We’ve been pointing out for some time that Germany has refused to budge from wanting contradictory things relative to the Eurozone. Germany wants to continue to run trade surpluses, which are now predominantly with other countries in Europe. That means it needs to finance its trade partners’ deficits. But Germany simultaneously does not want to do that, at least with other Eurozone members. The only way to square that circle would be if the euro were vastly cheaper, so that Germany’s trade surplus was more with the rest of the world than with its fellow Europeans, and that countries like Spain could come closer to a trade balance or achieve a trade surplus via trade with the rest of the world. No one has entertained that as a solution, since the required level of euro depreciation would be so large as to invite retaliation from Europe’s major trade partners (I haven’t seen good estimates, but early on, Wolfgang Munchau suggested between .6 to .9 to the dollar).
The whole premise of the EU/Eurozone project was successive crises would force further integration. We’d assumed that the Eurobanks were sufficiently wobbly that absent more banking integration (at a minimum, a deposit guarantee), you’d eventually see some sort of Big Problem (see an analysis by Josh Rosner from last year of the poor condition of the German banks). Yet the European officialdom has managed to pull off years of “barely enough at the last minute” salvage operations to keep things from falling over. But the Germans have also insisted on crushing and failed austerity, and refuse to relent even as compliant periphery countries keep missing their targets and in the case of Greece, the result of breaking a country on the rack is a failed state.
Even though we’ve had quite a few individual commentators from Europe argue in favor of a Eurozone dissolution, the pundit class has treated that as impossible because the costs were so high that whatever compromises needed to be made would eventually be reached.
Now something still has to break, but some of my correspondents who’ve just been in Europe now think that we will see a political crisis in Europe before we see an economic one, and that, like objects in your rear view mirror, may be closer than it appears.
I was disappointed at the fact that (based on the thin comments) few readers apparently read an important interview with James Galbraith that we posted last week (Ambrose Evan-Pritchard saw fit to link to it from the Telegraph).
JG: I think that ultimately the decision on the future of Europe will be made in Germany, and Germany has to decide, does it want it or not? If it wants it, it has to take minimal steps to stabilize it on the same principles on which they stabilized the East, and on which they built the Federal Republic in the first place. And if they don’t want it, well, it will go away.
RS: I think even if they want it, they’re not going to stabilize it.
JG: In which case they’ll lose it, and then we can see what is left. But when it’s lost, Germany’s going to have the problem it had before of an appreciating currency, and an industry that quickly loses competitiveness, and there’ll be higher unemployment. And its markets will have collapsed and its debts won’t get paid.
Germany is not going to escape the consequences of this. Again, it’s a choice that Germans can, and I’m sure, will make. But what is necessary is to state clearly what the choice actually is….
But one needs to recognize that you have a project which has built up a standard of living of the European continent, and that’s a project of integration. Integration has a lot of efficiencies associated with it. In any event it creates a world in which there are cross-border interdependencies. And if you want to break them up, you can, but the price is enormous. In the experience that we’ve had recently, it’s on the order of 40%. So that’s a good benchmark for what might happen to living standards if you suddenly went back to capital controls and trade barriers and national industries. And good luck trying to build national industries that will compete with the industries that will be in Germany that are highly competitive, but will not have markets because nobody will be able to buy their goods.
While it is hard to tell if a tipping point is nigh, Yanis Varoufakis seems more evidence, despite the considerable cost of a Eurozone breakup, that the experts are struggling to find a resolution that is acceptable politically to Germany.
By Yanis Varoufakis, professor of economics at the University of Athens. Cross posted from his blog
Klaus Kastner has been in regular correspondence with me and with readers of this blog. A thoughtful commentator, he has held on to the thought that Greece can be revived within the Eurozone under the current mix of ‘fiscal consolidation’ policies. From the outset, he seems to have appreciated some aspects of our Modest Proposal but has maintained the position that countries like Greece can reform from within, independently of what Europe does to re-form the Eurozone. While appreciative of the Eurozone’s architectural faults, and the errors of its response to the crisis, he was never particularly convinced by my emphasis on the Eurozone’s brittle foundations or my arguments that the Eurozone is doomed if it fails to adopt policies like those in the Modest Proposal. Instead he has been consistently choosing to place his emphasis on micro-reforms and on institutional changes that the countries of the Periphery must enact.
