So far in this astonishing episode, the world’s financial systems have held up well. Remarkably, lessons have been learned from the Great Financial Crisis, both in the behaviour of policymakers, and in the resilience of banks. But many claim that the Euro is especially vulnerable. Are they right?
The crisis so far has not been good for the egos of the Europocrats. The response has been led almost totally by the governments of its member states. It turns out that the EU really is just a free trade area after all. When something more important than trade comes along it has nothing important to do. And when its leaders at last got together to sort out a financial response, the outcome was pathetic, and spoiled by the sort of bickering shows that there is little solidarity amongst the member states.
Yanis Varoufakis, the former Greek finance minister, called this out on BBC Radio 4. The most important part of the EU’s infrastructure, the Euro, has turned into an instrument of oppression. The rich northern states, notably Germany and the Netherlands, were vetoing any serious aid to the most afflicted states, such as Italy and Spain, while not allowing them to help themselves. He said that German leaders should level with their public: the Euro was really good for their economy, but to keep it going they needed to be more generous to other members. The Italians, in particular, are throughly disillusioned and could provoke an existential crisis for the zone.
There is plenty of truth in what Mr Varoufakis is saying, but nobody should bet on the dissolution of the Euro just yet. Critics of the system miss two things. Firstly, as this week’s Buttonwood column in The Economist has pointed out, the European Central Bank (ECB) has learned a lot from the previous crisis and has now become the EU’s most effective institution, and not bogged down by the bickering that undermines the more overtly political arms. It has, amongst other things, rushed to buy up debt from Italy and Spain, thus greatly assisting a strong fiscal response to the crisis. This has the effect of mutualising their debt by stealth. The ECB has learnt the art of doing just enough to keep the Euro going, while being unable to fix its deeper flaws.
The second point is more subtle. It is wrong to suggest, as Mr Varoufakis does, the Euro is in effect a plot by Germany to rob Italy. It is better understood as a conspiracy between German workers and Italian savers. The Germans get plentiful and secure jobs, because their currency is held down, allowing its industry to run a surplus. Italian savers get more buying power for their money in a currency that is stronger than their own would be, with less risk of inflation. The victims are Italian workers, whose firms struggle to make progress with such a strong currency, and German savers, who lose buying power. It is arguments between these victims that drive the acrimonious politics of the Eurozone. Politicians like to blame an outsider, so German ones like to blame lazy Italian workers for low returns by their savers, and Italian ones like to blame the Germans for screwing their businesses.
So the Euro’s losers drive the day to day politics, but as soon as it looks as if they might succeed in their goal of causing the collapse of the Euro, the winners, German workers and Italian savers, hoist it out of trouble with a twitch upon a thread. The clearest example of this is Marine Le Pen’s tilt at the French presidency. Her bid featured resentment at the Euro, and it got her into the final round against Emmanuel Macron, but it rapidly collapsed when, in one of the debates, she floated the idea that France might leave the Euro. French savers, many of them older voters sympathetic to Ms Le Pen’s anger at liberal elites, suddenly realised that there could be a cost to their protest and deserted her. Something like this effect will happen in Italian politics if anti-Euro politicians get too much traction there.
So the Euro is safe but the politics is grim. What is needed are two things: more enlightened self-interest from northern leaders, and more willingness to embrace economic reforms by southern ones. The big trading surpluses by northern countries mean that they could easily be more generous to their southern neighbours by buying their goods and services or through direct aid (though lending them money simply builds trouble for later). Each of the southern economies has economic inefficiencies that their leaders should do more to tackle. In Italy it is excessive petty regulations to protect economic vested interests. In Spain it is lack of labour market flexibility. In Greece it is a failure to collect enough tax, especially from the better off. Until they tackle these they will always be supplicants and politically vulnerable.
For all that, the Euro has some very challenging times ahead (as do the US dollar and the Chinese Yuan, for differing reasons). Italy could easily be faced with a banking crisis, at a time when the attempts to mutualise banking risk across the Eurozone are incomplete. The acrimony will continue.
And this will set the EU on a trajectory that makes it more and more resemble the Holy Roman Empire. This was a tangle of German states, led by an Emperor with little practical authority. It was much despised by Enlightenment thinkers, and finally brought to an end by Napoleon. But it was the foundation of the strong commerce and devolved administration that makes Germany (and Austria) such successful states today. This is something Anglo-Saxon observers almost never understand.
“The European Central Bank (ECB) has learned a lot from the previous crisis and has now become the EU’s most effective institution and not bogged down by the bickering that undermines the more overtly political arms.”
