert Mundell and Marcus Fleming, also referred to as the “impossible trinity”) holds that it is impossible for an economy to simultaneously maintain a fixed exchange rate, free movement of capital, and an independent monetary policy. The Commission report agrees: “Owing to the impossible trinity all central banks participating in the ERM had de facto renounced an independent monetary policy”.

Maastricht Treaty draft

Prime Minister Aníbal Cavaco Silva of Portugal; Prime Minister Ruud Lubbers of the Netherlands; Foreign Minister Hans-Dietrich Genscher of Germany; and Jacques Delors, the president of the European Commission toast a draft of the Maastricht Treaty in February 1992 (Jerry Lampen/Reuters)

During this second phase, the Single European Act was passed in 1986, moving towards a single market in the EEC. The then-Commission President, Jacques Delors, established a committee to examine a possible future monetary union, which produced the ‘Delors Report’ in 1989 – the document that led to the Maastricht Treaty of 1992 (endorsed by EEC governments in 1991 but ratified in referenda in Denmark and France in 1992). The Delors Report promoted the view that there was a need for national budget deficit rules, which became the Maastricht convergence criteria, and proposed a new institution, independent of member states, with responsibility for monetary policy – the European Central Bank. In 1990, following the Delors Report’s roadmap, capital controls among members of the EMS were abolished. These developments occurred against the backdrop of the disintegration of the Soviet Union and of German reunification.

From September 1992 until March 1993 the EMS experienced a severe crisis. Some of the members of the EMS were experiencing rising inflation which they were unable to reduce. Currency speculators targeted the over-valued currencies. Fears that voters would reject the Maastricht Treaty on a monetary union, proposed in 1991, contributed to the speculative currency attacks. In June 1992 the Treaty was rejected by 50.7 per cent of Danish voters in a referendum. A similar referendum was held in France, which narrowly endorsed the Maastricht Treaty in September 1992, with 51 per cent of voters supporting it. But massive speculative pressure in the lead-up to the French referendum contributed to the worst crisis in the history of the EMS, which led to the forced ejection of the pound sterling and Italian lira from the ERM, the devaluation of Spain’s peseta, and threats of forced devaluation of other currencies. The fluctuation margin of the EMS was widened to an enormous plus or minus 15 per cent in 1993 in a bid to stop other currencies, particularly the franc, from having to exit. Italy later rejoined the ERM in 1996.

The final phase of the EMS lasted from 1993 until 1999 when the Eurozone was launched by its original 11 member states – Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain. Greece joined the Eurozone in 2001, Slovenia in 2007, Cyprus and Malta in 2008, Slovakia in 2009, Estonia in 2011, Latvia in 2014, and finally Lithuania in 2015. An ERM II is in place, supposedly to draw non-Eurozone members of the EU into an alignment of exchange rates, but only the Danish Krona is a member currently. The single market was completed in 1993, allowing the free movement of capital, labour, goods and services, becoming formalised in 1994 by the European Economic Area (EEA) agreement.

by Admin

Eurozone’s permanent austerity based on failed ideology

This is an excerpt from the economic discussion document launched by MEP Matt Carthy on October 27, entitled The Future of the Eurozone. Download the full document for a referenced version of Chapter One, below.

BACK IN 1929 when the Wall Street crash hit, the response of then-US President Herbert Hoover was to restrict government spending – an action now almost universally acknowledged as having turned the stock market crash into the Great Depression.

The free-market ideology underpinning Hoover’s austerity policies held that an economy with high unemployment could return to full employment through market forces alone. Instead of boosting public spending, the government should do the reverse. By cutting government spending and increasing taxes, the government deficit would be reduced, which would restore market “confidence”. This restoration of confidence would lead to increased private investment, and the market would adjust itself to return to full employment.

The confidence fairy

The confidence theory was demonstrated back in 1929 to be incredibly damaging and to achieve precisely the opposite effect of what it aimed to achieve. The actual effect of implementing austerity in a period of economic downturn was to cause a contraction in the economy, thus weakening the economy further, causing tax revenues and national income to fall, and the deficit to increase. The contractionary impact of austerity policies during a downturn was explained by John Maynard Keynes during the 1930s, and Keynesian models have proved to be a reliable predictor of growth (or lack thereof) in the wake of the 2007-2008 crisis.

Countless books, academic studies and articles have outlined how the programmes imposed by the Troika – the European Commission, the European Central Bank (ECB) and the International Monetary Fund (IMF) – on the Eurozone’s “peripheral” economies since 2008 have exacerbated the crisis. In the decades before the global financial crisis, these same policies had caused the exact same devastating contractionary effects when imposed under the guise of “structural adjustment programs” by the IMF across Africa, Asia and Latin America.

But while Keynesianism was experiencing an academic and policy revival internationally following the global financial crisis, Europeans somehow managed to cling to the confidence theory, which persisted in the decades beyond the Great Depression to this day. It is the dominant theory that has shaped both the structure of the Eurozone and European Union (EU), and the EU response to the global financial crisis of 2008.

In 2011 at the height of the Eurozone crisis, Nobel Prize-winning economist Paul Krugman memorably dismissed this theory as the “confidence fairy”. Two years later, commenting on the theory’s persistence in the face of overwhelming evidence to the contrary, he added: “European leaders seem determined to learn nothing, which makes this more than a tragedy; it’s an outrage.” Fellow Nobel Prize-winning economist Joseph Stiglitz has dubbed the free-market fundamentalists’ obsession with reducing deficits as “deficit fetishism”, pointing out that “no serious macroeconomic model, not even those employed by the most neoliberal central banks, embraces this theory in the models they use to predict GDP”.

Europe’s lost decade

It is common for scholars to refer to the results of the IMF structural adjustment programmes from the 1970s-1990s in Latin America, Asia and Africa as having caused these continents “a lost decade” or “lost decades”. Europe has lost a decade but there is a danger that it may lose several more – not only because of the policy responses to the crisis but because of the actual structure of the Eurozone. The results of the European response to the crisis are damning. Three patterns are obvious: the Eurozone countries have in general fared far worse in terms in terms of recovery than countries outside of the common currency; the recovery within the Eurozone has been sharply asymmetrical, with divergence between strong and weak countries increasing; and there has been a significant rise in inequality across Europe.

Growth in the US and Britain has been weak since the crisis but it has far outpaced the Eurozone recovery. It is difficult to even use the word “recovery” to describe the Eurozone experience – only last year did Eurozone GDP reach its pre-crisis level. In June 2016, the Eurozone unemployment rate was still in the double figures at 10.1 per cent; while the EU-28 had unemployment of 7.7 per cent. But the unemployment figures in several of the crisis countries remains double the Eurozone average – in Greece by 2017 the unemployment rate was 21.7 per cent while at the same time in Spain the jobless rate was 17.8 per cent. The figures are masked by the huge levels of emigration that the crisis countries experienced as well as the fact that number of hours worked per worker has declined across the Eurozone.

Stiglitz notes that youth unemployment persists at twice the level of overall unemployment. “The persistence of high unemployment among youth will have long-lasting effects – these young people will never achieve the incomes they would have if job prospects had been better upon graduation from school.”

While the Eurozone stagnated for a full decade following 2007, countries within the EU but outside the Eurozone had a GDP 8.1 per cent higher than in 2007 by 2015. The United States had a GDP almost 10 per cent higher in 2015 than in 2007. Over the same period, the Eurozone’s GDP grew by just 0.6 per cent.

When measuring living standards it is more accurate to examine GDP per capita than GDP overall, and while in the US GDP per capita increased by more than 3 per cent from 2007-2015, while over the same period in the Eurozone it actually declined by 1.8 per cent. As living standards have declined – devastatingly in crisis countries, and especially in Greece – income inequality has also risen drastically. In its Economic Forecast last autumn, the European Commission warned of a potential “vicious circle” as expectations of long-term low growth affect investment decisions, and that “the projected pace of GDP growth may not be sufficient to prevent the cyclical impact of the crisis from becoming permanent”.

The declining level of growth in the British economy since the Brexit vote means a “strong downward revision of euro area foreign demand”, while the “sizeable depreciation of sterling vis-à-vis the euro is expected to have an adverse direct impact on euro area exports to the UK”. Eurozone exports were forecast to decrease slightly this year and stagnate in 2018, while possible financial crashes in China or the US and the ongoing non-performing loan banking crisis in the Eurozone pose serious risks.

Despite these sober warnings, European leaders and the financial press have raucously celebrated the anemic growth in the Eurozone’s GDP in the first two quarters of this year, of 0.5 per cent and 0.6 per cent respectively – crucially, driven by a slow increase in domestic demand as opposed to export-led growth. But this celebration ignores the fact that in normal circumstances, these figures would be viewed as abysmal, and that global economic forces pose serious threats to this fragile recovery.

Fairies and leprechauns

Predictably, these feeble shoots of growth are described as being the result of austerity policies by those who have claimed for the past 10 years that austerity will start to work any day now. A slightly recalibrated confidence theory has been proposed by a small number of economists associated with the neoliberal school of thought since the 2008 crisis – that of an “expansionary fiscal contraction”, with Harvard’s Alberto Alesina and Goldman Sachs’s Silvia Ardagna leading the charge with their joint paper in 2009. What they are actually recommending largely amounts to recovery through beggar-thy-neighbour competitive devaluations (or in the common currency, internal devaluation).

Stiglitz points out that these instances of economic recovery are actually cases where certain countries had “extraordinarily good luck” in that “just as they cut back on government spending, their neighbours started going through a boom, so increased exports to their neighbours more than filled the vacuum left by reduced government spending”. Several papers from the IMF itself have backed up this analysis.

This is largely what happened in the Irish economic recovery, which has become the EU’s poster child for austerity policies. The narrative goes that the Irish state followed the German model – it followed all of the EU rules and implemented the Troika’s structural reforms, slashed government spending to reduce the deficit, cut wages to increase competitiveness, and as a result restored market confidence, depressed domestic consumption and experienced a corresponding rise in exports.

The reality is more complex, and is based on a combination of growth in jobs in the indigenous sector, including the services sector, arising from favourable exchange rates for the Irish state; and on the illusory “growth” of GDP caused by the industrial-scale corporate tax avoidance strategies undertaken by US multinationals in the technology, pharmaceutical and aircraft-leasing sectors.

There has also been a certain level of export-led growth since 2009 but it has been hugely exaggerated and difficult to reliably quantify. But this export-led growth did not in any way fit into the German model and “expansionary austerity” narrative of an internal devaluation based on lowering wages and domestic demand. Rather than being based on manufactured exports with a competitive edge because of wage cuts, export growth took place among firms in high-wage service sectors such as technology and finance during a period in which wages in these sectors were going up.

Of course, last year’s ludicrous announcement that Irish GDP had grown by more than 26 per cent in 2015 raised an enormous red flag that all may not be what it seems in Ireland’s economic recovery. Krugman, coiner of the “confidence fairy” term, found another apt folkloric description for the occasion: “leprechaun economics”.

