Keeping Markets Happy

It's not public-sector deficits that are at fault for the euro crisis -- it's the policies that have enabled the financial sector to wield so much power.

The new fiscal pact agreed to by the majority of EU countries (save Britain) on Dec. 9 in Brussels will do little to avoid a pending catastrophe. It neither addresses the main causes of the current eurozone crisis nor calls for the economic policies urgently needed to restore stability and increase employment and growth.

The dominant discourse of the pact places the blame for the crisis squarely on public-sector profligacy, yet the crisis did not begin in the public sector. It began in the private finance sector, where it was triggered by risky overleveraging by the unregulated shadow banking system of non-bank financial institutions, many of which were exploiting a dangerous housing bubble in the United States and Europe that went neglected by authorities. It quickly became a public-sector deficit crisis, however, as lavish bank bailouts were put together and tax revenues fell because of the economic recession. Yet the initial problems of the unregulated nature of the financial sector and its reckless use of derivatives and commodity market speculation, not to mention the "too big to fail" moral dilemma, have not been resolved at all, leaving the door open for the possibility of more financial crises in the future.

Another root cause of the eurozone crisis lies in the unwillingness of the European Central Bank (ECB) to modify its current rules so that it can act more like a proper central bank. Although the ECB's recent moves to cut interest rates for the second straight month and expand emergency financing for cash-starved banks are steps in the right direction, its continued unwillingness to buy the bonds of troubled eurozone countries will only deepen the crisis. True, there is a technical ECB rule prohibiting unlimited bond purchases, yet one would think staring into the abyss of a global depression might be a good enough reason to break this rule.

This fundamental failure to act with bond purchases reflects the eurozone's neoliberal architecture, which overtly seeks to diminish the role of the state and enhance the power of the market. This thinking is also reflected in the ECB's monetary policy, which is narrowly focused on maintaining low inflation over other goals such as promoting higher employment and growth. Because eurozone governments do not control their own national currencies and thus cannot devalue their way out of the crisis, the only other option for increasing their export competitiveness is to drive wages down and further weaken labor rights, a process referred to as an "internal devaluation" through the adoption of "labor flexibility" reforms.

In fact, the new EU plan to restrict deficit spending to 3 percent of GDP and have EU countries cut and starve their way out of this recession smacks of the misguided fiscal and monetary policy of 1937 and the same anti-growth, anti-worker, and anti–public investment toxic cocktails that have long characterized the IMF's approach in developing countries. These policies to drive wages lower and adopt budget austerity in the current context of a recession will surely fail as consumer demand falls further, unemployment worsens, tax receipts continue to decline, and public deficits rise anyway.

Also at fault in the crisis is Germany's long-standing beggar-thy-neighbor approach of using low inflation and low wages to out-compete its EU trading partners, which eventually created destabilizing imbalances within the eurozone. The approach worked so well over the last decade that it earned Germany a massive trade surplus while saddling the country's less competitive EU partners with large trade deficits. In so doing, however, it wiped out the purchasing power in these markets, which can no longer afford to buy German goods, thus killing the goose that laid the golden eggs.

So if these are the problems at the heart of the debt crisis, what are the solutions? European leaders could avoid eurozone imbalances in the first place by adopting sanctions against both deficit and surplus countries. Surplus countries could be required to provide countercyclical long-term financing to deficit countries during crises through a system of regional transfers, and adopt stimulus or even mildly inflationary policies at home to help boost the exports of deficit countries. But such steps to avoid imbalances in the future will require abandoning the current laissez-faire architecture of the eurozone.

Europe must also turn its attention to meaningful regulation. In the 1970s, the finance sector famously complained that too much regulation was constraining its animal spirits and amounted to "financial repression," prompting U.S. President Ronald Reagan and British Prime Minister Margaret Thatcher to set finance free with financial liberalization. But how free is too free, and at what point does a reckless and oversized finance sector become a problem? These are the questions that voices ranging from the Occupy Wall Street movement to Adair Turner, chairman of Britain's Financial Services Authority, are now raising, yet they are questions policymakers are still ignoring. Economic historians such as Hyman Minsky and Joan Robinson have noted that over the last 300 years, periodic financial crises have been preceded by exuberant speculative bubbles enabled by periods of financial liberalization, triggered by a crescendo of risky overleveraging, and followed by a period of re-regulation. Notably, however, there was no period of re-regulation following either the collapse of the dot-com bubble in the late 1990s or the more recent housing bubble in 2008. Finance may have avoided re-regulation after these recent bubbles because of the political power it has amassed over the years, as suggested by former IMF chief economist Simon Johnson in his Atlantic article, "The Quiet Coup."

