Archive for category Greece

Greece and the EU

Greek protesters in support of the Syriza party, a left wing party that dominated last month's elections.

Greek protesters in support of the Syriza party, a left wing party that dominated last month’s elections.

In 2008 the global economic crisis unmasked the structural weakness of the economies of southern Europe.  Greece was by far in the worst shape.   In 2010 the EU brokered a bailout deal for Greece, predicated on the country embracing a very painful austerity program.   In 2012 Syriza campaigned against the cuts and urged Greeks to chart a course not dictated by the EU.   Greek voters, skittish about loosening ties with Europe, said no, and Syriza won just 78 out of 300 seats.  Three years of painful recession later and the Greeks have had enough – Syriza won 149 seats, just short of an absolute majority.  The left wing party joined in a coalition with ANEL, a small right wing conservative party to form a government.

Greece has a debt of about $500 billion, 180% of it’s GDP.   60% of that debt is owed to the Eurozone, so a default would have serious, though not disastrous implications.   Very little of that debt is held by Greece.   After the election Greece’s 10 year treasury bond yield skyrocketed to over 10%, meaning rising the debt would be prohibitively costly.

Syriza’s leader, new Prime Minister Alexis Tsipras, vows to keep this campaign promises, all of which violate the conditions of the bailout.  These include increasing the minimum wage, cutting property taxes, increasing pensions, rehiring fired public sector workers, and giving free electricity to those “suffering the most.”   Since he doesn’t want more debt, the only way to do that is to print money – but Greece is in the Eurozone and monetary policy is controlled by the European Central Bank (ECB).   So what next?

Syriza's leader Alexis Tsipras

Syriza’s leader Alexis Tsipras

One might wonder if Tsipras is out of touch with reality, wanting to increase spending to get out of debt.   But he makes a good point that austerity simply increased the scope and depth of the recession.  The ‘bailout’ benefited Eurozone banks more than the Greek people.   He believes his policies would stimulate the economy so that Greece will be able to pay back its debts and show itself to be solvent.

Unfortunately the Greek economy was built on sand – debt and public sector employment hid the fact the Greek economy is structurally flawed.  Just ending austerity won’t change that, nor alter the dynamics that created the crisis in the first place.

Last week Tsipras and his Finance Minister Yanis Varoufakis visited European leaders to try to assure them that they weren’t going to rush out of the Eurozone, and to convince them to support a bridge loan to fund the government through September.   On Sunday Tsipras said that the Euro was a “fragile house of cards” and if the Greek cards were pulled it would collapse.   On Wednesday Eurozone finance ministers are meeting to discuss what to do next.

The Euro is not likely to disappear whatever Greece does.

The Euro is not likely to disappear whatever Greece does.

Tsipras is playing a game of chicken – pushing the EU to accept his policies and offer help in exchange for Greece holding on to the Euro.  More importantly, if he were to leave the debt owned by Eurozone banks would become toxic, threatening a banking crisis.

Still, the threat to the Euro is much smaller than it was back in 2010, or even during the election of 2012.   At that point high bond yields threatened a number of countries, especially Spain and Italy.    Today Italy’s bond yield is 1.76%, while Spain’s is 1.38%.   Those are below the US yield of 1.94%!  This suggests the fears of contagion no longer exist and Greece is being treated as an isolated case.   With 19 countries now using the Euro – Lithuania joined last month – it could withstand a Greek departure.

But the Prime Minister does not want to leave the Eurozone, and therein lies the rub.   Greeks know that leaving the Eurozone would put them on a path towards increased isolation and continual crisis.    He’s betting he can arrange a bridge loan through August, and that while Greek debt is high, the Greek economy is small.   The cost to the EU member states would not be prohibitive.

While some European leaders are sounding cautiously optimistic about making a deal with Tsipras, German Chancellor Angela Merkel is having none of it.   While not dismissing anything out of hand, she says it’s up to Greece to come up with a plan.   Tsipras has said he’s working on further reforms designed to mollify EU critics, but it’s unlikely he’ll convince Merkel, who fears this will simply enable Greece to go back to its old ways.

Tsipras and Merkel will meet for the first time this week.

Tsipras and Merkel will meet for the first time this week.