These figures were so detached from reality that they were cause for serious alarm but, incredibly, the Irish government welcomed them. According to the figures, per capita income apparently rose to 130,000 in 2015, and the state’s industrial base doubled in just one year. But the Net National Income grew by 6.5 per cent in 2015 while consumer spending rose by 4.5 per cent. These income and consumption figures are a far more accurate reflection of real economic activity and growth. Official GDP figures have a major and serious role to play in fiscal planning, spending and borrowing. They need to be credible and a measurement of real economic activity.

Most alarmingly, the figures reveal a glimpse at the level of dubious accountancy tricks being played by multinationals in Ireland during a period in which the Irish government claimed it was committed to playing its part in the global crackdown on tax avoidance. The Irish Central Statistics Office (CSO) identified relocations and inversions by multinational enterprises as the major contributing factors to the so-called growth. It seems as though there was a rush by multinationals to ‘turn Irish’ in 2015 in the context of global action on tax avoidance and tax havens, through inversions – where a multinational corporation changes tax domicile after it buys up a smaller Irish-registered company. The transfer of financial assets and intellectual property patents into Ireland does nothing to actually create jobs or contribute to growth in the real economy.

In response to the fantasy figures for 2015, the Central Bank of Ireland published a study stating that to measure growth or activity without the reality being skewed by the activities of multinationals, GNI* (Gross National Income, modified) should be used instead. GDP and Gross National Income differ as a result of the “net factor income from abroad” (eg, repatriated profits and dividends of multinationals). While GDP is a measurement of the income generated by the economy, GNI measures the income actually available to its residents. Irish GDP is more than 20 per cent greater than GNI, one of the largest differences among all economies globally (the two figures can usually be used interchangeably).

But even using GNI is not sufficient to get an accurate picture of real economic activity according to the CSO, which developed a measure of “modified gross national income” or GNI*. GNI* is Gross National Income “adjusted for retained earnings of re-domiciled firms and depreciation on foreign-owned domestic capital assets” – ie, modified to account for depreciation on intellectual property owned by technology and pharmaceutical firms. When GNI* is used to measure the Irish economic recovery, the picture is not so rosy. “The Irish economy is about a third smaller than expected. The country’s current account surplus is actually a deficit. And its debt level is at least a quarter higher than taxpayers have been led to believe,” the Financial Times reported on the first set of “de-globalised” data on the Irish economy in July this year.

For 2016, the value of the Irish economy according to its GDP was €275 billion, but according to its GNI* its value was €190 billion – a huge difference that indicates that not only is the Irish economy not nearly as strong as the official narrative portrays, but also that the Irish state may have facilitated multinationals in avoiding up to €85 billion in tax in one year alone. The CSO reported that in 2015, government debt was 79 per cent of GDP but 100 per cent of GNI*; and that while the state’s fiscal deficit was 1.9 per cent of GDP, it was 3.4 per cent of GNI*, well above the 3 per cent limit imposed by the EU’s fiscal rules.

There has also been growth in employment over the past three years in the Irish indigenous sector. For example, job growth took place in the agriculture and food sectors, and in accommodation and tourism. This growth was based on two related factors. The first was the depreciation of the euro against the dollar and sterling as a result of the crisis, and the second was the relatively higher economic growth in Britain and the US, the Irish state’s two largest trading partners. The (temporary) lower value of the euro was critical to the recovery experienced in the Irish indigenous sector. The relative growth in the US and Britain was also influenced by the fact that these two states are not constrained by the Fiscal Compact rules – borrowing in the US and Britain did not fall below 3 per cent since 2008.

But the specific circumstances of the Irish state’s trading patterns mean that this “recovery” cannot be transposed or replicated in other member states of the EU. It also poses significant risks, especially the risk of a significant fall in the value of sterling as a consequence of Brexit. A sharp depreciation of sterling against the euro – something we are already beginning to see – would likely jettison this recovery. Worrying signs of a technology bubble, a new Irish housing bubble and a massive shadow banking sector are all factors that may also influence this recovery. Crucially, the structure of the Eurozone itself, and the austerity ideology it has enshrined, make another economic slump inevitable.

The evidence shows that the Irish recovery happened in spite of, not because of, the EU austerity recipe – and it would have happened sooner, and with far less pain to the Irish people, had ideologically driven deficit fetishism been rejected.

A fiscal straitjacket

In 1992 the member states of the European Economic Community (EEC) signed up to the Maastricht Treaty, which laid the foundation for the common currency. The Maastricht Treaty enshrined the so-called convergence criteria – a set of rules members and potential members of the common currency were obliged to follow. To join the Economic and Monetary Union (EMU), states had to pledge to control inflation, and government debt and deficits, and commit to exchange rate stability and the convergence of interest rates. The blanket, one-size-fits-all fiscal rules in the criteria – that member states must keep public debt limited to 60 per cent of GDP and annual deficits to below 3 per cent of GDP – were proposed by Germany, based on its national Stability and Growth Pact.

The convergence criteria, as the term suggests, were aimed at achieving convergence among the diverse economies that were to form the Eurozone. The founders of the euro acknowledged the tendency for economic shocks to hit diverse economies asymmetrically in a monetary union. Without convergence, a common currency won’t work – for example, with diverse economies the interest rate set by the ECB for the entire Eurozone may impact positively on one country but negatively on another country with different economic characteristics. Without convergence, it would be difficult if not impossible to ensure full employment and current account (external) balance among different economies at the same time.

There are many spillover effects that one economy can have on another in a monetary union – for example trade imbalances and internal devaluations – but the only one that the Maastricht Treaty focused on was members’ fiscal policy. “Somehow they seemed to believe that, in the absence of excessive government deficits and debts, these disparities would miraculously not arise and there would be growth and stability throughout the Eurozone; somehow they believed that trade imbalances would not be a problem so long as there were not government imbalances,” Stiglitz comments.

Governments facing an economic downturn have three main ways they can aim to restore the economy to full employment: to stimulate exports by devaluing their currency; to stimulate private investment and consumption by lowering interest rates; or to use tax-and-spending policies – increase spending or lower taxes. Membership of the Eurozone automatically rules out using the first two mechanisms, and the fiscal rules largely remove the third option from governments.

(The confidence fairy is almost always accompanied by a fervent belief in “monetarism” among neoliberals – ie, that only monetary policy by an independent central bank should play any role in economic adjustment, and anything else would amount to dreaded government intervention in the economy.)

When a Eurozone member state experienced a downturn, its deficit would inevitably rise as a result of lower tax revenue and higher expenditure on social security. But when the convergence criteria kicked in, causing governments to cut spending or raise taxes, it would invariably worsen the downturn by dampening demand. Moreover, debt and deficits did not, and do not, cause economic crises. Ireland and Spain were running surpluses when they experienced a crisis, and both had low public debt.

The convergence criteria are purely ideological and economically unsound. But as the European Central Bank (ECB) was preparing to begin operating to control inflation and interest rates, Germany pushed for the adoption of an EU-wide Stability and Growth Pact in 1997, including non-Eurozone members, to enshrine the fiscal control aspects of Maastricht, and more generally to increase EU surveillance and control over member states’ national budgets.

The Stability and Growth Pact has been called a lot of names in its day – the “Stupidity Pact”, a “Suicide Pact”, the “Instability Pact”, and more. And it is deserving of each one. In 2002, then-President of the European Commission Romano Prodi told reporters the pact was “stupid”, while French Commissioner Pascal Lamy called it “crude and medieval”. In practice, the Stability and Growth Pact has proved to achieve the opposite effects it claims to aim for. Cuts to government spending have a contractionary effect and cause the economy to shrink; when the national income shrinks, spending on unemployment benefits have to rise, and the situation gets worse. This is exactly what happened in the aftermath of the recessions in Ireland, Spain, Greece and Portugal.

Early in the 2000s, both Germany and France repeatedly breached the fiscal rules. But they were not penalised, and were always provided with an extension to try to meet the targets. Almost all EU member states have breached the rules at some point – during the recession only Luxembourg did not go over the 3 per cent deficit target. Fiscal contraction will exacerbate unemployment, but it may eventually restore a current external account balance – when demand for imports becomes so low as a result of the recession that exports catch up.

University of London Professor George Irvin has described German Chancellor Angela Merkel’s insistence that government profligacy is at the root of the Eurozone crisis as betraying “near-total ignorance of how economies work”. “Budget balance for a national economy is fundamentally different from that of the household or the firm. Why? Because budgetary (or fiscal) balance is one of three interconnected savings balances for the national economy. The other two fundamental economic balances are the current external account balance… and the private sector savings-investment balance. If any one account is out of balance, an equal and opposite imbalance must exist for one or both of the remaining accounts,” he wrote.

But despite the vast evidence that the Stability and Growth Pact was counterproductive and unenforceable, Germany pushed for the fiscal rules to be tightened yet again in 2012 through the Fiscal Compact Treaty, which created the obligation for the convergence criteria targets to be inserted into the national law of the ratifying states.

The Fiscal Compact

In 2010, Germany proposed the reform of the Stability and Growth Pact to make it stricter, and “in return” pledged to support the creation of a Eurozone bailout fund that member states could draw upon if they were in dire straits – with strict fiscal conditions attached, of course. The reforms aimed at enforcing compliance of the Stability and Growth Pact known as the “Six-Pack” and “Two-Pack” of additional regulations and directives were adopted at EU level.

In 2012, an intergovernmental treaty – the Treaty on Stability, Coordination and Growth – was signed by all EU Member States with the exception of Britain and the Czech Republic. (When Croatia joined the EU in 2013, it declined to sign.) The Treaty, known as the Fiscal Compact, incorporated the Stability and Growth Pact, the Six-Pack and Two-Pack requirements, and more. Its central principle is that member states’ budgets must be in balance or in surplus, which the Treaty defines as not exceeding 3 per cent of GDP.

Critics of the Stability and Growth Pact had called on the EU to focus not on the general deficit but rather the structural deficit – what the deficit would be if the economy were at full employment. But instead of dropping the general deficit limit, the Fiscal Compact has adopted rules on both the general deficit and the structural deficit. The structural deficit limits are set by the Commission on a country-by-country basis and must not exceed 0.5 per cent of GDP for states with debt-to-GDP ratios of more than the 60 per cent limit, and must not exceed one per cent of GDP for states within the debt levels.

The “debt-brake” rule is the convergence criteria rule that government debt cannot exceed 60 per cent of GDP. The Fiscal Compact enshrines the rule that members in excess of this limit are obliged to reduce their debt level above 60 per cent at an average of at least 5 per cent per year. The structural deficit rule – called the “balanced budget rule” – must be incorporated into the national law of signatory states under the Fiscal Compact. An “automatic correction mechanism”, which is to be established at member state level and kicks in when “significant deviation” from the balanced budget rule is observed, must also be incorporated into national law.

Of all the member states who signed the intergovernmental treaty, only the Irish state put the Fiscal Compact to a referendum. The Fiscal Compact Treaty was adopted by just over 60 per cent of the voting electorate, with around 50 per cent turnout. The Fine Gael/Labour government’s decision to hold a referendum was not based on a belief in the right of the Irish people to have their say on their economic future, but rather their desire to go one step beyond simply incorporating the permanent austerity rules into legislation, and to insert them into the Constitution – despite the fact that the government’s Fiscal Advisory Council recommended the legislation option. Fine Gael, Fianna Fáil and Labour representatives urged the people to vote yes, dangling the carrot of access to the new bailout fund. The vote in favour was hailed by the government as an endorsement of its austerity policies.

