American and British commentators are often surprised, annoyed or dismayed by the fact the Euro trudges on, as both the European Central Bank (ECB) and the core states of Europe do what is necessary to protect the currency and avoid contraction of the Euro zone. Why are German taxpayers willing to pay so much to protect banks in Ireland, or government debt in Greece, Portugal and Spain? Why do Greeks accept an austerity program that put them into depression – and in 2012 elect a new government that favors that very program?
First, what is the Euro crisis? On the surface it’s a sovereign debt crisis – southern European states have so much debt that investors are doubting they can pay it back. This means that to sell bonds states have to offer a higher interest rate, since the risk is higher. However, it’s not just a debt crisis. Consider these bond rates:
Note how Germany and the UK’s rate has been dipping, meaning it’s easier for them to sell bonds, while Spain and Italy’s cost more – though historically near the average. Only Ireland and Greece had an extreme crisis. Those two were caused by very different factors. Ireland’s deregulation of the financial sector was patterned on American practices, and thus they got hit hard by the bubble bursting.
The problem for Greece is not just debt, but structural weakness in their entire economic system (that’s why it’s always a false comparison when politicians try to compare the US or even California to Greece).
The first is telling – there has been a debt explosion throughout the Eurozone, including Germany. This makes clear that one of the structural aspects of this crisis is a need to reduce debt. Debt always goes up in a recession since revenues are down and claims for aid increase – yet with the bursting of the bubble it has become crystal clear that debt to GDP ratios above 60% are unsustainable.
The second chart shows that there is wide variation of debt growth since 2008 – but Ireland, Greece, Spain and Portugal have had the greatest debt increase, and are four of the problem states. Italy’s debt growth is less, but while Italy hasn’t had a debt explosion, they’ve had consistently high debt.
Italy’s actually made significant structural reforms and was not hit as hard by the recession as others in terms of new debt – yet it’s debt level is one of the highest in the Eurozone.
The problem in Europe is that there is a core set of countries with strong economies that simply have to find a way to reduce debt and a set of weaker economies that have managed to hide their structural problems with debt or financial gimmicks. The recession laid that structural weakness bear.
Many Americans want to blame European social welfare programs for the crisis, but that’s’ also easily disproven. The chart showing debt to GDP ratio growth since 2008 shows Sweden actually reducing debt, and the Scandinavian countries faring well. Germany is running a 7% current account surplus and remains the engine of Europe. Countries with the best social welfare systems are faring very well, even better than the US.
This is evident in bond rates. Germany’s 10 year note now has a yield of 1.3 %. That means that despite high debt levels, investors have faith in German bonds thanks to the strength of the German economy. The US, UK, Sweden, and France all have yields of about 1.8% – still very cheap. Ireland’s yield is now under 4%, thanks the EU and IMF recapitalizing Irish banks. The worst of their crisis seems over – Ireland’s was a banking crisis caused by financial deregulation and that’s easier to solve than structural debt crises.
Ever since the ECB, EU and IMF made clear they’d do whatever it takes to protect the Euro, Spanish and Italian yields have gotten down around 4.5% – historically a common yield. Portugal is over 6%, and Greece still over 11%, meaning that markets still aren’t confident about Greece despite the EU bailouts. Clearly, though the sense of crisis is passing, the smart money is now on the Euro.
So why – why has the Euro proven so resilient and gotten so much support? Simply, the Europeans realize that if the continent fractured between the wealthy core and poor fringe, it would harm everyone. Greece, Spain and Portugal, late joiners of the then European Community (EC), would see their progress towards modernizing their economies punctured. The core countries would also suffer. They’d lose markets in the fringe countries, and their currency — perhaps a contracted Euro – would appreciate so much that their exports would suffer.
If the Euro were to break up, the poor countries would do like Iceland did – allow a depreciation of the currency to effectively cut everyone’s pay by 50%. But defaulting and inflating on the fringe would do severe damage to the core’s banking system, as they are heavily exposed to that debt. So it’s in the core’s interest to make sure that doesn’t happen.
German Chancellor Angela Merkel, in demanding countries undertake austerity programs and reform their economic structures in exchange for bail outs, has been criticized as wanting to force everyone to have the German model economy. Germany’s gaining control of Europe! But the German model works – and it’s what Sweden and other northern European countries follow. You base your economy on supporting production and having sound fiscal and monetary policies.
If Italy, Greece, Spain and Portugal aren’t forced to structurally adjust to the realities of 21st Century globalization, they’ll fall behind and might never recover. If they do – as hard as the next few years will be – they could emerge with new economic structures in place to allow them to grow and have sustainable, productive economies. That will be good for everyone.
What the skeptical commentators don’t get is that the European Union has developed a different notion of sovereignty, one that sees the destinies of the European states as linked. That’s a different way of thinking, people aren’t just German or French, but also European. Such a re-conception of sovereignty is incomplete and has pockets of opposition. But as Merkel pushes the EU towards a model of fiscal union, with other states recognizing it is in their self-interest to follow, the European Union might once again defy skeptics and prove itself stronger than ever.