• Ending The Euro Crisis

    The Spanish bailout last week was initially greeted as evidence of the determination to protect the euro and as a step towards much-needed European economic stability. Yet, as subsequent events have quickly shown, what really happened was merely a further staging post in a slow-motion and ultimately inevitable disintegration of the eurozone as we currently know it.

    The first signal that the bailout was not the triumph proclaimed by the Spanish Prime Minister is that the need for it was repeatedly denied, right up till the last minute – and denied largely because it was recognised that it represented a defeat for the policies pursued both by the Spanish government and by the European authorities. The attempt to argue that the bailout vindicated those policies must be regarded as simply putting a brave face on a serious reverse.

    There are, however, much more substantial reasons for reservations about the bailout. Once again, the measures put in place in order to avert disaster have done nothing to recognise, let alone address or remedy, the underlying issues. Those issues, for as long as they remain unresolved, will continue to throw up crises which seem increasingly likely to drive the European economy into recession and the eurozone into a failure that will threaten the whole European project.

    What are those underlying issues? There are probably two that warrant particular attention. The first is what might be described as a fundamental flaw in the initial design of the euro which made it unlikely that it could ever succeed; and the second is the determination to continue with economic policies, particularly in response to the global financial crisis, that have made recovery from that crisis more difficult than it should be.

    As to the first issue, I was not alone in arguing from the outset (as I had argued about the euro’s two predecessors – the European Monetary System and the Exchange Rate Mechanism) that the euro could not possibly work. I argued this because it seemed clear to me that in a hugely diverse European economy, (and that diversity has surely now been demonstrated beyond doubt), it was beyond belief that all parts of that economy could be equally well served by the single monetary policy which a single currency would require.

    In particular, it seemed inevitable that that single monetary policy would be dictated by and would serve the needs of the most powerful parts of the European economy, which inevitably meant Germany. A monetary policy that was congenial to the Germans would almost certainly be less appropriate for weaker parts of the European economy – and today we can see that those weaker parts would necessarily include countries like Greece.

    The Greeks were of course misled into believing that their membership of the eurozone was the entry ticket to the prosperity that the stronger members enjoyed. They were encouraged by the apparent guarantee of support from those stronger members – the sense that “we’re all in this together” – to take advantage of the asset inflation (what can now be seen to have been a “bubble”) created by easy Europe-wide credit, and were allowed not to worry too much about the potentially damaging concentration of productive capacity in Europe’s industrial heartland that a single economy made inevitable.

    It was not just Greece, of course, whose interests were put at risk in this way. Other stronger economies – Spain springs to mind – also suffered in due course from the same combination of apparently risk-free expansion and consumption on the one hand and the weakening of their productive base on the other – both the inevitable consequences of throwing in their lot with much stronger core economies in the wider Europe.

    In due course, even those stronger countries – Germany and its more or less satellite economies – which were the immediate beneficiaries of the single currency and the single monetary policy began to suffer a downside. In the longer term, when the periphery of the wider European economy began to slow down – even to close down – this was inevitably bad news even for the central core, whose markets would be less buoyant and whose obligations to weaker members would be likely to increase.

    It was precisely because the euro would eventually handicap the whole European economy, as well as individual potential members like Britain, that I opposed it so strongly. Sadly, any such stance was dismissed at the time by most commentators as being simply “anti-Europe”.

    The adverse impact of the euro on the European economy began to come to a head, as luck would have it, just as the global financial crisis burst upon us. We need not pause to dissect the global causes of the GFC, other than to observe that they included factors that were already at work in Europe. What has mattered, however, is the response that has been made by the eurozone to the difficulties created by the GFC.

    In line with, and illustrative of, the economic dominance of Germany in the eurozone, the measures adopted to help Europe escape from recession have been largely dictated from Berlin and reflect a particularly German view of what is required. Those measures focused on the suddenly revealed vulnerability of governments in weaker countries to rapidly increasing public sector deficits – deficits made inevitable by the constraints imposed by euro membership and by the impact of the GFC on the relatively loose policies pursued by those countries within the apparent comfort of the eurozone.

    The reduction of those deficits became the main and essentially short-term goal of German policy. The Germans were increasingly nervous that they would be required to finance any rescues that might be needed; and the German government’s own domestic political and ideological preferences (themselves now increasingly challenged within Germany itself) pointed strongly to austerity as the correct response to recession. The consequence has been that the travails of eurozone, and particularly of its weaker members, have been exacerbated by the inevitable consequences of austerity.

