More Europe for the Euro

The duo to not only save but also strengthen the Euro

The European Union has a history of turning crisis into opportunity.    At many times during its existence people thought that the project went too far, and that sovereignty would trump interdependence.   There was the ’empty chair’ crisis in 1966 when De Gaulle threatened to leave the EEC (then a group of six states) if they didn’t agree that all decisions have to be unanimous.

It was for many proof that sovereignty would always win.   Yet while they did let DeGaulle have his way on the issue he was angry about, the Luxembourg compromise that brought France back did not embrace DeGaulle’s principle of sovereignty first.   He accepted that because he was facing a revolt from below – the French people and French business thought DeGaulle was endangering France with his brinksmanship.   Already the eight year old organization had altered national interest.

Giscard and Schmidt ignited the “Franco-German engine” of European integration

In the seventies it appeared that the loss of the Bretton Woods system fixed exchange rates doomed the EC (now 9 states) to having no coherent monetary cooperation.   That could undermine the whole project, it was argued.   However, right when so-called Eurosclerosis was at its worst two people turned the situation around completely.   Former Finance Ministers and now leaders Helmut Schmidt of Germany and Valery Giscard d’Estaing of France developed the European Monetary System, the precursor to the common monetary policy.   Then when the Cold War ended many people thought the EC had run its course, that Germany would look eastward, and the organization might perish.

Instead German Chancellor Helmut Kohl and French President Francois Mitterrand forged the treaties that created the European Union, introducing a common currency and ultimately embracing rather than fearing the states of eastern Europe.    Now the EU has 27 members, 17 of them part of the Eurozone (states using the Euro as their currency).

In that backdrop the current crisis should be seen as a precursor to another step forward in bringing Europe together.   However, commentators in the US and Great Britain seem eager to declare the Euro dead or something that should have never been tried.   They are wrong.

The current crisis is serious, and shows some fundamental problems with Eurozone policy up until this point.   When it was originally planned, leaders knew that states could only support a common currency if they had similar fiscal policies.   That led to strict criteria demanding convergence on interest rates, inflation rates, budget deficits and total debt to GDP ratios.  If those criteria had been strictly enforced, there would be no crisis today.    Unfortunately, those criteria were loosened, often for political grounds.   In order to speed the spread of the Euro, economic dangers were discarded.

The problems began when the cost of unifying Germany turned out to be immense, causing Germany to violate the original criteria.    France also had an economic slowdown leading to a similar loosening of the rules.    They were the ones who needed to enforce discipline, and once they broke the rules it was hard to keep others in line.

They might have tried, but the bubble economy of the first decade of the 20th Century created an illusion that all was well.    Debt may be high, but the world economy was growing and investments were yielding considerable profit.  In that deluded atmosphere countries like Greece, Italy, Ireland, Spain and Portugal ignored the warning signs — and their problems were ignored by those in the EU who should have known better.

Even if France and Germany lead, Greece may not follow. Populist Alexis Tsipras could lead Greece a different direction should he emerge victorious on the 17th – but even he has to understand the consequences.

The southern states bring to the EU a different ethos than the northern European states.    Greece is a prime example.   The level of corruption and public sector employment is immense while the actual productive economy is small.   Getting into government is a way to make money and gain perks.   As their public sector boomed, it was funded via debt and risky investment schemes.    When the bubble burst in 2008, the problems were laid bare.

Yet its not just a problem for the south.   Someone had to finance that massive debt, after all — and those someones were predominately northern European banks and investors.     So a default on debt or economic collapse in the south would quickly spread all through the EU, bringing down German banks as quickly as Spanish ones.   The economic contraction could yield a depression that might spread far beyond Europe.   In short, the bubble delusion led northern Europeans to finance the southern European excesses, making them just as vulnerable.

The map is slightly out of date – Estonia joined the Eurozone last year (2011)

The problem is that the creators of the Euro were right at the start:  you can’t have monetary union without strict rules forcing fiscal policy coordination.   They were wrong that just setting criteria would be enough — criteria can be ditched, after all.

