Jean-Claude Juncker’s boast about the euro is an insulting fantasy

CapX, January 4, 2019

History may or may not repeat itself, but hubris certainly does. In April 2008, as the euro approached its tenth birthday, Joaquín Almunia, the EU’s then Commissioner for Economic and Monetary Affairs, recalled how its construction had been accompanied by “dissenting voices”. “One economist” had jeered that it was “at best, an act of uncertain merit”. Another had denounced it as a “great mistake”. Fools! Almunia bragged that “the euro [had] proved an economic success”.  Within 18 months Greece was in crisis.

Earlier this week Jean-Claude Juncker marked the euro’s 20th anniversary of with words seemingly so far removed from reality that not even sciatica could explain them away: “The euro has become a symbol of unity, sovereignty and stability. It has delivered prosperity and protection to our citizens…”

Goebbels once wrote that “the English follow the principle that when one lies, one should lie big, and stick to it. They keep up their lies, even at the risk of looking ridiculous”. However, he would not have expected the English to mock those who they were trying to convince.

Juncker, no Englishman, but known to some as “the master of lies”, has rarely shown much concern about appearing ridiculous. Nevertheless, boasting that that the euro has delivered prosperity insults almost every member state other than Germany, particularly those hit hardest by the bursting of bubbles wholly or partly inflated by the single currency. Most may have crawled out of the A&E (or in Ireland’s case done rather more than that), but memories of what they went through are fresh. And in some instances, they aren’t even memories. Youth unemployment in Greece has only recently fallen below 40 per cent. GDP per capita in Italy (where the euro’s corrosive effect is real, but more difficult to assess) stands roughly where it did in 1999.

On the other hand, Juncker’s claim that a currency which has brought chaos and division in its wake is a symbol of “unity” and “stability” may seem equally absurd, but seen from Brussels, it makes good sense. To appreciate why, note the reference to “sovereignty” as another of the qualities symbolised by the euro. A country that relinquishes its own currency gives up some of its sovereignty, but Juncker was focused on where that sovereignty had been transferred. And that was to “Europe”. Having its own currency represented a major advance in the EU’s step-by-step assumption of sovereignty, and with it, the attributes of a state.

Now adopt that same Brussels perspective to understand what Juncker meant by unity. Despite sharp disagreements, those running the Eurozone stuck together through the crisis, trashing treaty obligations, promises to voters, a referendum result, the integrity of the European Central Bank, economic logic and basic democratic norms to keep the currency union intact. They succeeded in a display of unity that also delivered Juncker’s notion of stability — a Eurozone that weathered the storm — as well as a strong indication that it will continue to overcome the challenges that come its way.

Part of the reason for that, is that once in the euro, there is no easy exit. “Ever closer union” are perhaps the three most important words in the EU’s definition of itself: They imply that there is no reverse gear. Nowhere is this more the case than, as its creators intended, with the single currency, described in 2012 by one top German civil servant as “a machine from hell that we cannot turn off” — words to remember amid current talk of widespread support for the euro.

But back to hubris. Like so much central planning, the euro was born of arrogance, over-confidence, conceit and ideological obsession. Cramming a large number of diverse economies into a necessarily Procrustean currency union made little economic sense—the savings flowing from the removal of foreign exchange risk were somewhere between minimal and illusory. It was also an invitation to disaster, made riskier still by the absence of any degree of fiscal union, something which might have provided a safety net, but would not have been politically acceptable in many of the countries signing up for the new currency.

One example of hubris overlapped with another. Some of those in charge of putting the euro together were aware of its innate flaws but expected that they would eventually lead to—as the phrase in Brussels goes— a “beneficial crisis”. This would be the catalyst for forcing through the fiscal union that had always been the logical counterpoint of monetary union and would also constitute a giant leap forward towards ever closer union. The hubris lay in believing that such a crisis would be manageable in the manner that Brussels hoped.

It wasn’t. Even allowing for its starting point, Juncker’s perception of unity is based on turning a blind eye to some highly inconvenient truths. Made even more destructive by its intertwining with the financial crisis, the storm that tore into the Eurozone essentially divided the currency union’s member states into two antagonistic camps, creditor nations in the north and debtor nations in the south.

The north’s distrust of the south, and the south’s resentment of the north, along with economic distress and the realisation that Brussels and its allies bore much of the blame for this mess (but had no interest in changing direction) also boosted political parties once confined to the fringe or triggered the formation of new parties that would once have found a home there. Those forces were given additional impetus by an unrelated issue— mounting unease over immigration and its longer-term implications. What’s more, many continental eurosceptics have been transformed from naysayers opposed to further integration into a force that actively wants to reverse the direction of ‘ever closer union’. Populist governments (of very different hues) have come to power in Greece and Italy.

Germany and other ‘northern’ states are now even more firmly set against fiscal union, rightly regarded as a device to milk their taxpayers in perpetuity. In the Eurozone’s south, meanwhile, there is increased resistance to Germany’s insistence on enforcing its sometimes counter-productive brand of fiscal discipline on everyone else. It’s significant that, with Emmanuel Macron’s own plans for fiscal union floating face-down in the Spree and gilets jaunes roaming France’s streets, his government will now be breaching (just a one-off, of course) the EU’s budgetary rules.

All that said, betting against the survival of the euro is unwise. The political will to keep this vampire currency going should, as the last ten years have shown, not be underestimated and populist parties are just as conscious as their more orthodox rivals of the general public’s fear of ‘something worse’.

But European growth prospects are deteriorating despite years of the ECB doing “what it takes”. The economies (and balance sheets) of many of the Eurozone’s weaker member-states continue to suffer from the after-effects of the last crisis and remain confined to the straitjacket of a one-size-fits-all currency:  They will not be well placed to cope with a fresh slowdown. It’s hard to avoid the conclusion that another Eurozone drama may well be approaching, with political consequences that are likely to be much trickier than last time around.

One way to head off some of the worse of what might lie ahead would be by splitting the single currency into ‘northern’ and ‘southern’ euros which would better reflect the economic realities of the domestic economies they serve. This would be far from straightforward, but it beats sticking with a status quo that offers much of the Eurozone little more than stagnation at best, and catastrophe at worst.

But such a split runs against the idea of the irreversibility of ever closer union. It’s never going to happen.

Don’t believe the EU – Greece’s crisis is nowhere near over

CapX, August 17, 2018

With Nemesis dodged, however ruinously, it has not taken too long for Hubris to reemerge from under the rubble.

“The Greek crisis ends here tonight,” declared the EU commissioner for Economic and Financial Affairs within minutes of the conclusion of the June meeting at which it was agreed that Greece would receive the final slice (€15 billion) of its third Eurozone bailout this August.

Even though Greece’s graduation from rehab had been sweetened by its Eurozone creditors extending the repayment date of almost €100 billion of debt (about a third of the total) by ten years, this claim of victory was both tasteless (youth unemployment currently stands at nearly 40 per cent) and premature. Greece will be left with a cash cushion of €24 billion, which should enable it to avoid having to approach the financial markets for around two years — a handy breathing space, to be sure, but one that is more likely to be a respite than the preamble to a cure.

The country’s GDP expanded by 1.35 per cent in 2017, after almost a decade of annual declines interrupted only by the annus mirabilis of 2014, the one year when it eked out a positive return, a miserly 0.74 per cent. The IMF reckons that the pace will pick up to 2 per cent in 2018 and 2.4 per cent in 2019, which is at least something, if less than hoped earlier.

Perhaps that might happen — if the global economy keeps ticking over (and the neighbourhood remains calm: let’s not talk about Turkey and Italy) — but it’s impossible to miss the subtext lurking within the IMF’s recent report on Greece. Has a slump as deep as America’s Great Depression, but more prolonged, left behind enough of a country to make its own way? And will, as the IMF clearly worries, the continued policing of Greece’s finances by its reluctant rescuers be so severe that it shrinks the scale of a desperately needed recovery?

Formal exit from the bailout regime will mean an end to the harshest of the austerity measures that went with it, but Athens will still be required to maintain an annual “primary” (i.e. before debt servicing) budgetary surplus of 3.5 per cent until 2022. The straitjacket will then be loosened — somewhat. The government will be expected to achieve an average annual primary surplus of 2.2 per cent until, well, 2060.

Adding a culturally appropriate touch of Sisyphus to this already implausible undertaking (the IMF diplomatically talks of “very optimistic assumptions”), any new funding from the markets will be priced on far less generous terms than Greece’s rescuers have been charging.

And there’s no reason to be sanguine about that existing debt. It may be cheap and the timetable for its repayment leisurely, but its sheer size (some 180 per cent of GDP) means trouble ahead. After all, this is not a drachma-denominated liability that Greece once might have printed away. And it wouldn’t be a drachma-denominated liability even if Greece readopted the currency it should never have abandoned. A reborn drachma would plummet so far that the dream of repayment would quickly be replaced with the reality of default.

Brussels’ convenient conceit is that the EU’s new and improved Greece will grow out from under this burden, an unlikely prospect made more unlikely still by overly onerous budgetary constraints and the structural problems that should have made the country ineligible for the euro in the first place.