My predictions:

1.  Those predicting the end of the Euro will be disappointed.   Countries are politically committed to monetary union as the best way to assure economic stability.   Businesses and banks – the people who really run the show – are almost unanimously in favor of it.   Now that Italy and Spain are no longer seen as “the next to go” if Greece leaves, the Euro is not in existential danger.

2.   Tsipras and EU leaders, particularly German Chancellor Merkel and French President Hollande, will engage in tough negotiations, but are likely to reach a deal.   It’s in their interest.   The EU leaders do not want their banks to suffer due to the Greek debt they hold, nor do they want instability associated with the first departure from the Eurozone.   Prime Minister Tsipras knows that the Greek economy would be severe crisis if he actually tried to go back to the drachma, perhaps worse than the last few years of recession.

3.  The agreement might work.   Merkel needs to be firm on the need of Greece not just to stimulate their economy, but to restructure it.   Greece needs to develop a productive and sustainable economy.  They do not have one now.  Tsipras has to recognize that reality..

The telling point is that nobody involved wants Greece to leave the Eurozone.   It is in their interest to maintain it, even strengthen it.   It is in the EU’s interest to have Greece develop a sustainable, productive economy.   The bailout and austerity program didn’t work – even though the Greek voters gave it a chance back in 2012.   With some creative thinking, it may be that contrary to expectations, the victory of Syriza may end up being good for the EU.

 

 

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Why the Euro will Survive – and Thrive

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:

bonds

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).

debt explosiondebtgdp

 

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.

spainitalydebt

 

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.

germany

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.

Some of called Merkel the "Abraham Lincoln" of Europe, keeping the EU together

Some of called Merkel the “Abraham Lincoln” of Europe, keeping the EU together

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.

 

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The EU Deserves the Peace Prize

When I first got to know the European Community it had ten states and some people continued to call it the EEC – the European Economic Community.   It was in a funk.   Greece was the newest member, but progress towards increased integration was fleeting.   The British were angry about paying so much into the system, divergent monetary policies meant that exchange rates fluctuated rapidly, and the word of the day was “Eurosclerosis” – the project to build a united Europe was stagnating, and could perhaps fail.

Studying at the Bologna, Italy Center of Johns Hopkins SAIS I took a course on “The Politics of European Integration” by Dr.  Gianni Bonvicini, a young and enthusiastic supporter of the European Community as it was called then.     As we learned about integration theory, I found myself fascinated by the process through which countries that had caused war and devastation moved towards peace and cooperation.

The choice of the EU for the Nobel Peace prize surprised many

The war and devastation had been profound in Europe in the first half of the 20th Century.   The Europeans gave us the holocaust, Communism, and colonialism.   Conquering the world, taking slaves, draining other lands of resources and wealth, the Europeans reflected the most violent civilization of human history.   To be sure, the violence was often sanitized by claims they were spreading Christianity, bringing civilization to the primitives or ‘exploring the world.’   Even now we express horror at the Taliban killing a young girl while our own drones kill innocents more often than we realize.   (Update:  ‘Europe’ here refers to the “West,” which includes the US.)

The violent and social Darwinistic turn taken by the Europeans in the 19th Century came home to roost in the first half of the 20th.   Violence, depression, war and ideological conflict took the most powerful set of countries on the planet and left them devastated.   As the US and the USSR began their Cold War, the Europeans realized that they’d never have a brighter future if they didn’t rethink the basis of their political culture.

It started small.   Former wine merchant Jean Monnet, a war time planner, recognized that cooperation and trade yield benefits while conflict and isolation lead to war.   When they couldn’t convince the Europeans to leap forward to a United States of Europe — nationalism would not die so easily — they took another track.

Jean Monnet, the “father of Europe.”

After the war the European Coal and Steel Community (ECSC) was created in order to put coal and steel under supranational control.   Since most of the coal and steel came from Germany, this was designed to both deny Germany such control, but allow Germany to use their resources for economic gain.   West Germany, France, Italy, Belgium, the Netherlands and Luxembourg were part of this organization, and it worked well.