The reality is that the Irish electorate was blackmailed into voting in favour of a proposal that endorsed a damaging austerity framework based on free-market fundamentalism as a result of the threat of crisis funds being withheld in future, and by the promise of the debt burden being relieved through the direct recapitalisation of the failed Irish banks by the future European Stability Mechanism. And after the approval of the Fiscal Compact Treaty and the constitutionalisation of austerity in Ireland, the Fine Gael-led government quietly dropped its call for the EU to recapitalise the Irish banks. Unbelievably, by 2015, the same Irish government representatives who had urged voters to approve the Fiscal Compact Treaty were pleading with EU authorities for more flexibility for Ireland’s implementation of the rules.

Irvin points out that Germany’s debt-brake cannot be good for other Eurozone countries, or even possible, for three reasons – that Germany’s exports to the Eurozone are by definition another member state’s imports; that there is insufficient global demand to sustain all Eurozone economies becoming net exporters like Germany; and that the public debt-brake completely ignores the problem of private debt, especially in the over-leveraged banking sector.

In a scathing critique of the Fiscal Compact, Francesco Saraceno and Gustavo Piga highlight that “no other country in the world has ever considered [such a rule], and with good reason” and say that the adoption of the Fiscal Compact has been “untimely, unfortunate and unequivocally wrong”. “Its uniquely negative effects, as the experience of Italy clearly shows, lie in the perverse features whereby, even if a government is allowed to renege year after year on the promised path toward a balanced budget, it is still required, every year, to recommit to a medium term (3-4 years) adjustment toward that balance. In so doing, business expectations are negatively affected, private investment plans are postponed, and stagnation becomes a permanent feature of the economy,” they write.

Return fiscal powers to member states

There have been repeated efforts, led by Germany, to exercise control over the budgets of member states. For several decades now, France’s demand for a European monetary union was always met with the German response that it must be accompanied by fiscal union, or German-led surveillance and control over national budgets. The same argument continues today, based on the same flawed ideology.

There have been several important proposals to reform the Fiscal Compact – for example, to focus only on the structural deficit; or to exclude capital investment from the rules. But while these proposals may loosen the straitjacket a little, it would be better to just take it off. As part of the Fiscal Compact treaty, the Council is required to adopt a formal decision on the Fiscal Compact by 1 January 2018 on whether or not to insert it into the EU Treaty. Saraceno and Piga argue: “If a number of important countries were to veto that move, this could set in motion a profound rethink of the appropriate fiscal policy infrastructure supporting the euro zone in future, one consistent with recent developments in macroeconomics.”

The Fiscal Compact has already been proven to be unworkable. The European Council voted last year to adopt the Commission’s recommendation to impose no fines for excessive deficits on Spain and Portugal in a clearly politically motivated decision. The austerity lie is losing its power, with even the IMF and the Commission questioning its benefits after a decade of stagnation. Barry Eichengreen and Charles Wyplosz argue that the attempt to centralise fiscal policy at the EU level is “doomed” and should be abandoned. In a paper on minimum conditions for the survival of the Eurozone, they write: “The fiction that fiscal policy can be centralised should be abandoned, and the Eurozone should acknowledge that, having forsaken national monetary policies, national control of fiscal policy is all the more important for stabilisation.”

by Admin

Witnessing the Catalan referendum firsthand

Below is an account of the visit by an international parliamentary delegation of 33 elected representatives and a number of their advisors to Catalonia, hosted by DiploCat, during the Catalan referendum. While the delegation programme lasted for several days, this account covers only Sunday October 1, polling day. This is not a political analysis of the Catalan referendum but my personal account of what we witnessed.

I left my hotel at 7am on Sunday morning to meet up with the international parliamentary group and our DiploCat hosts. It was still completely dark and pouring rain but I knew thousands of people would have been gathered outside polling stations since 5am to defend them from police attempts to shut them down, which had been rumoured the day before to be scheduled to begin at 5am or 6am.

The international visitors were scheduled to leave in 10 small groups from a central meeting point at 7.30am. I was in a group with Sinn Féin Senator Trevor O’Clochartaigh, Swedish Green MEP Bodil Valero, Welsh member of the Westminster Parliament for Plaid Cymru, Hywel Williams, and Magni Arge, a member of the Faroe Islands and Danish Parliaments for the left pro-independence Republic party. We spent the day with our helpful DiploCat host, a young woman called Irina.

The official plan was to visit three or four polling stations in Barcelona and the surrounding towns; meet the mayor of Solsona for lunch at 1pm; then return to Barcelona by 4pm.

Sarrià-Sant Gervasi

Our first stop was a polling station at a school (Col·legi Orlandai) in the Barcelona suburb of Sarrià-Sant Gervasi, close to Gràcia, where two of the international groups, or around 10 observers altogether, arrived at 8am. It was bright by then and the rain stopped temporarily. Hundreds of people were gathered outside the school, whose entrance gates were closed. They cheered when we arrived, seeing our ‘international observer’ lanyards.

Approaching the first school at Sant Gervasi

Approaching the polling station at Sarrià-Sant Gervasi

Two uniformed members of the Mossos d’Esquadra, the Catalan autonomous police, stood at the edge of the crowd and observed.

We started to speak to some of the voters gathered, sometimes in English and sometimes having the conversation translated by Irina or by Bodil from Sweden, who has fluent Catalan. They said the Mossos had earlier informed them they had been instructed to prevent voting, but that they did not intend to, in the interests of protecting public order and public safety.

Trevor suggested we speak to the officers. I hesitated for a second, not being a big fan of police, having both experienced and witnessed police violence at peaceful public gatherings and rallies on several occasions. But we went over to introduce ourselves. Both were polite and friendly, and chatted comfortably with us in English. One of them, finding out Trevor and I were Irish, told us he had lived in Dublin for close to a year. I asked if it was okay if I took a photo of them speaking to Trevor and they replied, “Of course it is”.

mossos-talking-to-trevor.jpg

Sinn Féin Senator Trevor O’Clochartaigh chats with the two Mossos officers at Sarrià-Sant Gervasi

Some of the assembled voters told us the majority of the crowd had been there since 5am, and that the school was one of those that had been occupied since Friday afternoon. The parents of the kids who attended the school had slept inside the school building on the Friday and Saturday nights. There were three or four young women half-asleep on thin mattresses just outside the building, under the shelter of an overhanging roof. People carefully stepped over them, as did we.

Just then, at around 8.15am or so, the parents began to exit the school building into the waiting crowd, carrying their mattresses and sleeping bags, to cheers and applause.

Internet shut down

Some of the organisers then invited us to come inside the school, and we squeezed through the voters to walk through the gate. The front rooms were set up with desks for ballot papers and ballot boxes, and around a dozen volunteers were working intently on computers and laptops. Voting was due to begin at 9am but their electronic electoral system was down and the entire internet seemed to be down too.

I tried to get online on my phone when inside the school and couldn’t – sometimes my phone would say  ‘No service’ but even when it didn’t, I was still unable to use the internet. I couldn’t get online for hours that morning. It was the same for the other visitors, though some of them seemed to be able to get online for two or three minutes at a time. Outside, one of the organisers called on the voters to all switch their phones onto airplane mode in the vain hope that it was a capacity overload problem, a request everyone quickly and willingly cooperated with.

Someone told us the polling station staff were attempting to get online by using a Belgian proxy; it didn’t work though. We heard through text messages that not only the electronic voting system was down, as was expected, but the entire internet was down at a number of other voting stations too. “Do you think it’s the Spanish government that’s responsible?” I asked one of the frazzled volunteers. She looked at me as though I were a moron and said, “Of course it is.” We both had to laugh.

The voters outside were patient and cooperative, occasionally breaking into chants of “Votarem! Votarem!” (“We will vote!). We could see each other through the gates; organisers outside communicated constantly with those inside, and passed phones, coffees and mini-pastries through to the volunteers. Bodil did an interview with a Swedish journalist holding a recorder through one of the gaps in the gate.

waiting-in-the-rain.jpg

Voters wait in the rain

When it rained, the voters shared large umbrellas through the crowd. At one stage an organiser was lifted on top of someone’s shoulders to call on the voters to clear a path for the elderly, people with special needs and people who had to go to work that day to be able to come up to the front and vote first. Two older women were brought into the school building so they could sit down; an elderly, frail man refused the offer of coming inside and continued to stand outside at the front of the queue using his umbrella to help support himself.

It was at that point that texts began to come through saying there had been attacks by riot police on other polling stations in Barcelona, including some that were close-by.

Shortly before 9am, the two Mossos officers entered the school building, with voters clearing a path for them. They asked the volunteers to assemble so they could speak to them all together. The international visitors hung back but within hearing distance, and Irina and Bodil translated for us.

The Mossos informed the workers that the National Police was attempting to close several polling stations in Barcelona. They repeated what they had told us and the voters earlier; that they had been instructed to prevent the vote from proceeding, but that they were not going to, as their intention was to act in the interests of preserving peace, public safety and public order. They added that if the Spanish police arrived, they would not be able to intervene, but that they would try to act as mediators between the Spanish police and organisers.

Mossos talk to organisers inside

The Mossos officers talk to polling station workers

One of the Mossos then approached the seated older women, crouching down to ask if they were feeling okay, and offered them water. Then they left through the gates, to applause.

The first votes

The volunteers resumed working to resolve the internet problem. I remarked to one of them that the voters assembled outside were incredibly patient, waiting for hours in the rain; no-one was acting annoyed or frustrated at the fact that the polling station was still closed at 10.30, an hour and a half after it was scheduled to open. “They have been waiting their whole lives to vote,” she said. “They don’t mind waiting a little longer.” But anxiety about the possibility of a police attack was growing.

The polling station workers thought that if they had computers with older technology they may be able to connect to a wifi system – so people outside ran home to bring in two or three old laptops and an old PC, which they passed through the gates. At around 10.40am a cheer went up inside the building and we all started clapping – it had worked! They were connected.

One man inside excitedly ran to inform the others, through the gate, that they were connected to the internet and voting was about to begin. “I’m going to be the first to vote!” he yelled excitedly, to laughter. The two elderly women and a handful of others inside took up their ballot papers and voted.

Elderly woman casts her vote

One of the women who came inside to sit down casts her vote

Then the gates opened and the first round of people walked through. Everyone was cheering and applauding jubilantly – the voters outside, the workers inside, us international visitors.

 

The faces of those who came through were still calm and resolute but some became tearful after they voted. It was a really moving moment, and it’s hard to accurately put it in words. The best way I can describe it to say there was an overwhelming sense of dignity about both the moment and the people.

As the voting got underway, our DiploCat hosts organised the two groups to start moving to our next location; we had been scheduled to leave shortly after 9am but had decided to stay until the station opened. The voters lined up outside the school cheered us and said “Thank you!” in English as we left.

At Manresa

We started driving to Manresa, an industrial province of around 75,000 people in the centre of Catalonia, about 45 minutes outside of Barcelona. We had already seen a small number of videos on Twitter of police seizing ballot boxes and beating voters with batons in the brief moments where anyone could connect to the internet in the polling station at Sarrià-Sant Gervasi.