To start with, there is the matter of ensuring the economy can keep up with the rest of the Eurozone, not easy given the country’s persistently low productivity. Back in the days of the drachma, Greece could at least devalue its way into some approximation of competitiveness. With that option off the table, the conventional alternative, a domestic squeeze — an “internal devaluation”, to use the jargon — has been tried since the early stages of Greece’s long Calvary, and it is still being tried. But whatever its merits as a device to eliminate some of the worst aspects of the Augean state, there is scant evidence that it has done very much to sharpen the country’s competitiveness.

Indeed, in some respects it may have made things worse. Destruction can be creative, but sometimes it is just destructive. GDP stands at 2003 levels and at less than 60 per cent of its 2008 peak. Disposable income has fallen by about a third since 2010 and the private sector has been devastated. The banking sector is under-capitalised (credit is still contracting).

In short, so much has been smashed up that it is difficult to see where the type of turnaround Greece needs can come from. Three hundred thousand Greeks, including many of the nation’s best and the brightest, have emigrated in the last eight years, a move made easier by their right to settle anywhere within the EU. How many will come home?

A similar question can be asked about capital, which also moves freely throughout the EU and, as between the different countries of the Eurozone, with (the danger of eurogeddon apart) no currency risk: A French euro is a Finnish euro is a Greek euro. If a euro invested in Greece cannot offer the returns available from a euro invested elsewhere in the Eurozone, the country will struggle to attract investment, whether domestically or from abroad.

Rather than promote the economic convergence of its constituent parts, a currency union could well have the opposite effect. Capital will tend to flow to its winners and away from its laggards, a process that could doom Greece to ever more peripheral status. This slide will be accelerated by the unwillingness of the Eurozone’s member-states to agree to supplement their monetary union with a fiscal union that would, as in the US, establish the automatic transfer of resources from richer to poorer states that operates as a brake on a currency union’s natural centripetal pull.    

The task of modernising the Greek economy is, to put it mildly, incomplete, and there must be some doubt as to how much further its government is prepared to go down that route. The authors of the IMF report refer politely to “reform fatigue”. “Political pressures,” it warns, “to roll back reforms may intensify ahead of the 2019 elections”. Indeed they may, not only because of the agony associated with these reforms (made even more painful by outcomes with a tendency to disappoint), but also because of the largely accurate perception that they have been imposed from outside.

A good number of the real culprits — most notably those who took Greece into a currency union for which it was not ready and then squandered the opportunity it might have represented— are home-grown, but that’s not how it appears to many voters. Under the circumstances, it will not be surprising if some politicians are tempted to suggest to them that Sisyphus should shrug.

But even if Greeks do vote to stay the course — and the best guess is that they will, if only, in many cases, because they fear the alternatives —  and even if Italy’s new government does not trigger a broader Eurozone fracas, economics will eventually reignite the Greek crisis and, probably, sooner rather than later.

One of the rare, if partial, concessions to reality in the arrangements negotiated in June was that the Eurozone’s leadership will take another look at Greece’s situation in 2032 (2032!) to see if further debt relief is required. Well, it will be — and quite some time before then, because, in the end, nothing has really changed. Greece will continue to pay a terrible price for membership in a currency union for which it was, is and will be completely unsuited, but is understandably terrified to leave.

Its creditors, meanwhile, particularly in the Eurozone’s richer north, are terrified about the damage a Grexit could do to a Eurozone built on unstable foundations that they don’t want to complete, demolish or remodel. And so, after a re-run of a drama that will be stale before it has begun, there will be a fourth Greek bailout – and that won’t change much either.

A March of Folly

Ashoka Mody - EuroTragedy: A Drama in Nine Acts

National Review, July 26, 2018 (August 13, 2018 issue)

Near the beginning of his convincing, readable, and satisfactorily acid account of the rise and who-knows-what-now of the euro, Ashoka Mody cites basic monetary theory and grumbles that the European Union’s leaders “should have been aware that a single currency could not [by itself] deliver . . . prosperity.”

The EU owes its existence to the notion that Europe should avoid repeating the catastrophes of its 20th-century past. Yet by imposing a single currency on a large number of very different countries, it was blending elements of two lesser disasters — fixed exchange rates and central planning — into a combination that history (and some distinguished Cassandras) suggested would end very badly indeed.

No matter. Political ambition trumped economic risk on grounds that fail to persuade Mody. After all, the economic tensions built into a shared currency of such scope were more likely to divide than unite. But Mody overlooks the centrality of the three words “ever closer union” in the preamble to the 1957 treaty that paved the way to the EU. They set the course of the European project in only one direction — forward. To Brussels and its allies, the key attribute of monetary union was that it threw away the key: There was no easy way to check out. Under the circumstances, the governments signing up for the new currency should have paid more attention to flaws in its design that added to its already considerable risks. Perhaps most dangerously, in the absence of political support for a fiscal union to act as a safety net, the euro was launched without one. Once again, no matter: If a crisis developed, it would, enough of the right people evidently believed, overwhelm opposition to that fiscal union. The ratchet of integration would turn again.

This was not a novel idea. When the single currency was first formally proposed back in 1970, “falling forward” was to be “its guiding philosophy,” Mody writes. “Crises would make Europeans more determined to move forward. . . . Europe would emerge stronger and more vibrant.” This cynical strategy has worked well for Brussels in other areas, but, with the single currency, it was pushed too far. The EU emerged neither stronger nor more vibrant, but hobbled, embittered, and lopsided.

Mody, an economist and a visiting professor at Princeton, has worked at the World Bank and the International Monetary Fund. At the latter, his role included acting as a deputy director of its European Department, and he was responsible for the Fund’s relationship with Ireland during its euro-zone nadir. He is thus well equipped to describe the euro’s curious political and intellectually indefensible origins, as well as the new currency’s grubby gestation, the bubble the euro facilitated, and the bust that came close enough to breaking the euro zone apart. Mody recounts how the currency union was held together, before turning his attention to a recovery that may be no more than the calm between storms. Overall, he tells a tale of warnings ignored, of groupthink, of deception and denial, of both recklessness and an excess of caution, of myth, magical thinking, and technocratic illusion — and of reality’s relentless revenge.

For all Mody’s meticulous chronicling of events, he has room for broader themes too. These include a sustained attack — not without cause — on the German-led fixation on budgetary targets and, in particular, an overly emphatic insistence on “austerity” as the cure for the euro zone’s troubles. It is not an endorsement of fiscal profligacy to argue that, in certain cases, the screw was turned too tightly too soon. Compelling Greece, in essence, to try to deflate its way back to better days was already to ask a great deal. To be sure, the Baltic states (by then de facto members of the currency union) managed to do just that. But there were specific reasons that they could, just as there were specific reasons that Greece could not. And these were distinctions that could not be given the recognition they deserved, thanks to a one-size-fits-all financial regime that was taken far further in the euro zone — and, after the crisis erupted, applied more harshly — than sharing a currency would already necessarily imply. 

To understand why Berlin wanted the purse strings kept drawn so tight it is necessary to examine what lay behind what at first seems like purely habitual stinginess. Of course, it is unsurprising that German politicians thought that their successful homegrown model — a degree of frugality — was the right one to follow, but there was more to it than that. Berlin simply had no confidence that its partners (notably those in the south of the euro zone) had the willingness or ability to run their finances appropriately, a concern that Mody might have stressed more. This lack of trust may or may not have been merited, but it was a symptom of a monetary union flung together without enough regard for the psychological or political readiness of its member states for such a step. Even the requirement (reflected in the Maastricht Treaty) that they should converge economically turned out to be a joke, at best largely meaningless, at worst a sham.

Germany’s leadership was also nervous about the consequences of their voters’ having to pick up the tab for a currency union they had never wanted, a bill their politicians had assured them they would never have to pay. Mody is clearly conscious of these issues and, pointing to America’s experience during the Great Depression, highlights the fact that the U.S. government had both the “legitimate political authority and the concurrence of sufficient numbers of the country’s citizens” it needed to help struggling states. It still has. Its counterparts in Germany (and the euro zone’s other “creditor” nations) had scant justification for claiming that they had either. There was one other vital distinction: Americans were being asked to help their compatriots. Notwithstanding grand proclamations of a shared EU “citizenship,” the tie between Michigan and Missouri is infinitely more binding than that between Germany and Greece.

Meanwhile, the stakes for countries beyond Germany — especially in the euro zone’s hardest-hit nations — were raised by the legacy of Berlin’s stipulation that the European Central Bank (ECB), like the Bundesbank before it, should (at least nominally) be free of political interference and, unlike the Federal Reserve (which also has to foster employment), focus solely on price stability. That can work, as it did in Germany (where memories of Weimar’s inflation linger), with sufficient popular consent, but, in countries where that consent does not exist, it can be an invitation to radicalization when tough times come calling — and they did come calling. That invitation was made even easier to accept by the way that the unaccountability of the ECB is reinforced — as Mody demonstrates in some of the most disturbing passages in a frequently disturbing book — by the EU’s high-handedly technocratic ethos. It is an essentially post-democratic approach, and as Mody (without resorting to that adjective) shows, it bears no small part of the blame for the euro-zone fiasco.