The solution is clear:  1)  Find ways to eliminate and/or pool the debt from the southern European states.   While this is often correctly decried in countries like Germany as a bailout of states with incompetent economic policies, not doing so could also bring down the financial sector of the big, rich, northern states.    Therefore, Germany and others have to bite the bullet and help pay for the corrupt folly from the south.   However, that also leads to 2) there needs to be a tighter set of rules and institutions to force rational fiscal policies on the southern European states.    Often decried as an ‘austerity’ that simply deepens the recession in the south, it’s a necessary step to a sustainable economy.   Adding to debt and spending more without restructuring those economies will simply make the problem worse.

So if Germany and states in the north have to pay more, states in the south have to give up a kind of easy money life style that allowed them to live excessively beyond their means for so long.  Tax evasion, early retirements, massively large public sectors and the like will have to give way to an economy built on productivity and work.

If it works, the restructuring will be good for everyone.   Southern states will start to have real rather than faux prosperity and develop their productive capacity.   Not only will this save banks in the north from massive loses due to defaults, but will also be an engine of eurozone growth.

The poor/corrupt/unproductive south is unsustainable in a 21st Century European Union.    The difficult but necessary transition they’re going through will ultimately end the rich/poor dichotomy between northern and southern Europe.    The Euro will emerge stronger, and a Europe with much better coordinated fiscal and banking policies (overseen by real institutions not just vague rules) would be a far better bet than leaving the national economies to follow their own idiosyncratic paths.

Merkel and Hollande know the stakes.   They know that they can join past Franco-German duos in turning a crisis that many thing will tear the EU apart to one that strengthens it and brings it together.   The negotiations won’t be easy, but given the history of the EU and the recognition that the era of fully sovereign independent states is over in Europe, I’m confident they will be able to accomplish the task and make the EU a model of how political economy in the era of globalizationn can be structured.

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  1. #1 by Black Flag® on June 6, 2012 - 00:40

    No nation in Europe will agree to be ruled by France, let alone Germany.

    Without force to apply economic sanctions, no nation will follow a prudent auster budget.

    The Euro will collapse and with it take out the EU – good riddance to both.

    • #2 by Scott Erb on June 6, 2012 - 00:47

      Of course there will be the possibility of sanctions – and its not rule by Germany or France, it’s the EU as a whole. They’ve already long surpassed traditional sovereignty, that boat has already sailed (and one reason Americans and Brit Euroskeptics are so often wrong in their predictions of gloom and doom for the EU is that they interpret Europe through obsolete notions of sovereignty).

      • #3 by Black Flag® on June 6, 2012 - 01:53

        What sanctions? How are the banks going to enforce sanctions on a sovereign nation?

        It will be rule by France and/or Germany – they are the larger economies and they will -in any real economic union- dictate the terms, including budgets. No nation will allow that – they lost 30 million dead to resist that and they will not let such a thing creep in.

        We will see in a few months – so far, I’ve been right and you … not so much 😉

        PS: Nice blogging re: your trip – you made me wish to go!

  2. #4 by Black Flag® on June 6, 2012 - 00:45

    😉

  3. #5 by Scott Erb on June 6, 2012 - 02:50

    You have an obsolete notion of sovereignty. The EU states have already given that up. They have done so by treaty, and treaties can approve sanctions. Sovereignty is pooled through the EU – sovereignty is becoming obsolete in an era of globalization, the EU is simply farther down that path.

    • #6 by Scott Erb on June 6, 2012 - 03:01

      Remember, sovereignty itself was a social construct created to deal with the loss of power by the Roman Catholic church and the break down of the old political order. That change came due to an information revolution led by the printing press. Now we’ve got a new info revolution altering the nature of political organization. Sovereignty no longer serves the function it was designed for 360 years ago, we need to construct something new.

    • #7 by Black Flag® on June 6, 2012 - 03:09

      No sir.

      You hold a strange sense of sovereignty.
      There is nothing an EU state has given up – what do you think the EU will do if Greece tosses out the Euro? Answer: nothing

      No, the world is going to more decentralizing – not more centralizing. The era of Super-States is collapsing.

