My recent admission that I erred when thinking that the
Euro in its present form could survive in the longer term earned me a lot of
criticism. Above all in the blog comments of Prof. Varoufakis who was kind enough to
give my article wide distribution. This is why I want to clarify some points
which were/are behind my reasoning (and it’s going to be a long clarification…).
1. The headline of my article quoted Lord Dahrendorf as
saying, back in 1995, that "The idea of a common currency union is a big
mistake, an adventurous, reckless and mistaken goal which will not unite Europe
but, instead, divide it". I had linked Dahrendorf’s original statement in
my article. I could also have linked the Delors Report of 1995 which,
essentially, said the same thing. Sadly, Dahrendorf’s quote (and its timing!)
was ignored by my critics and what incited their criticism was my reference to the book "The Euro Liars” and, particularly, to the author of that book.
2. The author’s conclusion was that the solution to the
Eurozone would be a split into a North-Euro and a South-Euro. I had not subscribed to that
solution. If anything, I would have my doubts that the problems of one common
currency could be solved by creating two common currencies. However, I had
totally subscribed to the author’s diagnosis.
3. That diagnosis (and the essence of the book; thus it’s
title) was that there has been consistent lying since the outbreak of the
crisis. Lying mostly on the part of EU-politicians but also on the part of
national governments. We normally digest the news of a year in portions of
1/365th. By mid-year, we have forgotten what was said at the
beginning of the year. When one gets 3 years in a condensed version of a couple
of hundred pages, then one really gets worried because one really becomes aware
of all the lying which has taken place. At least, that's what happened to me. I
really didn't learn anything new from the book. However, it became clear to me
that when liars run the show, the show won't have a good ending. Now, ‘lying‘
is an offensive term. More polite people would call it ‘denial’.
4. Do I think that the Euro was doomed from the beginning?
Not necessarily, but it would have required the management of macro-economic
trends within the Eurozone. Maastricht alone was not enough because it only
addressed national budgets. What matters much more than national budgets (even
though they may be a consequence of them) are national macro-economic trends. To
manage those would not have required a United States of Europe but it would
have required EU-institutions and, above all, EU-politicians who paid attention
to macro-economic trends and who would act in consequence.
5. The most important indicators of cross-border macro-economic
trends are national current account balances because they drive net cross-border
capital flows. Or, one could say that net cross-border capital flows drive
national current account balances. This is a chicken-and-egg process. It is an
irrefutable mathematical fact, however, that in a world of local currencies,
there can be no net cross-border flows of foreign currency capital if there are
not current account surpluses/deficits. In the world of the Euro that’s quite different
because the foreign currency (i. e. the Euro) also acts as the local currency.
6. Current account surpluses/deficits can be good or bad;
that depends on the situation. However, excessive and chronic current account
imbalances are bad; regardless whether they are positive or negative. When they
are positive, it is not so easy to understand that because one is led to
believe that the role of an “export world champion” is a virtue whereas the
role of an “import world champion” is evidence of profligation. In financial terms, both have the same
consequences.
7. Current account surplusers are (and have to be) net exporters
of capital and current account deficiters are (and have to be) net importers of
capital.
8. There were net cross-border foreign currency capital flows
before the Euro. However, in a world of local currencies, there were brakes on
them, the most significant of which was that one might run out of foreign
currency capital (because foreigners were no longer willing to transfer foreign
currency capital and/or made it too expensive).
9. The real kick-off to the misery was actually
EU-membership. Two of the four “EU-freedoms” were the free movement of
products/services and capital. Still, these two freedoms did not cause undue damage
prior to the Euro because of the brake I described above.
10. The Euro did away with that brake. By intention? No, by
default instead. Theoretically, the no bail-out clause should have cautioned
capital to flow excessively to weaker economies. But financial risk is not an
objective criterion. It is very much in the eyes of the beholder. And those
beholders were the owners of capital.
11. Capital always flows to areas where its beholders assess the
risk-adjusted return to be the highest. The owners of capital assessed the risk
of Greece & Co. more or less the same as the risk of Germany & Co. This
was not the case prior to the Euro because Greece, for example, had to pay 5-7%
more on foreign currency loans than, for example, Germany.
12. In consequence, capital (much of it German and French
capital) flowed to the South and the "5-7%" eventually became less than 1%. Political
leaders at the time praised this on the grounds that “convergence” was evidence
that the Euro was very successful. And in the South, it facilitated excessive
current account deficits.
13. Thus, what used to be a ‘brake’ became a ‘gas pedal’.
Banking regulations accelerated the process because Basel-2 classified
sovereign debt of EZ-countries as ‘risk-free’, thereby not requiring equity to
support sovereign loans. Deutsche Bank today has about 5 times as many ‘risk-free’ as it has ‘risk-weighted’
assets. In the absence of leverage controls on banks, banks went overboard with
lending to ‘risk-free’ borrowers (because it often tended to be more profitable
than lending to ‘risk-weighted’ borrowers).
14. Maastricht would have contained this a bit if it had been
adhered to (i. e. if Germany and France had not been the first two countries to
violate it). But Maastricht could not have contained the net cross-border
capital flows into national private sectors. Spain and Ireland did not get into
trouble because of government profligation. They got into trouble because they
wanted (or were forced) to bail-out their over-indebted private sectors.
