Oliver Hartwich: The never-ending Euro crisis - anatomy of an economic policy disaster
Last night The New Zealand Initiative’s Dr Oliver Hartwich gave the University of Auckland Economics Group an update on the never-ending Euro crisis, including a brief history of monetary union (we’ve seen all this before!), and a look at current issues and public debt, and hidden aspects like TARGET2. “Germany is the key player in this crisis,” he says.
I took notes…
There is no easy solution any more.
Monetary union: Today's Euro is not the first European monetary union to have been undertaken, or to fail. Mid-nineteenth-century France pushed for a Europe-wide monetary union, called the Latin Monetary Union (LMU), which lasted for a half a century. It was however burdened with problems, and by the time it disbanded in 1927 it had already long collapsed—killed off by more silver in the system than its clunky mechanisms could handle, the lack of any recognised and respected central organiser (which the system demanded), and widespread cheating and outright fraud by participants. Especially Greece. Sound familiar … ?
At war with Turkey, Greece printed paper to pay its bills, its currency see-sawing between being silver-based to paper-based to silver-based to paper-based to (finally) the LMU, entry into which it hoped would provide stability, and deeper access to capital markets. (Sound familiar … ?) But, why should the LMU want Greece?
From a Greek point of view, it was perfectly understandable why they were so keen to join the club. The only question is why the other members of LMU admitted Greece despite its poor economic structures.
Not even observers closer to the historic events could see the point of Greek membership. In his ‘History of the Latin Monetary Union’ report, University of Chicago economist Henry Parker Willis summed it up nicely, and it is worth quoting at length:
"It is hard to see why the admission of Greece to the Latin Union should have been desired or allowed
by that body. In no sense was she a desirable member of the league. Economically unsound, convulsed
by political struggles, and financially rotten, her condition was pitiable. Struggling with a burden of
debt, Greece was also endeavouring to maintain in circulation a large amount of inconvertible paper.
She was not territorially a desirable adjunct to the Latin Union, and her commercial and financial
importance was small. Nevertheless her nominal admission was secured, and we may credit the
obscure political influences … with being able to effect what economic and financial considerations
could not. Certainly it would be hard to understand on what other grounds her membership was attained.”
Replace ‘Latin Union’ with ‘European Monetary Union’ and the paragraph quoted above could have been published today. In fact, it was published in 1901. Already back then, Willis came to the conclusion that monetary union in Europe did not work, which again sounds like a prophecy of things to come:
"The Latin Union as an experiment in international monetary action has proved a failure. Its
history serves merely to throw some light upon the difficulties which are likely to be encountered in
any international attempt to regulate monetary systems in common. From whatever point of view the
Latin Union is studied, it will be seen that it has resulted only in loss to the countries involved.
Instead of bolstering harmony between nations, the union helped to fostered mistrust and hatred instead. The LMU was effectively over by the time Europe plunged into WWI.
The current Greek tragedy is just history repeating, having once again achieved the opposite of what the Eurozone’s architects intended.
What did they intend? Go back to 1989 and the fall of the Berlin Wall. The 2+4 negotiations in 1990 set up German reunification, raising new fears in its former enemies. Many in the UK, France, Italy and the rest of Europe were scared of the strength of a reunified Germany. All denied for years any link between reunification and the Euro currency zone, and continued to deny any link for years. One of the 2+4 negotiators Robert Zoeller however confirmed only 2 years ago, as if everyone already knew, that the two were so obviously linked it would be foolish to pretend otherwise.
Monetary union was supposed to “calm” Germany. To restrain their growth. (How? Somehow.)
In addition, the Euro currency union was supposed to stop the continuing embarrassment of European leaders eager to stop constant devaluation of their currencies against the Mark. From 1963 to 1998, all European currencies lost at least 63% of their value against the Mark--reflecting a tight Bundesbank, and high German productivity. This was humiliating to all other Europeans, so reunification was offered as a carrot to get Germans to join monetary union.
How exactly did they see European Monetary Union (EMU) acting as a restraint?
It was presumed German ascendancy would be contained by having the Mark go into the Euro at such a high rate that German labour costs and exports would be priced out of the market. The attempt has completely backfired. After a few difficult years in which the restraints prompted Germans instead to greater productivity and lower labour costs, German influence has now never been higher—it can now dictate fiscal policy to all Europe. But it pays for all of Europe.
The Euro crisis started the day the Euro was introduced! Behind the facade of unity in the ill-named European Monetary union there was:
- Divergence in competiveness, now resulting in diverging labour costs and product prices (Germany going through hell after going in with too high rate, southern Europeans partying at a low rate. At first.)
