Tango Lesson

The Weekly Standard, December 12, 2011

Casa Rosada, Buenos Aires, August 2011 © Andrew Stuttaford

There are good days and bad days, but even on the good days the abyss is never too far away. The eurozone’s dangerously original mix of innovation, incoherence, and unaccountability makes it difficult to identify a single event that could finally push it over the edge. But, with confidence already shot, there is one obvious contender, a series of old-fashioned bank runs given a brutal new twist by the logic of currency union as cash pours out of the stricken banks and the country (or countries) that hosts them. Unless the European Central Bank could show that it has what it really takes, fear would feed on itself, credit markets would seize up, and that, quite possibly, would be that.

The extra liquidity offered by the Fed and other central banks on November 30 was a sensible precautionary move, but its extent and its timing were clear signs of anxiety that, while the eurozone’s leadership moves from grand plan to grand plan, the building blocks of disaster are falling into place. U.S. institutions are wary about extending short-term funding to many European banks. European banks are wary about lending to each other.

Of all the sickly banks surviving on the Rube Goldberg life support systems now being deployed in the eurozone’s grisly ER, Greece’s are probably (and the implications of that “probably” are appalling) the most vulnerable to the panic that could set everything off. Their country is the closest to default. If Greece goes under, its banks will, without fresh capital, go under too. So what are their depositors doing?

They are not yet running. But they are walking away at an ever quicker pace (deposits have fallen by over 20 percent since January 2010) that can only have accelerated since the moment in early November when Angela Merkel and Nicolas Sarkozy first conceded that a country’s eurozone membership might not be irrevocable after all.

To understand just how bad things could get, the best place to look is Argentina in early 2001. In 1991, just 10 years before, Latin America’s most gorgeously faded republic had decided to turn over its latest new leaf. It linked its peso to the dollar at a 1:1 exchange rate. This peg was backed by reserves held by a currency board. Despite its distinctly permissive, distinctly Argentine, characteristics, it was designed to use external market pressure to force the country into the tough financial discipline that it had found impossible to impose upon itself. Those Greeks who regarded the EU’s single currency as something more than a free lunch supported signing up for the euro for pretty much the same reason.

At first, the Argentine experiment worked well. The economy grew briskly, and foreign lenders were pleased to feed its growth in a manner well beyond the capability of Argentina’s relatively small banking sector. After all, they told themselves, the country had changed its ways, and, thanks to the peg, exchange risk had been hugely reduced. What could go wrong? If you think that sounds a lot like the talk that accompanied the prolonged surge in international lending to Hungary, Latvia, Greece, Ireland, and all the other future catastrophes crowded into the euro’s waiting room (and, subsequently in some cases, the eurozone itself) just a few years later, you’d be quite right.

What could go wrong, did: Deep-seated structural flaws within the local economy, a series of external shocks (starting with the Mexican crisis of 1994), weaker commodity prices, and stresses flowing from the fact that the dollar and the peso were an ill-matched pair all combined to push the country into difficulties made cataclysmic by ultimately unsustainable levels of foreign debt. Private lenders shied away. Private capital fled. Taxpayers hid. Ratings agencies screamed. The cost of borrowing soared. The resemblance to Greece in 2011 is unmistakable. Interestingly, the Argentine storm was gathering strength at the same time as Greece was being accepted, not without controversy, into the eurozone, raising the question what in Hades the EU’s leadership was playing at. The implicit warning for Greece contained in the Argentine disaster was as clear as Cassandra, and just as ignored.

In any event, as the 20th century lurched into the 21st, Buenos Aires previewed Athens. There were differences, of course, not least the fact that Argentina had hung on to its own national currency, but that meant less than it might have done. By the end of the 1990s, 90 percent of Argentina’s public debt was denominated in a foreign currency, marginally better than Greece’s 100 percent (for these purposes the euro is a “foreign” currency everywhere), but not by enough to give any comfort. And it wasn’t just the debt: Wide swaths of the economy had been dollarized.

And so had the banks: According to the IMF, close to 60 percent of the Argentine banking system’s assets and liabilities were denominated in dollars throughout the second half of the 1990s, leaving the banks horribly exposed in the event that the peg broke. Indeed, the potentially enormous cost of breaking the peg was a good part of why it was maintained, a logic similar to that now keeping the embattled PIIGS (Portugal, Italy, Ireland, Greece, and Spain) on the euro’s leash. This should come as no surprise: The stability that such mechanisms can bring largely rests on the absence of any obvious exits. Countries that sign up for them need to be sure that they have what it takes to stay the course. Slinking in on fudged numbers and, ludicrously, expected to maintain some sort of pace with Germany’s Porsche economy, the Greek jalopy stood even less of a chance than had far-better-intentioned Argentina.

Argentine headlines in 2000-01 must have read much like those in Greece today. The country accepted billions in international assistance (from the IMF) in exchange for the imposition of austerity measures that pummeled an already faltering economy. There was a voluntary debt swap (on terms as absurdly expensive as those proposed for Greece earlier this year) that bought time, but no confidence.

Massively widening spreads between peso and dollar debt signaled the market’s fear that the peg was doomed. But, to quote the IMF’s invaluable Lessons from the Crisis in Argentina (approved by one Timothy Geithner), it was “the resumption [in July 2001] of large scale withdrawals from Argentine banks [that was] perhaps the clearest sign of the system’s impending collapse.” Indeed it was.

The banks—and, of course, the country itself—were quite literally running out of the dollars that made up a monetary base already depleted by previous capital flight, and a growing current account deficit. The rules of a currency board (even in its looser Argentine variant) meant that it was not possible simply to print money to fill the gap. This is a problem familiar to those of today’s PIIGS who have to watch the money drain out of their economies, yet are blocked from direct access to the printing press by the European Central Bank. Argentina’s more sinuous treasuries (provincial and then national) tried to meet this challenge by issuing a series of evocatively named quasi-monies (IOUs, basically), but these patacones, porteños, quebrachos, and lecops were harbingers of doom, not a solution.

And when the dominoes of finance finally fall, they fall quickly. To return to the IMF’s grim textbook: “The crisis broke with a run [on] private sector deposits, which fell by more than $3.6 billion (6 percent of the deposit base) during November 28-30.” At that point the game was up. The authorities’ response (notably the introduction of the corralito) should alarm depositors throughout the PIIGS as they mull how their governments might stop precious euros escaping to safe havens abroad in the wake of bank runs at home.

The corralito limited cash withdrawals from individual bank accounts to the equivalent of $250 a week (the dollar value would soon fall sharply). And the response to it should worry those now running the PIIGS. Argentinians took to the streets and reduced the country’s political order to chaos. Depending on how you define the term, Argentina had five presidents in less than a month, but none could change the inevitable. The country defaulted on its debt, the peg was scrapped, the peso tanked, and the corralito was replaced by the corralón, the centerpiece of an even tougher regime. Depositors were allowed to withdraw a little more money than before, but only in heavily depreciated pesos. Term deposits were frozen, and transfers of money out of the country heavily restricted. Not so long after, dollar deposits were switched into pesos, and the ruin of Argentine savers, many of whom lost their jobs as the economy crashed, was complete.

History does not always repeat itself. Maybe those remaining Greek depositors are confident that, however battered their nation’s finances, its guarantee of bank deposits up to some $135,000 will hold up through the toughest times. Maybe they have faith that Greece will stick with the euro. And maybe they trust that, should the walk from Greek banks turn into a run, the European Central Bank will do what it takes to put things right. But if they do have any doubts, they can, for now, easily move their euros to a part of the eurozone—Germany, say—where there is no currency risk and bank deposits are blessed with a guarantor that is, you know, solvent. Thinking like that is how a run on the banks can begin. Paranoid? Well, if you were a depositor with a Greek bank, what would you do?

And, if you were a depositor in an Italian bank, watching all this and aware that money is ebbing away from Italy too, what would you do?

I know what the Argentine advice would be. Run.

And if the Greeks run, and the Italians run, who will be next?

Right but Repulsive

Peter Oborne and Frances Weaver: Guilty Men

The Weekly Standard, October 31, 2011

A doctor ignored by a smoker won’t celebrate if lung cancer strikes. Britain’s euroskeptics are generally too worried about the consequences of the Eurozone’s thoroughly predictable crisis to submit to the temptations of I told you so.

Well, most of them are. The United Kingdom may be outside the Eurozone, but some British Banquos have managed to crash its beggar’s banquet nonetheless. One, Foreign Secretary William Hague, has compared the currency union to “a burning building with no exits.” He can be forgiven his bluntness. As Tory leader, he had said the same and much more besides when that ill-fated building was still under construction. The reward for his prescience was to have his words used against him as part of a vicious and deceptive campaign that failed in its specific objective, yet succeeded in a wider task: contributing to a political and cultural climate that doomed Hague to vilification and defeat in the 2001 general election, and Britain to years more of Tony Blair.

That campaign—to persuade Britons to adopt the euro—has now been retrieved from the memory hole and made the subject of Guilty Men (Centre for Policy Studies), a brutal, brilliant new pamphlet by Frances Weaver, a freelance writer and researcher, and Peter Oborne, the Daily Telegraph’s chief political commentator. The title is provocation and insult. Published in 1940, the original Guilty Men was a savage, if not always accurate, attack on British politicians of the appeasement era. To revive its name was to hurl down a gauntlet.

Guilty Men should be seen as the third in an Oborne trilogy that began with The Rise of Political Lying (2005). That volume and The Triumph of the Political Class (2007) are two of the finest books on British politics in recent years. Their titles speak for themselves, and their message ought to resonate far beyond Britain. The same is true of Guilty Men. Within its covers you will find the description of an elite unimpressed by its homeland, enthralled by transnationalism, seduced by the main chance, and buttressed by a mistaken conventional wisdom that it chose to defend by any means possible. None of this, of course, could ever happen here.

Like all the best thrillers, Guilty Men begins with a dastardly foreign plot. In its introduction, Peter Jay, a distinguished journalist and a former British ambassador to the United States, describes a lunch in Paris he attended as a 15-year-old in 1952. The guest of honor was the French diplomat Jean Monnet, the man who launched what eventually became the European Union. Dismayed by the spectacle of a France now eclipsed by the United States and Soviet Union, Monnet apparently explained that the only way that la gloire could return to France was within a Greater Europe. But this would have to be a superpower created gradually and by indirection, “by zig and by zag,” until, as Jay puts it, “the walls of old-fashioned national sentiment collapsed in favor of a new focus of national unity, Europe itself.”

In the nearly 60 years that have followed, there has been plenty of zig, and plenty of zag, and rather too much European Union, but the United States of Europe has yet to emerge. And as for “the dimension of empire” that EU Commission president José Manuel Barroso claimed to detect within Brussels’s realm back in 2007, well. . . .

