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| Explosive Spain : the next challenge to the Euro? (Photo credit: NASA Goddard Photo and Video) |
Is it "just" a problem of sovereign debt and speculative attacks fed by the bond markets conviction that the Euro is not defended by credible institutions and financial power the way the US dollar is? Or are other factors at work here, in particular cultural divergences and globalization?
Let's take them in turn.
Public Deficits
On June 2nd,
Soros, in a
memorable and much-discussed speech in Trento (Italy) has made the point that
Angela Merkel is the one single source of the crisis: she put a stop to Germany
in its traditional role as the engine of a federated Europe. How did she do
this? By declaring in 2008 after the fall of Lehman Brothers that "the virtual guarantee extended to
other financial institutions should come from each country acting separately,
not by Europe acting jointly." It took the markets a while to digest this
declaration but once they had, speculators (guided by the credit rating
agencies, Moody's et al) realized that the weaker economies on the Euro
periphery were open to attack - and attack they did, starting with Greece.
Furthermore,
he made an important and very convincing prediction that Germany (and the
Bundesbank) have only three months to stem the Euro crisis (see articles below
and if you can, take time to read Soros' speech here: it's
really worth the read).
UPDATE: A few days ago, Soros's speech was taken down from his website and re-loaded without any of the references to Ms. Merkel that I quote here...no doubt as a result of diplomatic pressure placed on Mr. Soros: I can only suppose that the German authorities did not appreciate and Ms. Merkel was not amused. But this changes nothing to the thrust of his arguments...
Soros is convinced that “the euro crisis threatens to destroy the European Union."
UPDATE: A few days ago, Soros's speech was taken down from his website and re-loaded without any of the references to Ms. Merkel that I quote here...no doubt as a result of diplomatic pressure placed on Mr. Soros: I can only suppose that the German authorities did not appreciate and Ms. Merkel was not amused. But this changes nothing to the thrust of his arguments...
Soros is convinced that “the euro crisis threatens to destroy the European Union."
Frightening
words! For him, the European Union itself is similar to a financial bubble. It
grew as a "fantastic project" from one "small step forward"
to the next, each time forcing politicians to take the necessary measures to
move it forward, closer to European union. That's how it went from the original, relatively
modest Coal and Steel Community in the
1950s to the current European Union, a process feeding "on its own
success, very much like a financial bubble."
Now, when
the Maastricht Treaty created a common currency without prior political union,
it took a step that was too big. And at the wrong time when
Germany, having obtained unification with East Germany had largely lost
interest in the European Union project. To this potent brew, add the fact that
the common currency threw together countries at very different levels of
development: for Germany (and other northern European countries like Finland or
the Netherlands – i.e. "the center"), the Euro was an opportunity to
expand exports (since the Euro was cheaper than the national currencies had
been) and they took the necessary measures to improve competitiveness (restraint
on salary increases etc). For Southern European economies (i.e. "the
periphery") the Euro became a source of cheap credit feeding a
dangerous consumption and housing boom.
Meanwhile commercial banks were allowed to accumulate government bonds
without having to set aside equity capital; so they were tempted to "to
accumulate the bonds of the weaker euro members in order to earn a few extra
basis points." When the 2008 crash came, "many governments had to
shift bank liabilities on to their own balance sheets and engage in massive
deficit spending. These countries found themselves in the position of a third
world country that had become heavily indebted in a currency that it did not
control. Due to the divergence in economic performance Europe became divided
between creditor and debtor countries." But it was a while before the
financial markets discovered that government debt was no longer sovereign and
could actually default. At that point, banks loaded with bonds discovered they
were insolvent. As Soros points out: “that constituted the two main components
of the problem confronting us today: a sovereign debt crisis and a banking
crisis which are closely interlinked."
The
international financial authorities moved in, but unfortunately they are
reacting to this crisis exactly the way they did in the 1982 banking crisis:
creditors are shifting the burden to debtors. Soros has some striking things to
say about this: "Just as in the 1980’s all the blame and burden
is falling on the “periphery” and the responsibility of the “center” has never
been properly acknowledged. Yet in the euro crisis the responsibility of
the center is even greater than it was in 1982. The “center” is responsible for
designing a flawed system, enacting flawed treaties, pursuing flawed policies
and always doing too little too late. In the 1980’s Latin America suffered a lost
decade; a similar fate now awaits Europe. That is the responsibility that
Germany and the other creditor countries need to acknowledge. But there is no
sign of this happening."