Now we spent the journey uploading our own photos, footage and observations from the morning onto social media, and passing around phones between the seats so we could all view the latest footage of the police attacks – gasping, murmuring “Oh my god,” and exclaiming “Jesus Christ!” as the snippets of film from the other polling stations showed increasingly brutal violence and rubber bullets being fired into defenceless and panicking crowds. It was not just the National Police we saw in the footage anymore but also the Guardia Civil. Hywel was uploading live videos in Welsh to Twitter, describing our visit.

When we arrived in Manresa centre around 11.30am we stopped for a coffee for a few minutes and stood at the bar with our eyes glued to the TV which was, of course, broadcasting the footage from the polling stations. The building in the square were adorned with colourful flags saying “Sí!” and “Democràcia!”, like in Barcelona, and it had stopped raining entirely. Then we walked to a polling station, a school, where the people queuing outside again cheered as we approached. There were still large crowds waiting to vote as we entered at around noon, and spoke to the polling station workers. The National Police had not arrived at the station; the queues were orderly and  the mood bright. Two Mossos stood outside.

Voters queue in Manresa

Voters queue up outside one of the polling stations in Manresa

One of the polling station volunteers offered to walk us around to the second voting station open in Manresa centre, which was nearby, and we agreed. During the walk the volunteer said worriedly to our DiploCat guide, Irina, that the route we were taking to the second site wouldn’t show us the best side of Manresa; Irina translated her concerns while laughing kindly. Relaxing, the local volunteer then joked that we were walking down “Las Ramblas” of Manresa.

This station, too, was busy, but calm and orderly, having received no visit from the National Police or Guardia Civil. Each polling station had a ‘president’ – a coordinator or presiding officer. Many of the volunteers were wearing stickers that identified them as both activists of the ANC (National Assembly of Catalonia) and also of ERC (Republican Left of Catalonia). I spoke to the president at this site in English for some time about how the day had unfolded, and he outlined the same difficulties with their voting system and internet access that we had experienced early in the morning.

I asked him if he was a member of any political party as I was curious as to whether the volunteers were all affiliated to political parties or whether there were also unaffiliated community members and activists. Almost apologetically, he said he wasn’t a political activist, but worked in IT – and that his mother, an ANC activist, had called him the night before to say they needed people with technological expertise as they anticipated hacking attacks. “So here I am,” he smiled.

Baby on shoulders Manresa

Voters wait their turn to enter the polling station in Manresa

As we left, the crowd queuing outside applauded and started chanting “Thank you! Thank you!”. By this stage we had asked Irina to teach us how to say “Good luck” in Catalan, so we replied “Bona sort!” as we left. I grinned to hear a man in the queue describe us as “briagdistas internacionales” as we walked past; he and his friends laughed and waved goodbye.

Waiting in dread at Sant Joan de Vilatorrada

Irina told us there were fears of a nearby polling station being attacked so we drove to another school at Sant Joan de Vilatorrada, just a few minutes from Manresa centre. The atmosphere was different here, subdued. People queued outside, but quietly. There was no cheering.

Inside, the volunteers told us that the polling station had been attacked violently by the Spanish police that morning, before it had even opened. Witnesses told us that the National Police had used a battering ram to enter, and smashed a man’s finger in the door four times, crushing the bone and severing the tendons. They took the ballot papers, boxes and began attacking the voters outside.

A teenage girl explained to us that her and some other voters had run up to the two Mossos present and asked them to do something; they said they couldn’t intervene but called their superior officer who arrived and had a heated argument with his counterpart in the National Police, after which the Spanish police withdrew. The injured man had left hours earlier to get medical attention so we couldn’t speak to him.

On the lookout for police at Sant Joan

Voters wait anxiously following rumours the police were planning to return to the school they had attacked that morning

The organisers and locals were anxiously expecting the National Police to return – they had received encrypted WhatsApp messages from organisers and activists at nearby stations and on nearby roads who reported they had seen around 60 Spanish police officers in the area. The locals knew they didn’t have the numbers to resist another entry attempt by police. We walked up to a perimeter fence that voters and activists had gathered by, all of us peering through warily. An enormous cheer went up as a number of uniformed firefighters walked up the hill together to the school.

Firefighters talking to us by Bodil

The firefighters who outlined the situation to us. Photo by Bodil Valero.

We spoke to the firefighters and others for around an hour, waiting for the police to arrive, but they never did. One firefighter in particular spoke to us at length, describing his view of the general situation. “I’m not very political,” he said. “But we just want to vote. It’s simple.”

Then we heard through WhatsApp messages that the Guardia Civil had attacked another polling station just a five-minute walk away. The firefighters sprinted off down the road as a handful of teenage boys sprinted off another way, obviously knowing a short-cut. Irina said we should think carefully about whether we wanted to try to catch up with the police, but we all quickly agreed we did.

‘I had my hands up’

Our driver zipped us around to the school that was under attack and we arrived to scenes of lines of around 20 Guardia Civil officers jostling voters who had their arms raised. Several Mossos and firefighters formed a line of their own in between the voters and the Guardia Civil.

The people were peaceful but angrily chanting, “No passaran!”, “Catalunya! Catalunya!”. After a tense and angry standoff of around 15 minutes, the police backed off and left.

We were on the street, and couldn’t see the school building through the crowd, so I misunderstood the situation we had walked into. I thought the Guardia Civil had arrived, realised they were heavily outnumbered, and decided to leave. But that’s not what happened – we had got there too late.

They had already smashed down the glass doors of the polling station, seized the ballot boxes and beat a 70-year-old man over the head with a baton – just because he was in the process of voting. As the Guardia Civil left, he was sitting outside being cared for by other voters.

(Below is footage from @QuicoSalles on Twitter of what happened in the moments before we arrived.)

We had all been separated, but the same teenage girl who had spoken to us at the previous school had come running up to find one of the international observers – my Sinn Féin colleague Trevor – who went and spoke to and filmed the injured man. He had had his head split by the baton. “I had my hands up,” he said. “I was voting, I had my hands up.”

We jumped back in the car based on more WhatsApp messages and tried to get to the next site we believed was going to being targeted before the police did, around five minutes away. People were gathered outside anxiously and some were clearly in shock, having arrived from the same polling station we had just come from.

I spoke in English to a teenage boy wearing a Nirvana T-shirt and told him we had just come from the school. White-faced and shaking, he said he had been inside the polling station with his grandfather when the Guardia Civil had burst in and started hitting people with batons. Every few words he would almost choke, finding it hard to speak. “I need to go home,” he said after telling us what he saw.

The firefighter who we had earlier befriended at the first school we had visited in Sant Joan de Vilatorrada came up to us and told us that the organisers had just shut the polling station voluntarily in order to try to prevent an attack. They wanted to protect people from violence and also protect the ballots they had from being seized. It was around 3.30pm. He told us of their standoff with the Guardia Civil and said that like us, the firefighters had arrived too late to do anything to prevent the attack.

“But the fact that you guys and the Mossos got there stopped them from beating the voters on the street after they had taken the ballots,” Magni, the Faroese visitor, said.

The firefighter wasn’t going to be consoled. “Now they are laughing at us,” he said, meaning it both literally – the Guardia Civil had taunted and laughed at them during the stand-off – and figuratively, as in, they had left with people’s votes. He said the words with such a sense of powerlessness and humiliation that, for me, it was the lowest point of all that we observed that day.

As people began to disperse after the closure of the polling station we got back in the car; one of the volunteers had suggested we could drive to the local Spanish police station to see it, perhaps to try to speak with some of the officers. A number of roads were closed, though, so we couldn’t get there.

We saw one of the empty roads closed off by Guardia Civil vehicles and Hywel wanted to go and speak to them and take photos. I told the others that our phones might be confiscated if we tried to take photos because of the (2015) Spanish gag law that, among many other restrictions, banned taking photos of police officers. We all left our phones in the car and walked down to around eight officers who were blocking the road with large vehicles. Bodil translated our questions for them and their responses. She asked why the road was blocked; they replied that it was because someone had been taking photos of the police, which was illegal.

“Because of the gag law,” Bodil replied, provoking protest at the phrase. They said they were “just doing their job”, but then moved one of their vehicles to clear the blockade of the road. We weren’t going that way anyway, so, to the confusion of the Guardia Civil, drove off in the opposite direction.

At Solsona

We had been due to have lunch with the mayor of the town of Solsona at 1pm and were now at least three hours late. Irina insisted that we had to eat something, so we set off further inland to Solsona, another 45 minutes or so away, though I think it’s safe to say all of us had lost our appetites. Back in the car we took turns charging our phones, and passed around the phones in use to see the latest images and footage of attacks at the polling stations. Hywel delightedly informed us that his press officer told him he was trending on Twitter in Wales due to the updates and images he had been sharing all day, which lifted our spirits a little.

festival atmosphere

Voters gather outside in tents and with music playing at Solsona

We arrived at the main polling station in Solsona, a town of around 9,000 people in the province of Lleida, at close to 5pm. The mayor, David Rodríguez, and others came out to welcome us. As well as being the mayor of Solsona, David is also a member of the Catalan Parliament for the ERC, the Republican Left of Catalonia. The polling station was striking for how well organised it was.

Two massive tractors formed the main part of a barricade at the entrance of the centre, and another tractor blocked off a smaller way in on the footpath. You could still enter, but only on foot. There were very large crowds of people gathered on a grassy area outside of the building in a sort of festival atmosphere with some music and tents, and several firefighters, who got an enthusiastic round of applause every time they waked from one place to another.

Tractor barricades

Tractors forming barricades at Solsona

The polling station itself was a large gymnasium-style building. The volunteers inside were on edge and were expecting police to arrive shortly. They were preparing to shut down the station and hide the ballot boxes at the first sign of a raid.

I spoke to one of the volunteers, a young man, at length about their high level of organisation. “We don’t think they will be able to get in,” he said. “We think the doors and walls are strong enough to keep them out, none are made from glass. The only way they could get in is if they use vehicles to smash through the walls.” He paused, realising the absurdity of it, and shook his head, saying, “It’s so strange to talk like this, of vehicles smashing through walls. It’s like a war.”

Trevor with David

Trevor O’Clochartaigh with Solsona Mayor and ERC MP in the Catalan Parliament, David Rodríguez

He explained to me that they believed there were enough hiding places in the building that they could temporarily hide the ballot boxes if the police managed to enter. They had taken the step of stuffing two ballot boxes with empty envelopes and “hiding” them in an easy-to-find spot.

I laughed at the ingenuity. Everywhere we had visited, people were dealing with the problems they faced collectively, with great creativity and even with humour.

David asked us to come and have lunch at a Japanese restaurant, a couple of minutes’ walk away. We were reluctant to leave as people were expecting the arrival of the Guardia Civil, but he assured us we would all return immediately if we heard any reports of their arrival.

He introduced us to the owner of the restaurant, who greeted us warmly and told us he had moved from Japan to Solsona 27 years ago. Then for 30 rather surreal minutes we ate sushi and talked across the table, finishing with more coffee. The owner’s son, around seven years old  and playing outside in an FC Barcelona jersey, kept running up to the window to wave excitedly at us. We grinned and waved back.