Critically, there is, to borrow the unkind observation of Václav Klaus, the Czech Republic’s splendidly Thatcherite president, “no European demos—and no European nation.” There are, of course, the institutions—the parliament, the Commission, and so on—and the pretensions and the massive regulatory overreach. There’s a pretty flag and, via Beethoven and Rhodesia, a nice enough anthem, but that’s about it. To the extent that there is any European patriotism beyond the expensively furnished lairs of the upscale and, let’s concede the point, some genuine enthusiasm for Europe’s Ryder Cup golf team, it finds its most powerful expression in, significantly, something negative—distaste for the United States. These are too-flimsy foundations on which to build a challenge to the world’s colossi.

Thus it was not some atavistic dream of empire that persuaded so many of Britain’s best and brightest to rally behind the campaign to sign their country up for a shoddily constructed currency that was, whatever Paul Volcker (oh yes) might have said, clearly ill-suited to the U.K. economy. For some, career was the motive, and not only in an obvious way. Brussels can pay well, directly and indirectly, but, more than that, opposition to the euro had been cleverly smeared as a badge of the bizarre, an ornament to no résumé worth having.

The sharply told tale of how the opponents of the Eurozone’s madhouse money came to be regarded as nuts takes up some of the most interesting sections of Guilty Men, but it’s worth pausing to note how the structure of Britain’s politics and media makes it easier to manipulate public opinion there than in the United States. Power is much more centralized. There are fewer movers and shakers who need to be convinced. There are no awkward states to cajole. The press is ideologically diverse, but television and radio matter far more, and in broadcast the loudest voice is that of the officially nonpartisan, taxpayer-funded BBC, a megaphone for the pieties and prejudices of the soft left. There is no meaningful equivalent to Fox News or America’s gung-ho Genghis talk radio to bite back. And at the time when the euro wars were at their most intense, the blogosphere was still being born, and Twitter had yet to hatch.

The BBC had therefore an immense advantage, and it abused it. In the course of one nine-week period in 2000 on BBC Radio 4’s influential Today program, Oborne and Weaver record, “the case for the euro was represented by twice as many [speakers], interviews, and soundbites [as] the case against.” That’s not the end of it. A controversy can be defined by the way that it is framed by the media. When euroskeptics were heard on the BBC, it was often in the context of hugely exaggerated reports of splits within Conservative ranks over the single currency. A divided party is electoral poison, and the splits became the story. The argument against abandoning the pound was shelved for another day.

Word games of a type all too familiar from America’s mainstream media were deployed (it was euroskeptics who were the “hardliners”). Scare stories of the terrible fate that awaited Britain outside the Eurozone made headlines, inconvenient statistics that cast doubt upon them were buried. If you think that sounds a lot like much of the American media’s treatment of the global warming debate, you’re correct.

The BBC was not the only prominent media institution to play these tricks. The Financial Times is widely perceived as authoritative, serious, informed, the voice of British business, the house journal of the City. It is meant to be something more than a mere newspaper. Oborne and Weaver demonstrate how, when it came to the euro, it was very much less. Not all its writers played along, but too often the Financial Times resorted to a camouflaged advocacy journalism that may even, ironically, have contributed to the Eurozone’s present mess. How many bankers will have read the paper’s ecstatic accounts of the euro’s progress and felt just that much better about lending to Greece, Ireland, or Portugal? What could go wrong? On May 26, 2008, the FT ran a leading article with a headline that included these words: “Europe’s currency union has been a remarkable success.” Remarkable indeed. Less than two years later the first Greek bailout was under way.

With such purportedly fair-minded grandees lending weight to the cause of the euro, and the Tories burdened by the irrational popular loathing that had swept them out of office, the vitriol of more openly partisan journalists came to be treated by many as something approaching gospel. In its viciousness their work anticipated the high-minded nastiness seen in the coverage of the Tea Party a decade or so later. Weaver and Oborne have plenty of examples showing just how low reputedly respectable detractors of “euroskeptic pus” could stoop. The euroskeptics were a “menagerie of has-beens, never-have-beens, and loony tunes.” They were “a sect” of “intellectual violence . . . [stoking] the phobic fire.” They were keen on “Hun-bashing,” yet had something to do with the Latvian SS. They were liars, they were hatemongers. They were a “paradigm of menace and defeat,” “extremist,” “dogmatic,” and “hysterical.” Surely someone somewhere must have said that they were “bitter.” They were “maniacs.” Their opponents were “sane,” a loaded adjective frequently abused in American polemics too.

This dark mood music was deftly conducted by Prime Minister Blair and an entourage skilled in the blackest arts of politics. What was there to lose? An economic illiterate, Blair didn’t grasp how destructive dumping the pound could be, but as an iconoclast he appreciated the break with the past. And campaigning for the euro could bring its own rewards. The Conservatives’ opposition to a change supported by some of the country’s smartest could be used to reinforce the image of the know-nothing Tories, out of touch and not even “sane.” The assault was relentless: Addressing the Labour party conference in 1999, Blair launched into an attack upon the “forces of conservatism,” a faintly totalitarian diatribe that implicitly linked the jailers of Nelson Mandela to the euroskeptic threat. The idea was to push the electorate’s perception of the Tories to a point where the Conservatives would be viewed as oddballs who deserved to be driven out of parliament and, indeed, polite society altogether: Under former Conservative prime minister John Major, explained Blair, “it was weak, weak, weak. Under William Hague, it’s weird, weird, weird. Far right, far out. . . . The more useless they get, the more extreme they get.”

Naturally, a place in the respectability room would be found for those “sane” Conservatives who would sign up for the “cross-party” crusade for the euro. Quite a few did just that.

Polite society paid attention. Conventional wisdom builds upon itself, especially when self-interest is greasing the way. It wasn’t just individuals on the make who discovered their faith in currency union; it was companies too, dancing the corporatist waltz. Obama’s GE would understand. Firmly in the pocket of big business interests confident of their ability to play the EU game, the influential Confederation of British Industry (CBI) threw itself behind the campaign, lending it further credibility and then, less helpfully, incredibility. The CBI’s polling data showed that 84 percent of British business supported the euro. Once this distinctly Soviet result was revealed (thanks to the work of yet another determined euroskeptic “crank”) to have been arrived at by distinctly Soviet math, the pushback slowly began. Within a few years the CBI found itself (in the words of one well-known journalist) “tugged towards the new extremism and europhobia.” In other words, it adopted a neutral stance on the euro.

But don’t see this saga as evidence of some giant conspiracy. There were a few plotters to be sure, notably in the Labour party and, doubtless, Brussels, but for the most part the surge of support for the euro among the U.K.’s chattering classes was the result of something more insidious and less planned: This was a scheme they simply felt to be right. For many British intellectuals, the cultured Europe of their vacations and their imaginations has long been a finer place than their grubby, greedy, and in all senses insular homeland. The weather is nicer, the food is better, and the ambience is both pleasingly picturesque and refreshingly sophisticated. Most alluring of all, Continentals treat the intelligentsia with a respect rarely to be found in unruly, ill-read Blighty.

To such folk, confident in the inadequacies of what they prefer to describe as their midsized nation (then perhaps the fifth-largest economy in the world, with nukes to boot, but let that pass), the EU was a safe haven that only the mad or the bad would disdain. The fact that it had evolved, not into the superpower of Peter Jay’s fears but into the vaguely utopian, proudly progressive post-national technocracy that was Monnet’s greater vision, only added to its appeal. If signing up for the euro was the price of admission to the EU’s inner circle, why would any civilized, “sane” individual want to object? And who knew anyone who had?

There was a lady called Pauline Kael who once asked a question much like that.

In the end, the thin red line held, maintained by politicians of integrity (and, yes, sometimes eccentricity), the caution of British voters, and, crucially, the venom of Gordon Brown, the finance minister, too jealous of the upstart Blair to allow him to take the U.K. into the Eurozone. Britannia stayed out, and has weathered the current economic storms far better than she could have done with the euro around her neck. Signing up for the single currency will be off the agenda for quite a while.

A happy ending then? No, it’s more a “to be continued.” As Weaver and Oborne understand, the opprobrium heaped on the Conservative party for being, as it turned out, right about the euro helped derail the careers of three Tory leaders and paved the way for “modernizers” such as Prime Minister David Cameron, determined to avoid “banging on about Europe” at a time when that’s just what he needs to be doing. The increasingly desperate attempts to resolve the Eurozone crisis are likely to include proposals to change the EU’s legal framework in ways that will require the approval of all member-states. That will be a good moment (if Cameron can be persuaded to seize it) for the U.K. to finally play hardball with its European partners over the repatriation of powers that should never have been transferred to Brussels in the first place. Britain’s euro-claque will noisily object. A reminder to the rest of the country of just how hard that still largely unapologetic claque worked to shove Britain into the Eurozone’s abyss is just what such a debate could use. And that’s what Guilty Men is designed to provide.

Oborne and Weaver give plenty of indications of how much it will be needed. One of the guilty, former EU commissioner Lord Patten, chairs the BBC’s governing body. His vice chairwoman, Diane Coyle, is a lady once deeply concerned about the “gut anti-Europeanism and Little Englandism” of the pound’s “elderly” defenders. This dismal duo will find little in the Beeb’s current EU coverage to disturb them. The Financial Times is now edited by its former Brussels chief, another cheerleader for currency union. He is in charge of a newspaper that appears sadder these days, if not much wiser. Waiting, perhaps, for a fresh euro-dawn, former CBI boss Adair Turner is currently using another collective mania to hobble the British economy. He’s chairman of Britain’s Committee on Climate Change, a perch from which he can admire similar efforts by Britain’s destructively green energy minister, Liberal Democrat Chris Huhne, a europhile who has lost none of his vim. And then there’s Tony Blair, continuing to pontificate to anyone who will pay attention or, at least, pay. He’s not the only member of the Labour party who still believes that Britain should sign up for the single currency—when the time is right, of course.

Zig and zag.

The Euro Endgame

The  Weekly Standard, August 1, 2011

Billion by billion by billion, showdown by argument by ultimatum, Greece’s latest bailout is being put together by those who run the eurozone. The country’s finances are so bad, and its prospects so poor, that even the new $159 billion rescue package announced on Thursday will (assuming it comes into effect) probably only prove to be a reprieve.

Never mind. Buying time is the name of the game. If Greece can be kept going, and Portugal and Ireland too, financial markets might, fingers crossed, calm down, and the threat that panic might engulf Spain and Italy—two economies too big to bail out—and the banks that have lent to them might recede. Then, come July 2013, the $1.1 trillion European Stability Mechanism will spring to life. It will be backed by the 17 members of the eurozone, be policed by Brussels, and it will inherit the proto-IMF powers now being proposed for the European Financial Stability Facility that it will succeed. Well, that is the plan (at the time of writing), complete with a hint of Ponzi, a dash of Micawber, and dire warnings of what the alternative might be.

There’s a lot that needs not to go wrong, but of all the elements that could, the most dangerous may come from a source that Brussels has long tried to write out of the plot: the ballot box. There’s an irony to that. If there was anything (other than misplaced Carolingian nostalgia) at the heart of the project for a European union it was the idea that, after the wars of the first half of the twentieth century, the peoples of the old world could no longer be trusted with their own sovereignty. It’s never been much of an argument, but it’s worked well enough for the EU’s emerging technocratic elite.

