What the Euro Has Wrought
Quadrant, July 3, 2015
Jean-Claude Juncker, the President of the EU Commission, may be widely referred to as “the master of lies”, but when he spoke to a group of students in Belgium in early May he was not at his best. The Eurozone, he claimed, was an “area of solidarity and prosperity”. There are no reports of laughter but in Hades Tacitus could be heard repeating that old jibe of his, “ubi solitudinem faciunt, pacem appellant”: They make a desert and call it peace. A desert it is, at least in the currency union’s south. About the only abundance is in miserable statistics. To take just a few, Greece’s GDP fell by roughly a quarter between 2008 and 2014. In Spain, youth unemployment stood at slightly under 50 per cent this March, some 10 per cent worse than in Italy, a country with an economy that has barely grown since the turn of the century. There has been a wave of emigration from Europe’s south in which the best and the brightest are over-represented. Talk of a lost generation is not hyperbole.
When the euro was being put together, numerous economists warned of disaster to come. They were ignored. The politics of European integration trumped economic principle. But then, the politics of European integration have long trumped just about everything, a phenomenon that can be traced back to the conviction that, after two world wars, the European nation-state was too dangerous a beast to be allowed to survive. That voters have consistently disagreed has meant that democracy too has had to take second place.
As coups go, the manoeuvrings to lead Europe towards “ever closer union” have been gentle, gradual, deceptive, and even generous. No tanks have rolled, but the irreversible transfer of powers, sometimes small, sometimes large, from the nation-state to an unaccountable supranational authority has been as relentless as it has been sly. The trick has been to slide the devil into the details. To quote Juncker again:
We decide on something, leave it lying around and wait and see what happens … If no one kicks up a fuss, because most people don’t understand what has been decided, we continue step by step until there is no turning back.
A repudiation of the nation-state came with a faith in better men who knew best, conventional wisdom in an era when central planning rode high. In dirigiste Brussels it still does, yoked now to the fantasy that the nation-state is not only dangerous but archaic, unable to keep up in a big-bloc world, a notion convenient for technocrats on the make, a punch in the face for everyone else.
But when it came to the question of a common currency, the usual sleight of hand would not suffice: people would notice if francs and lire disappeared from their pockets. And yet currency union remained a holy grail, an essential step forward in the process of European integration. Addressing the House of Commons in 1978, Enoch Powell, one of the rare British politicians of that era to understand both monetary economics and the European project, explained why:
All economic decisions lead back … to the exchange rate … Surrender the right to control the exchange rate—surrender control over it to another body—and one has, directly or indirectly, surrendered the control of all the economic levers of government.
Taking the next step, moving from fixed exchange rates to a shared currency, would signal that this surrender to the EU’s technocratic authority was for good. And democratic accountability? Ah well …
In the meantime, fixed exchange rates were thought to be a useful managerial tool in their own right. Fluctuating currencies were untidy expressions of market mechanisms distrusted and misunderstood by both continental Left and (heavily influenced by Roman Catholic tradition) Right. The free market was an alien, “Anglo-Saxon” vice.
The price of a country’s currency can be buffeted by speculation, but over the longer term it ought to reflect how its economy compares with that of its competitors. Fixing an exchange rate is a political attempt to deny economic reality, a strategy that rarely ends well, a lesson that Europeans should have learnt in the quarter-century before the euro’s misbegotten launch. The two quasi-fixed-currency regimes that preceded it (the nastily-named “snake”, and its more durable successor, the European Exchange Rate Mechanism) were rocked by occasionally dramatic devaluations. The turbulence within the latter was particularly ominous: The ERM became the antechamber to a single currency. Its periodic crises suggested that the countries within it were not economically aligned in the way that a smoothly functioning currency union would require. France was not Germany and Germany was not Italy.
But Texas is not Mississippi and Mississippi is not New York. They can share a currency mainly thanks to a federal government that transfers money from the richer states to the poorer. Mississippi does not have to devalue its dollar to (sort of) keep up. New Yorkers might grumble, but at a fundamental level they accept that they and their countrymen down south are one people. That’s not how Europeans feel about each other. There was no nascent European nation, no United States of Europe waiting to be born. The votes were not there for the political integration necessary to make a currency union work properly.
