May 10th 2010 is a new foundation day for Europe, but not for a europe we should welcome. It is not a new foundation for the EU, which has shown itself to be remarkably unfit for dealing with the economic imbalance of massive savings in Germany and shaky borrowing at the periphery, but rather the Council of the Eurozone, the body hastily defined and rapidly presided over by President Sarkozy. The huge financial guarantee that France and Germany finally agreed at the week-end means that the Euro will last. It also means that the Euro has become more like an ordinary currency, with serious state funds behind it and authority to act directly in debt markets.
At the end of February, I argued that the Krugman/Trichet divide over whether the Euro formed a good-sized currency area was a choice between the Scylla of an undemocratic, non-politically integrated Brussels and the Charibdis of national technocrats engaged in original sin. Now that Trichet has won the political battle, we should ask what kind of politics can make this currency union work.
It is worth going back to understand why the debts of Greece, and possibly Portugal, Spain and Ireland have been so hard for the Euro to deal with in order to understand what this resolution means for the future polical complexion of Europe.
Rather schematically, we can think of Germany as having generated a huge excess of savings over spending in the last 15 years. German savers - firms and households - were offered attractive financial products by their banks who then had to find a way of putting the capital to productive use. We have found out a lot during the Goldman Sachs/IKB/Toure debacle about what happens next in this chain: an irresistible sales team composed of the attractive 30-40 year old saleswoman from JPM, GS or wherever it is, the nerdy quant and the safe-pair-of-hands money manager descend on the provincial German bank, wine and dine the investment manager, and sell him a complicated wholesale financial product. As also became clear in February, that financial product often included Greek government debt that had been made to look a safer bet than it was by the attentive financial massage given to it by the same group of banks as were hawking the products to savers.
A great desire to save in Germany; expert financial massage from the intermediaries; governments that regularly drank the Brussels kool-aid and believed that German-level incomes came from borrowing and spending through unreformed clientelist political institutions ... no surprise that asset prices shot up, southern households felt rich and borrowed and governments failed to reform.
If all this had occurred on a small scale - meaning some scale not large enough to threaten the entire global financial system – the unravelling would have been simple: borrowers default and tighten belts; savers pick up pieces, nurse their losses and promise themselves not to lend to those people again without a large risk premium; intermediaries are blamed by all sides as facilitators of dodgy deals and some management or junior heads in banks might even fall. This should be, on a small scale, the stuff of every-day cut and thrust in modern capitalism. Indeed, it is interesting to see the unions on the left in Greece demanding the government default on its debt, which is exactly what the most free-market economists worried about moral hazard have also been asking for during the financial crisis–these are the famous haircuts for bondholders that have never materialised.
What is normal on a small-scale cannot work on a large scale because the people affected organise politically, and at least a good many of them do so because they feel that they have been misled. The political class in the over-stretched countries do not want default because the blow to reputation for credit-worthiness would make government without access to debt very hard (they are the equivalents of managers in defaulting companies worrying about their ability to fund future projects); German savers would like to spread the losses they face as widely as possible–their goal is to bring as many taxpayers into the fold as possible; exposed German and French banks want to avoid loss of confidence in their entire institutions and want to patch things up for long enough to pass the toxic parcel, repackaged, on to someone else.
The bail-out of Greece is really a bail-out of German and French savers by German and French taxpayers. In this, it is rather like the sub-prime crisis in the USA of 2008/9: it was lenders and their intermediaries who risked losing most from the normal, capitalist unravelling. Although some argued that "Germany did not want" the bail-out, and was persuing a "Germany first" policy, the truth is more complicated: the German banks and politicians knew their vulnerability to Southern defaults, and preferred to see taxpayers rather than their customers make up the losses. Commenters on the CDU/CSU/FPD coalition's loss of a majority in the German upper house this week-end cannot agree whether this was punishment for indecisiveness over Greece, or punishment for being soft on Greece points to the fact that Germany has conflicted interests: the banks and savers wanted large-scale decisive action, while as taxpayers they preferred Greek default.
What we would like to come out of this crisis is a system that might resolve the underlying problems that got us here in the first place, that is:
- responsible investment behaviour by savers and their intermediaries
- honest, sustainable borrowing levels by deficit-running European governments
Savers and banks appear to have been let off the hook by the 1/2 trillion Euro bail-out, so any increase in responsibility will have to rely on reform of the financial system coming from elsewhere. Moral hazard continues victoriously. It can also be argued that the imperative of political reform has also subsided: the very painful deficit reduction plans can be presented as being imposed, ultimately unfairly, from the outside. Expect this to create a long-standing, populist anti-Brusselsism in the European south. This is comparable to the Mid-Western support for Bryant's progressives in late nineteenth century USA which has contributed so much to various forms of populist isolationism in the USA during the twentieth century.
In other words, the powers of centralisation have had a good week-end, but the solution they have crafted will be costly in the long run. This suggests an important political aspect of Mundelian optimal currency areas: they are not simply about the degree of labour mobility, but should take the wider question of units of political legitimacy into account. If currencies are made outside legitimate political units, the solutions they impose sow the seeds of a longer-lasting poisoning of politics.