The effects of this ruinous monetary experiment have not been confined to political radicalization (a phenomenon not reserved to the euro zone’s weaklings) or the stirring up of antagonism between the nations it was designed to bring closer together. The currency union’s laggards have suffered immense economic harm, and the damage, warns Mody, to their potential for growth may endure long after the current trauma has receded. This implies that the chance of genuine economic convergence within the euro zone — never much of a likelihood despite all the promises — will slip even further out of reach. The natural tendency of a currency union to draw economic activity away from its periphery (a topic discussed by Joseph Stiglitz in his 2016 book on the euro) could make matters worse still — not a pretty prospect when that periphery includes entire nations.

The euro-zone drama still has a long way to run. Some months after Mody’s manuscript went to press, a coalition government of populist Right and (sort of; it’s hard to explain) populist Left, with a suspicion of the euro and a distaste for Teutonic austerity in common, took office in Italy. Much larger than Greece, Italy is, Mody contends, the “eurozone’s fault line.” He may well be correct, but don’t expect a cataclysm quite yet. The most impressive thing about this misbegotten currency union is the political will to keep it in one piece.

Mody himself peers into the future towards the end of the book. One supposedly brighter vision features debt forgiveness, a loosening of the euro zone’s fiscal fetters, improved sovereign-bond issuance, and standard panaceas from education to technology. Much more intriguing is a suggestion tucked away in Mody’s description of a (more plausible) downbeat scenario in which, broadly, those steering the currency union do little to change course.

Amid dark talk of sluggish growth and vulnerability to new shocks — not to mention the cascading defaults that could follow an Italian exit from the euro zone — Mody floats the happier alternative that Germany might either readopt the deutschmark or form a new currency bloc with other like-minded “northern” countries. Meanwhile, those states remaining in the old euro zone would still be able to repay their debts in euros, thereby dodging default while benefiting from the increased competitiveness created by a currency that would undoubtedly devalue sharply once the virtuous had left the picture.

Put another way, the best way out of the euro-zone mess remains, as it has been for years, partition. Such a move, however, would represent more than a few steps backwards in what is meant to be a perpetually forward march.

And that would never do. 

How Not to Fix the Euro: More Leftism

Joseph E. Stiglitz - The Euro: How A Common Currency Threatens The Future of Europe

National Review, October 10, 2016

Imagining that a large number of very different economies could be squeezed into a single poorly constructed currency was one fatal conceit. Imagining that the story of what happened next could be squeezed into one rigid “narrative” was another — but that’s what economist Joseph Stiglitz has done in The Euro, a badly flawed book about a disastrous idea.

Stiglitz, a Nobel laureate and a Columbia professor, has been crusading for years now against the wickedness of “neoliberalism,” a term that, like “late capitalism,” says more about the person using it than about what it purports to describe. Check out the titles of some of his more recent books: “The Great Divide: Unequal Societies and What We Can Do about Them,” “The Price of Inequality,” “Freefall: America, Free Markets, and the Sinking of the World Economy.” The Euro is the latest installment in a long leftist tirade.

Stiglitz has valuable points to make on the EU’s dangerous monetary experiment, but it’s easy to lose sight of them amid all the pages devoted to his insistence that the devastation caused by the single currency is another example of the havoc that “market fundamentalism” has wrought.

Yet the euro was, at its core, an exercise in central planning. Stiglitz concedes that it was a “political project” to accelerate the process of European integration. But more than that, it was to be a challenge to the supremacy of the dollar and a permanent brake on the unruliness of foreign-exchange markets, ambitions far removed from market fundamentalism. Indeed, one of the earlier critics of the proposed new currency was Milton Friedman, not that Stiglitz finds the room — or the grace — to mention it.

Stiglitz questions the economic rationale behind the euro (arguing, intriguingly, that, contrary to the claims of its advocates, it was always likely to operate against convergence within the bloc) and the way that it was put together: The structures needed to make it work properly weren’t there. Yet his list of those responsible for the inevitable crisis is tellingly incomplete. To be sure, he acknowledges the important (and often overlooked) fact that individual governments could — even within the constraints of the euro zone — have done more to head off disaster than conventional wisdom now suggests, but, for the most part, he blames the Left’s preferred bogeymen, greedy bubble-blowing bankers and their accomplice, light-touch regulation.

But while there were undoubtedly areas in which regulation was too lax, the greater problem was that regulators were nudging financiers in wrong directions, whether it was toward real-estate-linked lending or into the belief that Greek sovereign risk was not that much greater than German. In the early years of the euro, Greece had to pay (on average) less than 0.3 percent more to borrow than Germany. That was nuts, but those steering the euro zone had persuaded themselves that the economies of the countries now locked into the currency union had truly converged. They hadn’t. And, crucially, the warning signals that would have been sent by the currency markets of old — a drachma crash, say — had been silenced. Ideology trumped reality, politics trumped markets, and the result was catastrophe. There’s a lesson in that, but Stiglitz doesn’t appear to see it.

Stiglitz is on safer ground criticizing the steps, from bullying the Irish government to assume private bank debt to the indiscriminate emphasis on “austerity,” taken by the euro zone’s leadership after the crisis erupted. The former is very hard to defend, and the latter was, in some cases at least, overdone, poorly timed, or both: There’s a limit to the extent to which a country can be expected to deflate its way to recovery. But to attribute — as Stiglitz does — the tough love shown by the “Troika” (the European Central Bank or ECB, the European Commission, and the International Monetary Fund) responsible for the euro zone’s bailouts to market fundamentalism is, to put it at its kindest, a misreading. What drove it was the complex internal politics of the currency union.

Stiglitz rightly highlights the difficulty of reconciling the management of the single currency and basic democratic principle. As he notes, voters in the euro zone’s laggards were offered no serious alternative to the harsh and sometimes questionable treatment prescribed for their countries. Beyond that essential but unremarkable insight, he touches on a broader, somewhat neglected issue: what it means when a democracy transfers the oversight of key areas of the economy from the legislature to technocrats and, specifically, to “independent” central banks such as the ECB, a practice Stiglitz attributes to the then (supposedly) prevailing “neoliberal ascendancy.”

That’s a debatable proposition to start with and it has next to nothing to do with the independence of the ECB, which echoes (as Stiglitz recognizes) the traditions of the Bundesbank (Buba), Germany’s legendary central bank. Far from being the product of late-20th-century neoliberalism, Buba’s independence — and its inflation-fighting mandate — date back to its origins in a ruined country that believed it knew where debauching a currency could lead.

Without Germany, there would have been no euro. But, proud of their Deutschmark, German voters didn’t want to switch to a new currency. Sadly, they were never given the chance to reject it, but assurances from their government that the ECB would, for all practical purposes, be a Buba 2.0 were part of a package of promises (no bailouts was another) designed to soothe their unease. Stiglitz discusses the fact that Germany shaped the ECB but fails to give enough weight to the democratic concerns that help explain why.

In any event, those promises were broken, and not just by a series of bailouts. Whether by effectively permitting local central banks to “print” new euros, or by allowing unpaid balances to mount up in its clearing system, or, belatedly (Stiglitz would argue), by a series of increasingly elaborate market operations culminating in the European version of “quantitative easing,” the ECB has turned out to be far less stingy a central bank than German voters had been led to believe it would be.

Stiglitz does not seem too bothered by this: Some democratic failures are evidently more equal than others. He is (legitimately) angry about the way that the Troika forced out the socialist Greek premier George Papandreou (his “long-term friend”), but he has nothing to say about the not-dissimilar putsch that replaced a less ideologically sympathetic figure, Italian prime minister Silvio Berlusconi, with an unelected, obedient proconsul.

Then again, this is the Stiglitz who claims that the objectives of European integration included “strengthening democracy” — a revealing interpretation of a project born of the notion that Europe’s voters could not be trusted to keep the peace. The idea behind what became the EU was that power should be transferred away from democratic nation-states to a supranational authority staffed by largely unaccountable technocrats. And over the decades, it was, often by the sleight of hand made necessary by European electorates’ stubborn suspicion of Brussels’ relentless drive toward ever closer union.

But a new currency was not something that could be introduced on the sly. People would notice. To a greater or lesser degree, the inhabitants of the future euro zone would have to consent to such a change, and to a greater or lesser degree they did. But they were not prepared to surrender enough sovereignty to give the euro a better chance of success. As much as Stiglitz might wish otherwise, that hasn’t changed. If there is to be any realistic prospect of keeping the current euro zone intact while restoring prosperity to its weaker brethren, it will, one way or another, involve a pooling of resources, but the richer countries won’t agree to that on terms that the poorer could accept. This impasse owes nothing to market fundamentalism and a great deal to the absence of a shared identity: Germans are Germans, Greeks are Greeks; neither are Eurozonian. They lack the needed sense of mutual obligation.

Stiglitz maintains that if the euro zone’s members won’t agree to a more comprehensive monetary union, big trouble lies ahead, threatening not only the euro but, maybe, the broader European project. I’m not convinced: “Muddling through” with what Stiglitz labels a blend of “temporary palliatives” as well as some “justly celebrated” deeper reforms has kept the currency going so far, albeit at a terrible cost. It could continue to do so for quite a while yet. And, despite the best efforts of the rebellious Brits, the EU seems set to endure too.