- Official interest rates were set to reflect German problems, not at the periphery, promoting bubbles and a phony prosperity in Ireland, Spain etc.
- Deficits were run by all govts, despite promises not to. Enormous deficits.
The EMU was also dysfunctional because it was such a complex beast. 27 member states in the Euro Zone, with17 in the EMU using the Euro currency unit. There are far too many supranational Euro-qangos and world-quangoes involved in running this system. EC, ECB, ECSB, IMF, FSAP, SSM … all their actions too hard to predict. [regime uncertainty, anyone? – Ed.]
Messy too because the interests of different Europeans are all different, and incompatible in the current framework. Problems have been and are all being glossed over.
The most destructive mechanism on the horizon presently is called TARGET2. This ‘Trans-European Automated Real-time Gross Settlement Express Transfer System’ – or in short TARGET 2 – is meant to facilitate bank transfers across all EU member states (with the notable exceptions of the UK and Sweden). In ordinary times, Target would have been a technical tool without political implications. But times in Europe are not ordinary, and so over the past four years Target has become a potential time bomb for Europe’s financial system. Set up as “an interbank payment system for the real-time processing of cross-border transfers throughout the European Union,” it is nothing more than a doomsday machine. A potential time bomb.
The TARGET system has set up a huge balance of payments crisis in Europe.
Since the beginning of the financial crisis interbank lending from core to periphery European countries has all but dried up. At the same time, periphery countries have experienced massive capital flight out of their countries. On top of that, there are trade deficits in European periphery countries which need to be financed by capital imports.
All three factors combined have triggered a European balance of payments crisis under the Target system. Put simply, central banks in surplus countries have to fill the gap caused by capital flight and trade imbalances because private capital is no longer available to do just that.
In this way, central banks from the healthier core of the eurozone are now sitting on enormous amounts of claims against the euro system. The German Bundesbank as the biggest lender has so far accumulated claims totalling more than €460 billion (approximately $615 billion). This sum is more than twice the guarantees given by the German government to the European rescue fund EFSF, for which the German parliament, after a long discussion, had only provided the comparatively modest sum of €211 billion.
The only other major creditors within the euro system are Luxembourg, the Netherlands and Finland, whereas all other eurozone countries are net debtors within Target.
To put it another way (given the small size of Luxembourg, the Netherlands and Finland), the TARGET2 system means Germany is effectively financing all the trade imbalances in Europe. And there are plenty.
Putting it simply, Germany will take a multi-billion Euro hit every time a defaulter leaves the EMU. But they will take a multi-trillion Euro hit themselves if they leave—half a trillion Euros the total sum to date, and climbing.
Is this sustainable? No. There is no incentive for restraint, but nor is their any easy way out.
The Fiscal Currency Union has been transformed into a Fiscal Irresponsibility Union. All are waiting for the (ECB) to step in with a magic wand and guarantee everything. But all sums involved are now gigantic, no Europeans can even borrow these sums.
European Central Bank governor Mario Draghi however has perked people up momentarily with a promise to print money to infinity to inflate away all those sums.
This is still an ongoing, ever-rolling, never-ending crisis. All “cures” have only lasted for weeks, even days, yet the announcement of each new “cure” has been hailed. Things are changing however in Germany, which is the key to any real solution—if there still is one.
While the Merkel Government continues to talk up the “cures,” Germany's highest courts and academics are now openly doubting the EMU in its current form. As Hartwich wrote recently:
In September last year … the German constitutional court’s preliminary ruling on the legality of the European Stability Mechanism (“Has Germany’s court set the stage for an exit"? 20 September 2012). Most commentators at the time believed the court had simply okayed the ESM. They also thought that the court had brushed aside doubts about Germany’s ongoing commitment to the EU’s various bailout policies
I wasn’t so sure. Back then, I pointed out that, in fact, the court had made its concerns about the nature of the euro rescue policies quite clear. The judges had signalled their willingness to seriously examine the European Central Bank measures such as bond purchases from struggling euro member states.
Last week, Germany’s business daily Handelsblatt revealed that the court now got what it asked for. A 29-page leaked dossier prepared for the court, by the Bundesbank (Germany’s central bank), explains why the ECB’s measures are not suitable to end the crisis; why they could cost Germany dearly; and why the court should intervene.
It was not the only sign that patience with the euro has worn thin even at the highest levels of Germany. A few days before the Bundesbank leak, the head of the German Finance Ministry’s Academic Advisory Council, Kai Konrad, gave an interview to Sunday newspaper Welt am Sonntag. In it, he deviated markedly from the government’s line that the euro had to be defended at all costs.
Professor Konrad’s assessment was blunt: “Europe is important to me. The euro is not. I don’t think it has a high chance of survival beyond the medium term.” When asked to specify what he meant by that, he said that realistically he would give it another five years.