But the machinery of integration ground on. Cart (monetary union) would have to come before horse (political union). The pretence was made that this was a first-rate second-best. There was a plan! With targets! Only those countries with economies that had “converged” could sign up for the single currency. Convergence would be proved by tests—the “Maastricht Criteria”—demonstrating that these countries’ economies were so sufficiently in sync that they could share a currency without the safety net that political (or at least fiscal) union would have provided. These tests included low inflation, exchange rate stability and (in principle) public debt and deficit ratios that would not alarm frugal Germans too much.
National economies are complex organisms that have evolved over centuries. To maintain that a collection of often very different economies had converged on the basis of a series of snapshots was madness, even more so when many of the photos were photo-shopped.
In 2012, Der Spiegel secured the release of German government documents that gave an indication of just how much of a sham the exercise had been:
Instead of waiting until the economic requirements for a common currency were met, [German Chancellor Helmut] Kohl wanted to demonstrate that Germany, even after its reunification, remained profoundly European in its orientation. He even referred to the new currency as a “bit of a peace guarantee”.
That, half a century after the fall of Hitler, Kohl genuinely believed that such a “guarantee” was necessary—and there’s little reason to think he did not—is a reminder of how much the EU’s “ever closer union” is still shaped by the paranoia of old men, a paranoia they have passed on. Meanwhile the new currency has poisoned European politics. There are once again Nazis on the streets of Athens. It’s cold comfort that this time they are home-grown.
There were other, arguably more rational, reasons for pushing the new currency through, but these too were about politics, not economics. Germany’s European “partners” relished the idea that the mighty deutschmark, over which they had no control, would be absorbed into the euro, over which they did. And if the euro could be used to cage the deutschmark, it could, it was reckoned, also be developed as a rival to the dollar, long resented as a pillar of American power. Sticking it to Uncle Sam has always been an important element in the European project.
Most Germans opposed jettisoning the deutschmark. Their objections were bypassed (Kohl later admitted to having acted “like a dictator”) but their fears could not be entirely ignored. Thus the Maastricht criteria were not just the price of admission to the Eurozone, they were also meant to be a continuing obligation (there was even an enforcement mechanism of sorts, the Stability and Growth Pact), designed to bring a reassuring—to sceptical Germans—touch of Teutonic rigor to the operation of the new currency.
There was more. No Eurozone member would be responsible for the debts of any other, and nor would the EU. Additionally, both the European Central Bank and the now subordinate national central banks were barred from any direct financing of any Eurozone country’s budget deficit. This played well in Germany, but it was also common sense, an attempt to ensure that feckless nations could not take advantage of the thrifty. It was also a reminder of how far the members of the Eurozone were from seeing themselves as one country. Speaking in 2011 about the bailouts that were never supposed to have been possible, German president Christian Wulff observed:
Solidarity is the core of the European Idea, but it is a misunderstanding to measure solidarity in terms of willingness to act as guarantor or to incur shared debts. With whom would you be willing to take out a joint loan, or stand as guarantor? For your own children? Hopefully yes. For more distant relations it gets a bit more difficult …
For more distant relations: Germans are not Greeks. Europe is not a nation.
Not all Eurocrats were as naive as their hymns to the new currency suggested. Some seem to have believed that its built-in flaws might trigger what in the cynical language of Brussels was termed a “beneficial crisis”. Yes, in the late 1990s fiscal union was politically impossible, but a crisis might change that one day. This was not a new notion. A united Europe, Jean-Luc Dehaene, a former Belgian prime minister (and erstwhile contender for the EU’s top job), once commented, “becomes reality through crises. We need crises to make progress.” That says a great deal about the lack of popular consent for ever closer union. That Dehaene was prepared to admit it says just as much about a political class comfortable with post-democracy. And complacent too: those willing to gamble on a “beneficial crisis” did not foresee that their reckless monetary experiment might generate a new crisis too chaotic to be contained. A lack of understanding of how markets work will do that.
There were early signs of trouble to come. The Stability and Growth Pact was quickly neutered after France and, ironically, Germany crashed through its budget limits with impunity.
And below the surface other problems were brewing. At their core was the illusion that convergence was for real. Politically convenient illusion paved the way for financially convenient delusion. Interest rates across the currency union moved down to German levels: to take the most extreme case, in the early 1990s ten-year Greek government bonds carried a coupon at least fifteen percentage points above their German equivalent. Ten years later, the spread was close to zero. Germany was Greece.
The windfall represented by these low interest rates should have been used by the Eurozone’s weaker countries to reduce excessive borrowing, smooth the restructuring of swollen state sectors, and help develop their economies’ international competitiveness. All too often it was binged away.