The establishment of the euro is thus best understood as just another stage in the progressive disenfranchisement of Europe’s voters. The replacement of domestic currencies with what was, in effect, foreign money meant that, as a practical matter, the countries (and particularly the weaker countries) of the eurozone lost much of what was left of their fiscal and economic autonomy. Previously a nation with subpar finances and/or an uncompetitive cost base could allow the depreciation of its lira, its drachma, or its escudo to restore some balance. Its standard of living might fall relative to its international competitors’, but it could usually muddle along in the fashion that its people had, one way or another, chosen.

Now that option was closed. Forget the voters; once a country could no longer print its own money it had to run itself in ways that ensured it could keep international creditors—which is to say all creditors—happy. More generally, it had to manage itself in a manner that allowed it to keep reasonably close to the pacesetters of the monetary union in which it now dwelt—and if that country was Greece and the pacesetter was Germany, that was only going to be possible (if at all) with wrenching political and cultural change. That change might have been desirable, but to think that external discipline alone would be enough to set it in motion was a fatal conceit.

After 10 years in the currency union, Greece needs to devalue its currency by perhaps 50 percent. With no drachma to debauch, the only alternative is drastic austerity, and that is where politics may spoil the unlovely technocratic party that is now being thrown for the Hellenic Republic. In early July, Jean-Claude Juncker, the Luxembourger who presides over the organizing committee of the eurozone’s finance ministers, announced that Greece’s “economic sovereignty” would be “massively limited.” But what if the Greeks say no?

So far, their parliament has voted through what it has to, but the opposition is not on board, and the economy is being pulled down ever further by debts that cannot be repaid and a currency that Greece cannot afford. With unemployment at an official 16 percent (or 43 percent of those under 24) and further street disturbances a certainty, how long will it be before Greece decides that it has less to lose than its creditors from the “selective” default it is now to be permitted? The crisis has already brought down the Irish and Portuguese governments and contributed to the humiliation of Spain’s ruling Socialists in recent local elections. For all the Brussels chatter of additional “structural funds” to be deployed in the “relaunch” of the Greek economy, how much do Greece’s politicians really have to lose by calling Juncker’s bluff?

Faced with a future that offers, at best, a bleak and humiliating road ahead, their counterparts in other PIIGS (Portugal, Ireland, Italy, Greece, and Spain) may come to feel the same. Thus the Irish are reexamining the wisdom of guaranteeing the liabilities of their broken banking system to the extent that they have—a promise that, at this stage, may be worth more to foreign creditors than anyone at home.

Those who have found themselves feeding PIIGS are unhappy too, nowhere more so than in Germany, the country that is effectively underwriting the euro, a currency that—true to Brussels form—its electorate was never truly asked to endorse. As for the risks, they were barely discussed with voters, and when they were discussed, they were denied. German taxpayers would not be on the hook for anyone else, oh no. But that’s not how it has turned out for them, and they are not well pleased.

This has put German chancellor Angela Merkel in a spot. Without German support for the eurozone’s crumbling periphery, decidedly unselective defaults will trigger the financial contagion that policymakers are trying to avoid. For all her disapproval of PIIGS sty failings, the pragmatic Merkel understands this perfectly well, but her power to force through another round of assistance is not what it was. She still commands a comfortable majority in the Bundestag, but, in part thanks to the controversy over German participation in earlier bailouts, she has lost her grip over her country’s upper house. There may be worse to come. Polls taken before the announcement of the latest rescue plan showed that over 60 percent of Germans opposed extending further money to Greece, and this discontent is penetrating her governing coalition.

And opposition to bailouts has been mounting amongst voters elsewhere in the eurozone’s richer north for quite some time. That’s ominous. The new Greek package, and the changes to the European Financial Stability Facility that accompany it, require the approval of every member of the coalition of the unwillingthat is meant to be providing the funds. Earlier bailouts have already riled voters in Austria, divided the ruling Dutch coalition, and helped propel the True Finns, a once-small populist party, to third place in April’s Finnish general election with 19 percent of the vote. Under the circumstances the notion that the Greek rescue plan will sail smoothly through all the national parliaments involved looks like fantasy.

The politics will be rough, and they will get rougher. Neither this bailout, nor the expanded European Financial Stability Facility, nor its successor, will be enough to unwind the imbalances now ravaging the eurozone’s periphery. The best chance of achieving that will be to move on to a quasi-federal budgetary, fiscal, and “transfer” union. That will be a hard sell to electorates in those countries that will be footing the bill (probably in excess of an annual $150 billion), and after the fiascos of the last year or so it will be politically too dangerous to try, once again, to bypass them.

Voters may well start to count after all.

Greater Europe, Lesser Europe

National Review, June 2, 2011 (June 20, 2011 Issue) 

By the time you read this, Greece may have defaulted on its debt. Or it may be preparing to default, but without the D-word. Most likely it will be negotiating another rescue package, but it may still be fighting to secure the latest payment under its existing bailout. Only one thing looks certain as I write. The eurozone crisis will not be over.

It’s been a long, hard journey since the first Greek bailout just over a year ago, a €110 billion loan package from the European Union (€80 billion) and International Monetary Fund (€30 billion) secured by pledges of drastic austerity. A €750 billion European Financial Stability Facility was announced a little later. The prospect of its billions’ being available to any eurozone country that ran into difficulties was intended to “shock and awe” (yes, that term again) the financial markets into calm.

It did not work out. Both Ireland and Portugal have since had to be bailed out. The destructive contradictions of the one-size-fits-all currency remain unresolved. The damage they caused is unrepaired. Then there’s the fact that the very nature of the eurozone leaves its weaker members vulnerable to fears of default. Most of their debt is in euros, and, for all practical purposes, the euro is a foreign currency. Once investors move out of, say, Irish bonds to safer euro debt elsewhere, all that Ireland can do to lure them back is increase interest rates and tighten its belt yet again. If that doesn’t work, the cash will run out.

Belgian economist Paul de Grauwe argues that a liquidity crunch of this type could force an otherwise solvent country into default. Maybe; but in Greece’s case that’s beside the point. The country has, financially speaking, ceased to be a going concern. Neither the 2010 bailout nor the (partial) introduction of austerity measures that are already at the limit of the politically possible have been enough to do the trick. Indeed, by depressing domestic demand, the latter have — at least in the short term — made the budgetary situation even worse. Tax revenues have been hit by the slump in an economy that shrank by over 4 percent last year, and will likely dwindle by another 3.5 percent this year. The conventional response — a massive devaluation designed to restore international competitiveness — is unavailable so long as Greece remains yoked to the euro.

And it’s not easy to break free. Capital controls would be introduced overnight. The Lazarus drachma would collapse in the morning. Inflation would surge the day after. The country would, de facto or de jure, default on its debt (as would a sizeable slice of its private sector). Greek industry would face a painful funding squeeze. Payrolls would plunge, a brutal blow with the official Greek unemployment rate already at 16 percent or so — and rising.

Beyond Greece’s borders, there would be panic selling of debt issued by some or all of the other PIIGS. With a number of EU banks heavily exposed to the PIIGS, an uncontrolled Greek default, and, more dangerous still, its consequences, could conjure up sweaty memories of the financial crisis. And those affected might include the European Central Bank itself. The ECB has been an active buyer of PIIGS debt. Writing down those holdings could be awkward, especially since the eurozone’s embattled taxpayers would be left holding the tab.

But if Greece’s departure from the euro is too risky to consider, that does not change the fact that the May 2010 financing has not worked. And default would be default whether inside the eurozone or out. It’s all very well criticizing the dodgy process by which Greece was admitted into the currency union, and there are few words ugly enough to describe the squalid state of Greek public finances. Nevertheless, for creditors to insist that the country can cut, privatize, and tax enough quickly enough to stave off disaster is to allow indignation to prevail over financial and political reality. Greece lacks the social cohesion (and shared memory of recent hardship) required to weather the kind of drastic “internal devaluation” that (fingers crossed) took the Baltic countries through their recent debt crises.

According to the EU Commission, Greece’s debt/GDP ratio will rise to 166 percent next year. The annual budget deficit will stand at just under 10 percent of GDP. Under the terms of the May 2010 bailout, that number is supposed to fall to 3 percent by 2014. Dream on. On May 30, Greece’s two-year bonds were yielding over 26 percent. The market’s message was clear. Without substantial additional external financing, default was on the way.

Adding to the concern have been worries that Greece might not satisfy the conditions necessary to allow the IMF (more rule-bound, it is speculated, in the wake of Dominique Strauss-Kahn’s departure) or EU lenders to release their next portions of the original bailout funds. You may know if they have agreed to do so by now, but the best guess must be that these monies will somehow reach Athens, even if it takes a new bailout agreement to get them there. If they don’t, that could, within weeks, trigger the “hard” default that no one wants.

Arranging a fresh bailout will be an unpleasant process, thanks not least to politics. After years of restraint at home, financing the feckless abroad has proved highly unpopular in Germany, the EU’s principal paymaster. The single currency has been a boon for the country’s exporters, but its voters don’t seem to care. They never wanted the euro, and the events of the last twelve months have only reinforced their suspicion that their beloved Deutsche mark was replaced with an extremely expensive dud. Forcing through the earlier support for the PIIGS was a nightmare for Chancellor Merkel. To ask this most cautious of politicians to demand yet more from restless German taxpayers is to ask a great deal. And lender discontent, a useful reminder of how little grassroots appeal EU “solidarity” really enjoys, is not confined to Germany. The Austrians are unhappy, the Dutch government is floundering, and anger in Finland over its participation in eurozone rescue parties has helped propel the populist-nationalist True Finns to the top of the polls. A new bailout will only add fuel to these fires. Merkel, it seems, may be preparing to walk through them. On May 31 markets surged on reports that Germany had dropped its insistence that any new bailout should be conditional on bondholders’ sharing in the taxpayers’ pain.

But despite, doubtless, additional austerity measures and fierce mechanisms to enforce them, new rescue packages will do little to solve the underlying structural problem in Greece and, for that matter, elsewhere. They may buy time but, in the end, there is simply too much debt for some PIIGS to repay. If an honest, old-fashioned default is too terrible to contemplate, that leaves three routes to a theoretically more permanent solution.

The first is, basically, what Merkel wants, “restructuring,” a default in sheep’s clothing, albeit one timed later than she would like. This would be designed in a way that allows banks to dodge the write-downs that could bring them low. The ECB is fiercely opposed to this approach, arguing that it will inevitably set off a fresh wave of financial contagion, even a new Lehman. Nouriel Roubini, Doctor Doom himself, disagrees. It is impossible to say who is right. Both sides are, in the end, making guesses about the mood of a perpetually manic marketplace. That said, the ECB’s stance implies the PIIGS will eventually be able to repay all their debt: an idea as implausible as the notion that they might fly.