David led us back in to the polling station and on the way back I spoke to a young woman who was shortly due to sit examinations to become a judge. She thought there was a good chance that her role in assisting the local referendum process would destroy her chances of becoming a judge, and said that one of her fellow students was too scared to even vote for the same reason. “But it’s worth it,” she said. Having done countless all-nighters for law exams myself I was left in awe.

David told us the organisers were still on stand-by to shut down the polling station. One of our group remarked to him that it must be a difficult decision – to close the polling station early before everyone had had the chance to vote.

“No,” he replied firmly. “There is no question. Our responsibility is to protect these people from violence. If we have to close the voting station early, even if the votes are stolen, the people here will be safe.”

We were scheduled to meet with the rest of the international delegation at 8.30pm to prepare a joint statement about the conditions in which the referendum was held, and both Magni and Bodil needed to get back to Barcelona to do media interviews before that time, so we began the drive back. Irina asked the rest of us if we wanted to take a break or visit another voting site, and Trevor suggested we go to the Josep-Maria Jujol school in central Barcelona – which both of us had visited during the occupation the day earlier. Trevor had also visited it at around 6am that morning and wanted to see how they had survived the day.

Back in Barcelona

There was a huge number of people gathered outside the school, possibly a couple of thousand, and they cheered loudly when we entered. “Gracias, bona sort!” we called back. It was around 7.30pm and they had been undisturbed all day – in my view, because they had the numbers required to deter any police intervention. Excitement was rising that they would manage to make it to 8pm, the end of voting time, without a police attack. Two Mossos walked around the entrance and they too were cheered.

A political scientist who taught at one of the Barcelona universities was the president of the polling station and showed us how they had been dealing with the technological problems in order to ensure the highest electoral standards were maintained.

At Jujol

The polling station president (centre) and other volunteers  speak to the international guests at Escola Josep-Maria Jujol

“We had people changing our IP addresses every 30 minutes to try to stay ahead of the hackers,” he explained. “If the system was down at any particular moment, we would mark people off on the paper electoral roll but put an asterix next to their name. Then when it was up and running again we would enter their names into the electronic system. So there may have been periods of up to 20 minutes at most where the system was down, but it would be virtually impossible for a person to vote twice at different polling stations in that time due to the queues.”

Inside the polling station I ran into a number of Basque friends who were visiting Barcelona in a show of solidarity. I joked darkly to them that they must have felt the same way right then as Irish republicans did when the DUP formed a coalition with the British Conservatives earlier this year – for a brief moment the world’s media attention shone a light on problems and outrageous behaviour that we struggle constantly to draw attention to. Of course this was on an even bigger scale. They laughed in grim agreement.

The author Liz Castro was also at the school, and interviewed Trevol, Hywel and I about what we had observed as we waited for 8pm. She tried to broadcast it live on Twitter’s Periscope feature, but the internet was too patchy, so she filmed it to upload later instead. At about 7.59pm a rumour spread through the building that the police were coming to seize the ballot boxes, causing a brief moment of panic. A minute later we were assured by the tense polling station president that the rumour was false.

Celebrating keeping the polling station open

At 8pm, a huge cry of celebration went up in the crowd outside and they began to sing the Catalan national anthem. They had made it to 8pm without an attack. The school gates were closed as they sang the final bars. (You can watch my video of this here.)

Inside, photographers and media camera crews filmed the two young electoral officers who began the official count of the ballots.

Officials start the count

Electoral officers begin the count at Escola Josep-Maria Jujol

I asked the volunteers if they had heard of any plans for mobilisations in Barcelona that evening, saying we had heard that there would be demonstrations in several cities in the Spanish state against police brutality.

“I’m not a political activist,” the polling station president replied, “so I can’t tell you about the mobilisations outside. My role, and one I take very seriously, is to facilitate the vote of the people here today and to defend those votes. But I can say that as a political scientist, the mobilisation of Catalan society is something that is fascinating to see and something that will not disappear overnight. Of course we can’t keep up this level of mobilisation constantly,” he said as other exhausted volunteers gathered around him nodded in agreement, “but this movement is not going anywhere.”

As we left to get to our meeting with the rest of the international delegation, we walked out behind the electoral workers. The people who had defended the polling station all day – and all weekend in fact, for many – again applauded us. You guys are the ones who deserve the applause, we kept saying as we shook their hands. I don’t think I’ve ever made such an understatement in my life.

@emmaclancy123

 

 

by Admin

The (grim) state of the Union

Juncker’s vision is for full EU control over members’ economies

Some quick first impressions of the economic aspects of today’s State of the EU address by European Commission President Jean-Claude Juncker.

Jean-Claude Juncker’s State of the Union address was remarkable for its strident, defensive and utterly oblivious tone, but for little else.

On deepening the Economic and Monetary Union, he outlined several proposals that have already been floated several times by the Commission in recent years. The most significant of these are to introduce a euro-area budget line within the EU budget, and to create a European Monetary Fund and a European Finance Minister to take over responsibility for administering the EU’s debt and deficit criteria – the austerity agenda currently administered by the Commission.

There are two main goals evident in the Commission’s proposal. The first is to ensure that the current informal economic governance structure that exists in the Eurozone – outside of the Treaties and beyond democratic oversight – is extended across the EU as a whole in order to pressure the non-euro member states to join the common currency as soon as possible, and to give the Eurogroup the veneer of legitimacy.

The second is to implant Germany’s failed and ideologically-driven deficit fetishism ever more firmly in the structure of the EU by creating a Ministry to surveil and structurally reform the economies of Member States, and to surveil and control their spending, taxation and borrowing through budgetary control.

After the election of President Macron in France this year, Germany and France set up a working group to discuss the creation of a European Monetary Fund, or EMF, to deal with future crises. The states who may require the aid of the European Monetary Fund are those of us in the periphery of the EU – the Irish state, Greece, Spain, Portugal – who are suffering debt crises largely as a result of Germany’s massive and damaging current account surplus.

Yesterday, El País reported that Germany is proposing that a German-dominated EMF take fiscal oversight away from the Commission – but that it is attempting to win the support of France and Italy for the move by including the promise that Germany, France, and Italy can each have a veto over its decisions. This will essentially give Germany strict control over the oversight of budgets of all the EU states who require the assistance of the fund, with only France and Italy having the right to reject the EMF’s conditions.

The French side has been pushing for the EMF to also require more risk-sharing and debt-sharing, which would benefit the peripheral states more. The Commission’s final proposal regarding turning the current crisis fund, the European Stability Mechanism, into an EMF, will be published in December. It is unclear from Juncker’s speech and its accompanying documents which aspects of the German and French proposals will form the basis of the detail of the EMF proposal – but if Juncker’s other proposals are an indication of the general balance of power, it’s safe to bet on the German proposal winning the day.

For several decades now, France’s demand for a European monetary union was always met with the German response that it must be accompanied by fiscal union, or German-led surveillance and control over national budgets. The same argument continues today, based on the same failed ideology.

Juncker’s speech was as significant in what it didn’t propose as what it did propose – it looks like the Commission is already walking back from, or at least stalling on, ideas it had previously floated in its ‘reflection paper’ on deepening the Economic and Monetary Union released earlier this year. These included ideas of creating a European unemployment insurance scheme and an investment protection scheme, both of which would go some way towards meeting longstanding French calls for some form of financial transfers from the core (Germany) to the small and mid-sized economies in the EU, albeit with destructive conditions attached.

There was no mention of these proposals today, and Juncker firmly told the periphery states that their hope for a common bank deposit insurance scheme (which would amount to one form of financial transfer from the core to periphery) is on ice until they start following Germany’s orders on risk-reduction. His exact words were: “To get access to a common deposit insurance scheme you first need to do your homework.”

Over decades of core vs periphery fights over debt and investment, the outcome is always the same – the so-called peripheral states surrender more and power over their spending, borrowing and taxation to German-dominated institutions in exchange for the promise of aid or financial transfers that simply never come.

So, no big surprises here: just confirmation that the brief talk of fundamental change of the structure of the EU that followed Macron’s election was just that – talk.

 

 

by Admin

The future of the Eurozone

Eurotower

Below is an abridged version of a speech I gave on behalf of Sinn Féin at a GUE/NGL conference on the ‘Future of the EU’ in Donostia/San Sebastian on 5 June 2017.

Last week the Commission released a ‘reflection paper’ on deepening the Economic and Monetary Union (EMU).

There is one positive element of this reflection paper – the Commission finally admits that the status quo, and the divergence it has led to, is unsustainable and has to change.

But the proposals to deepen the EMU entirely fail to address the problems caused by the structural flaws of the euro, which are becoming clearer and clearer and are now acknowledged by mainstream economists.

The reflection paper is not so much a new proposal from the Commission as it is the product of a political compromise between German chancellor Angela Merkel and French President Emmanuel Macron arising from their recent discussions.

Reading between the lines, we can see that the longstanding French demand for some limited financial transfers is proposed, in exchange for not taking any action against the massive and destructive German current account surplus, and for handing over yet further economic powers to the Commission.

The German surplus is the cause of existing debt crises in the Eurozone and will be the cause of future crises. If one country is constantly exporting more than it imports, other countries – in this case, the EU peripheral countries – will have to import more than they export.

This doesn’t just hurt the so-called periphery, or the South – German workers are also suffering the consequences of this strategy as their wages are kept permanently low, often at poverty level.

But while the EU’s “rules” set a limit for current account balances of plus-six per cent of GDP, no sanctions have been imposed against Berlin despite the fact Germany has exceeded this limit for 21 consecutive quarters and for 31 out of 40 quarters since the start of 2007.

The idea that every Eurozone country should adopt an export-led growth model should not only be rejected because it’s based on exploitation, but also because it’s just not economically possible.

Ireland, poster child for austerity

The Irish state is the poster child for the memorandum countries in terms of its recent economic recovery. The narrative goes that the Irish state followed all of the EU rules, swallowed the structural reforms and experienced export-led growth.

Leaving aside last year’s ludicrous 26% growth rate in GDP, based on Ireland’s facilitation of massive levels of corporate tax avoidance, there has been a certain of level of growth in employment over the past two years.

It’s important to note that these growth areas for jobs have not come from FDI or the Irish government’s tax-haven strategy.

Growth took place in the agriculture and food sectors, and in accommodation and tourism.

This growth was based on two related factors. The first was the devaluation of the euro as a result of the crisis, and the second was the relatively higher economic growth in Britain and the US, the Irish state’s two largest trading partners.

Devaluation of the euro was critical to the recovery experienced in the Irish indigenous sector.  The relative growth in the US and Britain was also influenced by the fact that these two states are not constrained by the Fiscal Compact rules – borrowing in the US and Britain did not fall below 3% since 2008.

But the specific circumstances of the Irish state also mean that this recovery cannot be transposed or replicated in other member states of the EU.

It also poses significant risks, especially the risk of a significant devaluation of sterling as a result of Brexit. The devaluation of sterling post-Brexit would likely have a devastating impact on this fragile recovery.

The Irish recovery happened in spite of, not because of the EU austerity recipe.

What Ireland is actually a poster child for is the role currency devaluation can play in recovery, when you’re trading predominantly with other currencies.

Transfers in exchange for rights?

