Hanging together and hanging separately in Europe

Greece, the euro and Europe

We can bang on all we want about what should have been. The narratives are well known by now. The orthodox rules for euro membership should have been strictly applied from the beginning. The orthodox rules for euro membership should have been accompanied by the stabilizing effects of a fiscal union as in other large currency areas (meaning countries). The orthodoxy itself was a mistake that has brought the euro zone to its knees in a lasting depression since 2008. Or that despite the failure to do one of those things originally, better late than never: Europe can still get it right once the tensions build up and the internal contradictions of the euro start hurting the citizens it was supposed to benefit. The current proponents of one path over the other now reflect the same divisions as 20 years ago, when the Stability and Growth Pact was fought over and adopted.

But those choices are an illusion. Europe cannot retroactively enforce orthodoxy on Greece now without destroying the country, its citizens and democracy. And it cannot force Greece out of the euro without destroying the EU and its reason for existing. Either the other critics of orthodoxy will follow suit and the euro will become a repeat of  Bismarck's kleindeutsche Loesung, or the eurogroup will set about suppressing democracy in other states as it has in Greece to keep the voters in line. The kind of gold standard European order that the eurogroup leadership is now trying to retroactively impose on its members has never been attempted before, and no democracy has ever survived the downward spiral that the imposition of such hardhip entails. The long persistence of the historical gold standard was only possible because regular people could not vote. We can't go back there, and so that path is a road to nowhere, at least for Greece. If the remaining members follow Germany, Finland, the Netherlands and Slovakia down that path, it will damage European democracy extensively. The old saying will become reality, that if it were possible to vote to change the system, it would be illegal.

If Europe had any smarts, it would find the courage to introduce a  fiscal union that would help keep the currency union together without the debilitating demise of the euro zone periphery, both economically and politically. It needn't be that big a transfer. But it would soften the internal divisions of a continent sufficiently to keep it together and prevent a far worse future.

As Franklin once said, we all hang together, or we all hang separately.

Europe was once about promoting and protecting democracy on the continent by supporting 

Germany limits the European Stability Mechanism

Germany's consitutional court ruled today that Germany may participate in the European Stability Mechanism, but with strict limits and conditions. The ESM is the permanent fund meant to prop up finances in some of the euro zone's countries.

Condition one is a cap on Germany's contribution at 190 billion euros. No salami tactics in which the commitment becomes larger.

Condition two is full consultation with the German parliament on an ongoing basis. This means the terms of the loans and the compliance with the terms.

Condition three is a new treaty to write those conditions down. Even a modification of the existing treaty is a new one, so that is clear.

These conditions mean that those opposed to the ESM's establishment will not get their way entirely. But they will have it in their power to make the recipients of ESM funds wish they had. Those in Germany that want to cut off Southern Europe entirely will have to settle for cutting them down to size. They will now have the tools do so with all their might. And Europe will suffer again.

Slovakia tumbles, and with it, aid for Greece

Expanding the EFSF: the European Financial Stability Facility, has just hit a wall as the Slovakian parliament refused to support it. The Slovakian government coalition has fallen apart as a result, smashed on political rocks that have nothing to do with Slovakia. You can be sure that Berlin will approach whoever is next in charge and start issuing demands. 

The argument in Slovakia was simple--that there was no reason why a poor member state of the EU should be forced to pay for policies over which it has no control. And they are right in principle. Forcing Slovakia against its will to pay for Greece was not only questionable on the grounds of economic fairness, but on democratic grounds as well. Slovakia has no democratic control over the bills that are being run up in Greece. If it accepted demands that Berlin should dictate its foreign policy and its budget policy, then the German plans to eclipse democracy in Greece would start spreading north. 

What all of this shows is that Germany (and France and the Netherlands) have become terribly attached to saving Greece at any cost. And that is precisely the problem, because the costs are not bearable. Haircuts are needed, i.e. a partial default that will limit the liabilities that taxpayers are expected to bear. This is doubly important because no one in their right minds believes the liabilities will be limited to what we know now, either in Greece or in other countries.