In 1955 talks started in Messina to undertake a bolder project.   What if the six ECSC states could form a customs union, a region with no internal tariffs and a common external tariff?    On March 25, 1957 they signed the Treaties of Rome to create the European Economic Community to do just that.    The Common Market was complete by 1967, with the ECSC, EEC and Euratom (an organization for the peaceful use of atomic energy) merging to form the EC – the European Community.

The economic boom that Europe was creating after WWII yielded the desired effect — spillover.   People saw that cooperating and trading worked and in 1973 the European Community expanded to nine states, adding Great Britain, Ireland and Denmark.   Then the energy crisis hit, exchange rates started to fluctuate wildly as the US abandoned the Gold Standard and fixed exchange rate system, and it appeared the EC had hit a wall.

He had jet black hair and was very young when Bonvicini prophetically told us where the then-EC was headed

Dr. Bonvicini told us not to be fooled by the apparent crisis in the EC.   It already has served its original purpose, he reminded us, making war between France and Germany — or any member of the EC — unthinkable.   But more than that, he said the process had not truly stalled.   France and Germany pushed for the creation of the European Monetary System (EMS) in 1978.   Wild divergences in monetary policies made the EMS seem almost pointless, but he predicted someday it would yield the desired outcome: a common currency.

That was pie in the sky fantasy in those days.   How could inflation friendly France and Italy ever unite with West Germany and the Netherlands, two countries with very tight monetary policies?   Impossible!   Unthinkable!   In fact, many thought the break up of the EC probable.  The British were demanding a rebate, sovereignty now was trumping supranationalism.

Bonvicini was right.   Britain got its rebate, and soon the EC moved towards a “Europe without frontiers,” the Single Europe Act designed to eliminate diverse regulations on goods and services to make trade truly free, and cross border investment easy.   Once that was done, countries found themselves forced to converge on monetary policy, lest investment dollars flow to countries with the most stable exchange rates.   When the Cold War ended, the French and Germans led the way to create a common currency, the Euro.

With that agreement the EC became the European Union, and after the Cold War it expanded from 12 states to 27.   Many East European states were veering towards corruption and authoritarianism, but the EU demanded they embrace democracy and rule of law in order to become members.   The economic allure of the EU was too great to ignore; authoritarianism was rejected.

By the dawn of the 21st Century countries that had fought each other in massive wars now gave up their currency for a shared one, and checks at borders were removed.  One could travel from Italy to Austria to Germany as easily as traveling from Massachusetts to Maine.   Workers can go anywhere in EU for a job, students can go anywhere to study.   Corporations merged as national economies became so linked and interdependent.   Sovereignty was transformed as Europeans were citizens of both a state and the EU.

The states of the European Union

The EU has also worked for peace world wide.  It is the only major actor on the world stage that has accepted both UN sets of human rights, economic and political.   It is the major force behind UN peace keeping operations, and the EU has signed and met the Kyoto accord agreements, proving that achieving those results is economically beneficial rather than harmful.   The wealthy states of Europe are now helping states like Greece and Spain deal with what otherwise would be complete economic collapse.

Simply, the world is entering an era of globalization in which past notions of sovereignty and self-interest are becoming obsolete.   States are no longer independent units but interwoven in a web of economic and political relationships.   The old way of thinking, still clung to by most in the US, is obsolete.    Transitions from an old order to a new one are often violent and lengthy as people can’t let go of old ways of thinking and doing.   The EU offers a model of what can work in the future.  It reflects the most promising sign that this global transition might be peaceful rather than violent.

So congrats to the EU – a fitting recipient of the Nobel Peace Prize!

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Greece Steps Back from the Abyss

New Democracy leader Antonis Samaras became Premier on Wednesday, heading a three party pro-European government.

Last weekend the Greek people faced a decision on their future with their second election in as many months.   The first election, held May 6th, was a shocker.   Greek austerity, forced upon the country by the European Union, led to a massive deepening of the Greek recession and a significant drop in the standard of living and quality of life in Greece.   Few countries have seen such a dramatic and unexpected decline as Greece has.

The people felt humiliated.   They realized that their leaders had been lying and gambling with their country’s future, putting the country in tremendous debt, fostering corruption, and then leaving the Greek people holding the bag when everything fell apart.    On top of that the Germans and the rest of the EU needed to bail them out, helping not average Greeks, but the politicians and banks that created the mess.   That anger came out in the election results.