Despite acknowledging that the status quo of the EMU is unsustainable, the Commission declares its firm support for the continuation of the European Semester and the Fiscal Compact.

Probably the three most significant aspects of the reflection paper from our point of view – all of which have been floated before – are its proposal of the creation of a European Unemployment Insurance Scheme, the proposal for an EU finance minister, and for an ‘investment protection programme’ to ensure public investment is maintained during an economic downturn.

In typical Commission fashion, the idea of a European Unemployment Insurance Scheme is dangled to gain public support – while the trade-off is the ‘harmonisation’ of labour relations and anti-worker reforms.

As for the proposed ‘investment scheme’, it is contradictory nonsense to create a scheme to protect investment during economic downturns while at the same time insisting on keeping the macroeconomic straitjacket of the Fiscal Compact firmly in place.

Limited transfers would require permanent structural reforms for Member States under the supervision of an EU finance minister.

We don’t oppose redistributive transfers to the so-called peripheral states to correct the imbalances that damage our economies, and of course we’re in favour of protecting investment levels in the crisis-hit countries.

But the point is that these measures are both utterly insufficient to address the underlying structural problems in the EMU, and they all demand trade-offs in rights, democracy and popular sovereignty.

So there will be a deepening of two major discussions in the EU in the near future – one on the EU budgetary capacity and one on improving social rights, linked to the Social Pillar but also linked to these proposals in the reflection paper, such as the unemployment insurance scheme.

We don’t oppose transfers to correct imbalances caused by the euro – but we will definitely oppose them if they are linked to conditionality. Social rights cannot be dependent on economic performance or a state’s following of the fiscal rules. Rights are rights.

The left in Europe shouldn’t fall for the trap of surrendering more ground to the Commission in exchange for these crumbs from the table.

New drive towards deregulation

 At the same time as you have these plans for deepening and completion of the EMU based on permanent austerity, and the dubious economic model of export-led growth, we also have a drive to dismantle the limited financial regulation that was enacted after the crisis.

We have a new drive too for the public to bail out the banks – we can see it both in the Commission green-lighting the Italian bailout last week using a loophole in the Banking Union legislation that you could drive a truck through, and through the EBA and ECB recently pushing the idea that public funds should be used to solve the ‘non-performing loan’ problem.

So taking all of this into account, the challenges for the left in the coming period will continue to be on the one hand defensive in order to try to halt the march of permanent austerity. We need to prevent the deepening and expansion of the EMU.

In the short term we need to campaign for effective sanctions against current account surpluses; for investment to be excluded from the fiscal rules; to try to reject the attempt to incorporate the Fiscal Compact into the Treaties at the end of this year; and for a real public investment plan to stimulate growth. We’re open to examining options for fundamental reform of the euro towards flexibility mechanisms or other possibilities. Some of the ideas outlined in Joseph Stiglitz’s book on the future of the euro are definitely worthy of consideration by the left.

But the option of an exit from the eurozone should also be viable and supported for member states that choose to do this as a result of their economic circumstances, just as states who want to remain within the eurozone should not be blackmailed or kicked out of the common currency against their will.

I’ll finish with a few comments on some recent and current election campaigns. We’ve all seen the elites across the EU celebrating the election results in the Netherlands and France, fostering a sense of triumphalism and complacency when what we should all be experiencing is alarm at the growth of the far right. But it is not inevitable that popular anger at the status quo is channelled into the far right.

We face the urgent challenge of developing, communicating and organizing around a programme that can win popular support, and the effective, bold and principled Labour campaign in Britain under the leadership of Jeremy Corbyn is something we can learn a lot from across Europe. Corbyn successfully managed to shift the debate from a narrow discussion on the terms of the British exit at the start of the campaign to one about what kind of country do people want to live in, what kind of world?

by Admin

Gernika: The beginning of aerial terror

Gernika Belfast

A mural of Pablo Picasso’s Guernica in Belfast

The following excerpt on the 1937 attack on the Basque village of Gernika is taken from an incomplete history piece on the Basque Country, from a chapter on the Second Republic and civil war. Tomorrow (April 26) is the 80th anniversary of the bombardment.

In early 1937, with Madrid still putting up a stiff resistance, Franco set his sights upon Bilbo with the aim of capturing the city’s iron ore and heavy industry to support his war effort. The Francoists quickly planned a northern offensive to be led by General Emilio Mola, who issued an ultimatum on 31 March in broadcast and printed leaflets dropped on Bizkaian towns saying: “If submission is not immediate, I will raze Vizcaya to the ground, beginning with the industries of war. I have the means to do so.” Most of the infantry on Franco’s side were raised from Nafarroa. The 50,000 heavily armed troops in four Nafarroan brigades were backed up by two Italian divisions, the Spanish Air Force, the Italian Aviazione Legionaria and the Condor Legion of the German Luftwaffe. Mola had 120 aircraft and 45 pieces of artillery at his disposal. The Republican Army in the North had almost as many troops but far less firepower, half the artillery and just 25 ineffective aircraft. The offensive began with an act of brutality when the village of Durango – not on the front line and undefended – was bombarded for four days by the Luftwaffe, with 248 civilians killed. Republican positions were falling fast and on 20 April 1937 a new Francoist offensive began in Bizkaia.

Gernika has long had a sacred status among Basques as the site of the ancient Basque parliament of Bizkaia, the Casa de Juntas, and of the legendary Gernikako Arbola (Tree of Gernika), an oak tree that has been a symbol of Basque sovereignty and the rights of the Basque people for close to a thousand years. In 1937 the town had a population of around 7,000 people, and Monday 26 April was a busy market day in the town centre. At 4.40pm the Luftwaffe’s Condor Legion and the Italian Aviazione Legionaria launched an aerial bombardment of the town that lasted for three hours, with waves of planes hitting the town centre every 20 minutes with high explosives and incendiary bombs of up to 1000lbs. each. Those who tried to run from the town or hide in the fields were machine-gunned. At 7.45pm, after the last planes had dropped their bombs, the centre of the town was destroyed. The assault killed 1,654 of the town’s 7,000 inhabitants. Gernika was 30 kilometres from the front. The Casa de Juntas and the Tree of Gernika had incredibly survived untouched.

A report by British journalist George Steer, war correspondent for the London Times, was published in the Times and the New York Times on 28 April. Steer had rushed to the town the evening of the attack to interview survivors and witness the devastation firsthand, and reported: “The most ancient town of the Basques and the centre of their cultural tradition, was completely destroyed yesterday afternoon by insurgent air raiders.”  His report from Gernika was all the more significant because Franco’s forces claimed the Basques had burned the town themselves as a propaganda stunt; then they claimed the Communists had bombed it. Franco denied that German forces were even participating in Spain’s Civil War. In response to the Nationalist propaganda, Basque lehendakari (president) José Antonio Aguirre made a public declaration : “I maintain firmly before God and History, who will judge us, that during three and a half hours German planes have bombarded the defenceless civilian population of the historic town of Gernika, pursuing women and children with machine-guns, and reducing the town itself to ashes. I ask the civilized world whether it can permit the extermination of a people who have always deemed it their duty to defend their liberty as well as the ideal of self-government which Gernika, with its thousand-year-old Tree, has symbolized throughout the centuries.” Franco replied: “Aguirre lies. We have respected Gernika, just as we respect all that is Spanish.” Mola was more forthright, saying: “It is necessary to destroy the capital of a perverted people who dare to oppose the irresistible cause of the national idea.”

Basque priest Father Alberto Onaindia witnessed the carnage in Gernika and wrote in desperation to the Primate of Spain, Cardinal Gomá: “I have just arrived from Bilbao with my soul destroyed after having witnessed the horrific crime that has been perpetrated against the peaceful town of Guernica… Senor Cardinal, for dignity, for the honour of the gospel, for Christ’s infinite pity, such a horrendous, unprecedented, apocalyptic, Dantesque crime cannot be committed.” He begged the Cardinal to intervene to sure the Francoists’ threat – that Bilbo was next – was not implemented. Gomá responded by insisting that Bilbo must surrender. Referring to the Basque Nationalist Party’s (PNV) loyalty to the Republic, he added: “Peoples pay for their pacts with evil and for their perverse wickedness in sticking to them.” Francoist forces viewed the scene a few days later, and a Carlist soldier reportedly asked a senior officer in Mola’s staff: “Was it necessary to do this?” The lieutenant colonel replied that it had to be done in all of Bizkaia and Catalunya. In 1970  PNV member Joseba Elosegi, one of the Basque soldiers from the Battalion Saseta which had withdrawn to Gernika for a period of recuperation and was present on the day of the bombing, carried out an act of self-immolation in a protest against Franco in Donostia, shouting “Gora Euskadi Askatuta!” (Long live the free Basque country!). Elosegi was badly burned but survived and described his protest as the desperate act of a man who had “obsessively remembered” for more than three decades the scenes he witnessed at Gernika.

Steer immediately understood the significance of the attack on Gernika, and in his Times article he wrote:  “In the form of its execution and the scale of the destruction it wrought, no less than in the selection of its objective, the raid on Guernica is unparalleled in military history. Guernica was not a military objective. A factory producing war material lay outside the town and was untouched. So were two barracks some distance from the town. The town lay far behind the lines. The object of the bombardment was seemingly the demoralization of the civil population and the destruction of the cradle of the Basque race.” His report was reprinted in the French communist newspaper L’Humanité on 29 April, where Pablo Picasso read it. The artist captured the international outrage over the attack in his world-renowned painting. He had been commissioned earlier that year by the Spanish Republican government to paint a mural for the Spanish government building at the World Fair in Paris. On 1 May 1937, he dropped his original plan and produced his most famous work, Guernica, instead.

by Admin

How do vulture funds manage to pay practically no tax in Ireland?

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The three key mechanisms for tax avoidance that have been used by multinational corporations (MNCs) in the Irish state over the past decade have been the Double Irish, inversions, and the use of Special Purpose Vehicles (SPVs) under the Irish state’s lax securitisation regime introduced in Dublin’s International Financial Services Centre (IFSC) under the Taxes Consolidation Act 1997.

Bloomberg reported in February this year that a survey by the Financial Stability Board found that the Irish state’s shadow banking sector ranked third with China as the largest in the world after the US and Britain, and at more than 2.3 trillion euros it was 10 times the size of the Irish economy. Half a trillion euros were held by unregulated SPVs, the FSB found. A Financial Vehicle Corporation (FVC) is a securitisation instrument as defined by the European Central Bank FVC Regulation, but while SPVs share many of the same features they are outside the Regulation.

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The Central Bank estimated that in 2015 there were 779 FVCs holding €415 billion – required by the ECB to report quarterly data since 2009 – and 600 SPVs in 2012 holding €150 billion. In its Macro-Financial Review published in June this year, the Central Bank said there was, as of December last year, 820 SPVs holding €322 billion in assets. SPVs were not required by the Central Bank to file reports until last year. SPVs are generally used for loan origination but can also carry out securitisation activities.

Section 110 companies

The Central Bank says that tax provisions introduced in the 1991 Finance Act aimed at allowing the creation of structures that were broadly profit and tax-neutral in order to facilitate the securitisation of mortgages. This was then expanded beyond the IFSC with Section 110 of the Taxes Consolidation Act 1997, which came into effect in 1999.