More probably, the ECB is relying on Brussels to push forward with the closer fiscal and economic union without which no large monetary union can succeed. This has always been on the European Commission’s agenda, but until this thoroughly predictable and most convenient crisis, it had been politically impossible. That’s changing. Fiscal and economic integration has gone farther and faster over the last 18 months than would have been imaginable just a few years ago. The Eurocracy may, despite current traumas, even see this all as a vindication of the great gamble that was taken when the euro was launched half-done. The problem for Brussels is that the events of the last year have left voters in the eurozone core free from any illusion as to how costly such deeper integration — which would essentially establish a permanent funds-transfer regime from north to south — would be. Will they go along? Will they even be asked?

The third, and, I’d argue, best alternative for now — the split of the euro into two, a strong “core” euro and a weaker euro for the PIIGS — is not without its difficulties, but it ought to work. It would give the PIIGS both the devaluation they need and a chance of avoiding default, and, in addition, it should trim some of the “excess” German surplus. This may be the best alternative, but it’s also the least likely. To Brussels such a velvet divorce would represent an unacceptable step back, and that would never do.

Estonia’s anti-euro campaigners compare the single currency to the Titanic. It’s easy to see why.

PIIGS to the Slaughter

National Review, December 2, 2010 (December 20, 2010 issue) 

Checking into a roach motel often seems like a straightforward decision.

Signing up for the euro, the shiny new currency supposedly saturated in German fiscal rectitude, not only pleased Ireland’s paymasters in Brussels (the country has benefited hugely from lavish dollops of EU “structural” assistance) but offered Dublin the prospect of riches far closer to hand than the end of the traditional rainbow. The combination of EU aid (amounting in some years to as much as 3 percent of GDP), domestic frugality, shrewd supply-side reforms, and (those were the days) a timely currency devaluation had already given birth to a Celtic Tiger nourished on export-led success. But that beast was now set to burn very bright indeed.

And so it did. Money poured in, bringing the traditional speculative excess in its wake. So far, so normal: Usually such festivities are brought to a more or less timely close by both external and internal pressure. Inflation heats up, the currency buckles, interest rates rise, fiscal policy is tightened, bank lending is reined in, and everyone is soon back on their best behavior — until the next time.

Joining the euro meant that much of this script was jettisoned. Market signals were muffled by membership in a unified monetary system in which one size truly did not fit all. In particular, Irish interest rates, determined primarily by the needs of the eurozone’s sluggish Franco-German core, were kept far too low (on average, they were negative in real terms between 1998 and 2007) for a roaring economy growing at an annual average rate of 6 percent between 1988 and 2007. Throw in a poorly regulated banking system, endemic cronyism, vast infusions of foreign cash (euro membership had dramatically reduced currency risk), a lending war led by the remarkably reckless Anglo Irish Bank, the genuine housing needs of a large new immigrant population (a striking phenomenon in this land once known for its emigrants), and briskly increasing wage rates, and the stage was set for a gigantic property boom. What could go wrong?

Just about everything; and it went so badly that (finally) doing the right thing may have made matters even worse. When the global financial crisis erupted and the Irish economy slumped (GDP fell by 7.1 percent in 2009 after a 2 percent decline the previous year), real-estate prices fell (they are now some 35 percent below their peak, and weaker still in Dublin), and the banks came down with them. The government’s response bore some resemblance to the approach taken so successfully by Sweden during a not-entirely-dissimilar banking crisis in the early 1990s. This included guaranteeing most of the liabilities of the country’s troubled banks (and troubled they were — by 2007, property-related lending accounted for some 60 percent of their loan books) and transferring toxic assets to NAMA, the National Asset Management Agency, a state-run “bad bank.”

But Ireland’s banking sector was far larger relative to its GDP than Sweden’s had been, and so was its real-estate bubble. The Irish government has also had to contend with a far less favorable economic climate, a difference made even more damaging by the fact that the Irish tax system is unusually sensitive to changes in economic activity. Tax revenues fell by almost 14 percent in 2008 and by 19 percent in 2009, bringing yet more misery to the republic’s previously respectable but swiftly deteriorating public finances.

Recovery from a mess like this is never plain sailing, but one way to lessen the pain is to arrange a currency devaluation (Sweden let the krona fall by 20 percent in late 1992) to give exporters a break. Unfortunately, membership in the eurozone had closed off that option. Ireland was thus stuck with an overpriced currency, an overpriced workforce, and a rapidly growing hard-money debt burden that could not be inflated away. All that was left was “internal devaluation.” That’s an ugly name for an ugly cure generally revolving around extraordinarily brutal public-sector austerity. The aim is to restore both the state’s finances and the nation’s international competitiveness, and it’s just what Ireland had been attempting since 2008 with a series of increasingly bleak budgets intended to reduce the deficit by over $19 billion.

Internal devaluation is a bitter pill to swallow even when it works, but when it doesn’t . . .

And in Ireland it may well not. As it has lurched its way through 2010, the government has fed ever more money into the country’s devastated banks (most notably the now-reviled Anglo Irish Bank), effectively canceling out the savings being generated by the austerity program and pushing the estimated 2010 public-sector deficit to some 32 percent of GDP (it would otherwise have been around 12 percent). This renewed the market’s worries about Ireland and, ominously, other fiscally fragile eurozone members. Exacerbating the rising tension, the European Central Bank appeared to be continuing with its effort to scale back the short-term support it had been extending to the eurozone’s financial institutions — support that was widely assumed to be vital to many banks in most or all of the notorious PIIGS (Portugal, Italy, Ireland, Greece, and Spain). Perceptions of sovereign and banking risk were converging, not unreasonably so given the way that governments were standing (either explicitly or implicitly) behind their countries’ banks. To take one example, when Fitch cut Ireland’s rating from AA- to A+ this fall, it specifically cited the mounting cost of the bank clean-up.

All this made October a terrible month for German chancellor Angela Merkel to demand that the European Stability Mechanism, which is scheduled to replace the current European Financial Stability Facility in 2013, include a provision requiring private holders of government debt to share in the pain of future sovereign bailouts. The provision is common sense. To call for it at a time of jagged nerves over European sovereign risk was not. Merkel’s comments related only to arrangements that might be put in place in the future, but given her frequent tirades against “speculators” and Germany’s key role in funding any bailouts to come, many in the financial markets worried that they might herald an attempt to change the ground rules well before 2013 — and not in a way that would be in the interests of bondholders. Yields on PIIGS bonds rose, while money continued to drift away from Ireland’s banks, and investors from its debt. Theoretically, the country still had enough money to meet its financing needs until mid-2011, but, if panic was to be headed off (at least temporarily), its government had to be persuaded to accept the bailout that it was desperately claiming not to need.

The risk posed by spreading financial contagion was simply too high, and not just for Ireland. The European Financial Stability Facility, which was created for the eurozone with such fanfare (there was talk of shock and awe) at the time of the Greek bailout, is not large enough to rescue Ireland and Portugal and Spain, the next two countries most likely to be hit should confidence fall any farther. Dublin caved. An outline rescue package was announced on November 21. The full details were released a week later. The total package will amount to $110 billion, including an immediate $13 billion injection of fresh capital into the banking system. In an unanticipated development, Ireland will chip in $23 billion from its pension reserve fund and various other pots of money. The balance is set to come from the International Monetary Fund, from the European Financial Stability Facility, and from three non-eurozone countries, the U.K., Sweden, and Denmark. The whole thing is conditional on the passing of yet another Irish austerity budget, one that contains an additional $20 billion in tax increases and spending cuts. These cuts, when added to the earlier bouts of slash-and-burn, amount to roughly 20 percent of GDP.

At the same time, more details were given of the planned new European Stability Mechanism, but — not insignificantly — with (some) dilution of Angela Merkel’s proposal for sharing the burden of future bailouts. It was also agreed that Greece should be given an extra four-and-a-half years to repay its emergency financing from earlier this year. Ireland, however, will no longer be obliged to contribute to Greece’s bailout. On a brighter note, and over the objections of some in the rescue party, Ireland was allowed to retain the 12.5 percent corporate tax rate that has served it so well.

The republic’s governing coalition, a dying partnership between the centrist Fianna Fail and the Greens, has to pass the new austerity budget within a few days with a parliamentary majority of only two and without much popular support. In a clear warning sign for the general election now set for January, Fianna Fail received a November 25 by-election shellacking from Sinn Fein, a party frequently described as the political wing of the IRA. The EU’s mandarins like to claim that their “ever closer” union is burying Europe’s old nationalisms. That’s not how it looked in Donegal South West that weekend.

Despite this, Ireland’s mainstream parties recognize that the deficit needs to be reduced soon — even if they disagree on the specifics of the rescue package. At the time of writing, things are very fluid, but the best guess is that the budget will probably squeak through, albeit with a great deal of shouting. If it doesn’t, there’s a clear risk that financial chaos will soon engulf some or all of the PIIGS, and, no less dangerously, the banks that have lent so much to them. Even if it does go through, don’t expect too much. The distinctly downbeat market reaction to both the initial announcement of an Irish bailout (yields on the PIIGS’ government debt rose; the euro fell) and its later confirmation reveals a widespread belief that this rescue is not the end of the story.

It’s not. More bailouts undoubtedly lie ahead, and, in the case of Greece and Ireland, so does a debt restructuring (that’s the polite word for default) at some moment when it is judged that the financial markets can cope with the news. So long as these countries are yoked to the euro, there is no feasible alternative. Their domestic demand will be crippled by the processes of internal devaluation. Their export sectors will be hobbled by a hard currency. Under the circumstances, they will struggle to grow their economies at a pace fast enough to reduce their debt burdens to manageable levels. There are good reasons the yield on their debt continues to rise.

Meanwhile, Brussels, apparently unshaken in its belief that one size can be made to fit all, will try to impose unified fiscal and budgetary rules across the eurozone. If this succeeds, it may reassure restless German voters that there are credible limits on the amount they will be asked to pay to support European monetary union. That the implementation of such zonal discipline will, if carried through, also deepen European integration is even more to the Eurocrats’ point. That it would doom a large swath of the continent to years of subpar growth is just too bad. The European project must move forward!

Splitting the single currency into a “northern” euro for Germany and those of its neighbors that want to come along and a “southern” euro for the rest is one more congenial, if risky, alternative route to take. It would retain important elements of the status quo while paving the way for the devaluations that the PIIGS so badly need. But to take this path would be an admission of defeat too humiliating for the EU’s leadership to accept, at least for now. And if that’s off the agenda, so, even more so, is a return by the nations of the eurozone to their old currencies.

The final alternative, for an Ireland or a Greece to exit the euro on its own, would involve national bankruptcy, the collapse of much of the domestic private sector, and Lehman Part Deux. 

It’s not always easy to check out of a roach motel.

Scapegoating les Anglo-Saxons

The Weekly Standard, June 21, 2010

Sutton Hoo

When America’s flimsier corporate colossi threaten to collapse, they tend to follow a wearyingly familiar script. Quarterly reports “disappoint,” the media begin to stir, and questionable financial dealings come to light. The CEO then emerges from his bunker to announce that all would be well but for the (vicious/ill-informed) press, (greedy/destructive) short-sellers, or both. Then all hell breaks loose. That’s how it was with Enron. That’s how it was with Lehman Brothers. And that, more or less, is how it’s going with the euro. A dangerous gamble with other people’s money, irresponsibly operated, and dishonestly sold, the European single currency has been showing signs of severe stress, and leading EU officials have been doing just what the Ken Lays of this world do: dodge.