New Democracy, the conservative party, had the most votes with 18.85%.  That won them 108 seats, thanks to the bonus of the largest party getting 50 more seats than the percentage should earn them.   That was down from 33% in the previous election, though they gained 17 seats since in 2009 they were not the largest party.

The ruling party, PASOK (left of center) fell from 43% to 13.18%, losing 119 seat (and ending with 41).    The surprise winner was the radical left wing party Syriza, led by Alexis Tsipras.   Tsipras tapped into the anger and humiliation to rise from 4% to 16.8%, passing PASOK.   The result took Europe by surprise.   In a 300 seat parliament, even PASOK and New Democracy together couldn’t form a ruling coalition, as they controlled only 149 seats.   Talks with other parties made it clear that any government that they formed would be shaky and could easily fall, which is not a good thing when the country has to make very difficult decisions.

37 year old Tsipras signals a left wing challenge to Euro-orthodoxy. If the main parties can’t show real progress, he could emerge stronger in the next election.

In the uncertainty of the moment they decided that the most prudent course of action was to ask the voters if they really meant it.   A new election was planned for June 18.   As the campaigning grew it was clear that Greeks were reading the election as a referendum on the Euro and to some extent the EU.    Should Greece remain in the Eurozone?

Tsipras made a confident, powerful and emotional argument that they should not, unless they get real concessions from the EU.   Do the Greeks really want to have their sovereign decisions made according to German dictates?   Should the Greeks accept an austerity that requires them to see the recession cascading inward and causing more pain for average folk?   Shouldn’t the politicians of PASOK and ND (New Democracy) be punished for their corruption and willingness to drive up such debt with horrific fiscal policies? Shouldn’t the Greeks be in charge of their own destiny?   After all, the Europeans want to “save” Greece to save their own banks — doesn’t that mean Greece has more bargaining power than they realize?

As Tsipras’ popularity grew many assumed Syriza would end up on top in the June election, perhaps with enough votes to form a stable coalition.   The result would dramatically increase the odds of a Greek departure from the Eurozone, even though Tsipras coyly claimed he simply wanted to negotiate “fair” terms.

After early reports had Syriza as narrowly winning as the largest party, the actual results gave that honor to ND.  ND earned nearly 30%, up over 10% from a month before, now with 129 seats.  Syriza also increased its share to 27%, gaining 19 seats.   That means that compared to 2009 it rose in popularity by 23%.    Although they didn’t come out on top, it was still a remarkable performance for a radical party once seen as too extreme to be taken seriously.    PASOK fell further, losing 8 more seats and down to 12.3% of the vote.     The former ruling party was clearly being punished.

Yet PASOK and ND could combine for 162 seats for a clear majority in government.   To provide added stability they added the pro-EU Democratic Left, whose 17 seats gives the coalition 179 out of 300.

The first recorded moves towards democracy came in Athens; it was messy but voters show democracy still works.

So what does this mean?  The Greeks took a hard look at what Syriza represented and found it scary.   The party is Euro-communist, and its radicalism would put it in opposition to the rest of Europe.  Many fear that it would drift towards dictatorship, like past Communist parties did.   That seems unlikely, but many Greeks angry about the situation didn’t want to leap to the far left or the far right — those ideologies have a poor track record.

They also had time to digest what would happen if they brought back the drachma.   First, they’d see the value of their currency plummet, which would force them to default on loans.   Second, they’d not be able to get new loans, people would trust neither the Drachma nor Greece’s ability to pay them back.    That would either mean a fall into near third world status or, should Greece try to use monetary policy to stimulate the economy, a risk of hyper-inflation.

More importantly, they wouldn’t be part of Europe any more, at least not the civilized united and progressive Europe that the EU represents.   The Greeks know that a small backwards troubled economy south of the Balkans could drift farther from the prosperity and stability that northern Europe represents.   Independence and sovereignty sound good in theory but in practice they represent a fading era.  Greece without Europe would be a Greek failure.

The problems have not been solved.   The austerity program as currently structured is too harsh and has no growth aspect designed to help Greece truly restructure its economy.    With the rise of French President Francois Hollande as a foil and potential partner to Germany’s Angela Merkel, the EU has the hard task of formulating a new approach that isn’t so harsh on Greece in exchange for stricter monetary policy controls.    The banks are going to have to take loses – the problem can’t be solved by governments alone.