      • #8 by Scott Erb on June 6, 2012 - 03:27

        The world is going to do more decentralizing and centralizing, as is the EU. Some things are done supranationally, others locally. We’re not going back to the hyper-localism of the Holy Roman Empire or the centralized bureaucratic state of the era passing. It’s going to be different — and it’s not yet clear how it will shake out.

        If Greece tosses the Euro the Greek economy will collapse into hyperinflation as they won’t be able to float a bond or do anything but print more money. They know that. If Greece leaves then the EU won’t lift a finger to help because they know that Greece will be an example to the bigger economies of Italy, Spain and Portugal that the consequences of ditching the Euro are dire — the consequences of staying in and being forced to undertake fiscal discipline in exchange for debt help are much more pleasant. European states have been giving up and redefining sovereignty by choice out of self-interest.

        The academic work now on the shifting nature of sovereignty (and how it’s virtually in theory only for good chunks of the developing world) is pretty interesting. The ideal form notion of sovereignty was probably never true in practice.

      • #9 by Black Flag® on June 6, 2012 - 03:44

        I could not disagree more.

        As you point out, the free flow of information is increasing – logarithmically.

        The State gains its much of its legitimacy in using violence by controlling information – propaganda.

        It has lost control of that flow of information – they cannot keep up, and every day the legitimacy of the State is eroding as its lies and its terror on innocent people is exposed and it comes under greater and more constant ridicule.

        The idea that a bureaucrat, 3,000 miles away – has any wisdom to make decisions about local people is under dispute.

        Further, the bankruptcy of the national governments – all over the world – will utterly shorten their reach. They will be essentially redundant. Local politics -civic politics (city/county) will -once again- become the major corner stone of policy and the “Federal” government will become nary a thought, as before 1792.

        Re: Greece.
        How do you believe hyperinflation will occur? The Greeks renege on all their debts and bring out the drachma – and say “Good luck collecting!!”, just like Iceland. As far as floating a bond, etc. they will have no trouble finding money – maybe not as much or as easily, but the “smart” big money ain’t so smart. Argentina et al have been playing that bankruptcy game for decades and other then a short-term pain, they are all fully loaded up with bonds again.

        Re: Spain
        I agree. Spain then Italy will all do the same thing. It is a sure thing. What sanctions can Germany banks force on Greece – none at all. So if Germany -again- bails out Greece -again- Greece will know they can play this game of “Chicken” another round. One day, Germany will say “no” and it will all come down anyway

        I think the Germans know this today.

        They will say “no” and let the chips fall where they go – because they are going to fall one day anyway.

  4. #10 by Scott Erb on June 6, 2012 - 13:15

    Well, BF, I think you need to read more on what would happen if Greece defaulted — even the Greeks are afraid of that (which is why experts put their odds of leaving the Eurozone at 1 in 3). Also, they’re a small state dependent on the states around them — they need the EU. You don’t get how interdependent these states are – their economies are linked, they share common regulations, border crossings are like crossing between states in the US, they can work and even vote outside their country of origin and the banking/financial sector has no one “home.” The vision of lots of separate countries is a hard one to banish from your mind, but that 20th Century reality is gone. Moreover, coordinating common regulations and policies – things that have fostered this interdependence and improved growth – require supranational decision making. The idea that in an era of globalization it will be pure decentralization makes no sense – it defies reality. There will be decentralization and centralization. The EU calls this “subsidiarity,” (as with it’s predecessor ‘sovereignty’ it was originally a church term). Subsidiarity says that problems should be dealt with as decentralized as possible. Power will go from the state to regions and local governments on a number of issues. But on trade, monetary policy, fiscal policy coordination, cross border regulation, and a variety of other issues (laid out in the treaty of the EU) there are supranational institutions. I think you – and most Americans – don’t get how different the EU is from the US, both in terms of how people think (I mean, even conservatives support universal health care) and how the economy and governments operate.

    • #11 by Black Flag® on June 6, 2012 - 14:07

      I think you need to get out of your sterile office and check the coffee.
      Greece default would be a problem.