There have been the “all is wells” from the likes of José Manuel Barroso, president of the EU commission—the man who boasted in February that the euro was “a protective shield” against the crisis. There have been the attacks on the press—often with an interesting twist. Spain’s transport minister, José Blanco, for instance: “None of what is happening including editorials in some foreign media with their apocalyptic commentaries, is happening by chance, or innocently. It is the result of certain special interests.”

Just who were those unnamed “special interests”? (Clue: Europeans traditionally believed that they wore Stetsons or bowler hats.) The Spanish prime minister reportedly ordered his country’s National Intelligence Center—the Inquisition no longer being available—to investigate. An alternative theory was conjured up at around the same time by Jürgen Stark, the European Central Bank’s chief economist. Asked by Der Spiegel whether he suspected that the “Anglo-American” media were “behind the attacks” on the euro, Stark replied that “much of what they are printing reads as if they were trying to deflect attention away from the problems in their own backyards.” That’s a nice try, but it’s also an answer of staggering disingenuousness. Can Stark really have been unaware of the long-running media furor in Britain and the United States over their domestic deficit disasters?

To be fair, the head of the ECB, Jean-Claude Trichet, did warn in May that “one should be wary” of talk of Anglo-Saxon conspiracies, but by then plenty of far-fetched plots had been dreamt up. Were those “apocalyptic commentaries,” for example, an ideological assault by diehard euroskeptics or were they, perhaps, part of a dastardly scheme to preserve the U.S. dollar’s position as the ultimate reserve currency? As conspiracy theories go, neither was bad, but such theories play even better when seasoned with a “speculator” or two. Maybe, the Anglo-Saxon media were in cahoots with Anglo-Saxon plutocrats looking to make a sleazy buck out of a sickly euro. By talking up the crisis, were these hacks simultaneously peddling a sexy story and filling the coffers of Wall Street and the City of London? Quelle horreur.

That there might actually be a crisis to talk about was only grudgingly conceded, and its true cause remained the stuff of denial. Far easier to blame the sons and daughters of Gordon Gekko. It was in this vein that Ireland’s minister of state for finance, Martin Mansergh, claimed last month to have gotten to the bottom of the market’s distaste for the euro: “If you had lots of separate currencies that would be more profits for the financial sector.” Let no one say that blarney is dead.

Wiser blamesayers have avoided conspiracy theories and stuck to abuse. Anders Borg, finance minister in Sweden’s (vaguely) right-of-center, (not so vaguely) Europhile government, grabbed headlines in May comparing market players to a “wolf pack.” The jibe might have had more weight had it not come from someone who had, just a few months before, sternly intoned that there was “no legal basis” for an EU bailout of Greece, exactly the sort of ill-starred comment that is now food for the wolf pack.

As zoological insults go, however, Borg’s lupine sneer was one of the best since the moment in 2005 when Franz Müntefering, then chairman of Germany’s Social Democratic party, compared foreign hedge funds and private equity groups to “locusts.” Yes, those investors had been buyers rather than sellers back then, but they had been the wrong sorts of buyers (short-term, asset-strippers, foreign).

To his credit, Müntefering spoke out when the times were good. Many of those now criticizing “speculators” held their peace when those wicked markets were betting on the “convergence plays” that kept interest rates down (and pushed asset prices up) in the countries now known as the PIIGS (Portugal, Ireland, Italy, Greece, and Spain).

But it was never more than an uneasy peace. The scapegoating of Wall Street and the City may be a diversionary tactic but there is nothing fake about the animus that lies behind it. The great majority of the EU’s political class disdains the Anglo-Saxon market capitalism that is, in its disorderliness, brutal competitiveness, and unembarrassed pursuit of profit, the product of an economic and political tradition that is the antithesis of its own. Americans expect that sort of thinking on Europe’s left, but it’s present on the continent’s right too. Outside the U.K., the dominant strain of thinking amongst the EU’s establishment right is in the Christian Democratic tradition. Its origins lie in Roman Catholicism—a creed never entirely comfortable with the free market. The mixed “Rhineland” model of capitalism is its model and “solidarity” its lodestar. For a very French example of this thinking, check out Nicolas Sarkozy’s Testimony (2006), where the future president attacked “stock market capitalism” and “speculators and predators.” (Note the date: Sarkozy was not one of those who kept quiet when times seemed to be good.)

Thus the rejection of the Wall Street way by European elites is philosophical and aesthetic as much as it is party political. Its roots are deep and its expression, sometimes, ugly. In November 1942, a French official wrote a piece for a pro-Vichy magazine (interestingly, the same issue features an article by one of the future architects of the euro, François Mitterrand) bemoaning those who would live “free” (his scare quotes) in the “soft, comfortable mud of Anglo-Saxon materialism.”

The “Anglo-Saxon” other (the Vichy crowd liked to throw in the Jews, as well) is a convenient target for European leaders looking for someone, anyone—other than themselves—to blame for the current shambles. But this is a scapegoat that the EU’s mandarins are also riding in pursuit of two long-standing objectives: crippling the City of London and, so far as possible, keeping Wall Street out of Brussels’s domain. Less than two weeks after the implosion of Lehman, Sarkozy announced that laissez-faire was “finished.” Wholesale reform of the global financial system was, he pronounced, essential.

Few would deny that some reform is needed. It’s even possible to assemble a respectable defense of the “anti-speculative” measures (such as certain restrictions on short-selling), if not their confidence-killing timing, recently put into place by German chancellor Angela Merkel. But look more closely at the underpinnings of Merkel’s actions and the picture darkens. The new measures can then be seen not as well-intentioned reform, but as the next step in Merkel’s populist crusade against the “perfidy” of international “speculators,” a crusade designed to mask the extent to which the current crisis (and the bill to German taxpayers) was brought on by the speculative scrip—the euro—that Germany’s politicians had forced upon their voters.

The fact that “speculators” have had little to do with the convulsions now shaking the eurozone means nothing to Merkel. It’s far easier to talk to the electorate about a “battle of the politicians against the markets”—a not unfamiliar tune to U.S. voters—than admit that the real battle that she has been fighting is against what remains of the political, democratic, and financial integrity of the European nation-state.

And we can be sure that the EU elite will continue to stand alongside Merkel in combating the bogeyman bankers, a wag-the-dog war that dovetails nicely both with short-term expediency and long-term belief, and is designed to cut the financial sector—specifically the Anglo-American financial sector—down to size. That doesn’t mean the death of the local big banks that have for so long been a part of the European financial landscape, but it does mean that their business will be reined in. They will see a return to the far tighter political control of the past with all the potential for abuse that can bring. Significantly higher taxes lie in their future, although increasing worries over the fragile state of many EU banks (not least because of their exposure to the PIIGS’ debt) may stymie such plans for now. The bonus culture will come under additional pressure (not all Americans will mourn that), and efforts will be made to ensure that the markets are just that bit friendlier to entrenched interests—such as those of governments that borrow too much. The news last week that France is falling in with Merkel’s recent initiatives and that both countries would like to see them extended across the EU, is an early indication of what is to come.

Much of this is bound to affect the business carried out by Anglo-American finance in Europe, but it is not directly protectionist. The same cannot be said of Brussels’s Alternative Investment Fund Managers Directive, a rough beast now slouching towards some kind of birth. The primary focus of the directive is much tougher regulation of “alternative” investments, such as hedge funds, private equity funds, and the rest of Müntefering’s locust class (funds, incidentally that have received no bailouts—but who cares about that in Brussels). That’s not good news for the players in this market—mostly in the U.K.—and it could also represent a major obstacle to U.S. funds operating within the EU. In neither case is this a coincidence.

Hogtied by recent changes in the EU’s rulemaking procedure, the U.K. cannot do much to stand in the way (should David Cameron’s new, not very City-friendly government even feel so inclined). That leaves Washington as the last line of defense. There are clear and reassuring signs that Treasury Secretary Timothy Geithner now recognizes the nature of the danger that American finance now faces.

That’s something. But will the Obama administration really be prepared to go to the mat for an industry that it too finds convenient to demonize? And even if it is, just how much will Brussels be prepared to listen?

As Rahm Emanuel once said .  .  .

The ‘Beneficial Crisis’

The Weekly Standard, May 31, 2010

It would have taken a heart of stone not to laugh. Wheeled out earlier this month for celebrations to mark his 80th birthday, a rickety Helmut Kohl announced that the fate of the EU’s floundering single currency was a matter of life and death: “European unification is a question of war and peace .  .  . and the euro is part of our guarantee of peace.”

The former chancellor’s dire warning might have been a touch more persuasive had it not been repeated quite so many times before. To take just one example, in the course of Sweden’s 2003 referendum on whether to sign up for the euro, a “weeping” Kohl told the Swedish premier that he did not want his sons to die in a third world war. A reasonable ambition, but hardly the strongest of arguments for junking the krona. Sensible folk that they are, the Swedes voted nej and are all the better for it today.

Panzers will not roll in the event of a euro collapse, but that doesn’t mean there isn’t a decent case to be made for the $1 trillion (actually $937 billion at the time of writing, but who’s counting?) support package for the EU’s single currency union announced on May 10. The growing financial panic triggered by Greece’s economic woes was metastasizing into a crisis of confidence in the eurozone’s southern and western rim—the now notorious PIIGS (Portugal, Italy, Ireland, Greece, Spain)—a development that threatened ruin for much of the EU’s fragile banking sector and the shattering of any hopes of European economic recovery. After a dangerous delay caused by German hostility to the idea of bankrolling the Greeks, a 110 billion euro ($137 billion) EU/IMF bailout of the Augean state had been agreed. But it came too late to head off the financial markets’ mounting unease.

Financial panics are best dissipated by a swift, decisive, and dramatic response that signals that a believable lender of last resort has arrived on the scene. This is why, for all its faults, TARP worked. Uncle Sam had rolled into town. There would be no need after all to storm the ATMs.

Jittery Europeans have had to make do with considerably less reassurance. The eurozone lacks the characteristics and resources of a unified nation. It is a hodgepodge of pacts—some observed, some not—whispered understandings, cultivated ambiguities, and clashing interests that does little to inspire confidence. The nearest it comes to a plausible lender of last resort is Germany, historically the EU’s most generous paymaster—a real nation, with real wealth but, awkwardly, real voters too.

Those voters have been up in arms at the thought of helping out Greece. This was the real reason that German chancellor Angela Merkel dithered so long before coming to Athens’s aid. She was right to be worried. Within a day or so of the Greek bailout, her governing coalition was thrashed in regional elections in North Rhine-Westphalia, Germany’s most populous state.