When you become too attached to one single outcome, and here it is the all-or-nothing approach to repayment you distort reality and your ability to deal with the real world. You develop, as any armchair crime investigator knows, pathological personality traits that start hurting yourself and everyone around you. In the attempt to preserve a 100% repayment rate, Germany is demanding that we throw good money after bad. The horror of the one scenario looms so great that the even greater horror of the path they're heading down is not acknowledged.

It's like telling the troops at Stalingrad that there will be no retreat, no change in plan, a denial of the realities on the ground. We all know how that worked out. 

The fall of the Slovakian government, but above all, the arguments that were made in refusing to pay further (they had already paid into the pot and said that enough is enough) is a wake-up call to Europe's creditor countries to rethink how they want to deal with the crisis, and whether they really want to start crushing European democracies to ensure that some bonds get repaid.

And the War Continues

It has been but a few days since European leaders agreed a new bailout for Greece and financial markets are already tightening the screws as if little had happened. This applies not only to Greece, but to Italy, Spain and Portugal as well. Why?

In a nutshell, the problems are simply to big and the resources are simply too modest to dampen future speculation against southern rim countries in the EU. The first set of problems lies within the affected countries themselves: there is still no sign from Athens or from Lisbon that they have adopted a new way of looking at things and will radically restructure their public finances. We are seeing emergency measures in Greece, but there is no discussion of what sustainable finances look like. As long as Greece and Portugal remain in the euro, and as long as the euro zone resists institutionalised fiscal transfers, sustainable will mean stingy. Tax collections will have to increase, social benefits will have to decrease, and public infrastructure will have to be sold off to private corporations. What little is left will have to go into regulating the private companies providing previously public services, if anyone is capable. The bottom line is: more for less and a loss of public control over the necessities of life. If I were 20 and Greek, and the country continued down this path, I would leave, period.

The second set of problems lies with Europe itself and the way it takes decisions. The response to the Greek crisis in particular has been a series of talks between France and Germany, long periods of German absence from discussions intended to heighten the sense of desperation by others, and German reluctance to spend much of anything. Of all the options available to it, Europe seems incapable of forcing real policy change in targeted countries, incapable of  kicking a country out of the euro, and incapable of agreeing on the fiscal transfers required to keep a country inside. Something has to give, and there will be changes yet to come.

The third set of problems is one that Germany seems intuitively aware of, and if so, is entirely right about: that if they continue throwing money at the countries that are now in trouble, they will themselves be pulled under water. German banks have been worried about the impact that a Greek default would have on their balance books (as have been French and British banks), but the other side of the coin is that ratings agencies have already started to warn that the credit ratings of Europe's more solvent countries would eventually be at risk if the problems in Europe's south are not solved. This is the reason why the European declaration stated time and again that under no circumstances would the arrangements be extended beyond Greece, and that everyone would strictly adhere to the budget and debt criteria. The word 'strictly' was used a lot.

Given all of this, there has been a lot of money spent, but it isn't by far enough to solve the euro zone's problems. The war will continue. Until Europe gets off the pot and does something real.

Germany blocks the ECB

Jean-Claude Trichet, the President of the ECB, has a term of office that extends into October and cannot be renewed under the existing rules. And yet, Europe cannot agree on a replacement.

Let me rephrase that. Germany cannot bring itself to support the candidate that everyone else seems to have agreed on. This is despite the fact that the Chancellor herself has praised the candidate, his policies and his credentials. Mario Draghi is the current Chair of the Financial Stability Board, the global body responsible for ensuring that there will not be another financial crisis. In terms of policy, Draghi brings everything to the table the Germans want. He is clear on the question of whether the ECB should continue to purchase bonds from bankrupt eurozone governments as Trichet has reluctantly done. He says the ECB wouldn't do that on his watch. He would be tough on inflation. What more can Germany want?