The pathologies associated with the financial sector's dominance over the rest of the economy were on full display in recent days as European policymakers found themselves in impossible positions to please financial markets. Investors seem to be happy when governments impose harsh austerity to shore up confidence that bond issues will be repaid in full, and then unhappy when that austerity produces worsening economic projections. This whiplashing of elected officials and near-total surrender of economic policy to the whims of the financial markets suggests that things have gone too far. It also suggests that any steps toward restoring both financial stability and higher economic growth will necessarily involve reinstituting some of the constraints that conservatives used to deride as financial repression. It is increasingly apparent that after 30 years of financial liberalization, we are today in desperate need of restoring policies that can again incentivize investment capital to move away from the casino economy and back into the real economy that produces jobs and growth. But this, too, will require jettisoning neoliberal policies.

Given the recent replacements of the Italian and Greek governments with others more to the market's liking, it is easy to get swept up in the notion that the bond markets have somehow seized control. As Wall Street investment banker Roger Altman has stated, financial markets have become "a global supra-government. They oust entrenched regimes where normal political processes could not do so. They force austerity, banking bail-outs and other major policy changes.… Leaving aside unusable nuclear weapons, they have become the most powerful force on earth.'"

But citizens must resist this characterization of financial markets as a mysterious, uncontrollable force of nature and the driving force in this drama. In fact, these developments are merely the result of a particular set of policy choices. The circumstances under which financial markets brought about a run first on the debt of Greece, Ireland, and Portugal, and more recently on the debt of Italy and Spain, were created by the ECB's neoliberal policies. Chief among these is the priority of keeping inflation at low levels at all costs. The ECB has also enshrined "central bank independence" in its architecture, which in theory enables the bank to fight inflation without citizens, parliaments, or finance ministries seeking to increase deficits and print money during economic recessions (thus jeopardizing the priority of low inflation). While the bond markets very much like low inflation (it keeps the value of their bond issues from deteriorating before they get repaid), neoliberal policies have effectively subordinated fiscal policy -- even in times of crisis -- to the goal of keeping these markets happy.

Other monetary policy choices and ECB architectural designs exist, and these alternatives deserve consideration today more than ever. The ECB, for example, could have pursued a different policy that focused on promoting growth and employment, and it could have acted to buy troubled eurozone bonds to diffuse the immediate crisis. New thinking in macroeconomics, on display at a remarkable IMF conference this March, has increasingly questioned the single-minded focus on inflation-targeting in central bank policy. There is a growing appreciation for context and complexity and the use of more targets and instruments in monetary policy, but none of this seems to have been absorbed yet by eurozone policymakers. Sadly, the ECB has opted for a deliberate neoliberal policy of lessening the role of the state, and it appears to be using this crisis to underfund governments with a fiscal straitjacket and compel them to drive wages lower and weaken labor generally, thereby guaranteeing a deeper, longer, and harsher recession yet to come.

The policies that today give so much power to the whims of the bond markets are not etched in stone, and history shows that reasonable people can decide to make new arrangements at any time -- if citizens would only mobilize to demand such policy changes. For now, under the current policies, it looks like everybody is going to lose.

Milos Bicanski/Getty Images


What Turkey Can Teach Egypt

Can Egypt’s powerful, secular military take a page from Ankara and learn to get along with the country’s new Islamic parties?

In this year of upheaval in the Middle East, a barely mentioned story may mark one of the most important developments in the region.

In July, the Turkish army's top four generals resigned in what critics say was a misbegotten attempt to trigger a national crisis. The generals, led by Chief of Staff Isik Kosaner, seemed to be hoping that their dramatic departure would topple the country's moderate Islamist government and restore the military's primacy in Turkish politics.

The story is what didn't happen next. The generals' resignation briefly roiled the waters of Turkish politics, but failed to overturn the civilian government. Prime Minister Recep Tayyip Erdogan quickly reasserted control over the military brass, replacing Kosaner with a general of his own choosing. He then convened a meeting of the Senior Military Council, a high-level assembly usually co-chaired by the prime minister and the chief of staff. This time, however, Erdogan sat alone at the head of the table -- sending a clear signal that the civilians were now in charge.