It’s worth adding that Stiglitz’s definition of that more comprehensive monetary union begins, understandably enough, with a credible “banking union,” debt mutualization, and the like, but then spills over into a vision of a command-and-control euro zone that — if that is what is really required to make the currency union work well — is another good argument for putting a stake through it once and for all.

A different way to go could, reckons Stiglitz, be the creation of a system under which euro-zone countries (or groups of countries) adopt “flexible euros” that trade against each other within a (much) more tightly managed version of Europe’s earlier exchange-rate regimes. He also puts forward yet another solution, some form of “amicable divorce”: Either Germany (alone or in conjunction with other northern European countries) should quit the euro zone, or the currency should be divided into new euros — northern and southern, a division that has, in my view, long been the right way to go. What unites these alternatives is the welcome recognition that one size does not fit all: A currency must reflect the realities of its home economy. Tragically, there’s no sign that the central planners in Paris, Brussels, Frankfurt, Paris, and Berlin agree. After all, they tell us, the euro-zone crisis is over.

We’ll see

A Vulnerable Equilibrium

Jens Nordvig: The Fall of The Euro

National Review Online, April 29, 2014

He ate poisoned cakes and he drank poisoned wine, and he was shot and bludgeoned just to make sure, but still Rasputin lived on. And that gives me just enough of an excuse to use the mad, almost indestructible monk to begin an article about a mad, possibly indestructible currency. The euro has crushed economies, wrecked lives, toppled governments, broken its own rule book, made a mockery of democracy, defied market economics, and yet it endures, kept alive by the political will of the EU’s elite, fear of the alternative, and the magic of a few words from Mario Draghi, the president of the European Central Bank (ECB) back in July 2012.

Speaking to an investment conference, Draghi said that, “within our mandate” (a salute to watchful Germans), the ECB was “ready to do whatever it takes to preserve the euro.” “Believe me,” he added, “it will be enough.” Those few words, and their implication of dramatic market intervention, did the trick. Financial markets calmed down, and there are now even faint hints of economic recovery in the worst corners of the euro zone’s ER. And all this has happened without the ECB’s actually doing anything. Simply sending a signal sufficed.

The crisis has been declared over by the same Brussels clown posse that always declares the crisis over. They may be right, they may be wrong, but a calm of sorts has descended on the euro zone — not peace exactly, but quiet, punctuated occasionally by tremors that may be aftershocks, but could be omens of fresh chaos ahead.

That makes this a good time to take a look at The Fall of the Euro, a guide to the EU’s vampire currency by Jens Nordvig, global head of currency strategy for the Japanese investment bank Nomura Securities. If you are looking for a quick, clear, accessible account, free from financial mumbo-jumbo, that explains how the euro came to be, why trouble was always headed its way, what was done when the storm broke, and what might happen next, this book (which was published last autumn) is an excellent place to start.

It is written from the point of view of a market practitioner. Nordvig is not too fussed about the deeper European debate. He mainly wants to know what works. Here and there he will nod politely to democratic niceties, but this is a book where worries over lost sovereignty are dismissed as “sentimental.” Overall, Nordvig is a supporter of closer European integration (“a noble ideal,” he maintains — it isn’t, but that’s another story), but one with considerably less time for illusions than most in his camp.

And the euro, he argues, was built — and run — on illusions, the illusion that Germany was Italy, Italy was Portugal, and Portugal was Finland, the illusion that one size would fit all. Its creation was a “reckless gamble.” Politics prevailed over economics. No one made any preparations for the rainy day that could never come. The foundations for catastrophe were laid, and then built on by regulators, policymakers, and financial-market players only too happy to believe that the impossible was possible. Imbalance was piled on imbalance, and a shared currency masked the nightmare developing underneath. Employed by Goldman Sachs at the time, Nordvig saw how markets viewed the euro zone as an indivisible whole. But Greece was still Greece. And Germany was still Germany.

“Policy makers,” writes Nordvig, “can attempt to circumvent the basic laws of economics, but over time, the core economic truths take their revenge.” Unsustainable boom was followed by what has seemed, until recently, like permanent bust.

Nordvig does a fine job of explaining how the euro zone has been kept intact since the storm first broke, but he focuses more on the how than on the implications. Thus he relates how some of what has been done appears to “circumvent” a clear legal prohibition on European Central Bank financing of public-sector deficits, but seems to see that as more of a curiosity than cause for concern. But concern is called for: The EU’s combination of lawlessness at the top (remember how the Lisbon Treaty was used to “circumvent” those French and Dutch referenda) and tight control over everyone else has been a hallmark of tyranny through the ages.

Then again, financial types generally focus, understandably enough, on the financial rather than the political. But when the two look to be at risk of colliding, market attention shifts. Nordvig suspects that the euro zone may be getting closer to one of those moments.

He sees the euro zone as having emerged from its travails into what is now a state of “vulnerable equilibrium.” But to work properly, it needs substantially deeper fiscal and budgetary integration — something resembling the set-up that underpins monetary union in the U.S. He’s right about that, and that he is goes a long way toward explaining why euroskeptics are so opposed to the single currency. A realist, Nordvig concedes that the political support for such a step is simply not there, and he’s right about that too. New Yorkers might grumble about the way that, courtesy of the federal government, they effectively send cash to Mississippi, but they accept that their two states are in the same American boat. Germans look across at the Greeks (and other mendicants) and realize that they have been conned into bailing out a bunch of foreigners. That’s why, when Germany accepted the need for some sort of fiscal union to keep the euro zone in one piece, it insisted (as Nordvig explains) on an arrangement that falls far short of how such a union is usually understood. The Fiscal Compact that ensued is intended to minimize deficit spending in euro-zone member states rather than give Brussels additional spending power, spending power that could have been used to help out the battered periphery. It is no “transfer union.”

All that is left for the euro zone’s weaker performers is yet more austerity (sensibly enough, Nordvig sees the current currency regime as akin to a gold standard, and not in a good way), adding further bite to the deflationary crunch which these countries face. And it’s a crunch made worse by the perception, both fair and unfair, that it is being imposed on them from “abroad.” Greece is not Germany. And nor is France.

With bailouts resented in the euro zone’s more prosperous north, and austerity loathed elsewhere, it’s surprising how passive voters have been. There are plenty of explanations for this, but Nordvig is right to stress fear of the turbulence that abandoning the euro might unleash (a fear reinforced by establishment propaganda and the failure of many of the euro’s critics to articulate a credible alternative). A residual attachment to that “noble idea” of closer European union has also played a part as has, Nordvig notes, the determination of the dominant parties of center right and center left to hang onto the single currency. That’s something that has left anti-euro, but otherwise mainstream, voters struggling to find an outlet for their discontent.

That said, the prolonged economic grind is increasingly forcing voters in the direction of less respectable parties (such as France’s Front National) that believe that the euro zone and EU need much more than a mild course correction (the FN would pull France out of the euro). If these parties gain significant ground in May’s elections to the EU parliament (the betting is that they will), the danger (or opportunity) is not that they will overthrow the prevailing consensus in the EU parliament (they have neither the numbers nor the cohesion to do that), but that their success will shove their mainstream opponents in a more euroskeptic direction back home. Credibly enough, Nordvig identifies the possibility of a revolt within the political center (which could take very different forms: The Finns, say, may decline to support another bailout, while the Greeks might eventually turn away from austerity) as another potential block on the road to the closer integration that the single currency needs.

Even if the euro zone’s leadership does manage to fumble its way to agreeing on how closer integration could be secured — a deal that would inevitably involve massive transfers of sovereignty to Brussels — it will not be easy to push such a package through without the approval of a referendum or two. On past form, and in the electorate’s present mood, that will not be easy.

But, warns Nordvig, “if further integration is not feasible, some form of breakup is inevitable.” Nordvig may be sympathetic to the European project, but he is too much of a realist to pay too much attention to the Brussels myth that there is no alternative to preserving the euro “as is.” Specifically, he rejects the argument that, just because a “full-blown” breakup would be cataclysmic (as Nordvig convincingly shows, it could well be), all forms of breakup must be too. That’s a claim he heretically and correctly regards as little more than “a convenient tool to bind the euro zone together” and one, moreover, that has been used to stifle any proper analysis of what the costs and benefits of, say, a particular country’s quitting the euro might be. Such a departure, he believes, could be engineered “without intolerable pain.”

In understanding what Nordvig means by this, pay attention to his observation that “the cost of exit may be more concentrated around the transition phase, while the cost of sticking with the euro accumulates gradually over time.” Jumping out of a burning building is never easy, but it often beats the alternative.

Nordvig deftly summarizes what the costs and benefits of that jump might be, concluding that quitting the euro would be very tough for Ireland, Greece, Portugal, and Spain, easier than perhaps expected for France and Italy, and easiest (although far from problem-free) for Germany (I’d agree). That’s a position that logically takes him not too far (although he doesn’t quite arrive there) from support for a division of the single currency into northern and southern euros, something that has, in my view, long been the way to go. According to Nordvig, however, the most likely quitter is a country reduced to a state of such excruciating agony (not only in that burning building, but on fire) that exiting the euro finally comes onto the agenda. That is highly unlikely to be Germany, the nation most able to cope, inside the euro and out.