Are you listening Ms. Merkel? Your policies are
flawed and you are always doing too little too late! Wake up! Or do you want
Europe to suffer a lost decade? It could even be much more than that: a lost
historical opportunity, the killing of the European dream of a peaceful,
prosperous union! You always say you want "more Europe", but do you
really?
Okay, Ms. Merkel always
manages to make me very angry. Let me get back to the argument at hand. The
European Union is a political bubble about to burst. And it is also an economic
bubble. How? This is a little complex (if you want to know all about the arcane
Target 2 mechanism for the Euro, read Soros!) but in simple terms, what is
happening is this: financial institutions (central banks and commercial banks)
are reordering their financial exposure along
national lines, meaning the "center" is shedding bonds from the
"periphery" and conversely there's a capital flight from the
periphery towards the stronger Euro countries (i.e. towards Germany in
primis - German bond yields are practically zero...).
By March 2012 the Bundesbank had claims of some 660 billion euros against the central banks of the periphery countries - so now it is pulling everything in. It is against expanding the money supply (Euro-bonds are a no-no for them!) and it has taken measures to limit the losses it would sustain in case of a breakup. Alas, this is a self-fulfilling prophecy: once the Bundesbank does it, they all do it. As a result, credit to enterprises, especially the medium and small ones that are a major source of employment, becomes less available and unemployment soars.
Hence a deeper crisis. A wider divergence between Germany and the rest of the eurozone. A greater risk of political and social disintegration. Increased public opposition to austerity and distrust in the Euro.
In short: blow-up!
Why does
Soros give three months to the Germans who are in the "driver seat"
to reverse the situation? He expects that the Greeks in the next election (June
17) will elect a government ready to accept the bailout agreement but unable to
meet the conditions. So that “the Greek crisis is liable to come to a climax in
the fall. By that time the German economy will also be weakening so that
Chancellor Merkel will find it even more difficult than today to persuade the
German public to accept any additional European responsibilities. That is what
creates a three months’ window."
Between now and September.
And reversal will require some extraordinary and courageous measures. Among them:
- a European Bank Deposit Insurance scheme to stem capital flight;
- a functioning European Stability Mechanism capable of providing sufficient financial support to the banking system;
- euro-zone wide supervision and regulation.
And all within the existing European Treaties! By end June, a European Summit should come up with proposals on all these points.
A Euro-break up would be catastrophic at this point in time and will impact the whole world from the US to China. An orderly break-up is not possible mainly because the current re-ordering of Euro financial exposure within national boundaries has not been completed, far from it. And the ones who would ultimately suffer most from the break-up would be the Germans, no question about it. They've benefited the most from the Euro so far - a cheap Euro has been the source of Germany's success in exports - but they will also suffer the most if the Euro collapses: a restoration of their dear Deutschmark would be very dear indeed, as it is bound to be valued much higher than the Euro ever was.
Soros
believes Germany will do whatever is needed to preserve the Euro but no more, allowing the internal
divergences between the center and periphery to grow, thus profoundly altering
the very nature of the "fantastic European union project". Killing
off the dream of peace and prosperity. What is needed is to
convince the Germans to do more. Sure, this is bound to be difficult for the German
government confronted with a people who doesn't see or feel the problem: jobs
are still opening up in Germany, immigrants are coming in; the influx of light
capital is causing a housing boom. As Soros put it: "We need to do
whatever we can to convince Germany to show leadership and preserve the
European Union as the fantastic object that it used to be. The future of Europe
depends on it."
Can Ms. Merkel be convinced? Maybe.
I personally doubt that more than a strict minimum will be done by September this year. We'll need to boot Ms. Merkel out of Germany first, and that won't happen until 2013. By then, the current recession may well have bitten into German prosperity as it finds difficult to sell exports abroad: after all, recession winds are again slowing down the US and China.
2013 will be a year of reckoning and Germany might well be more amenable to sustain the Euro and solve the euro management problems.
But what if Soros was wrong: what if his reading of the situation was limited and some other negative forces were at work in Europe?
Cultural Divergences
Cultural divergences could well be the factor that will tilt the boat.
Some researchers and most recently NYT columnist David Brooks (see his excellent article here) have argued that the European union project makes no historical sense in the face of deep-set cultural divergences. Brooks reminds us how the world, after the disasters of World War II, yearned for peace and harmony: it was in this favorable setting that multicultural and supranational entities like the United Nations were created and with it all the international organizations still with us, chief among them the World Bank and the IMF. Those were also the years of the birth of the European Union project that began with an optimistic effort by Germany and France to bridge their differences and "never" go to war against each other again.