Tsipras (center) has allies in Germany in “die Linke” (the left), a party to the left of the Social Democrats. Here is talks with Klaus Ernst and Gregor Gysi in Berlin.

But some of the urgency has gone away.   They have time, and in Germany, Greece and elsewhere there is growing recognition that a contraction of the Euro to an inner core of wealthy countries would damage everyone.  And the longer this drags out, the less likely it is that things will fall apart.  The EU and the Euro are revolutionary, they are redefining what a “state” is, what “sovereignty” means and how economies are structured.   Such transformations are never easy, but most Europeans realize there is no turning back.

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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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Tired in Munich

“Goodbye Euro, why Greece must now leave the Euro zone” – a very interesting analysis.

A very short post today.  Our flights last night were good, we got in today, found our way into the city and our hostel, and then went for a walk tonight at the English Gardens, though rain came at the end.    Most of us had Doner Kepabs for dinner and now we’re trying to stay up until 9:00 to avoid jet lag.

Three thoughts occur to me as I read through really solid articles about the current crisis in Greece:

1)  Germany benefits from this in a very real way.    The Euro is weak due to weaknesses in Greece, Spain and Italy.    Germany has a strong, productive export economy and it’s growing.   If the D-Mark was the currency of record for Germany, it would be much stronger than a Euro pulled down by Greece.   That would make Germany relatively more expensive and weaken its growth.

2) There is a real wall of separation between concern for the future of the Euro and concern for the EU.   The EU is safe and still something Germans and Europeans prize.   The Euro is safe among a core set of countries.   Germany will never go back to the D-Mark again, the Euro is the German currency now.

3)  Students note how much less run down German cities are than American ones, and how the infrastructure is strong here.    That’s right – America is in decline.   You notice it when you travel.

Too tired to write more.  Good students, a fun day, and its nearing bed time!

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A Good Election for France and the EU

Socialist François Hollande defeated conservative Nicolas Sarkozy 52% to 48% to bring the Socialists back into the Presidency for the first time since François Mitterrand left office in 1995.   Angela Merkel’s partnership with Sarkozy – Merkozy, as it was called, had defined the plans to save the Euro and prevent the financial crisis from escalating.  Now that is in doubt.

Meanwhile in Greece elections look to show the two main parties, PASOK and New Democracy, could well fall short of having the capacity to build a coalition.  They are the only parties supportive of the bailout plan for Greece.   The rise of the far left and far right against the plan suggests that Greece could face a future without the Euro, especially if Hollande scuttles the “Merkozy” plans.   Financial markets in Europe are gripped with uncertainty as the Euro falls in value from about $1.33 to $1.29.   What does this mean?

The Greeks suspect that the severe cost of “austerity alone” simply means they’re paying to protect the big banks.

Americans and Brits tend to look at the EU with a jaundiced eye.   Americans especially don’t get it.   They don’t see how countries can link their destinies like that.   Others don’t like the EU and want it to fail so they hyperventilate over every crisis or bit of bad news.   That’s been going on for nearly 55 years and so far the EU has managed to grow and expand rather than fail.   Talk of the EU collapsing or even the Euro disappearing are way overblown.   The EU is not in danger, and the worst I can imagine for the Euro is that the number of participants could decrease by one or two.

What this means is that the Europeans will shift from an austerity focused German led recovery effort to one that is more nuanced and willing to challenge financial markets and big banks.   Austerity hasn’t been working out too well anyway.   Germany’s been the healthiest but Great Britain’s austerity has caused a second dip into recession and Greece is enduring a downward spiral.    The German economy is fundamentally healthier than others in Europe (and arguably our own), so they’ve avoided that kind of pain.

David Cameron ponders “what next” after his budget cutting helped push Great Britain into a double dip recession

Ultimately, a shift away from a Germanocentric policy is good for the EU.   German led austerity is not sustainable.   It will lead to resentment of the Germans, anger at the politicians, and the rise of the far right and far left.   Hollande will force Merkel into a partnership of the right and the left, and that’s always been good for Europe.