So what happens next? Suitably cautious in the face of such an uncertain environment, Nordvig lays out a number of different scenarios. While accepting, as he should, that political turmoil could upend everything, Nordvig appears, on balance, to conclude that the German austerity model will prevail, that a transfer union will be avoided, and that the euro zone’s laggards will trudge their way to an excruciatingly slow recovery. My own suspicion is that this assumes too much patience on the part of the periphery. Pushed both by common sense and fear of an increasingly unruly electorate, its governments will start a slow-motion revolt against what remains of the hard-money ECB that the Germans were once promised. Still in thrall to the cult of “ever closer union,” and terrified of the alternatives, Germany’s leadership will acquiesce. In fact there are clear signs that this process may be well underway.

This will lead to another of the scenarios sketched out by Nordvig. Loose money will try to fill some of the gap left by the transfer union that never was, and will do so just well enough to enable the euro to survive, but as a currency that is more lira than deutsche mark. That will be yet another betrayal of taxpayers in Europe’s north, while leaving the continent’s south still trapped in a system that does not fit.

And for what?

Cyprus Sinking

National Review, April 3, 2013 (April 22, 2013 issue)

It says something about the lunatic calculus of Europe’s monetary union that the Republic of Cyprus, a slice of a Mediterranean rock known mainly, if not always fairly, for sunshine, no-questions-asked banking for murky Russian money, and a history of ethnic conflict, has shared a currency with Germany for the past five years. And it says perhaps even more that in 2010 and mid-2011 its two largest banks passed EU-wide “stress tests” that, revealingly and not so revealingly, hugely downplayed the risks that banks were running with their holdings of government bonds. And, yes, those two Cypriot banks had a lot of government bonds — Greek-government bonds — and a great deal of other business in the hard-pressed Hellenic Republic besides. Wait, there’s more: Together those two banks in 2011 had assets equivalent to over four times Cyprus’s GDP. Overall the country’s banking sector had assets that amounted to more than eight times GDP. What cannot go on, won’t. By the second half of 2011, Cyprus was in the grip of a growing financial crunch.

After securing an emergency loan of € 2.5 billion from Russia, Cyprus’s former AKEL government (“Communists,” but not really) turned belatedly, in June 2012, for help to the bailout-hardened troika of the European Commission, European Central Bank, and IMF. Negotiations dragged. It took the election of the new center-right president, Nicos Anastasiades, in February finally to break the logjam. Anastasiades had a clear mandate to agree to structural and budgetary reforms of the type that the troika was looking for, but he balked at demands that depositors with Cyprus’s banks share in the pain. The longer-term consequences for Cyprus’s banking sector, a mainstay of his nation’s economy, would, he knew, be disastrous.

That was not something that worried Angela Merkel. She was said to have said that Cyprus “must realize its current business model is dead.” Helping out the banks in an offshore tax haven was never a proposition likely to appeal greatly either to the chancellor herself — no friend of international finance at the best of times — or to German voters. They are due to go to the polls in September. After years of bailouts that they never liked and that were designed to rescue a currency that they never wanted, there was an obvious danger that coming too generously to the aid of an oligarchs’ playground would be a handout too far. And so Germany played a major role in insisting that any bailout be accompanied by a “bail-in” that would shift a good part of the cost of a rescue onto depositors with Cyprus’s banks.

The Cypriots caved. The euro-zone nations and the IMF would together provide € 10 billion in new loans, but depositors in Cyprus’s banks would have to chip in too, a grim first in the grim history of the euro-zone bailouts. Deposits of over € 100,000 would be subject to a one-off tax of 9.9 percent. Then came an additional, dangerous twist. Depositors with less than € 100,000 would also be taxed — in their case, at 6.75 percent, a levy that made nonsense of the understanding that, within the EU, such smaller deposits are meant to be insured. That breach of faith could easily be seen as an unsettling precedent, especially elsewhere in the euro zone’s troubled periphery.

The Cypriot leadership probably chose to penalize the smaller fry in this manner because they worried that taking too much from the high rollers risked damaging what was left of Cyprus’s offshore-banking business, but it created such an uproar — on the island and beyond — that its overwhelming rejection by the Cypriot parliament a few days later came as a surprise to no one.

It was back to the drawing board. What emerged on the second go-round a few days later was structured somewhat more sensibly. Bank deposits of less than €100,000 are protected, but Cyprus’s second-biggest bank, Laiki, will be restructured out of existence, quite possibly wiping out all uninsured deposits on the way. Its larger rival, the Bank of Cyprus, has been rescued, but this will come as cold comfort to its major depositors, who are likely to end up taking a shellacking so brutal that there will be little to choose between their fate and that of their counterparts at Laiki.

The good news was that this kept the troika committed to the €10 billion loan. That would, said Anastasiades, be enough to stave off bankruptcy. More modest than most euro-zone politicians, he did not claim that his particular chapter of the currency union’s interminable crisis was over, merely that it had been “contained,” an idea echoed by the fact that draconian “temporary” controls on the movement of money out of the country have been put in place. Even so, the president was being too optimistic. The banking sector is shrinking rapidly. Many other businesses have been badly damaged by the calamities of recent weeks and are now facing the prospect of operating in a near-siege economy — conditions that are, in addition, unlikely to attract the foreign investment that Cyprus will now desperately need. Making matters worse still, money will leak out, despite the controls. GDP will contract sharply, perhaps by as much as 20 percent over the next couple of years. Unemployment will soar.

With the economy in free fall and government debt-to-GDP set to rise to some 140 percent after the bailout, it will take a miracle for Cyprus to avoid a return to the begging bowl — a miracle so far-fetched that even Cyprus’s most senior cleric, Archbishop Chrysostomos II, cannot believe in it. The influential archbishop, admittedly long a strong nationalist, is urging abandonment of the euro, which would trigger the nation’s outright default. That won’t happen for now. Anastasiades has pledged to stick with the single currency. A majority of his fellow citizens are probably behind him in that, at least for the moment, for reasons that are easy to guess. A reversion to the Cypriot pound would mean a devaluation that would wipe out much of what’s left of the republic’s shredded savings, threaten massive inflation, and further disrupt an economy that has already lost its bearings. But the argument is not all one way: There’s a decent case to be made that an eventual exit from the single currency would, for all the pain, be the best possible way of repricing Cyprus back into the global economy. This is a debate that is far from closed.

In any event, the most intense phase of the Cypriot storm appears to have subsided for now, but it has left the euro zone even more battered than before. The two most dangerous threats to the survival of the currency union in its current form are a massive bank run and voter revolt. The disaster in Nicosia has made both more likely.

Let’s start with the banks. Depositors throughout the currency union have now been given a sharp lesson. Deposits above € 100,000 are riskier than they had previously assumed, a message reinforced by a series of comments from various euro-zone leaders who in the wake of the Cyprus deal, despite some hemming and hawing, made it clear that a new template is being put in place. Large depositors, bondholders, and other sources of wholesale money to a euro-zone bank are being warned that they should expect to take a hit if that bank runs into trouble. Properly tweaked, that’s a good principle — moral hazard and all that — but, with confidence in the euro zone and its often undercapitalized banks still shaky, now was not the moment to assert it. That was especially so in a week that had seen the introduction of strict controls on the free movement of capital — supposedly temporary (time will tell; precedents are not encouraging) — within a currency union that had allegedly consigned such restrictions to history.

This will mean that banks seen as vulnerable (or banks located in countries seen as vulnerable) will find it even more difficult — and more expensive — to attract funds. (Well, would you deposit more than € 100,000 with an Italian bank?) This is a perception that feeds upon itself, and, in the right wrong circumstances, can easily set the stage for panic. Even those with (supposedly insured) deposits below € 100,000 will have been left uneasy by those few days in which it appeared that the euro zone’s leadership was prepared to go along with a deal in which smaller depositors took a hit. Since then, there have been repeated reassurances that such deposits are safe. Protesting too much? Just maybe, and there’s no getting away from one uncomfortable truth: Those insured deposits are guaranteed at the national level, not by the euro zone as a whole. A guarantee is only as good as the guarantor. Insured depositors in Greece have, therefore, to hope that, in the event of a crisis, the Hellenic Republic is good for the money, or at least for a third bailout.

One possible, partial response to that part of the problem would be to institute a deposit-insurance scheme jointly guaranteed by all euro-zone members, but that would risk inflaming the source of the second great threat now stirring within the euro zone: democratic politics. One reason that deposit insurance has not expanded beyond national borders is the suspicion, most notably in Germany, that signing up for a broader European scheme would be signing yet another blank check, something that would be not only bad housekeeping but a quick way to antagonize the voters. The bailouts have long been unpopular among the electorate in the euro zone’s (reasonably) solvent north, but the eurofundamentalism of most of its political class has meant that, despite some heroic efforts in Finland, this sentiment has done little to derail the trainloads of cash and commitments heading toward the currency union’s embattled periphery.