With currency risk banished along with the drachma, punt and peseta and, supposedly, never to return (the agreements establishing the euro did not provide any specific exit mechanism), international lenders were all too happy to fund a lively periphery party that offered higher returns than in the subdued north. And, contrary to contemporary demonology, this was not just a matter of bankers running wild.
Regulators cheered the financiers on. Not only was little done to dispel the perception that the Eurozone would, regardless of any pesky treaty obligations, stand behind its members’ debts, but numerous signals to the contrary were sent. These included modifying international bank regulations in 2006 in a way that meant banks no longer had to set aside any capital against holdings of any Eurozone-area sovereign bonds. Germany was Greece. Meanwhile the ECB was content to accept Greek debt as collateral on a par with German. Germany was Greece. In case there were any remaining dullards who had failed to get the message, ultra-low and uniform risk-weighting was attached to lending by Eurozone banks to their peers within the currency union. Germany was Greece.
The cheap capital gushing into much of the Eurozone’s periphery fuelled consumption booms, asset bubbles (notably in Irish and Spanish real estate), sharply higher labour costs and a government spending splurge in Greece and Portugal. The ECB didn’t take away the punchbowl. Its interest rate policies were driven by the needs of the currency union’s three largest economies (Germany, France and Italy): one size would fit all, and if it didn’t, oh well, growing pains …
Meanwhile, Germany, to mix metaphors, both anchor and pacesetter of the currency union, had weathered earlier doldrums and was pulling further ahead. Swapping the deutschmark for the shared (and thus intrinsically weaker) euro was the functional equivalent of devaluation, but the beneficial effect on Germany’s competiveness was given an extra boost by tough labour market reforms of the type that its Eurozone partners failed to take. And now that they shared a currency, those partners could no longer devalue their way back into contention. When the time came, all that would be open to them was “internal devaluation”, a brutal squeeze on domestic costs, costs that had risen significantly during the boom years.
There was a time when imbalances of the type that were building up in Greece or Ireland would have set off an alarm in the shape of a currency crisis or have been choked off by a surge in interest rates, but these protective market mechanisms (“Anglo-Saxon speculators” can serve a valuable purpose) had been deliberately muffled, first by the fact of currency union (there were no longer any drachmas or punts to crash) and second by its management. Yes, the flip side of the capital pouring into, say, Spain, was the creation of a huge current account deficit there, but to be bothered about that was unfashionably retro, as irrelevant as worrying about a current account deficit in Tennessee. In aggregate all seemed to be going reasonably well in the Eurozone, and that, the planners in charge liked to suggest, was what counted. The party-pooping fact that the currency union was not a political union, and that Spain, in this sense, was not Tennessee troubled very few.
In 2008 Joaquín Almunia, the EU Commissioner for Economic and Monetary Affairs, mocked the “Cassandras” who had doubted the euro: “The economic advantages of EMU are overwhelming for all its members.” All?
Hubris was followed by nemesis and it debuted in a culturally appropriate place. In October 2009, Greece’s newly-elected Prime Minister, George Papandreou, confessed that his country’s budget deficit would be more than double the bad enough 6 per cent of GDP projected by his predecessors. The books had been cooked and now they were on fire. With markets battered by the financial crisis that had erupted in the USA, Papandreou’s admission (which itself was to prove optimistic: the deficit ended up at over 15 per cent) spooked jittery investors. They began to recognise just how badly Eurozone risk had been mispriced. Germany was not Greece. Reality was back. The emperor was discovered to have pawned his clothes. The Eurozone crisis was on.
Investors were right to fret. Greece’s borrowing would have been bad enough under any circumstances, but monetary union made it even more threatening. With no currency to call its own, all Greece’s debt was “foreign”. Greece could not, it was assumed, print money to fill the gap, or turn to its Eurozone partners for help (no bailouts, remember). To borrow, it would have to pay more, much more. Investors, both foreign and domestic, could buy euro-denominated assets elsewhere, so why choose Greece, or for that matter, stay there to face what could be some very discordant music? There was an obvious danger that the money would flee Greece, to be replaced by what exactly? Adding to the nightmare, the spectre of a run on Greece’s vulnerable banks (filled with belatedly suspect “assets”) loomed.
Greek interest rates surged. Ahead lay a clear risk of default and, possibly, exit from the Eurozone, triggering fears, so fashionable after the Lehman bankruptcy, of “contagion”. Investors rapidly realised that if Greece collapsed, there were plenty more dominoes to tumble, starting with Ireland, where real estate boom had already turned to bust, and a panicked Dublin government had guaranteed Ireland’s six main banks, a guarantee equivalent to nearly 250 per cent of GDP.