    In most circumstances, an economy that discovers that it has become uncompetitive, as evidenced by a trade or public sector deficit, or in the longer term by falling comparative living standards, will respond with a range of measures that will usually include the devaluation of the currency. A devaluation will have the merit of improving competitiveness across the board and doing so in a fair and impartial way, so that everyone bears some share of the short-term burden of the necessary adjustment. It also has the advantage of underpinning and launching an obvious and well-tested strategy for overcoming problems of lack of demand by promoting growth and expansion.

    The devaluation option was not of course open to eurozone members. Without it, they could grow themselves out of recession – which by definition occurs because of a deficiency in demand – only with the aid of a policy framework, in terms of both monetary and fiscal policy, that would encourage greater rather than less economic activity.

    That, however, is precisely what has been denied them by the proponents of austerity. The insistence that Greece and Ireland, Portugal and Spain, and perhaps eventually Italy as well, should cut spending and reduce demand in order to eliminate deficits has ensured that recession becomes persistent and almost impossible to shake off. As the experience of Spain shows most recently, slamming on the brakes means immediately higher unemployment, falling production, a slump in living standards, decimated public services, social unrest and – most significantly for the proponents of austerity – larger, not smaller, public deficits off the back of lower tax revenues. The Spanish bailout is the price being paid by the Spanish people for that mistake.

    Even within in its own terms, the policy is doomed to failure. Austerity is meant to provide an escape route from debt; but it has ensured instead that the bailouts provided to Greece, Spain and others constitute an increased debt burden that they have little hope of repaying while they are going backwards. Little wonder that the money markets immediately saw the Spanish bailout for what it was – a postponement of the inevitable.

    The threat to the future of the eurozone, which may also engulf the global economy, is therefore the outcome of policy mistakes, both in terms of deficiencies in the project itself and in the response to recession. If the measures taken so far have made matters worse, what should now be done to offer better prospects?

    The answer to that question from Europe’s leaders is not encouraging. Because they, and in particular the “troika” of the European Commission, the IMF and the European Central Bank have, through a failure of analysis, ignored the actual causes of the eurozone crisis, they have accordingly continued to press for exactly the wrong remedies. As one eurozone country after another succumbs to the burdens of both euro membership and austerity, the remedies proposed are simply an intensification of both of those burdens.

    It is simply not admitted that the burdens of euro membership have been too much for many members. No attempt has been made to distinguish between those countries that have prospered and those that have not, or to suggest refinements of the rules that might help those that have not. Those that have already demonstrated by falling into economic difficulties that they find membership burdensome, if not impossible, are now being told that if they want help they must accept still tougher rules within a banking union. This would make it even less possible for them to grow and repay debt and would require them of course to concede what remains of their economic sovereignty.

    Even if this proved politically possible (and elections in France and elsewhere seem likely to throw doubt on this), it is hard to see how such a “remedy” would do anything other than bury the root causes of the problems even deeper and make them even more difficult to resolve in the long term. It is the equivalent of plastering over the cracks while the foundations are crumbling. Reality is not averted simply by denying it.

    What is the alternative? The first step must be to recognise the reality that Europe as a whole is handicapped rather than benefited by the current breadth of the eurozone, and that it cannot possibly function well with such diverse membership. There should be a negotiated process for identifying those countries that would benefit from being, or that wished to be, released from the burdens of membership and for helping them to make an orderly withdrawal. Such a process would be complex and difficult, but by no means impossible, and in any case would be less disruptive than a disorderly break-up that otherwise seems inevitable.

    Those countries that chose and were able to remain within the eurozone would no doubt proceed to create what would be in effect a greater German economy. Even so, some of those might well baulk at the prospect of being absorbed into such an entity.

    Countries which chose to leave the eurozone would be able to return to their individual currencies, devalue to the appropriate level, abandon austerity in favour of a strategy for growth, and re-negotiate their obligations with creditors on the basis of a credible prospect of improving tax revenues. No one would pretend that this process is without problems, still less choose to start from here, but other countries, such as Brazil and Argentina, have negotiated similar issues and come out on the other side with improved prospects.

    The numbers of countries choosing to take this option might swell in due course once the practicality and advantages of opting out of the euro became clear. They could then set about, together both with the eurozone and actual and potential European Union members who are not members of the eurozone, the task of building a new kind of European cooperation – what might be described as organic or functional cooperation, in which the process of ever-increasing convergence in the pursuit of common interests did not get too far ahead of the political and economic realities.