In a recent post, that breaks with his narrative-so-far, he confesses to have lost faith in the Eurozone project; in the idea that the Euro Area can be maintained in a manner consistent with shared prosperity. He is not the first one. Many of my interlocutors of the past few years, who also thought that the Eurozone was salvageable, have changed their minds, turning to the position that it should be disbanded. For my part, I have not reached that position yet. In my mind, (a) a winding down of the Eurozone can never be smooth or controlled and will, most certainly, lead to another Great Depression for countries like Germany; and (b) the Eurozone can still be saved in the manner that we have been proposing for three years now. Having said that, Europe’s leadership seem determined to disprove me and to confirm the wisdom of Klaus’ recent turn.. For Klaus Kastner’s relevant blogpost…. read on..
“The idea of a common currency union is a big mistake, an adventurous, reckless and mistaken goal which will not unite Europe but, instead, divide it”. Lord Dahrendorf, 1995.
Since I started this blog, I have tried to be as self-critical as possible; taking differing views into account; pondering them; learning from them; incorporating them into my own views. This is my 11th effort to recognize the erred ways of my thinking – and it is a major one!
To make it short: I now believe that Lord Dahrendorf was right. Right not only then but, even more so, today.
My blog has focused on Greece; I have more or less ignored the situation in other countries of the periphery (and I have not paid enough attention to the German situation). Greece alone had made me optimistic. I had observed, on location, how a small economy which had totally collapsed could be successfully turned around in only a few years with the right domestic economic leadership and the right support from abroad (Chile in the late 1970s/early 1980s). And I thought the same could happen easily in Greece. Well, it’s not happening in Greece because the country does not have the right economic and political leadership nor the right support from abroad.
I had started wavering in my position some time last year but I forced myself to remain optimistic. What has brought me down to reality?
There seems to have been an intensified discussion of late about solutions to the Eurozone (at least in the media and blogs which I follow). I particularly refer to two articles in Prof. Varoufakis’ blog: Six Critical Responses to the Modest Proposal and James Galbraith on Europe (and the numerous comments to them). Those pieces were indeed thought-provoking!
However, the eye opener was the book “The Euro-Liars” by Hans-Olaf Henkel which I have just read. Henkel is a very provocative individual but one can discard his provocations. However, one should not discard his arguments!
Henkel’s principal – and irrefutable – argument is, like Lord Dahrendorf said almost 20 years earlier, that the Euro does not unite Europe but, instead, it splits it. There is massive evidence today that this is so. In my view, it is of secondary importance to analyze who is to blame for that because that always leads to endless loop-discussions without results. It is far better to recognize reality. And, secondly, Henkel argues that the Euro not only limits (if not destroys) economic potential in the South but also in the North.
It is futile, Henkel says, to impose a currency which doesn’t fit national cultures. Instead, national cultures have to shape their currency. The Euro, as it was designed, does not fit the cultures of countries like Greece, Portugal and Spain (Henkel also adds Italy and France!). Neither is today’s Euro suitable for the North because it makes it too easy for Germany & Co. to export (much of the exports are courtesy tax payers because tax payers lend the funds so that the periphery can pay for imports from Germany & Co. Put differently, a massive export subsidy!). If Germany & Co. were not in the Euro, they would have to become even more innovative and productive to remain competitive in the world and their surpluses would most likely come down.
In his critique of Six Critical Responses to the Modest Proposal, the American Uwe Bott (Bott Consulting, NY; contributing editor to The Globalist) writes more bluntly:
There will be no resolution to this crisis until European policy-makers come to grips with fundamental economics. The Eurozone never was and less and less is an optimum currency area. In theory the flaws in the construct are fixable, in reality there is not enough time or political will. It is the inescapable consequence that the Eurozone must be dissolved. In applying the lessons of German unification onto the Eurozone, it becomes unmistakably clear that even a willing Germany could never pay the price to make monetary union in the Eurozone work. The price tag for such exercise would be exponentially greater than the cost of German unification. Moreover, the ability to freely migrate in order to mitigate some of these problems simply does not exist in the Eurozone given cultural and language barriers.