That’s not to claim that relatively frugal sorts such as Chancellor Merkel have enjoyed making the handouts. They have not. The tough line that they are taking on Cyprus and, by extension, on banks throughout the euro zone is clearly intended to show that there are limits to their generosity with their taxpayers’ money and to the risks that they are prepared to take with their voters’ patience. In a recent poll, some 26 percent of German voters said they “could imagine” voting for a party that was opposed to the single currency. In late February, a new, achingly moderate center-right party, Alternative für Deutschland, was formed to appeal to just such voters. AfD won’t win, but if it takes even a few percentage points in September’s vote, it could make the election rather closer than Mrs. Merkel would like. She won’t want to give AfD any more ammunition than she has to over the next few months, which is just another reason to think that the next bailout drama (keep an eye on Slovenia) may be even uglier than the last: Bank depositors in the euro zone’s other struggling regions will, doubtless, be watching carefully — and anxiously.

But while politicians in the euro zone’s north have to contend, for the most part, only with the threat of voter revolt, those in the periphery have to contemplate dealing with far tougher opposition. If parliamentary approval for the final memorandum of understanding that seals the deal is required, there may be some sweaty interludes in Cyprus (the parliament’s speaker has already signaled his opposition), but the best guess must be that Cypriots are likely to be too traumatized to do anything but go along with the terms of their rescue for now. But the spectacle of their pauperization will not play well with their kin in Greece, already radicalized by years of slump and increasingly hostile to the idea of sticking with the painful austerity that many of them regard (not always completely incorrectly) as self-defeating. That austerity is the price of continued support from the north, not least because, without it, voters in Finland and elsewhere would likely finally say that they had had enough. Rock, meet hard place. For now the somewhat unwieldy Greek coalition government is sticking to the troika’s script, but its leaders can read the opinion polls — and their message of growing anger — as well as anyone else. Meanwhile, in Italy the success of Beppe Grillo’s insurgent (and anti-austerity) Five Star Movement (M5S) in the February elections has led to political paralysis. At this writing, there is still no government in Rome, and the prospect of new elections cannot be ruled out. M5S continues to ride high in the polls. The humiliation of Cyprus will be unlikely to have hurt its case. Meanwhile, Silvio Berlusconi’s PDL, itself deeply skeptical of the troika’s agenda, is also polling well. In the aftermath of the Cypriot deal, Italian bond yields rose, and Italian bank shares fell.

To repeat myself, if you had a deposit in an Italian bank, what would you do?

Tick tock.

Fight For The Finnish

The Weekly Standard, December 24, 2012

He won more votes than any other candidate in Finland’s 2011 parliamentary election, and the maverick party he leads is a profound embarrassment to the current eurozone regime, but there’s something refreshingly down-to-earth about Timo Soini, the leader of the euroskeptic Perussuomalaiset (PS), or, perhaps more easily for you and me, the Finns party. (The former translation of their name​—​the True Finns​—​was felt, a party official told me, to have an “ominous echo” in some corners of Europe of a sort that the PS did not wish to convey.)

Soini, 50, an eloquent, likable, and often amusing former “concrete boy” from Espoo, a city on the edge of Helsinki, was sitting across from me a few weeks ago in a restaurant in Midtown Manhattan. He’s a big man, with big opinions, haphazardly shaven, with rough-hewn features, thick glasses, a shirt with a touch of the lumberjack about it, and an air of genial dismay at my choice of Diet Coke to go with lunch. He has a beer (just one, I note, in case any of the more puritanical members of his party are reading). In his soft-spoken, pleasantly old-fashioned and very Finnish way, he’s outraged by what is now unfolding in Europe.

“A deal is a deal,” he says. The technocrats who once promised that under a shared European currency no country would ever have to bail out another now see things differently. As for the mendicants of the eurozone periphery, let’s just say that Soini is a man with a sharp sense of right, wrong, and history.

Unlike many European countries, Finland, Soini recalls, honored its debts throughout the Depression. And then it paid off the penalties imposed upon it by a vengeful Soviet Union after the Second World War. Later still, it worked its way out from underneath the wreckage of a savage banking crisis in the early 1990s. Left unsaid is the contrast with the Greeks, the Spanish .  .  .

Then it’s not left unsaid. They can be blunt, Finns. The mayhem that the single currency has brought in its wake has upset the European political order in ways that must shock even the utopian gamblers who originally calculated that a “beneficial crisis” was just what was needed to herd the EU’s recalcitrant nation-states into ever closer union. Governments have tumbled across the continent. The far left and neo-Nazis are on the march in Greece. The Catalans are eyeing an exit from Spain. Italy’s democracy has taken a timeout in favor of a technocracy that may soon be replaced by who knows what. Britain could, one way or another, be stumbling towards some sort of end to its unhappy European marriage. And there are plenty more melodramas to choose from.

Where there is Europe, there are euroskeptics. They are a motley crew, ranging from Britain’s neo-Thatcherite UKIP, to the Dutch Koran-bashers of Geert Wilders’s Freedom party, to the postmodern leftists of Beppe Grillo’s 5-Star Movement in Italy, to some groups to the east about whom​—​Soini rolls his eyes​—​the less said the better, and the list doesn’t end there.

Soini’s party, in time-honored populist style, draws on elements of left and right. In a nod to my Englishness, Soini describes his supporters as “working-class Tories.” Yes and no, I’d say. The PS, he explains, is for the workers (“but without socialism”) and for small businesses (“they create the jobs”). Like its counterparts elsewhere in Europe, it draws on the support of older folk and, in return, supports their right to a decent pension. The PS may not, strictly speaking, be socialist, but its 2011 program checked most of the boxes of the traditional Nordic welfare state, including high taxation as a moral good. The Tea Party it is not.

Soini himself is a Roman Catholic convert, exotic for Lutheran Finland. His opposition to abortion is, he admits, a minority view within his own party, but the PS is socially conservative, sometimes abrasively so. Like many euroskeptic parties, it is immigration-skeptic too, occasionally harshly so. When I ask him about this insult or that slur, he replies that a party should not be blamed for everything that one of its members might have said or done. That’s a stock response. What was not was his honest admission that not all his elected representatives are ready for prime time. Some, he sighs, are “stupid” or, he adds more kindly, “semi-stupid.” In a party that has risen so far so fast, that’s not surprising, but, that said, there is undoubtedly a harder edge to Soini’s lot than you’ll find with UKIP’s merry pranksters.

That the success of the PS and its kin elsewhere is due to the overreach of a project​—​an ever more deeply integrated Europe run by a small transnational elite​—​designed to head off such unruly expressions of populism is an irony to appreciate, if not always to savor. That it has happened in Finland only adds to its piquancy. Since joining the EU in 1995, Finland had always been a model pupil, diligent and thoroughly communautaire. Unlike Denmark, and despite initial considerable skepticism on the part of its population (in 1996 fewer than 30 percent of voters supported the idea of a single currency), Finland never negotiated an opt-out from its obligation to sign up for the euro, nor, like Sweden, did it simply grab one. The Swedes and the Danes then rejected the single currency in referenda, an opportunity never offered to the Finns. Eager to please the membership committee of a club they were desperately keen to join, Finland’s politicians were never going to risk allowing their electorate to second-guess the goal of monetary union.

For there was something else at work in Helsinki: the thought of a large and still troubling neighbor. Every step Finland took deeper into its new “European” identity, even the adoption of the EU’s funny money, was a step away from Muscovy. And it is not only the Finns who feel that way. Anxiety over the bully next door does much to explain the increasingly egregious Europhile posturing​—​plus royaliste que le roi​—​by some members of Poland’s political class, and, more poignantly, the reason given by the Estonian prime minister for signing his frugal, well-run country up for the madhouse math of the European Stability Mechanism: “Our objective,” he said, “is to never again be left alone.”

These are sentiments that Soini evidently understands. He shows me a photograph of his daughter standing on the apparently unguarded Finnish side of a stretch of the Russo-Finnish border that runs through the forests to the east. He reminds me​—​with a smile​—​that the U.K. did not exactly rush to Finland’s assistance when the Soviets invaded in 1939. I suspect he is not convinced that, if it ever really came down to it, Brussels’s umbrella would amount to much either. Finland must look after itself.

The still widespread idea that Finland needs Brussels to anchor it in the West is not one that the Finns party shares. It is opposed not only to Finland’s participation in the bailouts, but also to the euro itself (if a tad cagey about what to do about it). Most iconoclastically, the PS would prefer to see today’s EU replaced by a free trade area somewhat akin to the “common market” that gullible Britons believed they were joining in 1973. Within that looser association, Soini mentions there could be room for closer regional cooperation where it made sense, with the other Nordic nations, of course, and the Balts, say, and the Poles and maybe the Brits, too. And the Germans? “No, they would want to bring France with them.”

For now this is just talk. A large majority of Finns want to remain in the EU, and most still prefer to hang on to the euro. The bailouts of the eurozone’s weak sisters are a different matter. They are opposed by well over half of all voters.