    In economic terms, Europe would be much stronger as an entity if the constituent parts were able to apply monetary and exchange rate policies that were more suited to their needs and in particular to their different stages and rates of development. A Europe made up of economies each enjoying optimal macro-economic policy settings, trading with each other on special terms and negotiating trade arrangements with the rest of the world as a single entity, consciously pursuing convergence across the whole field of regulation , co-ordinating and aligning policy development wherever possible, increasingly working together in pan-European deliberative and eventually legislative bodies, would serve Europe’s economic interests much more effectively and do more to promote a genuine sense of European identity than the current abortive attempts to impose from above a European super-state that only a tiny elite has ever wanted.

    To acknowledge that there is not yet a United States of Europe, with a single political identity that makes it possible to accommodate without undue strain a range of divergent economic interests, is not to admit defeat but to recognise the need to build a Europe on the basis of democracy and popular will if the result is to be sustainable. The eurozone crisis may in the end be a blessing in disguise.

    Bryan Gould

    14 June 2012

    This article was published on the NewNations website on 18 June – at http://www.newnations.com/specialreports/theeuro.html

  • Europe’s Disaster

    New Zealand observers of the long drawn-out death throes of the euro-zone might be excused for finding it hard to understand what is going on. They will have lost count of the number of times that Europe’s leaders have proclaimed that they have yet again found a permanent solution to the euro-zone’s ills.

    The difficulty is compounded by the determination of Europe’s leaders – born of either self-delusion or a deliberate intention to deceive – to describe the worsening crisis in deeply misleading terms.

    As Brian Fallow explained in these pages last week, the talk in Berlin and Paris is all about deficits. The crisis is caused, we are told, because euro-zone governments have irresponsibly spent like drunken sailors and have allowed their deficits to spiral out of control. This narrative is of course very congenial to fiscal conservatives.

    The facts, however, tell a quite different story. Virtually all of the euro-zone governments, with the exception of Greece, have maintained a generally prudent stance, either staying in surplus or running deficits well within the 3% limit dictated by the Maastricht Treaty.

    There have been of course occasions when individual governments have, for a short time and for good reason, temporarily run deficits above the 3% limit. And interestingly, these supposed miscreants have included those governments that are now leading the charge to tighten the rules yet further.

    Even the Greek deficit is to be explained in terms that do not correspond with the story told by Merkel and Sarkozy. Greece is as much a victim as a culprit. Greece was never going to live with the monetary regime required by membership of the euro-zone and imposed from Berlin. It was the attempt to do so, without being allowed the usual remedies for lack of competitiveness offered by exchange rate and monetary policy that led directly and predictably to Greece’s current woes.

    What was true of Greece is also true – to varying degrees – of many other euro-zone countries. It is the futility of the attempt to require so many diverse economies, at different stages of development and with such different interests, to subject themselves to a single and largely inappropriate monetary policy, that is the true explanation of the euro-zone’s difficulties. The deficit contagion is the result and not the cause of the crisis.

    Not surprisingly, the mis-diagnosis of the malaise has led to a succession of misplaced remedies and, worse, a failure to grapple with the problem that demands and is susceptible to an immediate solution – the need to ensure that Europe’s banking system does not grind to a halt for lack of liquidity. That failure has placed the global economy in extreme danger of a double-dip recession.

    But it is the longer-term outlook for Europe that is even more depressing. The so-called “solution” agreed in Brussels will simply make matters worse. Far from releasing member countries from an economic straitjacket, Europe’s leaders have decided in their wisdom to give the lock a double turn.

    If the new arrangement holds, which seems doubtful, this would simply condemn Europe to an economic policy that makes it inevitable that half the European economy will, in effect, have to close down. Without access to exchange rate and monetary policies suited to their own circumstances, many euro-zone countries will collapse under the burden of policy dictated from Berlin. And just to make doubly sure, the new arrangement will tighten the rules and impose severe penalties for any breaches.

    Committing Europe’s diverse economies to a one-size-fits-all blueprint would be bad enough. But the dangers are compounded because the blueprint is in fact a recipe for increased austerity across the board, whatever the needs of individual economies. Germany may prosper in conditions decided in Berlin; others will not be so fortunate.

    The remedy for threatened recession is apparently that euro-zone governments must retrench, and achieve a fiscal balance at whatever cost, even if it means running their economies into the ground and thereby making their deficits worse. Such policies applied across Europe will simply drive the European economy into depression.