15. Thus, the two critical macro-economic indicators which
should have been regulated as much as Maastricht regulated the budgets were the
current accounts and the net cross-border capital flows. One could have said,
for example, that current account deficits must be limited to 3% of GDP and net
foreign debt to something like 100% of GDP. I don’t know how one could have
enforced that in a framework of free movement of products/services and
capital (should the Spanish government have prohibited foreign loans to their private sector?), but without it, we got the results which we have today.
16. Would the same results have happened without the Euro? It
cannot be ruled out. After all, capital had ‘gone crazy’ (the local currency
country Iceland was viewed as the new Wall Street of the North Atlantic; the
local currency country of Hungary ended up financing 80% of housing loans in
CHF). But I would argue that, without the Euro, common sense would have
surfaced sooner. And it certainly would have surfaced sooner if banks had been limited in their leverage.
17. All of this, as bad it sounds, would still not have
needed to end up in the situation where we are today. That, however, would have
required EZ-leaders, back in 2010, to recognize the problem instead of lying
about it. Or rather: instead of denying it.
18. If the problem began with exuberant net capital flows into
the wrong direction and the resulting current account imbalances, one would
have had to reverse these processes. One would have had to strengthen the weaker
economies through investments (even if that meant less investments in the
stronger economies) and to put them into a situation where they, out of their
own efforts, could reverse these macro-economic trends (obviously, the weaker
economies would have had to be prepared to do that).
19. However, if one reduces the problem to the phrase that “If
Greece fails, the Euro fails and if the Euro fails, the EU will fail”, one is
off on the wrong track. The proper phrase would have been “If Greece fails, many
of our banks will fail but we will deal with that separately. Our first
priority is to re-establish macro-economic balances in the economies of the
Eurozone”. And one lie (pardon me: I should have said ‘denial') led to
innumerable more. That’s what the book which I referenced pointed out.
20. The Euro (or any other currency) is not an end in and by
itself. It is a means towards something. The end should have been defined as
increasing the living standards, on a
balanced basis, of the people living in the Eurozone. Instead, the end was defined (on purpose or not) as meaning that "The common currency project should drill the countries to German behavior"
(Dahrendorf); or that the common currency would, by force, lead to a United
States of Europe. Such ends can never be accomplished by mandate.
21. I don’t remember whether it was 2010 or 2011, but a rumor had
erupted that Jean-Claude Juncker had called for an emergency meeting with the
Greek Finance Minister Papakonstantinou. Juncker vehemently denied that.
Unfortunately, he was subsequently filmed on his way to the meeting. He justified that
afterwards (I still remember that interview) that "when things get serious, one
has to lie”. That is not uncommon in politics but what is inexcusable is that
one publicly says so. After all, there is an invaluable good called ‘the
confidence of people in government’. If one willingly destroys that good, one
is responsible for the consequences. This and similar incidences had prompted me to
write an article, back in November of 2011, titled “A Nueremberg Trial for EU-Elites”.
22. As far as I can tell, there are no significant animosities
between the people of Iceland and the rest of Europe today. Yes, a lot of banks
lost a lot of money in Iceland and the Icelanders had a very rough time for a while. However, would
Iceland have been able to choose the course it had chosen if it had had the
Euro as its currency? Or would the 300.000 or so Icelanders today be liable for
the foreign debt run up by a few mad bankers?
23. I would agree with Uwe Bott when he says that “In theory
the flaws in the construct are fixable, in reality there is not enough time or
political will”. Yes, the problem could still be fixed but no, there are, in my opinion, exactly
zero indications that there is the political will on any of the sides involved. That would require responsible
politicians to recognize reality; admit mistakes; and go from there. That preparedness
is not recognizable as far as I am concerned and this is why I had a change of
mind, after extensive pondering, regarding the future of the Eurozone as it is.
24. I principally don’t expect the Eurozone to fall apart any
time soon. Instead, I expect a continuation of the process of ‘muddling through’.
Such a process can go on for quite some time unless it is interrupted by
unforeseen events. The most dangerous unforeseen event is civil unrest in one of
the countries concerned.
25. In my first year at an American college back in 1968,
economics professors explained to us why, from an economic standpoint, the
economy of the Soviet Union was doomed. Still, it lasted for another 22 years
(and it might have lasted even longer if there hadn’t been Gorbachow). However,
the point is: the longer an artificial system is maintained, the faster it will
collapse once it collapses.
In summary, my ‘admission of defeat’ was not an expression
that there could absolutely be no solution for the Eurozone as it is. Instead,
it was based on my assessment that, after observing the situation for 3 years
now (and after reading a condensed summary of all the lies which have been broadcast so far), there are no indications whatsoever that there can be a ‘European
Initiative’ which Prof. Galbraith referred to. Nor a Modest Proposal. And without an initiative of that (or similar) type,
there is no hope in the longer term.
PS: previous posts in this series: P1, P2, P3, P4, P5, P6, P7, P8, P9, 10, 11.