Something spectacular had to be done. And if $1 trillion isn’t spectacular I don’t know what is. The support package that finally emerged on May 10 falls into three main parts. The largest is the creation of a “temporary” (three-year) special purpose financing vehicle. This is authorized to borrow up to 440 billion euros ($550 billion) to fund or guarantee loans to member states who find themselves being frozen out of the capital markets. On top of this, there will be a 60 billion euro  ($75 billion) “rapid reaction” facility operated by the EU Commission and designed to help any eurozone country facing an immediate cash crunch. Oh yes, the IMF agreed to throw another 250 billion euros ($312 billion) into the kitty.

But, wait, there’s more. To make sure that struggling European financial institutions are not starved of dollars, a number of the world’s major central banks, including the European Central Bank (ECB) and the Fed, revived the emergency currency swap agreements put in place in late 2007. The ECB then topped up the punch bowl by commencing to purchase government debt from the PIIGS, a move explained by the need to move fast (it will be a while before the full support package can be put in place), but which opened the ECB to the charge that it had been reduced to printing money (“quantitative easing” is the preferred euphemism). The ECB denies this, saying the bond purchases are being “sterilized” by other maneuvers draining the excess liquidity the purchases create.

International investors feted the support package for all of one day. Then they recognized that, as Merkel conceded, it had “done nothing more than buy time.” The rot within the eurozone continues to fester. As for claims that this was all the fault of the wicked speculators of Wall Street and the City of London (a tiresome cry from the EU’s leadership in recent months that reached a new crescendo last week), well, that’s like blaming the canary for the gas in the coal mine.

The Greeks, Portuguese, and Spanish have all announced new austerity measures, but, even if we make the optimistic assumption that the recent riots in Greece will be the exception rather than the rule, these steps are unlikely to be enough to bring this story to happy ever after. Piled on top of existing budget cuts, the fresh rounds of slashing and taxing run the risk of crushing what’s left of domestic demand and with it an essential element in these countries’ ability to generate the additional tax revenues their treasuries so badly need. The usual remedy for such a predicament is devaluation and an export-led recovery, but with the PIIGS yoked to the euro that option is not available. The euro may be weakening against currencies outside the zone, but against their competitors within, the PIIGS are as uncompetitive as always.

It’s not easy to unscramble an egg. For one of the PIIGS to quit the euro would almost certainly mean both default on its public debt and the bankruptcy of wide swaths of its private sector. The domino effect across the rest of the continent, and beyond, would be appalling. Another, more promising, alternative, albeit one freighted with severe technical and practical risks of its own, would be for a German-led group to depart the euro and form a separate “hard currency” union of its own, leaving the PIIGS with the deeply depreciated (down perhaps 30-40 percent) euros they so obviously need. This would be tough on the PIIGS’ unfortunate creditors, but there would be a chance that default, and all its attendant dangers, could be sidestepped.

Yet no such alternative is on the menu. In confronting the hole into which joining the euro has dropped them, the eurozone’s leaders seem determined to dig ever deeper. We can debate their rationale, in all probability a mix of cowardice, conviction, careerism, and delusion, but not the likelihood of the conclusion to which they will come. Speaking in Aachen—the burial place of Charlemagne, an early Eurocrat—on May 13, Merkel made clear that she was still drinking the Kohl-Aid: “If the euro fails,” she warned, “Europe fails too, [and so does] the idea of European unification. We have a common currency, but no common political and economic union. And this is exactly what we must change. To achieve this, therein lies the opportunity of this crisis.”

Long before Rahm Emanuel’s infamous dictum, the idea of a “beneficial crisis” (to borrow the terminology of Jacques Delors, a former president of the EU Commission) was common in Brussels. Indeed, there is evidence to suggest that some smarter Eurocrats saw the flaws in the way that the euro had been set up as a feature, not a bug. The crisis to come would create the conditions in which the nations of the EU could be persuaded to submit to further federation.

On May 12, the current president of the EU Commission, José Manuel Barroso, argued that “member states should have the courage to say if they want an economic union or not. Because without it, monetary union is not possible.” The commission’s proposals include greater macroeconomic supervision, increased emphasis on deficit reduction, and the establishment of a permanent emergency financing mechanism. The most controversial idea is the suggestion EU governments submit their national budgets for review by their counterparts within the union before presenting them to their own parliaments. Whether this review would be merely advisory or carries a veto power has been left conveniently vague.

Barroso also wants a more punitive regime imposed on governments that persist in breaking the budgetary rules that supposedly underpin the euro. There are limits, however. The commission did not back Merkel’s call for provision to be made to allow the eurozone’s more persistent reprobates to be expelled from the currency union. Permitting such a procedure, even in theory, would imply that the grand European project could sometimes go into reverse, and that would never do.

Most of these measures will edge forward at best. Not all member states are enthusiastic about the push for what Herman Van Rompuy, the president of the EU’s council, has referred to as a European “gouvernement économique,” an elastic term capable of, in Van Rompuy’s sinuous prose, “asymmetric translation” in different languages, from the comparatively nebulous English “governance” to something altogether more concrete.

But, if some governments are not enthusiastic, it’s difficult to see what else they can do—unless they are prepared to quit the eurozone. And they are even less enthusiastic about that.

The next stage of this drama ought to have been something of an anticlimax as nerves were soothed by that calming trillion. Instead, Merkel sent markets sliding by imposing, amongst other measures, a “temporary” ban in Germany on “naked” short selling (selling securities that you do not own and have not made arrangements to borrow) of eurozone government bonds and the stocks of some of her country’s leading financial institutions. This was accompanied by promises of further regulation and yet more railing against speculators, “out-of-control” markets, and banks.

The message sent by the new rules was grim. And it was received. By playing the populist card, Merkel had highlighted the extent of the political problems she faces back home. That’s not what investors wanted to hear. Some also fretted that the new restrictions were a hint that the finances of Germany’s banking sector were even worse than feared.

So, what’s next? Predicting short-term currency movements at a time like this is a mug’s game. I’ll just stick with the word “choppy” and the belief that a trillion dollars ought to buy the euro some time. It won’t be a huge surprise if some of that time—and some of that money—is eventually used to smooth the increasingly inevitable “restructuring” of Greek, and possibly Portuguese, sovereign debt. Nevertheless that will not be the end of the matter. A trillion dollar band-aid is still a band-aid. This spring’s crisis has demonstrated that the existing system cannot survive as it stands.

To succeed, a monetary union the size of the eurozone needs a high degree of central control, consistent and enforceable budgetary discipline, and spending (and thus taxing) powers sufficient to ensure that the cyclical imbalances in its constituent parts can be evened out. That reality has now essentially been accepted by the German and the French governments. Although negotiating the details of common economic governance will drag on for years, in the end the French and the Germans will, despite some truly fundamental differences, get there—and they won’t be alone. Faced with the prospect of being excluded from the EU’s tightening core, more countries than might now be imagined will choose to jump in notwithstanding its tougher disciplinary regime. While today’s “two-speed” union will continue to exist, the division will deepen, and on one side of it there will be something that looks suspiciously like a European superstate.

The financial markets could still disrupt this transition, which is one reason that the EU’s leadership is so keen to rein them in. Trouble may also come from a group often ignored in the saga of “ever closer” union—the electorates of Europe.

One of the more telling characteristics of the EU’s progress is the way it has been forced through regardless of the wishes of ordinary voters. The “reuniting” of Europe has been a project of the elites, the fruit of mandarin cabal and backroom deal. Voters have rarely been given much of an opportunity to demur. And when they have been asked their opinion and called for a halt to further integration, the results have been ignored or subjected to do-over until the “right” result came through.

That’s not to claim that Europe’s mainland is seething with euroskepticism. It’s not. There is, however, widespread apathy and a profound alienation. As the voters of North Rhine-Westphalia have just reminded us, there’s not a lot of fellow-feeling in that imaginary European family.

This might have mattered less in economically more comfortable times, or in the times when Brussels was not stretching so far, blithe times when voters (foolishly) and Eurocrats (realistically) could, for the most part, pretend that the other did not exist. That’s over now. Building an economic union is messy and intrusive. It’ll be hard to slip it through on the quiet. The PIIGS are being ordered to take a long hard road. The peoples of Northern Europe will be told to pay for its paving.

What if either says no?

EUbris

National Review, February 18, 2010 (March 8 2010, issue) 

It’s a cliche to use the word “hubris” in an article involving Greece, but when that article is about the single European currency, what else will do? From its very beginning, the euro was a project of monstrous bureaucratic ar­rogance, a classically dirigiste scheme cooked up by an elite confident that it could ignore the laws of economics, the realities of politics, and the lessons of history. While the exact contours of the current crisis could not have been foreseen, the certainty that there would be a crisis could have. To build a monetary union without a political union (or something close to it), or, failing that, an extraor­dinarily high degree of economic con­vergence, was asking for, to use another Greek word, catastrophe.

But that’s what the Eurocrats did. And instead of having the humility to launch their new currency on a relatively small scale in, say, the genuinely converging economies of northwestern Europe — of Germany, say, and the Bene­lux — they redefined convergence. Any EU country that satisfied certain economic tests — the Maastricht criteria — would be eligible to sign up. In the first round (1999), eleven countries did, to be followed later by Greece and four others. The tests were tough, but not entirely unreasonable; yet in applying them as mechanically as they did, the architects of the single currency were in effect arguing that all it took to gauge an economy was something akin to a snapshot. This had the virtue of simplicity, but then so did Five-Year Plans.

Largely uninvestigated suspicions that some of those snapshots may have been photoshopped (there have long been doubts about the quality of the data submitted by Italy and, yes, Greece) were an early warning that the Maastricht criteria, which were also meant to be rules by which countries would continue to play once ensconced within the eurozone, would be enforced less vigorously than first agreed. As it turned out, there was little choice in the matter. The new rules were too rigid for the uncomfortable realities of the ordinary economic cycle, let alone the financial meltdown of the last two years. As things currently stand, they rank somewhere between a promise and a dream. That said, the revelation that Greece may have paid Wall Street’s sav­viest financial engineers to pretty up its national accounts is unlikely to play well in Brussels, except as ammunition for the claim that “speculators” are to blame for the mess in which the eurozone now finds itself.

The real culprits are closer to hand. The most important were those who in­sisted that convergence had been achieved when plainly it had not. The interest rates set by the European Cen­tral Bank were about right for the eurozone’s core, but they were too low for the nations on its periphery. The econ­o­mies of the latter may have had more capacity for growth, but they were also more vulnerable to inflation. One size did not fit all. Bubbles ballooned, then burst. Making matters worse was the damaging effect that the historically unusual combination of in­flation and a strong currency has had on the already shaky competitiveness of these countries’ industries. Nations with high inflation traditionally try to maintain their competitive position by devaluing their currency, but that option was not open to those now yoked to the euro. On some reckonings, Italy, Greece, and the other “Club Med” countries need to de­value by at least 30 percent to return to the competitive positions they held at the end of the 1990s. They need to, but they cannot.