    Democracy, of course, has played no role in any of this. The people of Europe are required only to bear the burdens of policy failure, not to express an opinion. In implementing the Brussels agreement, no consultation with democratic opinion across Europe is to be countenanced. Elected governments are to be supplanted by a political elite who, pinning their hopes on a political mirage rather than economic reality, are perfectly prepared to defy experience and common sense.

    Does any of this matter to us? A failure of the European banking system, and a renewed financial crisis, would certainly hurt us. Our overseas borrowing, for example, would become much more expensive and difficult – and a prolonged European recession would also depress our major export markets.

    But we should also be aware that the issues being played out in Europe have their echo here, albeit on a much smaller scale. The attempt to outlaw steps that elected governments in future might wish to take, for example, to get people back to work is not limited to Europe. Our own newly elected government has, it seems, signed up in its agreement with Act to do just that.

    Bryan Gould

    11 December 2011

    This article ws published in the NZ Herald on the 13th of December

  • The Wilful Obstinacy of Europe’s Leaders

    The first duty of political leaders is to deal with the world as it is and not how they want it to be. Yet too many of our global leaders insist that the world should accommodate to them and not the other way round.

    Nowhere is this more true than in today’s Europe. Not only are Europe’s leaders grappling with problems they created themselves; they are wilfully refusing to learn the lessons of their past failures. We will all pay the price of their ideological tunnel vision.

    Europe’s leaders created the initial problem by focusing exclusively on a political goal – the creation of a single European super-state – and ignoring economic common sense. The single-currency euro zone was never going to work. A single currency requires a single monetary policy – and Europe’s weaker economies were never going to live with monetary conditions framed to suit the interests of stronger economies like Germany.

    But they were induced to take the gamble by the implied promise that the strong economies would help them out if they got into trouble. They survived for as long as times were good; and they tried to keep pace by taking on extra debt. But when the crunch came, the strong economies reneged on their promise.

    The result? A debt crisis that has engulfed Greece and Portugal, to a lesser extent Ireland and Spain, and now – potentially – Italy. But instead of recognising their mistakes, Europe’s leaders have continued to ignore economic realities. They have treated debtor countries – not as victims of a failed political doctrine – but as moral lepers who must don hair shirts and pay for their sins.

    Even more sadly, they have insisted that their political goals should take priority and be reinforced. Far from acknowledging that the single currency did not wash away economic differences across Europe, but exacerbated them by trying to suppress them, the remedy they now contemplate is an even more determined bid to create a single European state by moving further towards economic union.

    What they obstinately refuse to recognise is that economic weakness cannot be wished away. Even if it is buried in a political framework so that it is out of sight, it will simply manifest itself in another way. Even if Greece or Portugal or even Italy became simply provinces in a wider Europe governed from Berlin, their lack of competitiveness could not be hidden; it would just mean that they became depressed regions, with no prospect of seeking their own salvation.

    They would have no chance of pursuing a monetary or exchange rate policy more suited to their needs. They would have to rely on decisions made in Berlin or Paris; and those decisions are unlikely to be helpful. German and French taxpayers, whose patience has already worn thin, would have little tolerance of regions whose weakness was seen as threatening living standards right across the continent.

    But the people of Greece and other debtor countries not only have to put up with the loss of self-government and lectures about their profligacy. Remarkably, the measures that Europe’s leaders now insist upon will make matters worse, not better – not just for the debtor countries, but for all of Europe and the rest of us as well.

    As the Irishman said when asked for directions, “I wouldn’t start from here.” But what Europe’s leaders should do is accept that they have to start from here, and to prescribe policies that offer a chance of turning things around.

    What they should do is cut Greece loose from the euro so that the Greeks can devalue sharply and then – on the basis of improved competitiveness – trade their way to generating the wealth needed to pay back their debts.

    Yet, Europe’s leaders insist that Greece – already going backwards at a rapid rate, with national output dropping like a stone – must cut a further hundred thousand public-sector jobs, slash salaries and pensions, cut health spending, raise taxes and sell off assets. It is impossible to see how – by slashing and burning – an economy that is already overburdened by debt, and with no capacity to service that debt, let alone repay it, can hope to work and trade its way out of its problems.

    And that problem will be compounded as other debtor countries are given the same advice. The whole European economy faces a bleak future if that advice is taken.

    Does any of this matter to us, or is it a problem for the Europeans alone? If the European economy tips back into recession, and if European bank failures were to provoke a renewed financial crisis, we would all suffer. Global liquidity would dry up, interest rates would rise sharply, markets would contract.