There isn’t the space here to detail the rescue packages, financing vehicles and open-ended promises that have, so far (as I write, the Greek melodrama has heated up again), kept the Eurozone intact, but if there has been one guiding principle it was the one recounted by France’s finance minister, Christine Lagarde, in 2010: “We violated all the rules because we wanted to close ranks and really rescue the Eurozone.”
Lagarde admitted that the EU’s treaty obligations were “very straightforward: no bailing out”. By this time, both Greece (€110 billion, including €30 billion from the IMF) and Ireland (€67.5 billion, including €22.5 billion from the IMF) had, well, been bailed out (in Greece’s case for the first time), and the Eurozone’s members had formed two bailout funds, the European Financial Stability Facility (authorised to borrow up to €440 billion), the European Financial Stabilisation Mechanism (authorised to borrow up to €60 billion). These were all, conceded Lagarde, “major transgressions”, but not major enough to disqualify her from being appointed the IMF’s Managing Director some months later: the supranational elite looks after its own.
An effort to bring at least some of this back within the letter of the law led in 2011 to a “limited” amendment to the relevant EU treaty (it was much more than that, but that designation meant—a characteristic touch—that any inconvenient referendums could be dodged) permitting the creation of a “permanent” bailout fund, the European Stabilisation Mechanism, authorised to lend up to €500 billion. That may have given some legal cover, but it’s hard to argue that it legitimised the institutionalised betrayal of German taxpayers that it represented.
The rescue effort staggered on. There was a Portuguese bailout (€78 billion, including €26 billion from the IMF), a second Greek bailout (€130 billion, including €28 billion from the IMF) together with a “restructuring” of Greek debt (less euphemistically described as the biggest sovereign default in history), a partial Spanish bailout (€40 billion), a Cypriot banking collapse, complete with a bailout (€10bn, including €1bn from the IMF) and capital controls that stretched EU law a very long way, but by this point …
Oh yes, the Eurozone’s leadership essentially replaced two democratically-elected prime ministers, Italy’s Berlusconi and Greece’s Papandreou, with technocratic proconsuls, one of whom had worked in the EU Commission, the other at the ECB. The substitute Greek prime minister had also been Governor of the Bank of Greece while that country “prepared” its application for the euro, but by this point …
Meanwhile the ECB had been doing its bit, much of it below the radar, close to the knuckle and highly technical (those wanting to know more should start with The Euro Trap, an invaluable, brilliantly-researched polemic by the German economist Hans-Werner Sinn). Contrary to some market fears, no Eurozone member-state has ever run out of currency to pay the bills. It appears that the ECB has effectively allowed local central banks to “print” new euros, a stretching of the ECB’s authority that includes permitting open-ended unpaid balances in Target 2, the ECB’s payments clearing system, balances dismissed as little more than an unimportant accounting issue by some, as a potential calamity for the Eurozone’s creditor nations by others.
Other ECB policies were announced with more fanfare and a flurry of initials: hundreds of billions in cheap financing for Europe’s embattled banks (LTROs), a program (SMP) used to purchase the bonds of weaker Eurozone sovereigns in the secondary markets, a conditional promise to buy government bonds issued by the Eurozone’s casualties (OMT) and, most recently, explicit quantitative easing (PSPP). In July 2012, ECB President Mario Draghi announced that his bank would do “whatever it takes to preserve the euro”. Where that has taken the ECB is a very long way from the Bundesbank 2.0 that unhappy German voters were promised. Naturally Draghi stressed that the ECB’s actions would always be within its “mandate”, a notion seemingly so elastic that it has been extended into territory where, as so often where the defence of the euro is concerned, the rule of law has had trouble keeping up, but by this point …
Means and ends and all that: we will see what unpleasant surprises Greece may yet deliver, but the panic that threatened to sweep away all or part of the Eurozone has subsided. Stock markets have rallied, interest rate spreads have once again narrowed, and there are signs of broader recovery. But this has been a bleak reprieve. Recovering from the debauch that the birth of the euro brought in its wake was never going to be easy, but the single currency’s flaws have meant that the Eurozone’s laggards, the notorious PIIGS (Portugal, Ireland, Italy, Greece and Spain) have had a far rougher hangover than after a traditional boom and bust. Deprived of the ability to depreciate “their” currency to a level that reflected domestic economic reality, they have been forced to squeeze the excess out by cramming down costs (primarily labour costs), the “internal devaluation” referred to above. That’s a cure that works much better in a flexible, export-oriented economy such as Ireland’s (where exports amount to over 100 per cent of GDP) than in Greece.