If the hit to private business has been bad, that to the state sector has been worse, albeit to some degree self-inflicted. For countries with weaker public finances, the euro offered both carrot and stick. The carrot was the lower borrowing cost that came from adopting a currency im­plicitly backed by the stronger econo­mies at the eurozone’s core. The stick was the fact that debt could no longer be repaid by the printing press. Un­fortunately, a number of governments, most notably Greece’s, ate the carrot and ignored the stick, but even those that tried to improve or maintain budget­ary discipline found their best efforts swept away in the financial tsunami of 2008–09.

The immediate trigger for the current crisis was panic over the prospect of a Greek default. That’s understandable. Greece’s debt-to-GDP ratio stands at 125 percent (more than double the notional Maastricht ceiling). The budget deficit is now projected at 12.7 percent (more than four times the Maastricht cap), compared with the mysteriously “low” 6 percent claimed by the outgoing government in October. It may still be understated. Nevertheless, however dysfunctional the Augean Greek state may be (did I mention the endemic tax evasion?), it is not alone in its woes, nor — despite the fact that it accounts for just 2 percent of the EU’s GDP — can it be treated as some inconsequential Balkan outpost.

If Greece defaults, a crisis of confidence in the credit of the eurozone’s other highly indebted nations is inevitable. Even in the unlikely event that default could be confined to Greece, a financial collapse in Athens would bring further devastation to Europe’s already battered banking system, both directly and, as sovereign debt was marked to market across the continent, indirectly. Ger­many’s banks have loaned a total of perhaps 20 percent of Germany’s GDP to Greece, Por­tu­gal, Spain, Italy, and Ireland, and French banks have loaned even more of France’s. “Con­ta­gion” is back. Greek withdrawal from the eurozone is legally possible, but it is no solution. The result would almost certainly be default.

Whatever the legal issues (a direct EU rescue may be illegal under the Union’s law), political complications (hard-pressed Eu­ro­pe­an taxpayers do not relish the thought of paying up for Greece), and risks of a dangerous pre­ce­dent (how will the other debt-struck countries react?), the only feasible short-term solution will be some sort of bailout, ideally involving the IMF (whatever the supposed blow to EU pride) acting in conjunction with the EU or a group of some of its richer member-states. For now, nemesis will not be allowed to follow hubris. The legalities will be dubious, the politics a charade, and the deal last-minute, but that’s EU business as usual. “In­ter­na­tion­al spec­ulators” will be blamed for just about everything. Angela Mer­kel will make the necessary fierce speeches re­fusing to pay and will then pay. The Greeks will agree to the necessary fierce cuts in public spending and will then be paid. Whether these cuts (currently targeted at 4 percent) could, should, or will be made in a climate of collapsing domestic demand will be a decision left for another day.

The euro will endure, somewhat de­bauched (it has already weakened since the Greek panic began), but not all Ger­mans will be upset by that. Germany’s economy is driven by its export sector, and in tough economic times a little devaluation can come in very handy indeed.

Looking farther ahead, the Greek crisis and the fragility of the balance sheets of so many countries within the eurozone suggest that, absent some dramatic re­covery in the global economy, the single currency is reaching a point where muddling along is no longer an option. One alternative might be for Germany and some of the other strong­er countries to quit the euro, leaving it as a currency more suited to the needs of the eurozone’s weaker breth­ren. What’s more likely is that those in charge in Brussels will grab the opportunity presented by this mess to move forward with two items on their long-term agenda. The first will be to push for stricter controls on global finance. The second will be to forge the closer fiscal union without which their monetary union cannot endure. If they succeed in the latter, the European superstate will be even closer to birth.

What was it that someone once said about a crisis being a terrible thing to waste?

Do Mention the War

The Weekly Standard, March 8, 2010

Tolstoy was wrong. Every unhappy family is not unhappy in its own way. Scratch the surface of a foundering relationship, and you’ll often find that money is, if not the sole source of the misery, undeniably the most poisonous. This is certainly true within the “ever closer” family that the European Union is meant to be. Some of the EU’s most savage fights have been about cash, an awkward fact that can equally be read as underlining just how far from familial this most unnatural of unions really is. The different nations of the EU remain, emotionally at least, nations. They continue to be foreign to each other. And who wants to give their money to a bunch of foreigners?

So it shouldn’t be any surprise that Germans are infuriated at the thought of having to stump up for a rescue of Greece’s Augean state. Their own economy is faltering. They have held back labor costs for years. They have, often painfully, maintained budgetary discipline. That’s not the way it’s been in Greece. With Greek government debt at 125 percent of GDP, a budget deficit of 12.7 percent, and distinctly shaky public support for any sort of austerity program, there is little, beyond beaches, about that country to appeal to citizens of the thrifty Bundesrepublik. Opinion polls show that over two-thirds of Germans reject the idea of contributing to a Greek bailout, and the venom with which that opposition is expressed suggests that exasperation has drifted into contempt.

To give more money to the Greeks would be akin to giving schnapps to an alcoholic, argued Frank Schaeffler, deputy finance spokesman for the Free Democrats, the junior partner in Germany’s governing coalition. Focus magazine ran a cover story on “The Fraudster in the Euro-Family” (a reference to the more creative aspects of the Greek government’s accounting) and illustrated it with the Venus de Milo, one-armed and flipping the bird. The tabloid Bild raged at the “proud, cheating, profligate” Greeks. A writer for the rather more heavyweight Frankfurter Allgemeine Zeitung asked whether Germans should have to retire at 69 rather than 67 to pay for Greek workers striking against proposals to increase their retirement age from 61 to 63. The mood in Germany was not improved by Greece’s deputy prime minister. Stung by all the criticism of his country, he grumbled that, having made off with Greece’s gold during the war, the Germans were in no position to complain “about stealing and not being very specific about economic dealings.”

Germany has long paid the largest share (currently around 20 percent) of the cost of Europe’s trudge towards union. Its annual payments into the EU now exceed what it gets back by over $10 billion. In part this has been viewed as a fair price for Germany’s readmission into polite society. It was also an expression of the once widespread belief—deluded if understandable—among Germany’s political class that an ersatz European patriotism could take the place of the German nationalism that had turned out so unfortunately just a few years before. Over six decades after Hitler perished in his bunker, however, these arguments are running a little thin.

Making matters worse is the debt (in all senses) that the Greek crisis owes to the establishment of the euro, the single currency for which German politicians ignored their voters and junked the deutsche mark in a two-stage process ending in January 2002. The deutsche mark had been one of the great successes of postwar Germany, a symbol of renewed prosperity and bulwark against any return of the hyperinflation that stalks that country’s historical memory. But, to those that counted—i.e., not German voters—the European Union mattered more. The deutsche mark perished, and the economic and budgetary rules—the Maastricht Criteria—designed to preserve the integrity of its successor (and reassure the twitchy German electorate) have not been kept in much better shape.

The new currency proved both an enabler of Greece’s profligacy and an agent of its economic troubles—a double whammy not confined to Greece. From the first, the euro’s interest rates were primarily determined by economic conditions in the eurozone’s core—Germany, the Benelux, and France—which meant that rates were too low for the nations on the periphery. One size did not fit all. The low interest rates fueled inflation, speculative bubbles, and, in some cases, excessive government borrowing in Portugal, Ireland, Greece, and Spain, the four “PIGS” in the financial markets’ insulting jargon. (You’re welcome to throw in another I for Italy.) The usual response to disruptions of this nature is devaluation. Signing up for a single currency, however, has removed that option.

Despite German voters’ hopes, this mess cannot safely be confined within the PIIGS’ sties. Drastic austerity programs by the debt-struck might in theory do the trick—although the wisdom of this is debatable at a time of deeply depressed domestic demand—but to succeed they require a degree of consent. Consent, however, is not the message that all those Greek strikes are delivering. So far, Brussels appears to be resting its hopes on the idea that talk of austerity, promises of support, and the prospect of closer economic supervision will be enough to persuade markets to keep funding the PIIGS’ budget deficits. Greece will for now be the sharpest test of that idea, but ultimately the country will not be allowed to fail. Even if it did not destroy confidence in the surviving PIIGS, a Greek collapse would, just as a start, trigger mark-to-market downgrades across the battered balance sheets of Europe’s largest financial institutions. German banks, for instance, have loaned the equivalent of 20 percent of their country’s GDP to the PIIGS, and their French counterparts even more.

Throwing Greece out of the eurozone might be emotionally satisfying (over half of German voters are in favor, though it probably isn’t even legally possible), but inevitably the result, pushing the country into default, would achieve nothing constructive. What would make sense is for Germany and the other countries at the eurozone’s core to abandon the currency. The euro would slump, giving the nations that still use it the devaluation they so badly need. But that’s not going to happen either. The European elites have sunk too much political capital into the single currency to give it up now. They will plough forward regardless of the current crisis. If the logic of that course provides the rationale, or at least an excuse, for the even deeper EU integration that most European voters do not want, then so much the better.

But the opinions of the electorate no longer count for that much anywhere within the EU. With feelings running as they are in her country, Chancellor Angela Merkel has to be seen to be talking tough and doing everything she can to avoid Germany being stuck with the Greeks’ bills. At one level she may mean it, but she knows it is just theater. Merkel will huff and Merkel will puff, but she will not risk bringing down what is left of Athens’s ruins. If a rescue party has to be put together, Germany will be a prominent part of it.

To be fair, it’s not all bad news for Germany. If Greece is indeed bailed out by some or all of its EU partners, the longer-term impact will be both to weaken the euro (which will help Germany’s important export sector) and, by preserving the eurozone as it is, keep many of Germany’s competitors within the eurozone most helpfully hobbled. The combination of higher levels of cost inflation, lower levels of efficiency, and a shared, hard currency has eroded much of the price advantage that was once the main selling point for the industries of Europe’s less-advanced economies. It is estimated that the PIIGS would have to devalue by more than 30 percent to restore their competitive position against Germany, a situation that is only going to get worse.

Like so much to do with Brussels’s strange imperium, this story is a lot less straightforward than it first appears.

Tough Times in EUtopia

The Weekly Standard, March 30, 2009

Sometimes truth just has to speak to powerlessness. Addressing the EU's sham parliament in mid-February, the Czech Republic's refreshingly tactless and refreshingly Thatcherite president, Václav Klaus, raised the awkward topic of what the EU euphemistically refers to as its "democratic deficit" and told MEPs that they were part of this problem, not its solution:

 "Since there is no European demos-and no European nation-this defect cannot be solved by strengthening the role of the European parliament either. This would, on the contrary, make the problem worse and lead to an even greater alienation between the citizens of the European countries and Union institutions."

Klaus's listeners were predictably outraged. They ought to have been terrified. With the EU economies falling apart at an unprecedented pace, there is nothing that these toy-town parliamentarians can do-except get out of the way.

The EU's insultingly undemocratic nature is not news (indeed, it is part of its rationale), but it remains the key to grasping how those who run the EU have, for better and worse, had so much success in ramming their agenda through. Not having to bother too much about national electorates has been a great boon to Brussels. As the continent's economies slide ever deeper into the mire, however, that once handy feature could end up crashing the entire system.

