Celtic Creditors and the Future of Europe and the Euro
by William K. Black
The struggle within the EU and the European Central Bank (ECB) over the nature of European project continues. The EU continues to be dominated by the French/German tandem. The Euro, once the great hope of the periphery – with Ireland as its brightest star – now poses a triple threat to the periphery. The Euro removes the ability to devalue a national currency. The European stability pact (which Germany and France see as essential to maintain the value of the Euro) sharply limits the use of fiscal policies to respond to a severe recession. The ECB’s sole mandate is to restrict inflation – regardless of its impact on unemployment – so monetary policy may also be pro-cyclical in a recession. Economists warned, before the Euro was adopted, that it would impair the ability of nations to respond to a serious recession and that this impairment could eventually undermine the value of the Euro. A group of economists gathered in Kilkenny, Ireland at an event called the Kilkenomics Festival to discuss how those fears had been realized as a result of the ongoing Irish banking crisis.
The global competition in laxity for national currencies has compounded the EU’s inherent triple threat. The EU is “losing” this competition. China’s aggressive under-valuation of its currency has triggered an international competition to weaken national currencies. The Japanese have recently announced (and demonstrated) their intent to drive down the Yen’s value. The U.S. has taken repeated actions to lower the dollar’s value. The EU has allowed the Euro to appreciate against many currencies. Germany’s high tech exports can survive a strong Euro, but Greece, Spain, and Portugal cannot export successfully under a strong Euro and their already severe economic crises can become much worse. The Irish will have serious problems, and their export problems would have been crippling if they were not a corporate income tax haven. Italy’s, particularly southern Italy’s, ability to export successfully is dubious.
The periphery’s financial crises also produce sovereign debt crises. In Ireland, it was the suicidal, crony-based decision of the Irish government to guarantee virtually all bank debts that turned a banking crisis driven by “control fraud” into a budgetary and sovereign debt crisis. The EU’s response to the initial sovereign debt crisis in Greece was to create a bailout fund that appeared to be so large that it constituted a “shock and awe” strategy. The bailout fund was supposed to intimidate currency speculators and cause them to turn their FX attacks on non-EU targets. Currency speculators, however, saw that the frauds at several major Irish banks had caused the mother of all bubbles and losses that would blow up the Irish debt to unsustainable levels. They also saw that the PIGS (Portugal, Ireland, Greece, and Spain) faced severe, increasing unemployment and long run budgetary problems due to the self-defeating nature of trying to adopt austerity in the face of lingering recessions. Currency speculators also recognized that Spain had gimmicked the accounting rules and adopted regulatory forbearance regimes that hid massive bank losses.
The Irish crisis exposed the ECB’s stress tests as obvious shams (the worst Irish banks passed the stress tests). The ECB’s effort to emulate the Fed’s strategy of using sham stress tests to reassure creditors backfired and further reduced the ECB’s credibility. The recent release of information by the Fed on loans (backed by junk collateral) to major European banks underscored the fact that the ECB was unable or unwilling to play the “lender of last resort” role even to stave off a potential second Great Depression.
If a recent BBC story (“EU to target private lenders in future bail-outs”) proves accurate, the EU is about to invite renewed, increased attacks on private and governmental bonds issued by the periphery. Chancellor Merkel has been shaken to the core by the willingness of German banks to fund control frauds and hyper-inflate financial bubbles. She has insisted on a remarkable strategy to try to make “private market discipline” a reality instead of the oxymoron it has been for several decades. The idea is to make creditors (banks) take substantial losses when they lend to banks and governments that are in financial crisis. The BBC article states that the EU will adopt Merkel’s strategy.
Creditors, of course, will respond to the new EU strategy by raising the interest rates they charge borrowers. The risk premium they demand will be substantially greater for the PIGS. This will exacerbate the PIGS’ budgetary crises and harm their economic growth. If interest rates on one nation’s sovereign debt increase sharply and a bailout become likely – and a bailout means that the creditors get stiffed under the new EU plan – then credit markets for that nation are likely to shut down and contagion to its sister PIGS is highly likely.
The new EU plan will also exacerbate political crises. Ireland’s government was insane enough to guarantee all bank debts – even subordinated debt owed by its massively insolvent banks. That government is discredited and falling. The new EU plan does not apply to Ireland’s creditors. Ireland, unless it defaults, will have to pay the creditors (most of whom are foreign) in full. Only Ireland will have to do this. The new EU plan would require approval of the EU member states. Any Irish government that approves the new EU plan risks extinction at the polls. Fiscal, debt, and unemployment crises often happen simultaneously. The trifecta is likely to cause governments to fall. The Latin American reaction to the surge in income inequality produced by “The Washington Consensus” has not been uniform, but it has helped produce the election of over a half-dozen sharply left-of-center regimes. To date, the EU economic crises have tended to move ruling parties’ policies to the right, into IMF-style austerity programs that mirror The Washington Consensus. Chavez, of course, had the advantage of controlling a major oil producing nation during a strong increase in oil prices. If a Chavez-analog comes to power in one of the PIGS he will not have that advantage.
This article first appeared at the weekly column at Benzinga.
William K. Black is an Associate Professor of Economics and Law at the University of Missouri-Kansas City. He is a white-collar criminologist and was a senior financial regulator. He is the author of The Best Way to Rob a Bank is to Own One.