This is true enough. However, it can only operate in the way it does by openly breaking both the letter and the spirit of the Treaties and EU law which created it. Fortunately, it can move a lot faster that the EU courts when legal challenges are attempted.
It has, amongst other things, rushed to buy up debt from Italy and Spain, thus greatly assisting a strong fiscal response to the crisis. This has the effect of mutualising their debt by stealth.
I’ve seen this argument several times recently but I don’t think it can be right. The only way to mutualise the debt is to issue EU backed eurobonds, or Coronabonds. If the Italians issue bonds it just adds to their debt no matter who buys them. The Germans and Dutch have, of course, repeated said “nein” and “nee” to eurobonds.
There can only be a strong fiscal response if the rules of the misnamed Stability and Growth Pact and European Compact are either scrapped or seriously revised. Just turning a blind eye to transgressions in the short term won’t be enough.
“…. the winners, German workers and Italian savers”
If Germany had its own currency it would be higher and so German wages and salaries would be higher too. No-one in the UK thinks they are personally better off with a lower pound, and yet, we think the laws of economics are somehow different for Germans. Italian savers, even if they had their own currency, could still save in the German currency. Or Swiss francs or US dollars. Or buy gold bars if they didn’t trust any of them.
Trade shouldn’t be a matter of winners and losers. If I’m good at growing apples and you’re good at growing pears it make sense to swap one for the other. But it doesn’t make any sense for me to consistently supply you with more apples for fewer pears and take your IOUs to make up the difference. I simply am accepting a an accumulating financial asset, or your debt, that you’ll increasingly be unable to repay.
The only way you’ll ever be able to do that is supply me with more pears for fewer apples.
It’s really no different for Germany and Italy. It means Italian debt will only be repaid if and when Germany starts to run a trade deficit. However it’s a matter of national pride for Germans that this must never happen.
The outlook is therefore bleak for the euro. It’s possible the ECB will paper over the cracks. But the system is fundamentally flawed and will inevitably fail sooner or later. I’m hoping sooner and that the coronavirus problem will finish it off.
I think you are being too theoretical Peter. I will try to expand on my thinking a bit.
Surely true of all EU institutions. It’s how they manage to survive for so long. The treaties have become practically impossible to change. Politically the ECB seems to be running into less challenge than before, this time.
Yes, the Italian government still has the debt, but the creditor is the ECB which can set its policy in light of the broader economic and political context; it will be much easier to roll over the debt than otherwise. Meanwhile the ECB’s action reduces the risk premium for Italy, allowing it to raise further funds more cheaply. The ECB then funds this with reserves, which is were the mutualisation occurs. Agreed that Eurobonds don’t look like a realistic proposition though it is interesting that the German SPD are warming to the idea, and I assume the Greens are already on board.
My assumption is that German workers feel they are paid enough, and would rather have job security. They certainly aren’t big spenders, and they aren’t even playing the property market much. I suspect, as I’m sure they do too, that the benefits of a higher exchange rate would ultimately go mainly to the capitalists (though that might include workers pensions)
In practice these aren’t practical options for most Italian savers (and it is numbers of them rather than value that is the politically important thing). They fave two problems. First is transaction costs, which quickly eat into the value of savings unless you have a large portfolio, and multiply as soon as you cross a border (I have spent a large part of my professional career wrestling with the consequences of this fact). Even in the age of high automation; one of the great failures of the Euro project is that it has not facilitated cross-border funds flows as much as expected. Second is risk, as it is prohibitively costly to diversify unless you are rich. Those investing smaller amounts are often, understandably, risk averse so stick with investments with people they know and the currency they spend in. Mind you Swiss francs look a pretty safe bet, though gold is not. With a weaker social security system than ours, Italians save a lot, but overwhelmingly though and with local banks, with a large part of their savings represented directly or indirectly by Italian government debt (which the banks are persuaded to buy). The one thing that could torpedo my argument is if the ECB let Italian banks collapse leaving large numbers of savers out of pocket. But the ECB appears to be well aware of this following the preference share crisis that followed the GFC; the Italian government was forced to bale out these shareholders, and the ECB forced to underwrite them.
Flawed the system may be, but the Euro has grown into a very powerful institution and the vested interests that want to keep it in being being are widespread and powerful. Not even the Greeks were able to leave it when push came to shove. My bet is that it will survive for a good while yet. But British and American commentators will keep saying that it will collapse because it offends their ideas about how currency and sovereignty should work.