Consider:  Social Democrat Helmut Schmidt and conservative Valery Giscard D’estaing helped put aside the crises of the 70s and forge a stronger community.    Conservative Helmut Kohl and Socialist François Mitterrand were the forces behind the creation of the Euro and the expansion of the EU.    Europe does best when its Franco-German engine powers a vehicle with a wheel on the right side and one on the left.   Both wheels on one side make it unstable.

François Hollande is not a raging ideologue.   His first moves after the election was to contact Merkel, assure financial markets, and receive an invitation from President Obama to visit the US.    As President Obama learned, it’s easy to rail against the system when you’re on the outside; once you have power there are many subtleties of policy that have to be considered.

Expect Hollande to fortify the resolve of those who want to reject austerity as the primary policy for the EU.   It’s not that there isn’t a debt problem; Hollande notes openly that at 80% of debt to GDP, France has a debt problem.   Rather, solving that and getting out of this crisis by focusing on austerity and budget cuts alone is economic foolishness.

Merkel and the Germans are very influenced by economic theories that emphasize avoiding debt and accepting recession as “necessary medicine” to correct economic imbalances.   To them high debt precipitated this crisis and it will not end until debt is reduced and a proper balance is restored to the economy.

Celebrating Hollande’s victory

Hollande and others argue that a country in recession could be unable to get out of it if there isn’t something to stimulate economic growth.    One can imagine setting budget priorities to stimulate growth but cut unproductive spending.

This is not in direct opposition to Merkel.   Germany’s success has focused on stimulating job creation in other ways and restructuring the German economy.   She has never proposed austerity along as a solution; rather, budget cuts and debt reduction have to be part of a broad range of plans.   This means there are plenty of areas for Hollande and Merkel to find common ground.

Moreover, Hollande’s approach requires international cooperation.  No one state alone can handle this, the EU and even cooperation between the EU and the US is more important than ever.   The problem is to assure currency stability despite high debts and the messy process of economic rebalancing.   For Hollande would throw a grenade into the works of the EU would be self-defeating and he knows that.

Hollande was not Merkel’s choice, but they will be forced to work together

On top of that, Merkel faces an election in 2013, and her party has been hurt in recent state wide elections in Germany.   The political reality within Germany suggests that she needs to take into account the need to take seriously the negative implications of budget cutting alone.    Germany’s economy has been the envy of the industrialized world since the crisis started in 2008, but austerity within the EU would drive down demand for German exports and could cause a contagion recession for Germany.

Up until now the EU has had an unsustainable plan to handle the impact of the financial crisis.  It’s relied on German money and German leadership but hasn’t addressed the need for countries who have had inferior economic policies to rejuvenate growth as part of the solution.   The focus has been too much on debt reduction and too little on the costs of austerity.   With Cameron’s UK sinking into a double dip recession, his “debt reduction first” model is in severe doubt.

François Hollande is in a position to help nudge Merkel and the EU into a more broadly accepted path forward.  If the Greeks don’t want to participate, fine — let them have the drachma back.    At this point European banks are better prepared for a Greek default than they were a year ago, the system can handle it.    If that happens, the inevitable disaster that will hit Greece will pressure other troubled states to avoid the Greek way.   That, plus a set of policies more sensitive to the dangers of austerity will make it an easier sell.   Contrary to conventional wisdom, Hollande’s election will aid EU efforts to handle this crisis, help stymie the rise of the far left and far right, and may push Merkel in a direction that will help her win re-election.

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Greece: Sovereignty and Democracy

European leaders reacted in horror, markets were panicked and a crisis brewed in Greece.   Why?  The Prime Minister had the audacity to put the agreed upon EU bailout plan up for a referendum vote.   The Greeks might actually get to vote on the issue, and they might not follow the dictates of big banks, big money and big government.

One “dirty little secret” of globalization is that it erodes state sovereignty and increasingly puts decision making power in the hands of a wealthy elite connected to global finance and the largest corporations in the world.   This has been a relatively recent phenomenon.   Before the 80s when regulations limiting the ability of capital to travel across borders with ease, only a few powerful actors were truly global in their investment and corporate structure.   Moreover, even if they could travel the limits on communication, information and control of distant parts made such ventures both risky and pricey.   Domestic economic activity was its own world.