It was voter anger over the bailouts that propelled the PS into the big leagues, but the party will struggle to take the championship. In the 2011 general election, it came in third with 19.1 percent of the vote, nearly five times the tally of four years before, but it was a triumph it failed to repeat in the presidential elections in early 2012: Soini (with 9.4 percent) was eliminated in the first round. In October’s municipal elections, the party won 12.3 percent of the vote, a result that may understate its real level of support but was nevertheless a disappointment when measured against the glory days of 2011.

The Finns party may have done its work too well. The two established parties most vulnerable to Soini’s appeal to rural and working-class voters have taken a markedly euroskeptic turn, not least the Social Democrats, from whose ranks the country’s finance minister is drawn. As a result, Finland has become an increasingly awkward member of the eurozone’s glum rescue party. The country insisted that its contribution to the second Greek bailout finalized in early 2012 be backed by collateral. And so (partially) it was, somewhat secretively and somewhat complicatedly, but good enough to allow the Finnish government to offer some reassurance to its restless electorate, a feat it essentially repeated for July’s Spanish bank bailout. Soini clearly remains skeptical about how valuable some of this collateral might eventually prove to be, joking that it really consisted of “stuffed penguins.” But whatever the role that Antarctic wildfowl may play in the efforts to protect the country’s finances, there is no doubt that, where it can, Finland is acting as a brake of sorts on the pace of largesse.

Yet still the ratchet turns. The aggressive actions of the European Central Bank have relieved some of the pressure on the eurozone for now, and Greece has just weathered its latest storm, but the crisis​—​not over by far​—​will continue to fuel demands for the cash and closer integration that the euro’s survival may require. That’ll be bad news for Finland’s finances and a disaster for its democracy, but when it comes down to the wire, the track record of its government​—​which includes just about everybody other than the PS​—​would suggest that it will be unlikely to say no.

The reasons for that might be respectable​—​unwillingness to risk the cost and the chaos that a euro collapse might involve​—​and they might be based on a genuinely idealistic, if misguided, belief in the virtues of deeper European integration, or perhaps even on humility: Is it really for little Finland to put an end to such a grand dream? Then again, less attractive reasoning could come into play. The groupthink of Brussels has a curiously powerful allure, as does the siren whistle of its generous gravy train, and the pleasures, as Soini, puts it, of the (ministerial) Audi.

Soini, who spent time in the belly of the beast as a member of the European parliament and didn’t like what he saw (he tells me a few tales of expense accounts), is not optimistic that Finland will bring this long farce to a close. On the other hand, this is the same Soini who, channeling Churchill, delighted the crowd at UKIP’s 2012 conference with his declaration that “we will never surrender.” Somehow I don’t think that he will.

Estonian Economics

National Review, September 27, 2012 (October 15, 2012 issue) 

Raekoja Plats, Tallinn, August 2012 © Andrew Stuttaford

Tallinn, Estonia – Sitting shirt-sleeved and without, sadly, his trademark bow tie, in his official residence here in the Estonian capital, this Baltic nation’s Swedish-born, New Jersey–raised president, Toomas Hendrik Ilves, looks pained. He’s chewing antacid pills (I’d guess), but it’s the name that I just mentioned that is the problem, not indigestion: “Krugman.”

He sighs.

“I know this has been done to death,” I admit.

Ilves does not disagree.

Estonia has a tragic history of being a battleground for other people’s wars. Thankfully, the latest conflict into which the country has found itself unwillingly drawn — the debate over how the West can emerge from its post-Lehman malaise — has involved nothing more than a “snide” (to borrow Ilves’s adjective) bit of blogging by Paul Krugman for theNew York Times. And even that, the president concedes, ultimately turned out to be “good publicity” for a tale of economic recovery.

In 2008, Estonia’s boom, fueled to overheating by (primarily Scandinavian) banks attracted by the country’s post-Soviet revival, turned, like so many others, into bust. GDP fell by 3.7 percent in 2008 and by 14.3 percent in 2009, taking tax revenues with it: The budget went into a deficit of 2.7 percent in 2008, shocking in a country that aims to run a structural surplus. Unemployment soared to 16.9 percent in 2010, from 4.7 percent in 2007. Housing prices crashed 40 to 50 percent from their peak.

In response, the country’s governing coalition of conservatives and classical liberals cut spending and raised taxes (Estonia’s flat-rate income tax was, however, left untouched at 21 percent) in a squeeze equivalent to over 9 percent of GDP. But it was what happened next that must have really bothered Krugman: After pain came gain. GDP jumped 7.6 percent in 2011, and should grow by 2 to 3 percent this year and next. Unemployment has dropped to 10.2 percent and seems set to fall farther.

That did not fit comfortably with the sometimes-cartoonish Keynesianism that the professor has been pushing since the era of hope, change, and stimulus. So he took to his blog, cropped a graph, and took aim at “the poster child for austerity defenders” — not a role that the Estonians had sought for themselves. There had, wrote Krugman, been a “depression-level slump” (true enough) “followed by a significant but still incomplete recovery. . . . This is what passes for economic triumph?”

Well, no, but that is not what the Estonians, a modest bunch, are claiming. No one I talked to described times as easy, but progress is progress. What’s more, if you push the graph back a touch earlier than 2007, which Krugman used as his starting date, the broader picture is revealed to be rather prettier than the Nobel laureate let on. Yes, it was true that GDP had yet to return to 2007 levels, but it still stood slightly higher than in 2006, no plague year. President of one of Europe’s tech-savviest countries, an irritated Ilves turned to Twitter to rough up the “smug, overbearing & patronizing” Krugman.

Let’s take a step back: Estonia is not Greece. Government is transparent and thrifty. Taxes are paid. Private borrowing ballooned during the bubble years, but that of the public sector did not. At the end of 2008, the state’s debt stood at a sober 4.5 percent of GDP, a figure that might have tempted some governments to try to splurge their way out of recession. In rejecting that route, Estonia did the right thing. It depends on its external trade: Exports amounted to 79 percent of GDP in 2010 (compared, for example, with Greece’s 22 percent). With the European economy in savage, sudden free fall, efforts to pump up domestic demand would have achieved little.

Instead the government concentrated on maintaining the fiscal discipline that is one of the country’s most valuable assets and waited for better times, helped in the meantime by the fact that its banking system (dominated by the subsidiaries of large, well-capitalized Swedish banks) kept liquidity flowing. The wait was not too prolonged. Benefiting from policies often very different from those pursued by the tightwads of Tallinn, many of Estonia’s trading partners pulled out of their post-Lehman dive rather more rapidly than might otherwise have been expected, dragging the Estonian economy up in their wake as exports picked up again. The budget is (broadly) back in balance, and the ratio of central-government debt to GDP stood at 6 percent at the end of 2011, a time, ahem, when the U.S. number was over 100 percent. Estonia’s finances remained intact.

And so, largely, did the population. Demography is a sensitive topic in the three Baltic states, small nations with (in the case of Latvia and Estonia) ethnic balances severely distorted by the influx of Russians who arrived in the Soviet years. The slump has triggered a large wave of emigration. Estonia has been spared the worst of this, not least because of the presence of Finland (Finnish and Estonian are closely related languages) just across the Baltic Sea. Why emigrate if you can commute? There’s probably something else at play, too. All three countries have come a long way since their escape from Moscow in 1991, but Estonia has gone the farthest: Perhaps its citizens were more willing to believe that hanging on would be worth their while.

Estonia’s is an impressive story, but it is a distinctive one, with specifics — including a history of budgetary prudence, the presence of those Swedish banks, a heavy export orientation, assistance from the EU’s structural funds, and a windfall from the sale of emissions quotas — that mean that advocates of an Estonian solution to the euro-zone crisis should proceed with care. Crushing the economic activity on which tax revenues depend is increasing the burden of government debt in many of the PIIGS. In that sense, Krugman was right. Estonia is not a poster child for “austerity defenders.”

But it is a poster child for Estonia: Its frugal, free-market, low-tax, and transparent democracy is indeed something to emulate. An Estonian-style tightening could never have ended Greece’s slump, but if the Hellenic Republic had earlier taken a path that was more Baltic than Balkan, it would not be in the mess that it now is. Coulda, shoulda, drachma.

The sting in this tale is that the euro’s distress may mean that Estonia will not be allowed to follow its own example much longer. This will not be the first time that the trickster currency has caused trouble in Tallinn. It was the prospect of Estonia’s adoption of the euro that triggered that last, fatal surge in Scandinavian lending. On the other hand, it has also represented an additional incentive (and some political cover) for the maintenance of that budgetary discipline without which — ironically, in the light of the shambles elsewhere — the country would not have been eligible for membership in the currency union.

Switching to the euro was seen by most of the Estonian elite as final confirmation that the country had left its Soviet past behind. Even though the Estonian kroon had been pegged to the Deutsche mark, and then to the euro, since its rebirth, many ordinary Estonians were not so convinced that it should be swapped for the single currency, but the terms of the country’s accession into the EU in 2004 rendered their discontent moot. Calls for a referendum were ignored, and Estonia moved over to Brussels’s funny money on January 1, 2011.