That is the question. Germany seems to want to teach Europe a lesson. Not just the 'deficit sinners' who will be cast into the fire, but France and Italy as well. The level of hysteria in the German press and in German politics against foreigners is breathtaking. They're not only mad at the so-called PIIGS, they're mad at the ECB as well. And that is run by a Frenchman.  Chancellor Merkel wanted a German candidate, Bundesbank President Axel Weber, to be the next head of the ECB. He withdrew from the running after citing opposition from Europe and from within the Bank itself to his intent to run a tight ship. And it seems in her eyes, the German chanting for European blood could only be appeased by a Teutonic captain at the helm of the ECB.

There is a saying coined by Carl Jung that what you resist persists. In the context of German hysteria, the Weber Affair blew up because it had to. Weber came across outside Germany as arrogant and contemptful of his European colleagues, echoing what Europe hates about Germany most. Only 10 years ago, Germany was an economic basket case. It flouted the rules that it demanded be applied to others. It defied the application of economic penalties in the mid-2000s when it passed one emergency budget after another. Now that it is back on track, it is screaming for obedience and punishment according to terms it would never accept for itself. 

Germany has been rightly criticised for a lack of sensibility in how it deals with its European neighbours. One might argue that there is little the German government could do in the face of such domestic revulsion for Europe. Except for one thing. Merkel forgets that Germany has been here before and chose European cooperation rather than an all-out War of the Roses. In 1991, Merkel's mentor, Chancellor Helmut Kohl, conceded minor points to the hysterical politicians who wanted to torpedo EMU. But he insisted that you had to compromise in Europe, that Germany actually had to get on with its neighbours. Germany's past, he argued, demanded that. 

Germany is at the verge of destroying Europe. It may not in the end, but it is making it weaker every day.

Europe's new economic constitution

France and Germany, with the support of the Netherlands, have agreed on the price for supporting the euro zone's weaker economies. It will be a stronger economic constitution devoted to a supply-side competitiveness policy for the euro zone, and indeed for the entire EU. The agreement will form the centrepiece of the EU's Spring Council on 24-25 March.

What does this mean? It means that national governments must do everything in their power to make their economies attractive for private investment capital. This means limiting government spending and  borrowing, and restructuring the economy to promote economic renewal in new economic activity. Subsidies must be cut, job protections removed and unemployment insurance modified so that capital--financial, industrial and human--can be re-allocated to more productive endeavours. Government spending and market intervention is allowed to the extent that it encourages businesses and individuals to shift from sunset industries, where emerging markets are on an equal footing with the advanced economies of Western Europe, to sunrise industries where first-mover advantages are hopefully still to be had.

France and Germany's demands will likely be a reform of an existing instrument, the Integrated Guidelines. These Guidelines are decided collectively by the European Council under the advice of the European Commission and are used to set the standard that national governments are supposed to strive for in economic, and increasingly social policy. National governments are then required to prepare National Action Plans each year, which the Commission reports on and their colleagues in the Council then evaluate--with approval or disapproval--and if they feel it is required, recommend changes to the government in question.

Once upon a time, the Integrated Guidelines were limited to macroeconomic policy and known as the  Broad Economic Policy Guidelines (BEPG). They were designed to coordinate economic policy for the euro zone members, but also for non-member states, as the idea was that they would join the euro sooner rather than later. That process started after 1992, once the political agreement to launch the euro had been made. The Integrated Guidelines added similar benchmarking, reporting and peer review for labour market policy (which covers certain aspects of skills development, education,  unemployment insurance and measures to promote work by older. minority and female residents) from 1997 onward, and competitiveness policy more broadly from 2005 onward. That was the year that the EU reformed and strengthened its goal to become the world's most competitive economic zone by 2010.