Taken together, these occurrences paint an interesting picture. Germany’s highest court, its central bank and the government’s top economic advisers now openly doubt the euro in its current form. This is astonishing since the German government’s official position is that the current euro arrangements are safe, forever, and beyond debate.
So what’s going on?
For a start, public opinion is changing. Whereas in 2007, according to a new Eurobarometer survey, 36 per cent of all Germans had no trust in the EU and its institutions, today it is 59 per cent. There is growing unease in Germany about the way the euro crisis has developed. The Cyprus bailout package and the Italian election fiasco have no doubt aggravated such fears.
Opinion polls reinforce the view that policies meant to save the euro are not working. The latest fiscal data is showing that the eurozone isn’t getting its debt problem under control (Fire and ice on Europe's debt march, 25 April 2013). At the same time, unemployment is spiralling upwards around the Mediterranean. In France, unemployment now stands at 11.5 per cent. This is undoubtedly high but not nearly as catastrophic as neighbouring Spain, where 27.2 per cent (and 57.2 of all under-25 year-olds) are without a job.
In these circumstances, it is not difficult to be sceptical about the future of the euro. Add the appearance of a new anti-euro party (Alternative für Deutschland) to the mix, and one can imagine what must be going through Chancellor Angela Merkel’s head.
Merkel has always made the case for the euro domestically, while at the EU level she was pushing for economic reforms and budget consolidation. It appears she is now failing on both fronts. Both within and outside Germany the euro is losing popularity. At the same time, the systematic weaknesses of a common currency for Europe can no longer be denied.
Despite all her previous utterings that the survival of the euro was a matter of war and peace and that there was no alternative, Angela Merkel would be a strange politician if she did not have an another plan for when public opinion changes or things go wrong.
There are many events which would require a reassessment of Germany’s euro stance: The need for another Greek, Cypriot or Spanish bailout for which there is no German parliamentary majority, let alone public appetite; hardening resistance in the euro periphery to austerity demands; new bailout requirements set by the constitutional court; or simply the growing popularity of anti-euro forces in German politics.
Angela Merkel may soon come to a point where circumstances do not allow her to continue her euro policies. By her nature, Merkel certainly is no revolutionary. But driven by events, and realising the futility of defending the status quo, she will eventually need to make a momentous decision. This could be to allow one or several euro members to depart from monetary union. It could even be to pull Germany itself out of the eurozone.
That an open discussion in Germany about the future of the euro has now begun is a taste of things to come. A failure of the euro is no longer a taboo subject in the highest echelons of society. It shows where the debate is moving.
There is growing unease in Germany. Polls reinforce that rescues are not working. The debt problem is not fixed, nor can it be without huge write-offs.
We hear however that in 2012, Eurozone annual budget deficits fell from 4.2 to 3.7% of GDP. Good news? No, since this average hides two huge extremes, widening the split in the fortunes of member states.
Such imbalances are the root cause of the Euro crisis. This schism will prove fatal.
With the common currency, differences were supposed to diminish, not increase. The opposite is happening.
Open discussions on the future of the EMU are no longer taboo in Germany. And since Germany is the largest and most healthy country in EMU, since they’re essentially bankrolling the whole thing, their decisions are the most important.
Major repairs are hidden as fiscal tinkering, like TARGET2. The ECB is totally independent, which in this case means there is no political restraint whatsoever. And in any case, all politicians know that without any political will to enact real solutions—which will be painful--that inflating away the numbers is only way possible politically. And hang the consequences.
Face it: Trillions of private and public debt will never be repaid otherwise, especially with calcified welfare systems nand an aging society. Monetising debt however will destroy savings, and strip the middle class. Expect not hyperinflation, however, but higher asset prices, especially in things that hold value like paintings, classic cars, art etc. Elsewhere, expect low yields, and economic stagnation.
The future is that every saver will be robbed every year by the central bank. The central bank is now on the barricades, with their printing press leading the charge.
The European Monetary Union was supposed to make Europe more German. Instead, it has made European money more like the lira—which makes it appropriate an Italian is now in charge of the European Central Bank.
This is not a cataclysmic crisis, but much worse. Since an Italian is in charge, it’s appropriate to liken what we’re seeing to a soul sinking through the several rings of hell in Dante’s Divine Comedy. And to conclude with the inscription Dante places over the entrance to the Gates of Hell: “Abandon all hope ye who enter here.”
NOTE TO SATIRISTS: This is not a transcript, but my writing from hastily-scrawled notes, and recent writing from Dr Hartwich to which he referred. The ideas and better formulations are Dr Hartwich’s; the errors and more tortured phrases are mine.