When the EU itself is a problem

Heads of government and state from the euro zone countries were meeting in Brussels to ratify the three-year bailout of Greece, running to somewhere north of €100 billion (Dh468.39bn). George Papandreou, the Prime Minister of Greece, was in attendance, promising his European peers that his country would reform its ways, stating: "We can do this. We must do this. We will do this together."

It is really quite difficult to imagine what the atmosphere was like in the room at the time. For what the leaders of the euro zone have gone and done is focus minds on the fact that Greece really is not alone. Substantially half the euro zone, by GDP, is in a pretty similar fiscal mess.

That's why we saw contagion across financial markets last week, culminating in the so-called "flash crash" on Wall Street. It is a roiled, chaotic rush away from "risk" – an acknowledgement that maybe governments don't actually have the tools to fix the problems that are now so painfully visible.

Euro zone leaders might say they have backstopped Greece, drawing a line in the sand. But observers know that the Greek crisis has not been solved. Pain has simply been delayed. Even if the country is able to impose the sort of austerity measures now being demanded, the fact is – three years down the line – Greece will be faced with impossible interest bills on its remaining debt.

Hence the widespread assumption that some sort of "soft default" – a rescheduling of debts and a "haircut" for creditors – has to happen at some stage. Hence contagion in financial markets: pretty similar scenarios can easily be created for Portugal, Spain, Italy, and so on.

It is important to note that at that meeting in Brussels euro zone heads were not actually bailing out the Greek public. They were bailing out the creditors of the Greek Government – largely banks from across the European continent, including those from supposedly fiscally-responsible countries such as Germany and France. It's the same pattern as we saw on Wall Street. The bailout of AIG and others was not about saving the jobs of those many thousands who worked at the insurance giant. It was about bailing out AIG's creditors – other banks on Wall Street, and in Britain and Germany.

That, essentially, is why in America there is so much public loathing of Wall Street right now. And that, essentially, is why we now see rioting on the streets of Athens. It is instructive here to consult the writings of George Friedman, an American political scientist who runs the Stratfor global intelligence consultancy. In particular, it is worth reading a paper called The Global Crisis of Legitimacy, published by Stratfor earlier this month. Friedman makes the point that what we have come to call "the financial crisis" or "the credit crisis" is actually a political crisis.

Financial panics are just part of capitalism, appearing when market conditions become over-cooked; they are part of the self-righting system, punishing those who are reckless to the benefit of those that are prudent. Political crises, on the other hand, come along when those who are reckless are seen to be benefiting during a crisis at the expense of the prudent. Specifically, real crisis comes along when the elite in society are seen to be taking unacceptable advantage of the many.

Here's Friedman: "The greatest systemic risk… is not an economic concept but a political one. Systemic risk emerges when it appears that the political and legal protections given to economic actors, and particularly to members of the economic elite, have been used to subvert the intent of the system. In other words, the crisis occurs when it appears that the economic elite used the law's allocation of risk to enrich themselves in ways that undermined the wealth of the nation. Put another way, the crisis occurs when it appears that the financial elite used the politico-legal structure to enrich themselves through systematically imprudent behaviour while those engaged in prudent behaviour were harmed, with the political elite apparently taking no action to protect the victims."

His argument is that the current crisis is not perceived to have been caused by one small, isolated reckless group, but instead by the global financial elite, who are seen to have taken advantage of the complexities of the financial system to enrich themselves at the expense of ordinary investors and employees. Some more – slightly chilling – words from Friedman: "The public, which is cynical about such things, expects elites to work to benefit themselves. But at the same time, there are limits to the behaviour the public will tolerate. That limit might be defined, with Adam Smith in mind, as the point when the wealth of the nation itself is endangered, ie, when the system is generating outcomes that harm the nation. In extreme form, these crises can delegitimise regimes. In the most extreme form – and we are nowhere near this point – the military elite typically steps in to take control of the system."

This is why, the Stratfor man argues, we are now seeing the likes of Goldman Sachs being hounded by the Obama administration: the political elite has to be seen to be doing something about miscreants among the financial elite.

This is also why the current situation in Europe is so challenging, since the distribution of power – the make-up of the elite tier in European society – is ambiguous. That, in turn, has hugely complicated the reaction to the crisis. In fact, the European sovereign debt crisis has triggered a much more worrying crisis of legitimacy. So Europe has double trouble here. The European Union itself is now widely seen as part of the problem, rather than the natural solution. Those heads of government and state meeting in Brussels need to get a grip.

Paul Murphy is associate editor of the Financial Times


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