My original optimism about Greece was based on the following logic: a long-term economic development plan (at least for 10 years) would be necessary to build up domestic economic value creation (and/or repatriate it through import substitution); a shift of the necessary foreign funding from loans to direct investment by foreign private sectors in the Greek private sector; EU-incentives to facilitate that (such as guarantees for the political risk including a Grexit); possibly temporary ‘infant industry protection’ (incentivating the repatriation of monies held by Greeks abroad and/or limitations on capital outflows). This is not happening (and I no longer have the hope that it will happen) because the EU never thought in those terms and Greek leadership never showed the will or, more importantly, the capability to effect the necessary reforms.
As Prof. Galbraith argues, austerity alone is not the solution; neither is stimulus alone the solution. It would require a ‘European Initiative’ comparable to what the US government might do in a similar situation. A United States of Europe with a federal government? Who would elect that government? Would national governments appoint it or would voters Europe-wide elect it? A Finn campaigning for election in Greece? A Greek in Germany?
The present EU as a role model for a future federal government? An EU which currently seems more outside of Europe than part of it? An EU which tells us which shape cucumbers must have; what kind of light bulbs we can buy; what kind of bathroom fixtures? Since I have about 10.000 qm of grass to take care of, I am particularly interested in the latest EU regulation which will tell me what type of machinery I can use during which hours of the day/week!
In short, an EU of self-possessed overpaid winetasters who regulate what must be done at the subsidiary level but who do not have one phone number which the US President could call on defense or foreign policy matters? If that is the price to pay for the Euro, the price is far to high! Europe is not a uniform continent. On the contrary, one of Europe’s USPs is its diversity of nations, cultures, languages, mentalities, etc. etc.
But something similar to the above seems necessary if the Euro is meant to survive in its present form. Some people argue that Germany should assume more ‘continental leadership’. That, however, ignores how many Europeans would be scared by that (most of all the Germans themselves).
Dissolving the Euro in its present form would cause very significant financial losses to all. True, but are those losses which could be avoided or are those losses which are already there but not yet realized?
The South has already paid much of its bill: unemployment; economic destruction; absence of future perspectives; etc. One could argue that it can’t get much worse and that a departure from the Euro in its present form would actually be beneficial: the South would become more ‘competitive’ in financial terms and it could draw on the capital which it has sent offshore during the crisis.
The North has, as yet, hardly paid any part of its bill. However, responsible accountants would have to book that bill as an ‘account payable’ and it is just a question of time when it will have to be paid.
So it comes down to operational questions: Who will pay for what part of the bill? What is the best mechanism for facilitating an orderly payment of the bill? Etc. One ought to be able to expect that a group of smart people would find a solution to that, if the EU were only willing to form such a group and give it a mandate.
Henkel makes an important point: it is not the deficit countries which should exit the Euro. That would be adding insult to injury. Instead, it is the surplus countries which should do that! There are various ways how this could be approached. Henkel proposes that Greece, Italy, Spain, Portugal and France should keep the Euro as it is (with France assuming leadership) and that the other countries should chose a new currency for themselves (Henkel proposes a North-Euro and a South-Euro). Some countries (Bulgaria, Romania, etc.) might want to join the South-Euro and other countries (CZ, Poland, Denmark, etc.) might want to join the North-Euro. Another alternative might be to introduce parallel national currencies. As I said, there are many alternatives (Merkel’s ‘no-alternative-position’ is an inconsistency in and by itself).
I sympathize with Greeks & Co. going on the barricades for having been deprived of a future. I also sympathize with Germans & Co. who feel that they have been (and are being) taken for a ride. Is that because of the Greeks & Co. and the Germans & Co.? I severely doubt it! Before the Euro, the Greeks & Co. and the Germans & Co. had a rather good time together. It is the Euro which has put the people of the Eurozone against each other.
So, I admit defeat in my belief that ‘European policy-makers would come to grips with fundamental economics’. They seem incapable of that. All those ideas which aim at solving the Eurozone’s problems through generating aggregate demand or through a Modest Proposal (which otherwise sounds very interesting) are pipe dreams. They might work in the United States of America with a strong federal government but they are pipe dreams in a Europe of administrators, technicians and bureaucrats focusing on national interests, all speaking in different languages and different directions.