If the alternative approach, retention and then devaluation of its own currency (frequently a useful tool in an economic crunch), was considered, it was not considered for long. Exports are vital to Estonia, but it adds comparatively little value to them. Devaluation would therefore have had little impact on their cost to international customers. What it would have done, however, is risk importing yet more inflation into Estonia’s small, open economy. Above all, devaluation would have, as Ilves explains, “wiped out” the middle class. Typically, the mortgages — often on properties that had since collapsed in value — that Estonians had taken out from those generous Scandinavians were denominated in euros. To repay them in depreciated krooni would have been a Sisyphean nightmare. Another alternative, redenominating those loans in local currency, was never a serious option: The liquidity that the Swedes provided throughout the crisis would have dried up overnight.

That was then. The problem now is that Estonia arrived in the euro zone at a very bad time. The safe haven has turned out to be anything but. And it could prove an expensive place to stay. Estonia dutifully helped underwrite the European Financial Stability Facility, the currency union’s temporary bailout fund, and just a few weeks ago ratified its commitment to the fund’s permanent successor, the European Stability Mechanism. If things go badly, that could leave this small country on an unnervingly large hook.

This has not played very well with the electorate. To date, the country’s voters, many of whom remember the infinitely harder Soviet period, have supported the hair shirt. The government was reelected with an increased majority last year. But bailing out feckless, richer folk in Europe’s south (for example, Estonian average earnings are only about one-third higher than the Greek minimum wage) has been a tougher sell. Most Estonians opposed participation in the EFSF and ESM. By contrast, the political class remains willing to trudge through euro-Calvary, although there are some signs that this resolve may begin to crumble if the bailouts grow bigger (and thus potentially more costly to Estonia) and more widespread. And it would be the insult, not just the cost. Should still-poor Estonia really be asked to stump up for Spain? Or Italy?

Ilves points out that, “to put it crassly,” Estonia has profited nicely from its membership in the EU (not least from the financial support that Brussels channels to the union’s less prosperous members), and it has — so far. But there’s an obvious danger that Santa could turn Fagin.

And the euro’s woes menace more than Estonia’s coffers. It now seems clear that attempts to fix the single currency will revolve around trying to integrate the euro zone into a deeper political and budgetary union. Such a union, were it to be formed, would be launched with promises of financial discipline, transparency, and democratic accountability, none of which, given such a construction’s artificial, ill-fitting, and unnatural character (not to speak of the EU’s own lamentable track record in these respects), are even remotely credible. And what then would happen to Estonia, trapped within a Frankenstein union that could be held together only by methods — budgetary and otherwise — that would be the antithesis of everything that independent Estonia has come to stand for?

Neither Ilves nor any other of the political figures to whom I have spoken in Tallinn appear to believe that this is what lies ahead, but, even amid the confidence that is the product of past success and satisfaction at Estonia’s hard-won arrival in “Europe,” it is impossible to miss some hints of uncertainty over what comes next.

That uncertainty needs to be replaced by alarm.

Europe’s Political Contagion

The Weekly Standard, June 11, 2012

That the eurozone has been reduced to a financial and economic shambles was predictable. How little that has changed the continent’s politics was not. To be sure, there have been massive protests in Greece and elsewhere, but the widespread disorder feared by many (including me) in the wake of the 2008/09 financial collapse—arguably the iceberg to the euro’s Titanic—hasn’t materialized, yet. If there is a revolt in the making, it is burning with a slow fuse.

Yes, government after government has fallen, but to what effect? Spain has witnessed the rise of the Indignados, a Mass Occupyish movement, but when the Socialists lost last year’s election, they were replaced by a conservative administration even more determined to trudge to Merkozy than its predecessor. Why so many Europeans have accepted so much misery so quietly so far is a mystery. Welfare narcosis? The calming effect of what’s left of boom-time wealth? It is no coincidence that the most dramatic political upheaval in Europe has been in Greece, the country where the social security net has frayed the most and living standards have collapsed the furthest. The continent’s increasingly post-democratic political structures have also operated as a brake on radical change. The defeat of one party by another has generally made little difference. The eurozone’s dominant political class, center-left, center-right, Tweedledum, Tweedledee, has signed up for muddy approximations of the social market economy and a concrete version of the “ever closer” European integration for which austerity has been the agreed-upon price.

Shortly before the December meeting that launched the fiscal pact designed to enforce better budgetary discipline within most of the EU (the Czechs and Brits kept their distance), a German journalist reminded me that a large majority in his country’s parliament favored plunging even deeper into the European swamp (not his word). When I replied that many German voters did not, his response was a shrug of the shoulders. Yet this mismatch—visible across the eurozone—between the opinions of those who sit in Europe’s parliaments and those that they purport to represent could prove dangerous in times as fraught as these. Elite consensus is forcing voters searching for alternatives to today’s destructive euro-federalism into some very strange places. They may not resort to riot, but their choices at the ballot box could amount to much the same, or, indeed, to something even worse.

Greece’s May elections saw the arrival in parliament of the neo-Nazi Golden Dawn and the dramatic rise of Syriza, a far-left anti-austerity coalition led by Alexis Tsipras, a wannabe Aegean Hugo Chávez. Come the next elections (June 17), Golden Dawn may run into a spot of dusk, but Syriza is likely to end up either in the catbird seat, or close to it. That may mean a hot summer, even by Athenian standards.

Fiercer political discontent is not confined to Greece. In Ireland, another eurozone casualty, voters approved the fiscal pact in a referendum on May 31, but Syriza’s surge has been echoed in gains by the leftist, nationalist Sinn Fein (traditionally the political wing of the IRA) on the back of a platform with distinctly Tsipras touches: opposition to austerity and rejection of a discredited political elite. Such sentiments are not confined to the currency union’s mendicant fringe. In the Netherlands, Geert Wilders’s populist-right PVV maintains that too much austerity is being asked too soon of the tolerably prudent Dutch (and can we have our guilder back?), while the ascendant leftists of the Socialist party just don’t like the idea of austerity, dank u wel.

In April, the first round of their presidential elections saw over 11 percent of the French opt for a leftist hardliner calling for a “citizens’ insurrection” against a sadly imaginary “ultra [classical] liberal” Europe. The far-right National Front grabbed third place and nearly a fifth of the votes. Its promise to junk austerity, and with it the euro, did it no harm.

Italy being Italy, there have been troubling terrorist stirrings, but its mutineer-in-chief is a comedian. Beppe Grillo’s Five Star movement emerged from hugely popular “V-Day” protests in September 2007 opposed to Italy’s rancid status quo (the V stood for vaffanculo, a phrase untranslatable in a respectable magazine but useful enough as an expression of inchoate rage). These demonstrations predated the eurozone’s meltdown (if not the euro’s steadily corrosive effect on the Italian economy), but have since been reinforced by it. After impressive local election victories in May, Grillo’s movement stands at almost 20 percent in the polls on a program that includes greenery, anticorruption, disdain for austerity, and hostility to the euro.

François Hollande’s ultimately successful campaign for the French presidency played skillfully into some of these themes. He harnessed the social resentment that has been sharpened across large swaths of Europe by economic slowdown, prolonged financial crisis, and the drive, however meandering, for austerity, and he rode it all the way into the Élysée Palace. The eurozone’s straitjacket could, he promised, be loosened to accommodate “growth.” Doubtless Mrs. Merkel will offer some cosmetic alterations, but that will then be that, and there will be little that Hollande can do about it. Instead he will have to face the bleak reality foretold by the flawed, darkly brilliant British politician Enoch Powell in a debate on European monetary union more than three decades ago:

Surrender the right to control the exchange rate .  .  . and one has, directly or indirectly, surrendered the controls of all the economic levers of government.

As the eurozone economy twists in the wind, that’s something that President Hollande will find tricky to explain to his voters. Even if Angela Merkel, the person closest to those levers (with solvency comes power), wanted to help him out (and in some respects she might)—the chancellor appears torn between German frugality and loyalty to European “solidarity”—her ability to do so may be constrained by the way that the euro’s woes are continuing to rile up a domestic electorate already deeply skeptical of the eurozone’s bailouts, particularly when headed in Athens’s direction. It’s not easy to work out exactly what the upstart Internet freebooters of Germany’s Pirate party (in another sign of Europe’s increasingly febrile politics, they have now swept into four state legislatures) stand for. But it seems not to include bailouts.

As for the once again fashionable miracle cure, “eurobonds” issued by the eurozone as a whole, that’s finding few fans in the country that would effectively be underwriting this paper. According to a ZDF poll in late May, 79 percent of Germans rejected the idea, and even its proponents in Merkel’s principal opposition, the left of center, more-euro-than-thou Social Democrats, were showing some signs of backing away.

Merkel finds herself stuck. Her support has, until recently, held up well at the national level, but that’s been bolstered by the hard line she has been taking on the eurozone. Austerity may be enraging many beyond Germany’s borders, and it may be the wrong medicine for what ails the single currency in which Merkel evidently still believes. Too bad it’s the only approach that her voters (who are, after all, paying the bill) seem prepared to accept. If she backs down now.  .  .

So many rocks. So many hard places.