In those days France and Italy could have expansive and inflation-friendly monetary policies while Germany and the Netherlands could limit inflation with tight monetary policies.   French and Italian capital had little capacity to leave their inflationary home for a more stable German investment.

That also meant that states were in control of their domestic regulatory and taxation regimes.   If a state wanted to enforce tough environmental standards, it could.   If it wanted to require companies offer benefits, or insure greater labor protections, it could do that too.   States didn’t have to, but at least in the advanced industrialized world it was up to the democratic organizations that comprised government.   The people through democracy made those calls.

As capital globalized and the technology revolution made control over distant and remote sites easier and ever cheaper, everything changed.   An embrace of laissez faire economics meant a dramatic reduction in regulations, allowing capital to go wherever a profit was to be made.   That meant pressure on states to downsize their regulatory structure, limit taxes on corporations, and do whatever they could to create a “business and investment friendly” environment.

By the 90s France and Italy had to give up their inflationary policies as capital was fleeing to find more stable currencies.   To get investment, they needed to mimic Germany and the Netherlands.   Absent the capacity for separate monetary policies, the common currency became possible.    This is what Thomas Friedman called ‘the golden straight jacket’ – states have to do things that bring investment and growth, otherwise they sink.

Friedman saw this as good, but it has two side effects.   First, it moves us away from the Westphalian system of sovereign independent states and towards something new — but we have no clue yet as to what it will be.  The idea that sovereignty is being eroded seems less obvious if you’re a big powerful state — but the current crisis is bringing home even to the US and China the limits of what a state can do.   If states are losing sovereignty and new international actors are gaining control — big finance, large corporations and to a lesser extent international organizations (e.g., the WTO) and non-governmental organizations — how will states respond?   How will the diverse power conditions be reflected in a world that is no longer the realist ideal of independent sovereign billiard balls interacting?

Secondly, for democracies this also means a real loss of democratic control.   Publics can demand tougher environmental standards, but governments will see that this will drive away investment and be forced to say no.   People can believe in hope and change, but if power is not really in the hands of the government, all politicians can do is make promises and hope they can persuade “big money” to look kindly upon their interests.   This has been evident for decades in small states (see Peter Katzenstein’s “Small States in World Markets” from the early 80s), but with globalization it increasingly limits large states.

That is a crisis for democratic political theory and democracy in general.   If power no longer resides with the people and if it is exercised by global actors pursuing agendas that are not focused on the general good of particular states, how long will people tolerate that without getting angry?   But even if people get angry, what alternative exists?  How can people impact global actors outside of state reach, lacking transparency and pulling the strings of governments both on the left and on the right?

Enter Greece.   Big money sees a threat.   Big European banks could be threatened by a Greek default.   CDS exposure (credit default swaps) in US banks could create contagion that might bring down the global financial system.   A Greek default makes Italian, Spanish and Portugese defaults thinkable.   Bond yields will rise there, and the crisis will expand (with increased exposure of both European and US banks).   Even China would be hurt badly by such events as it would decrease global demand for their goods.

So “big money” gathers to fix the problem.   Banks take a 50% haircut on bond exposure.   Governments vow to recapitalize the banks and fix Greek debt.   The Greeks are ordered to engage in massive austerity programs likely to enhance the recession that has already dramatically lowered their standard of living.    The Greeks don’t like it, but their government like all governments has to respond to the demands of big money.   The people are irrelevant.

And then, to the shock and dismay of elites everywhere Greek Prime Minister George Papandreou says that the Greek people have a right to vote on this.

Blasphemy!   Sovereignty is being asserted!  The Democratic right of the citizens to say no to global corporate finance and the nexus of big government and big money is proclaimed!   Chaos, panic, how could he do such a thing!   From Wall Street to Geneva to Frankfurt to Athens pressure is exerted, threats are made….how dare the Greeks assert sovereignty and democracy, don’t they know what’s at stake?

Yes, they do.

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A Greek Tragedy

All eyes are on Greece as the fate of Europe’s economy and the European common currency is on the line.    The IMF and G20 states have pledged to prevent an economic collapse in Europe which would, undoubtedly, have severe ramifications for the US.   As one German friend of mine joked “Greece, the cradle and the grave of western civilization.”