The assets that could be held, managed or leased by a Section 110 company was extended by the Finance Acts of 2003, 2008 and 2011. SPVs and FVCs use “orphan companies” usually held by a charitable trust in order to keep assets off the balance sheet of their true parent companies. The originating companies of the majority of SPVs in Ireland are from the US, Britain, Germany, France, Italy and Russia. The collapse of two Dublin-based SPVs that originated from German bank Sachsen Landesbank in 2007 led to a €17 billion emergency banking bailout by the state of Saxony.

To qualify under Section 110 the company must be resident in Ireland; acquire qualifying assets of at least €10 million; and notify Revenue that it wants to fall under the Section 110 framework. The qualifying assets can include shares, bonds, securities, insurance and reinsurance contracts, hire purchase contracts, money market fund investments and more. Since 2012, qualifying assets can include commodities, carbon credits, plant and machinery.

While an SPV is a taxable entity, and should be taxed at the non-trading corporation tax rate of 25 per cent, under Section 110 its taxable profit will be measured according to the rules of a trading company – so the SPV is entitled to a tax deduction for all trade expenses, such as interest paid. As a result, SPVs “can utilise various techniques to strip profit out on its underlying investments and can reduce or eliminate the tax it is required to pay” according to law firm Dillon Eustace. The International Tax Review states that Section 110 companies are “typically structured so that income earned is matched with its expenditure resulting in minimal taxable profits”.

The result is that SPVs, in particular vulture funds buying up distressed mortgages in Ireland, are earning millions of euros annually from mortgage-holders and shifting it offshore but are paying as little as €250 in tax to Irish Revenue. According to various media reports, between 2011 and April 2016, vulture funds in the Irish state purchased loan portfolios worth €62.9 billion against the backdrop of a mortgage arrears, housing affordability and homelessness crisis.

Banks are increasingly selling off distressed mortgages to vulture funds at reduced prices, who have proven to pursue repossessions of homes even more aggressively, fuelling the housing and homelessness crisis. In May Ulster Bank announced the sale of 900 family homes with distressed mortgages as part of a €2.5 billion property loan portfolio to vulture funds. This follows the purchase in March of 200 family homes by a Goldman Sachs vulture fund in Tyrellstown, Dublin.

It has been reported that the largest purchasers were Goldman Sachs, Cerberus, Deutsche Bank, Lone Star, CarVal and Apollo. In 2014 the Irish arm of US vulture fund Lone Star, which holds distressed German mortgages, generated €1.24 billion but paid less than €1 million in tax. Cerberus’s 2014 accounts show it generated more than €140 million of revenue on its Irish assets, but paid less than €2,500 in tax.

Goldman Sachs subsidiary Beltany’s 2014 accounts show that it generated income of €44 million – but paid just €250 in corporation tax. Cayman-linked Mars Capital generated revenue of €14 million in 2014 but also paid just €250, as did Launceston Property Finance, which originates from Luxembourg-registered CarVal and generated €16 million. Some of these banks are under the direct supervision of the European Central Bank, leading Sinn Féin MEP Matt Carthy to write to the ECB in June to request it to investigate the relationship between these banks, their associated vulture funds, tax avoidance and evictions in Ireland.

SPV structure

Source: Grant Thornton law firm, ‘SPV taxation’, 30 September 2015

Irish tax law enables tax avoidance by Section 110 companies

The specific features of Irish tax law that enable Section 110 companies to do this include the fact that there are no ‘thin capitalisation’ laws in Ireland (there is no minimum profit required for a company for tax purposes, so an SPV can strip out all of its taxable profits if it chooses). Any costs of raising finance are tax-deductible under Section 110.

The most important provision of the law has been Section 110(4) which permits a Section 110 company to take a deduction for “profit participating interest” if certain conditions are met. The Finance Act 2011 introduced anti-avoidance provisions that sought to deny deductibility for that profit element of interest, but included exceptions that made the measures meaningless.

The anti-avoidance provisions do not apply (so interest is fully deductible) where the recipient of the interest or other distribution is either a person resident in Ireland, or a person (resident in an EU Member State or tax treaty country who is not “connected” with the SPV) who is a pension fund, government body or other person who is exempted from tax which generally applies to profits, income or gains in that jurisdiction. Just in case any of those exemptions do not do the trick, the Finance Act 2011 also introduced an exemption on withholding tax on interest paid through quoted eurobonds.

The Finance Act 2011 also expanded the list of qualifying assets from only financial assets to also to include commodities, carbon credits and plant and machinery, aimed at making Ireland more an attractive site for the aircraft leasing industry. Tax treaties can be used to reduce withholding taxes on inbound payments for lease rentals, and Irish-resident SPVs can receive incoming investment management services without being subject to Irish VAT.

Section 110 companies are allowed to calculate profits according to the old Irish generally accepted accounting principles (GAAP 2004) instead of the new Irish GAAP or International Financial Reporting Standards (IFRS). Dillon Eustace law firm, which advises Ireland’s National Asset Management Agency and Lone Star, among others, says the legislation was amended after industry successfully lobbied Revenue over concerns that International Accounting Standards “could compromise the profit neutrality of an SPV”.
The 2010 transfer pricing rules do not apply to Section 110 companies.

Total return swaps, where the SPV swaps all of its receipts with another company in its group in return for enough funds to discharge liabilities, should be liable to tax but apparently are not in practice and are used as a profit-extracting mechanism. Dillon Eustace advises clients: “There may be a technical liability to Irish income tax for recipients (i.e. the swap counterparty) who are not resident in a country with which Ireland has a double tax treaty but, in practice, this liability is not enforced by the Irish tax authorities.”

Ireland’s membership of the EU and OECD (and its ‘white-listed’ status) and the listing of securities on the Irish Stock Exchange are further incentives for SPVs to domicile in Ireland.

SPVs generally use an orphan entity ownership structure that ensures the entity is not owned by its originating bank or hedge fund but by a charitable trust. Revenue have raised concerns about the use of charities for this purpose as revealed through Sinn Féin TD Pearse Doherty‘s Freedom of Information request last month. Dublin’s corporate law firms generally establish the charitable trust or provide the use of their existing charitable trusts to SPVs.

For example, Matheson has established its own charity, the Matheson Foundation, which it regularly uses to help incorporate SPVs for its clients. Its website says: “The Matheson Foundation has two clear goals: to help children in Ireland to fulfil their potential; and to encourage corporate philanthropy in Ireland.” The Central Bank has found that most FVCs and SPVs incorporated in Ireland have no employees.

Qualifying Investor Alternative Investment Funds

A second key instrument used by international banks and hedge funds to avoid paying tax in the Irish state is the Qualifying Investor Alternative Investment Fund (QIAIF), which replaced the Qualifying Investor Fund (QIF), which was originally established by NAMA in 2012. The QIAIF is primarily a structured fund for real estate investment and is often used together with an SPV to ensure access to double tax treaties. QIAIF assets in Ireland are valued at €302 billion. They require a minimum subscription per investor of €100,000 and are subject to almost no other requirements.

QIAIFs are entirely tax-exempt from income tax and capital gains tax regardless of where the investors are resident, as well as being exempt from withholding tax for any payments made to non-Irish resident investors. Irish Real Estate Investment Trusts (REITs), a vehicle with a collective ownership structure for real estate investment established in 2013, are also exempt from income and capital gains tax from rental payments in most conditions.

The Irish Collective Asset Management Vehicle

The Irish Collective Asset Management Vehicle (ICAV) Act 2015 came into effect in March last year. It introduced a fifth type of corporate fund structure, alongside the investment company, unit trust, common contractual fund and investment limited partnership, and appears to have been established with the explicit goal of facilitating tax avoidance by US investors.

Matheson law firm describes the ICAV as “the culmination of a joint government and industry project to make available to promoters a legal framework for a corporate fund vehicle that is specifically designed for investment funds. Matheson partners were extensively involved in the industry project to introduce the ICAV.” It adds that “it is expected to become the vehicle of choice for UCITS and Alternative Investment Funds in Europe”. If the government’s reaction to accusations it was facilitating tax avoidance by SPVs was disingenuous, its claims to be unaware of the use of the new ICAV structure for tax avoidance is ludicrous.

The ICAV has several features that distinguish it from other fund vehicles:
*An ICAV can classify itself as transparent under the US check-the-box rules in order to avoid taxation that may apply in the US to passive foreign investment companies.
* An ICAV has its own legislative code that will allow it to avoid compliance with several Irish and EU company law requirements.
* It is not required to spread risk, unlike an investment company.
*An existing Irish investment company can convert to an ICAV easily, and a foreign corporate investment fund can domicile in Ireland and convert to an ICAV without incurring Irish tax in either case. Matheson suggests the jurisdictions where migration to Ireland will occur are the British Virgin Islands, the Cayman Islands and Jersey.

Despite the Irish government’s formal support for the OECD-BEPS process and its limited moves to respond to international pressure since 2014, there are a large number of significant legislative gaps that remain in place in the Irish state that not only allow tax avoidance by MNCs and global financial giants, but actively encourage it. Each step forward has been accompanied by “exemptions” that serve to make the reform ineffective, and appear to have been directly designed by the US Chamber of Commerce, the Big Four accounting firms and the major Dublin corporate law firms: Matheson, Arthur Cox, William Fry, Dillon Eustace and others, in a stark illustration of the “captured state” concept applying in Ireland.

Some of these legislative problems will be addressed to a certain extent by the transposition of the European Anti-Tax Avoidance Directive over the next period (though certain provisions, such as exit taxation, won’t take effect until 2020). There are a number of issues that will not be addressed by the ATAD, and a number of glaring loopholes that need to be closed in the meantime – Section 110 being the most urgent of all.

by Admin

Ireland’s IP ‘Knowledge Box’ – another tool for tax dodgers

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This is the third article in a 4-part series on tax avoidance in Ireland.

1.Irish state marketed for tax avoidance since 1950s

2.Yes, we’re still a tax haven for tech giants

3.Ireland’s IP Knowledge Box – another tool for tax dodgers

4.How do vulture funds manage to pay practically no tax in Ireland?

US technology and pharmaceutical giants in the Irish state have benefited from varioustax credits, incentives and loopholes specifically relating to intellectual property and research and development, in addition to the low Irish corporation tax rate. But very little actual R&D is carried out in Ireland as a result of FDI, with US MNCs preferring to base R&D centres in Israel, China and India.

R&D tax credits against corporation tax were introduced in 2004 and expanded in Budget 2015 as the news that the Double Irish was to be phased out was announced. A 25 per cent tax credit is available on all qualifying R&D expenditure in addition to a 12.5 per cent tax deduction – so, a total of a 37.5 per cent tax deduction on such expenditure, or in other words, a corporate tax rate on R&D activity of around 3.3 per cent. Any company which trades in the Irish state and carries out R&D activities in Ireland or in the European Economic Area and incurs expenditure is eligible.