Now, the pendulum has swung the other way: cultural divergences are increasing, not diminishing. There is a "failure of convergence" not just between countries but also within countries. Consider the United States: a single country with a single currency, but as Brooks points out: "the country has become more polarized, not less. The country has become more difficult to govern, not less." This is what he calls "the segmentation century". With the rise of modern communication technologies and Internet, "people's tastes have become more parochial, not less."
For Brooks, "the failure of convergence is most striking in Europe. True, a tiny sliver of European society is becoming more transnational. But only 2 percent of Europeans live in a different European nation than their country of citizenship. On the whole, European nations still have very different understandings of the rule of law and political order, different work ethics and conceptions of citizenship. (italics added)"
True enough. For example, it seems that 40% of Danes believe that work is a “very important” part of their lives, compared with roughly 65 percent of the French. According to Pew Research surveys, 73 percent of Germans think that economic conditions are good right now. In France, 19 percent think that, and in Spain only 6 percent.
For Brooks, "the euro crisis is not a crisis of debt. Total European debt levels are not that high. It’s a crisis of legitimacy. Debt burdens are divergent across nations, and Europeans with one set of habits and values do not want to bail out Europeans with other habits and values."
Germans do not want to bail out the Greeks.
Europeans do
not trust Brussels. They don't believe in giving over their budgetary
sovereignty, the only ones who don’t mind are the Italians, according to Pew
research.
Add to that the fact that there's been a resurgence of local regionalism: the Basques in Spain, the Flemish-Walloon rift in Belgium, the Lombards' Northern Lega in Italy etc. Not to mention the remarkable success of nationalistic, anti-immigrant parties like Marine Le Pen's Front National in France, a veritable throwback to the 19th century chauvinism.
In this environment, it should come as no surprise that the European Union project has a hard time surviving...
But isn't there something else at work here? Let's turn now to the third negative factor at work, the one which I believe underlies the other two: globalization.
The Impact of Globalization
Much has been written about the effects of globalization, both good and bad, and there is no space here to go into details. But certain aspects of globalization are clearly impacting the eurozone and have had negative effects for the whole past decade:
- governments in Europe (and elsewhere, the US included) are losing control over their tax revenues: it becomes ever easier for big, global corporations and the ultra-rich (the 0,1%) to escape taxation. To illustrate, two examples will suffice: the Greek shipping industry is not taxed by the government, the theory being that if shipping magnates were taxed, they'd move elsewhere, hence it's useless to even attempt to tax them. So far, even the radical leftist Syriza does not specifically raise this issue: it just limits itself to calling for more "equality" and "taxes on the rich". General Electric, the American corporate giant, has over one thousand staff dedicated to exploiting tax loopholes with the result that GE pays one of the lowest corporate taxes in America: we all learned last year that despite $14.2 billion in worldwide profits - including more than $5 billion from U.S. operations - GE did not owe taxes in 2010.
- competitiveness in the industrial sector is threatened by emerging economies (the BRICS) and outsourcing is eliminating jobs causing increasing unemployment (agriculture is such a small part of GNP in the developed world that it doesn't enter the equation).
- the IT sector and other advanced technologies (eg. green energy) have not so far created enough jobs to cover the losses in industry - as a result, unemployment is not only sticky, it has grown especially large for new entrants in the labor market, i.e. the young.
Conclusion: Quo Vadis Europe, Can You Reform?
This is the general backdrop against which the Euro drama is unfolding. Which means that even if a "financial fix" is found to shore up the Euro, the long term downward economic trends due to globalization will continue as eurozone governments find it hard to raise adequate revenues; as European industry finds it hard to compete with cheap imports produced in the BRICS; as the loss of jobs in manufacturing is not compensated by gains in other newer sectors.
Over time, this means the eurozone as a whole is growing poorer (even if the Germans still feel rich!) And obviously less able to afford its expensive welfare system.
That means it will have to cut into pensions and health care benefits OR make the management of the welfare system MORE EFFICIENT.
That means reforming the state apparatus, cutting out unnecessary duplicative jobs, streamlining management processes, suppressing red tape etc. This concerns in particular the euro "periphery" though even the "center" is not immune to the need for administrative reform.
Are Europeans capable of reform? The Germans demand it. But will the cultural divergences stop reform in its tracks? Very possibly. People in the periphery are already rebelling against austerity: from there it's but a small step to rebel against any kind of reform, however much needed.
The only way to move forward would be to believe once again in something BIGGER: the "fantastic project" of the European Union. You need dreams to overcome the grim reality of chauvinistic retrenchment, each country behind its own borders.
Is the European dream dead? Can it be revived? I hope so. What do you think?
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