The plan looks good on paper.  Greece borrowed an unsustainable amount of money and now must cut spending and raise its taxes to balance the budget.   Meanwhile the EU and IMF will intervene to both help stabilize Greek’s finances and recapitalize banks that may be vulnerable to Greek default.    It should work, in theory.

In practice, though, things are messy.   One problem is Greek domestic politics.  Angered by the corruption and political incompetence that brought them to this point, the Greeks are engaged in a two day general strike that has essentially shut down the country.   125,000 protesters in Athens, Thessaloniki, Patras and Heraklion showed anger at the government and its austerity plan.   People’s incomes are declining in real terms, and the mix of spending cuts and tax increases make the recession even worse.     Calling the cuts “unfair, anti-social and inefficient” they demand the country reject the austerity proposals.  3000 police classed with 70,000 protesters in Athens, mostly peacefully but not always.

The Greek government is in bind.   They need to cut debt; their debt load is unsustainable.   The bond markets still show a 24% interest rate on Greek bonds, meaning that any more debt would be extremely costly, and would drive up bond yields further.   Greece cannot simply go along as it has been.   Moreover, austerity is the price the EU is demanding to help them avoid default and stay in the Eurozone.

The Greek government is thus implementing the austerity measures out of necessity.    However, they could decide not to, and simply accept default.      If Greece defaulted, the pain would shift to the banks of Europe which could fail unless recapitalized with government funds.   The danger would be that the Greek default could lead to a dumping of Spanish, Italian, Portugese and Irish bonds, creating a crisis far greater than the Greek default.  As I noted awhile back, contagion is the real danger.

To be sure, a Greek default would make it a bit easier for the country to dig itself out of its hole.  There would still need to be spending cuts and tax increases to get a balanced budget, but they wouldn’t have the burden of so much debt to repay on top of that.  That is the path favored by many protesters in Greece; bankruptcy is welcome if debt is weighing you down.    Any default, however, almost ensures contagion.     It might help the Greeks, but ignite a global crisis.

To try to minimize the risk of contagion, a Greek default would probably be coupled with a removal of Greece from the Eurozone.   Letting a country default while maintaining the Euro as its currency is something that the Europeans cannot allow.   If Greece leaves the Eurozone, the result would be inflation and devaluation of the Drachma.   Since new Greek bonds would have very high interest rates (especially given the certainty of inflation), Greece would find borrowing money nearly impossible, and still would have to institute austerity programs.   That would push Greece back into crisis, and serve as an example to others the potential cost of leaving the Eurozone.

The EU could then try to prevent contagion by making it clear that defaults by other states are not likely given the cost it would entail to have them leave the zone.     Seeing what happens when set adrift from the Euro, governments in countries at risk would be more motivated than ever to engage in austerity politics.   After all, those in power listen to the moneyed elite more than the people on the street.

For Greece the devalued drachma would lead to increased trade competitiveness and lure in tourism.   Over years they’d stabilize the economy and potentially be able to rejoin the Eurozone in a decade or two.   No doubt the EU would by that time enforce the criteria strictly — Greece never should have been allowed to join in 2001.  Greece could not leave the Eurozone without defaulting.   Otherwise the depreciating drachma would mean that Euro denominated debt would grow dramatically simply do to changing exchange rates.   So leaving the Eurozone must be coupled with default.

For the EU the dilemma now is whether they should continue trying to save Greece, or focus instead on recapitalizing the banks and defending against contagion.   They have already spent so much money to stabilize Greece that switching tactics would be seen as an admission they got it wrong on the tax payers dime.   That money would have simply been thrown into a pit, bringing nothing of value.

That leads them to want to see this through to the end.   Yet it’s like getting your car repaired over and over — at some point you have to eat the loses and just buy a new one, realizing you should have done so at the time of the first repair.   If Greek protests grow and the government becomes unstable, default may be inevitable.   In that case it would again need to be coupled with leaving the Eurozone to avoid contagion.

Watching this play itself out is fascinating, even though I think most people are oblivious to the implications this drama has for the rest of the world.     Where once the fate of Europe was decided in war rooms by generals with maps spread out tracking troop movements and supply lines, now it’s in board rooms with business and political leaders looking  at spread sheets and bond yields.

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