The Integrated Guidelines were a great idea, but they had very little impact on national policies, and now Germany and France have agreed that they should be granted more importance than they have had before. The Guidelines are part of what is known in Europe as the Open Method of Coordination, which stresses that governments should view the benchmarks as voluntary and that strict demands contradict the spirit of the arrangement, which is to let 1000 flowers bloom.

The Franco-German deal will install a much more extensive economic constitution for Europe, if the Council adopts it. The question is: how many obligations will a successfully agreed-upon reform of Europe's economic constitution place on EU member states? All must agree. France and Germany will not gain everything they want. Now that they have decided what they will strive toward, the next three weeks will be surely be devoted to various combinations of coalition-building, sweet-talking, side-deals, arm-twisting and brow-beating to make an agreement possible.

France and Germany must consider more strongly than they have in their press statements to date what their narrative of success and appropriate policy actually entails.  Messages from Berlin argue that Germany must be the standard for the new economic constitution. Parts of that are right, but parts of that are also surely wrong and inappropriate for Europe. Germany is a highly conservative country in which privilege, class and gender biases are institutionally reinforced. That is hostile to some understandings of how the state should govern society, and of what a good society should strive towards. Economic policy only survives intact if it is embedded in social acceptance. German ideas of what is right are not European ideas, nor should they be. In the time to come, France may prove to be crucial in determining the final outcome. It is not as dogmatic as Berlin, and it has a stronger tradition of state intervention in the economy and social justice as part of the public good that resonates well in many other parts of Europe.

Germany will not only have to make demands; it will have to listen as well and consider alternative visions in good faith of what the state is there to do.

A constitution is a political compromise, and it must reflect everyone to be legitimate and not do harm.

Paris, Berlin and the future of the euro

The French and German governments met together in Freiburg (Germany) today to discuss whether the euro zone countries should issue government bonds that they all back collectively. They also met to discuss whether the financial rescue fund created to save Greece and Ireland should be fortified with more cash as financial markets turn on Portugal. It is now clear that neither of these things will happen. For the moment.

The Paris-Berlin agreement comes a week before meetings with all EU member states on how to respond to the reality that they have now woken up to: that financial markets are far from finished with attacking euro zone countries.

Countries that are on the front lines of the speculative war on the euro have been understandably receptive to the idea of the new euro zone bonds. They would provide a source of cash that their more prosperous neighbours would likely end up paying for, given the disastrous nature of their own public finances. Germany and a host of other countries have been understandably relectant to commit to such a move. They understand well enough that the euro zone bonds would reduce pressure on the front line states to retrench their finances and lead effectively to fiscal transfers from northern to southern Europe. It is what some German politicians and most German economists feared would happen before the euro was created. That is why Germany insisted on the Stability and Growth Pact and the Excessive Deficit Procedure in 1995. Southern European governments would be institutionally and politically obligated to rein in their borrowing to prevent the question of bailouts from arising in the first place.

It is still possible that countries like Germany will give in to political pressue to save their southern neighbours, but blocking the euro zone bonds will ensure that they are not automatically obligated to do so, and that the pressure to cave in to southern European demands remains contained. Even a common euro zone bond would have to be underpinned by political agreements by the principal member states. The incentive structure, however, makes it difficult for a country like Germany to insist on placing conditions on other member states in return for saying yes. One would think that a bankrupt country with its back to the wall would be compliant with the demands of its saviours, but there is no reason to assume this.

For this reason, if Germany and its allies feel the need to assist the countries on the front line of this war, they will prefer to do this with the tools they have just agreed to rather than the bond proposal. The European Financial Stability Facility (EFSF) allows the donor countries more opportunity to retain the upper hand in negotiations. Governments that need the aid are failures and must submit to political demands, at least from a German perspective. The Germans have just come around to understanding that the EFSF should be allowed to exist in perpetuity, rather than until 2013. They are not willing to enlarge the amount of money it contains, and came to the talks in Freiburg insisting they would not budge on this demand. This ensures that pressure on applicant countries remains high. This runs the risk of the funds being insufficient, however.