Before 2015, a base year of 2003 was in place – ie, a company could only claim credit for expenditure over and above what it incurred in 2003. This was to be a rolling base year in order to incentivise companies to spend more but the year didn’t change, and the base year was abolished altogether in Budget 2015. Under a Freedom of Information request, the Irish Times found in January 2015 that Department of Finance officials “expressed concern that changes to tax breaks in Budget 2015 would cost at least €50 million in foregone taxes annually and reward a relatively small number of companies” – just 15 firms, in fact, including one that would benefit by €14 million. The names of the companies were blacked out in the FOI release, but according to the Irish Times, “records indicate many of the firms that stood to benefit lobbied in favour of the move”.

There were no audits carried out on the tax credit scheme for the first decade of its existence. It was reported in September 2015 that 200 audits carried out in 2013 found “several multinational firms have been found to be aggressively and improperly claiming tax credits for research and development to lower their corporation tax bills” and resulted in firms being made to repay €21 million in back taxes. Revenue has identified the tax credit as a “significant risk” and used scientists and technical experts in its audits to determine if the companies were genuinely carrying out R&D.

The OECD modified-nexus regime

Also announced in Budget 2015 (with the phasing out of the Double Irish), and introduced in Budget 2016, was the Knowledge Development Box, a corporate tax rate of 6.25 per cent for profits arising from certain forms of IP. Ireland had already introduced the first “patent box”, a lower rate of tax on IP-related profits, in 2000 before the introduction of the 12.5 per cent corporate tax rate. A British patent box with a rate of 10 per cent from British and/or European patents was introduced in 2013. Luxembourg, the Netherlands, Cyprus, Spain, France, Portugal, Belgium and Malta have all introduced special low tax rates for profits from patents.

Patent boxes have been described as mechanisms for tax avoidance. The OECD-BEPS project proposed action to reduce the potential for profit-shifting abuse through patent boxes by ensuring there was a genuine link, or nexus, between the lower tax rate and R&D that was initially developed in the home state. A German-British compromise in November 2014 resulted in the so-called modified nexus approach being adopted by the OECD, which retained requirements for genuine local initial IP development but added concessions for Britain including a transition period and a 30 per cent “uplift” in what counts as qualifying expenditure to reflect outsourced intra-group research activities and costs.

While the Irish government initially opposed the modified nexus approach publicly during the German-British negotiations, and actively sought the advice of US MNCs in drafting its own legislation, Finance Minister Michael Noonan clearly saw the writing on the wall. Part of the OECD agreement was that all new entrants into existing patent box schemes that did not comply with the modified nexus approach would have to cease by 30 June 2016 and be abolished by 2021. When introducing the KDB in Budget 2016, Noonan stated that it would be the first and only patent box in the world to be fully compliant with the OECD’s modified nexus approach. Following the adoption of the German-British modified nexus approach, the European Commission withdrew its investigation into patent boxes.

Ireland’s Knowledge Development Box

The Irish KDB took effect on January 1 this year. It will apply a 50% allowance in tax relief to “qualifying profits”, resulting in a 6.25% tax rate. Qualifying profits arise from specified trade in “qualifying assets”, being intellectual property resulting from research and development carried out in Ireland or an EU member state. The intellectual property forms that can be qualifying assets are defined as being copyrighted computer software, inventions protected by patents and supplementary protection certificates, and plant breeders’ rights. The formula for calculating the qualifying profits under the KBD is below:

Qualifying Expenditure + 30% Uplift Expenditure  x  Qualifying Asset = Qualifying Profit
Overall Expenditure

Qualifying expenditure is expenditure incurred in R&D activities that lead to the development, improvement or creation of the qualifying asset. Cost-sharing agreements where costs are outsourced to intra-group parties are excluded, but such intra-group expenditure and acquisition costs can be added as uplift expenditure up to 30 per cent. The overall expenditure is the full amount of costs incurred in the R&D and acquisition of the IP, so the qualifying expenditure is measured as a proportion of this. The qualifying asset is the profits made by the specified trade in the IP product and can include any royalty or other sum received in respect of the use of that qualifying asset – including sales income attributed to the qualifying asset on a “just and reasonable basis”.

The specified trade in the qualifying asset can include:
– the managing, developing, maintaining, protecting, enhancing, or exploiting of the IP;
– the researching, planning, processing, experimenting, testing, devising, developing or other similar activity leading to an invention or creation of intellectual property; or
– the sale of goods or the supply of services that derive part of their value from the activities described  above.

KBD open to abuse

The corporate lobby initially expressed disappointment about the government’s use of the modified nexus approach, with one lobbyist saying: “What the Government could have done is waited longer to produce it. If they waited a few years more the temperature could have dropped and there would have been less focus on international tax, and they may have been able to pick up ideas from other countries… It has certainly impacted on how effective the KDB will be for the future in terms of an incentivisation vehicle.”

The Big Four accountancy firms and some corporate law firms have been more optimistic – while they have criticised the “onerous” tracking and tracing provisions that require a separate profitability stream to be accounted for each asset, they have nevertheless welcomed the KBD as a means to reduce tax bills that will specifically benefit the technology and pharmaceutical MNCs provided they jump through a few extra hoops. For example, the pharmaceutical sector generally uses “serialisation” features that correspond with the tracking and tracing provisions, but these would need to be developed in the technology sector.

Deloitte stated: “In our view, the introduction of the Irish KDB regime is welcome, although the narrow scope of IP assets that will qualify for the regime ultimately will result in limited uptake [ie, not trademarks] outside of the pharmaceutical and technology sectors.” William Fry law firm has said: “Overall, the KDB is to be welcomed as it bolsters Ireland’s competitive tax regime and complements existing tax benefits for IP such as research and development relief and the capital allowances available in relation to intangible assets. Given the limitations where research and development is carried out by group companies, in the first instance, the KDB relief may be more beneficial to indigenous companies. However, with proper planning, the relief may also prove to be of benefit to multinational enterprises.”

There is no doubt that the KBD will benefit MNCs disproportionately and that the KBD is wide open to abuse. The definition of R&D activities is identical to the definition in the R&D tax credit legislation, and it too can be self-reported by corporations when filing their accounts. The hugely problematic nature of measuring the value of intangible assets remains. The weak existing transfer pricing regulations on the arm’s length principle from the 2010 legislation will be applied. There is a right for Revenue to consult with experts on the R&D being claimed if it wishes to, as under the R&D tax credit regime, but a corporation can appeal against such consultation on the grounds that disclosure would be prejudicial to its business.

Put simply, there is nothing in the KBD legislation to prevent it from being used to concentrate profits offshore. The Double Irish system where all non-US sales pass through Irish subsidiaries to dramatically reduce the tax bill can continue but in a simplified way, with both Irish subsidiaries being tax-resident in Ireland, with one that can collect sales profits and another that holds IP rights and receives royalties that are taxed at the 6.25 per cent rate.

Inevitable profit-shifting – a theoretical example

Here is just one theoretical example of how the KBD can be exploited: a technology MNC, Pear Inc, is headquartered in Silicon Valley where 90 per cent of its overall R&D is carried out. It has two subsidiaries in Ireland called Pear Ireland Ltd and Pear Ireland Holdings. Pear Inc develops a software programme, called iThing, with 100 per cent of the R&D carried out in San Francisco. Pear Ireland Ltd then works on the next generation of the product – iThing 2.0.

It could claim to spend 70 per cent of the relatively small amount of R&D expenditure needed to make a few changes or improvements to the original iThing programme in Ireland, resulting in the creation of iThing 2.0. The new programme would not need to be patented with the Irish Patent Office because computer programmes are generally excluded from patentability but are specifically included in the qualifying asset IP definition in the KBD.

Because the new variation of the programme is in itself a qualifying asset, the overall expenditure does not necessarily need to include the original expenditure incurred in San Francisco, only the 30 per cent of expenditure not attributed to Ireland. As intra-group cost-sharing agreements are not allowed under the KBD, Pear Ireland Ltd can under certain circumstances add 30 per cent uplift, equaling 100 per cent of overall expenditure.

To be sure, Pear Ireland Ltd can simply obtain an advanced opinion from the compliant Irish Revenue to affirm its calculation that it incurred 70 per cent of the R&D costs, as the track and trace provisions are only required to be checked by the home state. Pear Ireland Ltd then licenses the IP to Pear Ireland Holdings, which collects all of the non-US sales profits from iThing 2.0 but reduces its taxable income through paying royalties and/or licensing fees to Pear Ireland Ltd under the clearly ineffective existing arm’s length legislation.

Then 100 per cent of the royalties and licensing fees received are attributable to the R&D expenditure carried out in Ireland, calculated as qualifying profit under the KBD and taxed at 6.25 per cent (this is on top of the 37.5 per cent tax deduction available for R&D expenditure through the combined R&D tax credit and the 12.5 per cent R&D tax deduction). This is an extremely simplistic example of a structure but it could obviously be improved in terms of tax avoidance through the more creative use of royalty payments and subsidiaries around the world including in tax havens.

No evidence that patent boxes stimulate R&D

There is little evidence that patent boxes do anything to increase genuine R&D or attract FDI in the productive economy in the states they exist in. Speaking in Dublin in March this year, the head of the OECD’s centre for tax policy Pascal Saint-Amans, said the development of knowledge or patent boxes does little to actually foster innovation and the creation of intellectual property.

This was followed by an OECD report in June this year which said Ireland’s public financial support to R&D businesses was “skewed” towards R&D tax credits that benefited MNCs, and explicitly called for public resources to be redirected away from MNCs to local SMEs, where there was little growth, in order to develop indigenous enterprise and increase productivity. Despite more than a decade of generous R&D tax credits and other tax incentives to promote FDI, less than one-third of IDA Ireland companies invest in R&D at all.

But despite its limitations and potential for abuse, a system of R&D tax credits, targeted towards SMEs and indigenous enterprise, has a broader economic and social value if implemented correctly – whereas there is no such corresponding social and economic benefits arising from a patent box regime. A research paper on patent boxes in 2014 argued: “Tax incentives for R&D expenditure reward firms for the societal benefits from innovation that they themselves are unable to appropriate. It is hard to make the argument that a patent box serves the same purpose: patent boxes introduce a preferential rate for income from innovations that are already protected by Intellectual Property Rights (IPRs). IPRs enable firms to capture a large part of the societal benefits, such that the need for a tax incentive for protected innovations becomes unclear.”

The supposedly limited opportunities the modified-nexus compliant KBD presents for US MNCs to reduce their tax bills makes it all the more likely that it has been introduced in the full knowledge that it will be exploited, while the government will turn a blind eye. Based on the form of successive Irish governments in relation to tax avoidance, we can guess that the government had two goals with introducing the KBD: to send a political message to US MNCs that the Irish government remained committed to ensuring the Irish state could continue to be used as a conduit for tax avoidance despite the phasing out of the Double Irish; and to introduce yet another mechanism that is wide open to abuse in order to please MNCs.

In the context of the phasing out of the Double Irish and an international crackdown on the use of offshore tax havens, the Irish KBD is an attractive mechanism for creative “onshore” tax avoidance. Matheson law firm advises its clients that offshore tax havens such as Bermuda and the Cayman Islands don’t have “the necessary economic infrastructure to which value and ultimately profits can justifiably be attributed”, whereas Ireland on the other hand can construct “profit-generating centres defensible by reference to functions, risks and tangible assets of the Irish operation,” advice that has become all the more relevant in the post-BEPS context.

Continued: How do vulture funds manage to pay practically no tax in Ireland?