    But there would be longer-term implications as well. We might, for example, pause to consider, in the trans-Tasman context, whether a currency union as advocated by some would really be the panacea it is said to be.

    And, in case we feel a sense of superior wisdom when we contemplate European difficulties, let us not delude ourselves. If by some miracle of geography we were to find ourselves in Europe, our government would support the same failed nostrums as are insisted upon by Europe’s leaders and for the same ideological reasons.

    Bryan Gould

    23 September 2011

    This article was published in the NZ Herald on 26 September.

  • No Gifts for the Greeks

    Europe’s politicians and bankers have no one to blame but themselves for Greece’s current agony, but they insist that the price of their foolishness should be paid – not by any sacrifice on their own part – but instead by ordinary Greeks.

    The euro-zone was always a disaster waiting to happen.  Yet, even now that the inevitable has arrived, the architects of the arrangement insist that is for the Greeks to accommodate painful reality, and that their own illusions and self-deceptions should remain intact and unchallenged.

    We do not need the benefit of hindsight to know that it was always going to turn out like this.  Many of us warned from the outset (and even before that, when the euro-zone’s predecessor – the Exchange Rate Mechanism – was coming unstuck) that the euro owed much more to the grandiose posturing of politicians than to economic rationality.

    Writing in the Guardian on 14 August 2000, for example, I warned that “in a single economy, subject to a single monetary policy, productive capacity will concentrate in the most productive parts of that economy. Monetary policy will necessarily be framed in the interests of that most productive part. Other less productive parts will find it difficult to live with unsuitable monetary conditions. In the long run, they will, in effect, close down. This loss of economic activity will eventually depress the level of demand and activity in the economy as a whole.”

    I had in mind exactly the situation the Greeks now find themselves in.  The Greeks’ own foolishness may have contributed to their plight, but they were urged on into a quite unsuitable set of obligations by senior – and wealthier – partners who assured them that all would be well.

    Those senior politicians and bankers who insisted that the euro was a valuable and necessary step towards greater European unity (for which read the emergence of a European superstate, with a single Europe-wide government) must have known that bringing widely disparate parts of a wider European economy, with all their differing strengths and more particularly weaknesses and – most importantly – stages of development, under a single monetary policy would impose huge strains on the weaker members.

    The reality has, however, turned out to be even more cruelly callous of Greek (and perhaps, in due course, of Portuguese and Irish, and even Spanish and Italian) interests than even we Jeremiahs had warned.

    The euro has, in effect, betrayed the Greeks twice over.  First, they were duped into believing that monetary conditions which were generous enough to allow the Germans to develop and expand could be accommodated in Greece without creating a borrowing and asset bubble that would eventually burst.

    And, secondly, they had been led to believe that, if the going got too tough, the quid pro quo for taking on the challenge of sticking with the euro and feeling the pain of that for a time, was that the richer partners would come to their aid, with loans and regional assistance packages to ease them back into a prosperous future within the eurozone.

    Such an implicit guarantee was after all the only condition on which a weak and under-developed economy like Greece could possibly take the risk of footing it with an economic powerhouse like Germany.

    Foolish Greeks!  They should have got it in writing.  When it came to the reckoning, a German Chancellor – answerable to German taxpayers – showed herself unwilling to honour the cheque.  The Greeks, having been lured into the trap, now find that their gaolers have walked away with the key.

    The “remedies” so far applied to this desperate situation do no more than buy time while the politicians and bankers work out how much they can salvage.  The cure they prescribe for Greece is, of course, worse than the disease.  The time bought is merely a further period during which ordinary Greeks are required – in a futile attempted defiance of economic logic – to make the attempt to repay huge debt while decimating what they produce.

    The authors of the catastrophe meanwhile will tolerate no questioning of their grand design.  People may suffer, austerity and penury may rule, countries may founder, but the sanctity of the euro project must not be questioned.  Nor must be the right of bankers – however irresponsible their lending – to reclaim what they’re owed, plus interest.

    In these circumstances, what should the Greeks do?  Their government has no doubt that they must bite the bullet and condemn themselves to hard times for a generation or more.  The ordinary Greek, however, says that it is those who created the disaster who should bear the brunt.

    I do not often agree with Boris Johnson.  But, on this occasion, he is right.  If I have to choose between the posturing of politicians and the greed of bankers on the one hand, and the decent lives of ordinary people on the other, there is no choice.  The Greeks must default, abandon the euro and make a fresh start.

    Bryan Gould

    21 June 2011