Yves here. This post by Yanis Varoufakis gives a plausible scenario as to how the Eurozone could unravel. Most commentators believe the country that is most likely to rupture it is Italy. Italy has a primary budget surplus and also has a high saving rate, with the result that even under the gold-standard-like Eurozone, it still funds most of its debt issuance internally. Notice how quickly the Eurozone could fracture once one country exits.
Six years have passed since the Shanghai Crash of 2032, and Europe’s architecture is incapable of responding to its challenges in a way that offers hope of continental consolidation after 30 years of hideous fragmentation.
The reasons for its conspicuous failure can be traced all the way back to Europe’s mishandling of the crisis then, occasioned by the latter-day Wall Street crash of 2008.
Our predicament in 2038 began with modern Europe’s ill-fated second attempt at a currency union, the so-called eurozone; the first having been the similarly ill-designed 19th century Latin Union. Modelled on the Gold Standard, with the radical addition of common banknotes, coins and a European Central Bank (ECB), the eurozone proved just as incapable of sustaining shockwaves from the 2008 financial meltdown as was the Gold Standard after the 1929 Wall Street crash.
A central bank without a state to back it up, together with member states now without the chief instruments of a central bank to back them, once liquidity dried up with the near-collapse of the West’s financial sector Europe experienced a domino-effect insolvency of some eurozone banking sectors and states. The false choice that suddenly gripped Europe’s leaders was either to accept the awful truth that the architecture of the euro was faulty and that large banking losses and public debts had to cancel each other out, or to do what, sadly, they did. This was to “extend and pretend” by having the eurozone’s surplus nations pile huge new lo ans on the insolvent deficit states on condition that the latter agreed to reduce their national incomes, for that is what universal austerity accomplished.
For five years, Europe’s leaders stuck to their “extend and pretend” strategy. From 2011 onwards, and especially in 2013 when a banking union was proclaimed in name so as to prevent its implementation in practice, the writing was on the wall: the eurozone would disintegrate unless banks, debt and investment flows were somehow ‘Europeanised’.
The final stage of deconstruction began when the credit crunch reached its crescendo in the north of Italy and set in motion the process of “re-conversion”, as the eurozone’s disintegration was euphemistically called. The government in Rome, under immense pressure from businesses threatening to shift en masse their operations to the U.S. and to Eastern Europe, announced the introduction of an electronic unit of account in which tax payments would be made to the Italian state by businesses and households, allowing the government room to provide liquidity and tax breaks without the consent of either the ECB or, indeed, Brussels.
Amongst untold recriminations, Germany’s own central bank, the Bundesbank, told the ECB that unless Rome was reined in it, too, would create its own unit of account to safeguard German price stability. Almost immediately, an outpouring of capital from Spain to Germany caused Catalonia to threaten Madrid that unless Spain too created its own unit of account to lessen the impact of the credit on Catalonia’s exports, a unilateral declaration of independence would be on the cards.
Emergency summits of EU leaders led to fudges that left markets unimpressed. The capital flight from the eurozone’s periphery put enormous pressure on the ECB to activate its dormant bond-purchasing programme and to loosen its rules on the collateral to be held by commercial banks. Alas, a newly emboldened Bundesbank vetoed these moves. Meanwhile, the eurozone edifice was being tested daily by speculators, and Germany, the Netherlands and Finland announced they would issue a common electronic unit of account; the new currency that seven years later was to become the Thaler: a joint currency managed by the Bundesbank and commonly used east of the Rhine and north of the Alps, having been adopted too by Poland, the Czech Republic, Slovakia plus the three Baltic states.
The end of the post-WW2 Franco-German axis was as painful as it was significant, turning the European Union into an empty shell. The French government’s attempts to prevent the splitting up of the eurozone were hampered both by the Bundesbank’s dogged refusal never again to share authority over monetary policy with Paris, and also by the Banque de France’s undermining of its own government. Paris, exasperated, attempted a new Latin Union with Spain and Italy by issuing a new currency that it named the écu, hoping against hope that it would once again lead to a revived euro. Meanwhile, following the so-called Cyprus model, capital controls were introduced between the new currency zones, the Schengen agreement on the free movement of people faded away and the Single Market was reduced to no more than a name.
The failure of Europe in 2038 to respond constructively to the crisis that began in China, pushing Europeans even further apart from each other, can best be explained by referring back to the deep fault line that emerged in 2017 along the Rhine that divided Europe between the deflationary Thaler-zone and the stagflationary rest-of-Europe. If only Europe had taken a few simple steps back in the early 2010s to consolidate its banking sectors, to manage centrally part of its countries’ public debt and to design a common investment policy, then Europe might have had a chance.