Unlike their demand for automatic sanctions on countries that violate EMU's budget rules, Germany got its way this time. France chose to side with Berlin's demand to place increased pressure on southern Europe. Why is this consistent with France's previous position on automatic sanctions, which was to block them? Whilst the German camp and southern Europe lined up on opposite sides of this issue over the past two weeks, France remained uncommitted and sided with Germany in the end.

Those who saw Paris as the defender of southern Europe fail to appreciate the interest that France has in the policies and institutions of a strong currency. It has a history dating back to the mid-1980s of promoting a strong currency, le franc fort,  as a central component of its economic strategy for competitiveness and development. The political establishment in France is only too aware that Germany has achieved good results with its conservative policies during tough economic times.

And yet, this policy of the strong currency is sometimes at odds with the impulses that pervade French politics to ensure public intervention in economic affairs for the greater public good. This is the impulse that stood behind the French demand during the EMU negotiations for a measure of political discretion and control of economic affairs in an economic government for Europe.

The consequence of this is that whilst the German-led camp and southern Europe are very stable in their preferences and more or less balance each other out, France remains ambivalent and capable of swinging either way. Germany may have become the most powerful country in Europe in terms of resources and willpower, but it can't get its way without the help of France.

In this situation, France is not able to decide outcomes alone, but it is the fulcrum of Europe. When the inevitable fights over how to respond to an attack on Portugal, Spain or Italy erupt, France's position will likely tilt the European response in the direction it chooses.

That is power too.

Who pays when a country defaults?

Yesterday's deal to bail out Ireland rejected a long-standing German demand that investors holding Irish government bonds take a haircut in return for EU aid to the banks.

Accepting a haircut is financial market-speak for accepting a reduction in the value of the bonds you hold. The German government, which has been one of the most openly critical of the behaviour of investors during the crisis, has insisted that there is no reason to provide public insurance for private risk-taking. Investment is a rewarding business, but also a risky one, and when investments go bad, investors have to accept losses.
 
When a government like Ireland can't pay its debts, bondholders run the risk of receiving nothing in return for their scraps of paper. The alternative is that they collectively agree to avert total disaster by agreeing to take only a portion of what is owed them, and extending new loans to give the country extra time. This is what is known as restructuring a country's debt. Outside governments can increase the likelihood that they will agree by sweetening the deal with extra loans to the country that can't pay. This gives the group of private bondholders a bigger pie to distribute, it softens the blow for the country that can't pay, and it prevents the country from collapsing. This is why the most likely source of this outside funding is the country's most important trade and investment partners. This was the case for Mexico in the mid-1990s, when the United States helped bail it out. And it is the case for Ireland and Greece today. It's enlightened self-interest.

Except that the European Union, unlike the United States, asks nothing of bondholders in return. They are, unless anything changes, getting 100% of their investment guaranteed by the euro zone in the final instance. And they are using that money to wage a further war against other countries they have in their sights. This week, the first salvos were shot at Portugal and Spain.

This European attitude is something to watch. So far, Germany has been unable to convince its fellow member states to make bondholder haircuts a condition of EU aid. Instead, the message that the Irish and others, including the European Commission are sending out, is that they are terrified that bondholders will turn their backs on the country entirely.

Why watch this point if European countries are not united in their assessment of whether bondholders must share in the cost of the crisis? Because the war has only started. We have yet to see financial markets attack a large country. If and more likely, when that happens, the EU will have to make some very tough decisions about how much it is prepared to give now (and that is limited), how much, if any, it is prepared to borrow collectively to bail out its weakest states (which implies a radical re-thinking of European economic principles and law) and how much the bondholders must pay.

If European governments listen to Berlin and make bondholders share the burden, they will be doing nothing different than has happened many times before. International investment will not dry up as long as the crisis is used wisely to restructure the economy, improve corporate governance and improve the regulation of financial markets as Ireland rebuilds.