I’m not sure I understand you point about being “too theoretical”.
I know from my day job that it’s hard enough to get things to work in practice even when the theory says they should.
But, in the case of the euro, the theory is against it too. I can quote Stiglitz on the left and Friedman on the right who are saying, or have said, exactly the same thing. So it’s a technical rather than a political objection. On the other hand the euro is very much a political, rather than an economic, project.
The EU has cobbled a system together and hoped for the best. The best now can only be that either the euro is scrapped or that the EU becomes a single country, in which case there is no real problem. But can anyone see that happening?
Hmmm… If Stiglitz and Friedman agree on something then the contrarian in me says it must be wrong. I remember not so long ago when economists across the spectrum agreed that minimum wages led to unemployment. The theory behind that conclusion was and is impeccable. But if the facts don’t fit the theory, the theory must be revised. The Euro may have been a flawed compromise at launch, and disappointed expectations but it has survived 20 years and, to my mind, shows no sign of collapse now. I won’t offer a theoretical justification but I will observe that its critics largely come from the USA and Britain. These countries have little idea why so many European countries found the previous floating currency regimes so unsatisfactory, and were prepared to ditch them so readily. And still do: more countries want to join. A floating currency is one thing when that currency is the US dollar, or even the pound sterling – quite another when the currency is the Lira, Peseta or Drachma. The big mystery is why the Germans were so keen on it. But the critics are now saying that it was all a German plot… The problem with saying that the Euro has been a disaster is that the counterfactual – that floating currencies would have been any better – is impossible to determine. Europe’s economic problems in the late 20th century ran deep.
An interesting post. Of the two relatively recent EU integration moves, I think the Schengen zone can bounce back into health after the crisis has passed; but , as this post rightly implies, it is the medium-term future of the Eurozone which could be at risk. Before the Zone’s creation , many economists would have said that the Zone’s extent was larger than an optimum single currency zone; and experience since has arguable supported this view, given the way that the Zone’s single interest rate has at times been non-optimum for parts of the periphery. There have been major asset price bubbles in Spain and Ireland, and a major depression in Greece. Most of Italy – other than prosperous Lombardy – is part of this periphery. Might not the Eurozone do best to allow a managed exit of Italy from the Euro, if a political consensus develops in that country that membership is not in the Country’s interests? My guess is that a managed exit route would be possible through the staged introduction of a parallel currency. The Italians have taken the first step through the introduction of a type of Government debt which can be used to pay bills. Without such a step the Zone seems to me to be risking a major crisis over Italian economic and immigration problems which the rest of the EU is refusing to share.
Well it would be hard to argue that Italians or other southern Europeans could borrow more cheaply outside the Euro, and there is no sign of those bubble re-emerging. I can see no orderly way for Italy to exit the zone – after all it was not as if there experience with an independent currency was a happy one. What is needed is more flexibility for the Italians to manage fiscal policy, and for confidence among others that they wouldn’t use that flexibility like the Greeks did.
@ Matthew,
You’re saying:
” Remarkably, lessons have been learned from the Great Financial Crisis, both in the behaviour of policymakers…..”
Bill Mitchell posted on almost the same topic yesterday and he’s saying:
” the European Union is once again demonstrating their inability to respond to crisis. Nothing has been learned from the GFC.”
It looks to me that the EU are trying to create the impression of doing something without having to spend any real money! But maybe I’m being over-cynical?
We’ll have to see how it turns out.
http://bilbo.economicoutlook.net/blog/?p=44804
My remarks are mainly directed at the ECB, and the room for manoeuvre it has been left with by EU governments. The stability fund wasn’t there last time either, though its impact will be very limited, especially in the way that the Dutch have restricted its use. If you listen to the ructions around that and the Coronabonds issue, Bill Mitchell would have a point. But that’s a bit of covering theatre while the adults roll their sleeves up. Last time it took years before the “anything it takes” policy was established. This time it’s where they started. That’s a very big lesson learned.
This is a significant story for anyone who is interested in the EU.
I don’t quite understand though how the judges of a national court, rather than the ECJ, “instructed the ECB to sell the bonds accumulated under the PSPP (public sector purchase programme)”.
Can any national court make such a ruling or just the German one?
Incidentally, if the German court wants the Eurozone to fail, it is going the right way about it. The ECB may not be keeping to its Treaty obligations but it is doing the only thing it can do to try to hold a creaking system together.
https://www.bbc.co.uk/news/world-europe-52542993