The generals took a reckless gamble with the country's stability, but fortunately for the Middle East's largest and most successful democracy, they lost their bet. Instead of the expected crisis, the Turkish nation quietly bid farewell to 88 years of Kemalism -- the founding ideal that put Turkey on the path of modernization and secularism -- and the notion that the generals always know best.

While vivid scenes of the Arab Spring were becoming YouTube staples across the world, Turkey's ability to overcome this crisis in civil-military relations carries important implications for the entire region. The parallels are striking and the lessons instructive for Egypt, in particular, especially after the Muslim Brotherhood's victory in the first round of Egypt's parliamentary elections.

Both Egypt and Turkey have long histories of domination by their military establishments, which in both cases have been the benefactors of generous U.S. support. Since the founding of the modern Turkish republic in 1923, the army has staged four coups, and up until 1989 all but one of Turkey's presidents had come from a military background. In Egypt, the military has been in continuous control since 1952, when Gamal Abdel Nasser led a coup against the monarchy.

When the crowds in Cairo's Tahrir Square demanded the ouster of Hosni Mubarak, himself a former Air Force commander, it was the senior Egyptian military command that told him it was time to go -- and then quietly seized power for itself. The so-called Supreme Council of the Armed Forces, headed by Field Marshal Mohamed Hussein Tantawi, promised to step aside once a new civilian leadership had established itself, but now seems intent on retaining the privileges it enjoyed during the Mubarak era.

For Turkey, loosening the generals' grip has been a long and fraught process. The civilians only began to gain an upper hand with the rise of Erdogan's Justice and Development Party (AKP) -- an offshoot of a banned, avowedly Islamist party that was nevertheless committed to bringing Turkey into the 21st century. The AKP quickly proved successful at maintaining its pious roots while also being democratic, open to the West, and -- as it would turn out -- surprisingly good at running the economy.

When the AKP won a decisive victory in the 2002 election, Erdogan became prime minister and inherited an economy that had been constantly on the brink of disaster. Inflation was over 70 percent, the economy was posting a negative growth rate, and the banking sector was in the throes of a meltdown. A decade later, Turkey's economy has trebled in size and now ranks 17th in the world. And in the face of a lingering global recession, Turkish gross domestic product (GDP) last year grew by 8.9 percent.

Meanwhile, the only signs of creeping Islamization so feared by the generals were hefty new taxes on alcohol and cigarettes, a low-key crackdown on the country's still-legal red-light districts, and a cordial but cautious opening to the likes of Iran and Hamas.

But the generals remained unhappy. By early 2003, senior military officers and others who belonged to what Turks refer to as the "deep state" -- a term used to describe members of the military and other establishment figures who believed they could act outside the law to protect the status quo -- were allegedly busy plotting a coup. According to Markar Esayan, a journalist for Taraf newspaper, their plan was to create a crisis by bombing mosques, assassinating the Armenian patriarch, and shooting down a Turkish plane and blaming it on Greece -- a 2009 plot, code-named "Sledgehammer."

Since then, dozens of senior military officers and hundreds of others -- journalists, businessmen, and academics linked to the deep state -- have been arrested in a mushrooming prosecution.

The case has fascinated and divided Turkey. And while the prosecution of some suspects seems to carry more than a whiff of political vindictiveness on the part of the AKP, there is growing public support for ending the military's overweening role in politics.

In June's general election, Erdogan's party easily won a third term with nearly 50 percent of the vote, almost doubling the total of Republican People's Party (CHP), its closest rival.

Erdogan's success has not gone unnoticed in the Middle East. On a September state visit to Egypt, the Turkish prime minister received a rock star welcome. This was partially explained by his sharp criticism of Israel's blockade of Gaza and the expansion of Jewish settlements on the West Bank, but mainly it is because Egyptians and other Arabs appreciate that Turkey under Erdogan is both democratic and comfortable in its Islamic identity.  The Turkish leader appeals because he is religious, but not a demagogue -- because he is open to the West, but not submissive or servile.

"Erdogan," says Burak Erdiner, a senior official in Turkey's Ministry for EU Affairs, "is the only leader who can go to and pray in the mosque on Friday -- and on Saturday lecture the Muslim Brotherhood on secularism." Which is precisely what Erdogan did during the Cairo visit, telling a television interviewer that he hoped the new regime in Egypt would be secular.

With the Muslim Brotherhood's decisive showing in last week's election, Egypt is at a critical juncture. Whether the Brotherhood heeds Erdogan's advice -- and its generals learn from Turkey's example -- will go a long way toward determining the success or failure of the Arab Spring.