Adding to the misery, those countries that signed up for the eurodole were required to agree to restore order to their disorderly finances. That was good in principle, but tricky in execution, sucking further demand out of faltering economies, demand on which tax revenues depend. That, in turn, prompted a need for additional austerity, cutting demand yet more. Greek government debt now stands at over 175 per cent of GDP. Earlier restructurings make that more sustainable than the headline number would suggest, but that number was 143 per cent at the end of 2010. Sisyphus, I note, was Greek.
No democratically legitimate path has been found to the destination that, if the Eurozone is to be preserved “as is”, would make better economic sense, the move to a fiscal or (as it is now pejoratively, and accurately, known) “transfer” union, where creditor nations, mainly from the Eurozone’s more frugal north, helped out the wastrel foreigners down south. The northerners suspect that such arrangements would be permanent. Over 150 years after Italian union, Naples is still not Milan. How long will it be before Lisbon can keep pace with Munich?
Regardless of what the continent’s repeatedly snubbed voters might actually want, the EU’s ruling class will push integration forward. As ever, the process will be step by step. Beyond the bailout funds and the ECB’s manoeuvrings, various debt mutualisation schemes have been floated, and an emergent “banking union” (billed as a way of breaking the dangerous link between the EU’s banks and its sovereign borrowers) is not only a device for yet more centralised control from Brussels, but could ultimately lead to the Eurozone-wide pooling of a significant area of financial risk.
Meanwhile, all the EU’s member-states (bar the UK) have signed up for the “Fiscal Compact”, a tougher, but supposedly smarter, supplement to the original Stability and Growth Pact. Insisted upon in 2012 by Angela Merkel as an exchange of sorts for continuing German financial support for the currency her people never wanted, this treaty still relies on the procrustean logic of one-size-fits-all, while throwing yet more technocratic control into the mix: it gives greater enforcement powers to the EU Commission and its legal bag-carrier, the European Court of Justice. Needless to say, there are already signs that, at least for now, this new rulebook will be “interpreted” more flexibly than Chancellor Merkel would want.
That reflects the reality that austerity (not necessarily the most accurate of terms, given how large some deficits still are) may be approaching the limits of the politically possible, including, crucially, in France, the more ornery half of the Franco-German combination that is so central to the European project. Marine Le Pen’s anti-euro National Front is polling strongly there, just one of a number of European radical parties, some Euro-sceptic, some not (Greece’s Syriza is, in its fashion, Euro-integrationist), given their opportunity by economic agony and the refusal of mainstream parties to acknowledge that there might be an alternative course to the one now being set by Brussels. It’s perhaps unkind to point out that the euro was marketed, in part, as a device to ensure that Europe would never revert to the extremism of its past. That many of these parties have shown themselves to be open to overtures from Vladimir Putin is just another twist of the knife.
So what now? A Greek exit may yet rewrite the script, but even should that necessary (oh yes) event occur, the Eurozone is unlikely to change direction. Popular scepticism in the north over the costs of fiscal union will mean that movement will be hesitant and, where possible, camouflaged. Nevertheless bureaucratic and (within the elite) political momentum, not to speak of the underlying economic argument, remains strong enough to ensure that the trudge to a transfer union—and the final betrayal of northern taxpayers—will continue.
But the pace will be slow enough to ensure that the pain in much of the Eurozone’s periphery will persist, sometimes acute, sometimes merely chronic. One size will still not fit all. The vampire currency will linger on, draining democracy and prosperity as it does so, but no one will put a stake through it. The reasons include the EU leadership’s conviction that the European project must never go into reverse and, infinitely more understandably, fears of what might come next, fears that range from the thought that a break-up of the euro would turn out to be a bigger badder Lehman to worries that Europe’s reborn currencies would swing too far, threatening the pauperisation of the south (it’s telling that most Greeks still want to retain the single currency) on the one hand and the competitiveness of the stronger economies on the other.
What is certain is that there’s no easy exit (in 2012 a top German official was quoted describing the euro as “a machine from hell that we cannot turn off”). But somewhere to start might be the halfway house of a division of the euro into “northern” and “southern” units. It would be an imperfect and risky solution, but it might offer more hope than a status quo that is a forced march to a Europe that no one should want to see.