      It would not be the end of Greece. They’ve done it before, and believe me, they will do it again and again and again to a new set of fools.

      They were a small state before the EU and Euro – and they did “just fine” and they will do the same again – so what that their economies are interlinked – same like you, your personal economy is interlinked too. So what? You still make independent choices for yourself.

      Just because them leaving the Euro causes problems for Northern Banks is not a reason they cannot leave. They do not care about North Banks except to spend the money.

      There is nothing but hand wringing that prevents Greece from leaving. They will leave because they cannot repay.

      The yields on the drachma would not go down. But the Greeks can print drachmas unlike they can print Euro. They may be willing to trade short term inflation for relief of 100% of their debt. There is no certainty of “hyperinflation” – what would be the point? There is no debt to pay off.

      All cases of modern hyperinflation has been due to external debt payments- Germany/Israel etc.

      Greece would have zero debt.
      Why would hyperinflation come to pass?

  5. #12 by Scott Erb on June 6, 2012 - 13:27

    Oh, and if bond yields on Greek debt are high when they are in Euros and there is a strong sense that Greece will get help, it’s insane to think that if they declared bankruptcy and went to the drachma that the yields would go down! That’s not how the economy works, it would be like saying “if you stop eating healthy and go to junk food only your weight will go down.” If they get debt at very high interest rates, they’ll end up printing more money to pay that debt back, as well as go to monetary policies to stimulate the economy. That would likely lead to hyper inflation. And again – they are dependent on the EU.

    • #13 by Black Flag® on June 6, 2012 - 14:41

      Just for fun, here is what I think is going to happen

      The vote in Greece is on June 17.
      If no coalition — more uncertainty. Markets will punish Greece and bondholders.

      If there is a new government coalition, then will it declare itself ready to impose austerity, i.e., reduced government spending? My guess is simple: it will not.

      If it does not, will the bailout continue? I think it will.

      I don’t think Europe is ready for Greece to default. That would take down banks in Northern Europe.

      Germany’s Merkel mumbles. “No, no, no.” Then she capitulates. The banks are terrified. They tell her to promise whatever it takes to calm the bond markets. She does their bidding.

      But nothing changes. Greece, Spain and Italy will remain in a crisis.

      The investment world hopes that the ECB will take decisive action. The Bank says it won’t. But its #1 task is to bail out the big banks. It will intervene to save large banks, risking high inflation.

      I think the situation in Greece will not be anywhere near clear, let alone resolved, by June 19.

      The situation will be, by all measures, a lot worse.

      • #14 by Scott Erb on June 6, 2012 - 15:22

        The banks and the EU economy would be hurt by a Greek default, but not as bad as Greece. The banks have been preparing for the possibility for two years, they are in a better position now then they used to be. No, the fiscal union pact is going to be the path they take, that’ll be the price of a bailout.

        Greek was in essence a failed state before the EU – corrupt governments, military dictatorship, extreme poverty. The Greeks don’t want to go back to that. I think you really don’t understand just how different Europe today is than Europe 50 years ago, nor do you understand the commitment by leaders of all countries to make sure they don’t fall back into the chaos of the past.

      • #15 by Scott Erb on June 6, 2012 - 17:13

        To your other comment: Actually, I’ve just come back from two weeks in Germany reading up on the crisis and the plans, and a lot about Merkel’s personal opinions. She’s a strong woman, she doesn’t back down if she thinks she’s right (she’s still a physics professor, a scientist at heart). She’s not going to go a long with just a bailout unless there is a strong move to fiscal union.

        And that fits with the historical evolution of the EU. From a common market, to coordination in monetary policies, to common regulation and the elimination of border checks, to a common monetary policy, and now towards a kind of fiscal union. Crises drive each move forward.

  6. #16 by Alan Scott on June 6, 2012 - 23:44

    Scott,

    Don’t you think that a currency which gives Germany an overwhelming advantage over it’s EU trading partners is doomed . Germany is booming and southern Europe simply cannot price it’s goods to trade effectively . Spain and Italy have to able to devalue their currency . Greece is a lost cause .

  1. Irish dream for the Euro nightmare. «

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