An economic debacle on the current scale is going to shake any political structure, however securely moored, but the EU's persistent recourse to a form of soft authoritarianism has left it peculiarly ill suited to weather the storm to come. After decades of routinely bypassing its voters the union may well no longer have what it takes to secure their approval for the harsh medicine and painful sacrifices necessary to bring the EU through this ordeal in one piece. After all, it can barely even get them to vote: Turnout for the most recent (2004) elections for the EU parliament sank to a record low of 45.5 percent. Admittedly that total was dragged down by massively uninterested Eastern Europeans (only 16.7 percent of Slovaks voted and 20.4 percent of Poles), but it was sparse almost everywhere: Only 39 percent of Brits showed up, about the same percentage as made it to the voting booth in the Netherlands, one of the EU's founding nations.

As the history of the union's occasional, grudgingly granted referenda-a sorry saga of chicanery, rejection and do-overs-reminds us, appeals to the supposed solidarity of that imaginary European demos have never really worked. And that was in the good times. They surely won't do the trick now, nor will arguments based on the logic of a free market ideology widely, if inaccurately, said to have failed. Yet to steer a course through what may become hideously hard times without much in the way of popular consent threatens to push already alienated electorates in the direction of the extremist politics of left or right.

The story of this slump is too familiar to need repeating here, but it is worth pausing to consider how the introduction of the euro has left the EU marooned on a circle of economic hell all of its own making. Imposed on most of the European heartland by a characteristic combination of bullying, bribery, conclave, and legerdemain, the single currency was put in place with as little regard for the real world as for the ballot box. To squeeze a wide range of vastly divergent economies (and to do so with few safety nets) into one monetary system made little sense except when understood as a matter of politics, not economics. But economics has a nasty habit of biting back.

Up until the eruption of the present crisis, the European Central Bank's interest rate policy primarily reflected the needs of France and Germany, Euroland's largest economies. This left rates "too" low for naturally faster growing countries like Ireland and Spain, which in turn inflated unsustainable housing bubbles. These have now burst-in Ireland's case taking much of the banking system down with it. On some forecasts Irish GDP may shrink by 10 percent between 2008 and 2010, a dismal number that could eventually prove too optimistic. Gloomsters joke bleakly that the difference between Ireland and Iceland is six months and one consonant. Spain meanwhile now boasts an official (in other words, understated) unemployment rate of 14 percent. Over 600,000 migrant workers have been laid off. This is not a recipe for social peace.

In other countries, most notably a horribly in-hock Italy (public sector debt over 100 percent of GDP and expanding fast), low interest rates allowed governments to put off long overdue structural reforms. Instead of forcing the introduction of the badly needed discipline that was allegedly one of the principal reasons for its adoption, the euro (a hard currency when compared with shabbier predecessors such as the lira or drachma) was treated as a free pass. It has been anything but. Even before the current mess, Italy's crucial export sector was finding it difficult to cope with the brutal combination of rising cost inflation and a currency far stronger than the accommodating, and periodically devalued, lira. On some estimates, this latest recession is the fourth that Italy has suffered in the last seven years. Back in 2005 Silvio Berlusconi described the euro as a "disaster" for his country. He was not exaggerating.

Devaluations are to GDP what steroids are to sport. In the long-term they may be unhealthy, but in the short-term they frequently work miracles. The problem is that the option is no longer so easily available for the nations that adopted the euro. Italy, Ireland, and a number of other countries are in the grip of a one-sized currency that could never fit all, and the euro is now for them little more than a straitjacket or, more accurately, a noose. They have theoretically retained enough sovereignty to quit the euro, but for one of them to do so, especially if other states stick with the common currency, would be to risk something close to complete economic meltdown.

Money would pour out (so much so that capital controls would probably be required), interest rates would soar, and the reborn national currency would plummet. In the absence of a bailout from the eurozone it had just abandoned, the exiting country itself would probably be driven to renege (either de facto or de jure) on its foreign debt-as would much of its private business. In its consequences, this could be a Lehman-plus trauma with possibly devastating effects on already chaotic international capital markets. No less critically, it could set off a crisis in confidence in the credit of those weaker nations that had kept faith with the single currency, not to speak of feebler economies elsewhere. The cure, therefore, could well be worse than the disease.

In the meantime, in a damned-if-you-do, damned-if-you-don't spasm, the markets are fretting that the disease is turning ever more dangerous-and, in a process that feeds upon itself, ever more infectious. Spreads on sovereign debt yields within the eurozone (between German Bunds, say, and paper issued by Spain, Greece, Portugal, Italy, and Ireland) have widened noticeably. This is a warning that investors are beginning to think a once unthinkable thought: that one or more of the zone's less resilient members might go into default. On this logic these countries can neither afford to keep the euro nor to junk it. Rock, meet hard place.

These worries are made even more pressing by concern over the impact of Eastern Europe's spiraling economic woes on the already shattered finances of the western half of the continent. Contrary to some of the more excitable headlines, not all the countries of formerly Warsaw Pact Europe are, yet, in deep trouble, but the problems of those that are (notably Hungary, Ukraine, Romania, and Latvia) threaten to wreck confidence in those that are not. And those problems will not be confined safely behind the Oder-Neisse line: Two of Sweden's largest banks, for instance, are frighteningly overexposed to the faltering Baltic States, while their counterparts in Austria, seemingly lost in nostalgic Habsburg reverie, have reportedly lent out the equivalent of 70 percent of their country's GDP to once Kaiserlich und Königlich territories and parts nearby.

Eastern Europe's problems are Western Europe's and, given Eastern Europe's dependence on Western capital flows, vice versa, a state of affairs that neither side appreciates. Infuriated by the impression that they were being sidelined by the upcoming "G-20+" summit in London, nine of the EU's former Soviet bloc members held their own breakaway meeting earlier this month to discuss what to do. Meanwhile, led by Germany's indignant Angela Merkel in full prudent-Hausfrau, Thatcher-handbag mode, the Westerners have tried to damp down the East's increasingly aggressive demands for assistance. Good luck with that. Demonstrating a keenly cynical awareness of which buttons to press, the Hungarian prime minister warned that a severe slowdown in the East could lead to "a flood of unemployed immigrants traveling to Western Europe in search of jobs."

If you suspect that all this leaves the EU looking somewhat stuck, you would be right. But then this is no accident. The lack of democratic responsiveness so thoroughly ingrained into the union's architecture was always intended to stop the bloc's politicians from succumbing to the temptations of protectionism, beggar-thy-neighbor devaluations, and other questionable devices often found in the toolbox of an economically desperate national government. That's all very well, and all very praiseworthy, but it doesn't do anything about the desperation, a desperation that will be felt all the more sharply by electorates looking for their leaders to do something, anything, in response to this crunch-only to discover to their chagrin (to use too gentle a word) that there is little that the EU will, legally or politically, allow those leaders to do.

To take just one example, earlier this year Britain saw a series of wildcat strikes protesting the importation of cheap foreign workers from elsewhere in the union as a means of undercutting the locals. The facts that triggered the dispute are murky, but what is certain is that even if the British government had wanted to intervene under EU law it could not. Equally, while the opposition Tories grumbled, nobody was fooled. If the Conservatives had been in charge, they would have done just the same as Labour: nothing. If you want to drive voters to the political extremes, stories like this are a good place to start.

Except that "start" is the wrong word. Parties of the extreme, whether of left or right, already have more than a foothold in Germany and France. "Populists" of every description can be found in the legislatures in countries from Belgium to Denmark to Latvia to Austria to Poland to Hungary. Take your pick: There are plenty to choose from. Even in never-so-sedate-as-it-seems Britain, a country that has made a fetish (if not always convincingly) of its moderation, the much-reviled far rightists of the hitherto tiny British National party are showing some signs of evolving from being useful bogeymen for the left into a party with demonstrable political clout within elements of a white working class that has been neglected for too long.

The backgrounds and the prospects of these movements vary widely from country to country, as do the pasts and the resentments that have shaped them, but in recent years their appeal has begun to grow in sections of the electorate pummeled by the dislocations brought about by mass immigration and globalization-dislocations made all the more painful by the realization that the ruling elites who never really asked them for their opinion on these changes, let alone their agreement to them, couldn't give a damn about their plight. This is a perception that will only be sharpened when the populations of these countries, more and more of whom are losing their jobs, are told by that very same political class that protection is off the agenda and that austerity is on, that saving local industries is unacceptable, and that helping out foreign countries is a must. And, oh yes, none of this was our fault-it was all the bankers' doing-and, oh yes, they and their bonuses have got to be rescued too.

So what's next? The leaders of the EU countries will do their best to muddle through in rickety, unpopular unity. Here and there they will cheat both on each other and on the key EU principle of a single market. The warning signs are already there. In February, President Sarkozy attacked the way that French auto companies were supplying their home market from manufacturing facilities in the Czech Republic. The previous month, Britain's Gordon Brown had criticized the amount of overseas lending by the UK's beleaguered bailed-out banks. Nevertheless, however awkwardly, however reluctantly, the EU's members will attempt to hang together-for as long as (or indeed longer than) their domestic politics comfortably permit, an effort that will inevitably further boost the appeal of the wild men of the fringes.

That said, as the EU's leaders are all too well aware, the slump has so far brought down two European governments (in Latvia and non-EU Iceland). Nobody wants to be next, let alone run the risk of political and economic breakdown. The few remaining traces of the budgetary discipline that supposedly still underpins the euro will therefore probably be scrapped. The euro may hang on to its reach, but only at the cost of its integrity. To ordinary Germans this will be seen as a betrayal, a Dolchstoss even. A people haunted by memories of where a debauched currency can lead, they only agreed to part with their much-cherished deutsche mark on the understanding that the euro would be run with Bundesbank-style discipline. That was then.

So money will be thrown around, the imperiled brethren of both East and West will, after much shoving, screaming, and hesitation, be bailed out. Some protectionist measures (directed against those outside the EU) will be brought in and all fingers will be crossed. It won't be pretty, but with luck, it might be enough to stave off catastrophe. Pushing their luck, some glass-is-half-full Europhiles believe that the fact that no country can easily work its way through these tribulations alone will conclusively make the case for still closer European integration to some of the EU's more reluctant federalists. You can be sure that this is a rationalization that Brussels will look to exploit: Rahm Emanuel is not the only politician unwilling to waste a crisis. The EU's policy response to the slump is likely to have two objectives: the reconstruction of member-states' economies and the destruction of what's left of their autonomy. Going for the latter could well drive even more disaffected voters into the extremist fringe, though Brussels is arrogant enough to persist. There are already indications that the eurocrats may be pushing at an open door. In a startling example of mistaking the Titanic for the lifeboat, Poland has become just one of several nations speeding up plans to sign up for the euro-and the safe haven it is meant to represent.

On the other hand if, as appears disturbingly likely, the economic situation grows far darker, it's easy to draw an alternative picture in which both euro and union come under previously unimaginable stress, stress with unpredictable and potentially ominous consequences, stress that will be echoed and intensified by mounting political and social disorder in a Europe that discovers, too late, that there was something to be said for democracy after all.