Why Germany cannot save the euro
This week I am doing the weekly newsletter in two parts, both outside the paywall. This is part one.
As Charles Wyplosz has recently written, the euro zone’s rescue strategy adopted in May 2010 has failed. Like his column, this column argues that it was folly for the euro zone to believe the bailout approach would succeed because the problems in the euro zone run much deeper than just Greece. Further, this column argues that if this approach continues for any longer, the entire euro zone will break apart.
Yesterday, we re-published an excellent piece by Charles Wyplosz that originally appeared at VoxEU. After we published it, I also tweeted an excerpt which I felt representative of the tone of the piece:
"Chancellor Angela Merkel has sent word that Germany cannot save the euro. She is right." bit.ly/Mzew7v".
I got some pushback, however, from a journalist I respect. She pinged me, writing that she enjoyed my tweets but that the quote of Wyplosz’s piece was misrepresentative of what he was saying.
This article is an extended response as to why I think the Merkel quote is important.
The problem in Euroland
The main reason the IMF is involved in Europe aside from the desire to get more firepower than Europe alone can muster is that Europe’s crisis is a balance of payments crisis. The euro zone is one giant vendor financing scheme. The persistent current account imbalances are a dangerous form of vendor financing, whereby surplus nations finance the purchases of deficit nations. And yes, vendor financing can work successfully – but only so long as the lender makes sure the customer can pay back the loans. And clearly, they cannot at this point. Now the question is what to do about it.
When the crisis first hit, I thought the Germans would realise – at least because of the vociferously anti-bailout stance in the German public – that Germany cannot save the euro, that violating the EU’s anti-bailout clause would be a mistake. I even wrote a piece in March 2010 saying that they wouldn’t do so, laughably entitled "The Germans will not bail out Greece". I like to remind myself of this miscue not only because it is Merkel’s choosing the bailout approach which is why we are in a policy cul-de-sac now, but also because the reasoning in the post still holds. Let me repeat some of that article here with some follow on commentary:
Now, it has to be remembered that the Euro was adopted in Germany without any democratic vote by the German electorate. It was imposed by fiat from the Federal Government unlike in Denmark where the Euro was put to vote before the electorate and rejected. In fact, there was a lot of concern in Germany at the time that the Germans would have rejected the Euro had it been voted upon – and this is the very reason a vote was not held.
Many ordinary Germans feel their good money is now being trashed. They already had a currency union between Ostmark and Deutsche Mark, with Western Germans submitting to a “solidarity tax” in order to finance the upgrading of Eastern Germany’s infrastructure. So, to this day, many Germans look at larger Euro notes to determine if they were printed by the Germans, Italians, or Greeks – sometimes rejecting notes printed in countries viewed with suspicion like Italy (see the Telegraph’s 2008 story on this here).
With this as background, you should see the 2009 election of the CDU/CSU/FDP coalition as a signal that the German government is unlikely to submit to a bailout. With the FDP replacing the SPD in government, the likelihood of a Greek bailout decreases. The FDP is the libertarian junior partner in this new coalition (the same coalition which produced the SGP, by the way) and they are under enormous pressure from their constituents not to permit any bailouts. If Germany allows German tax dollars to go to the EU in order to bail out the perceived profligacy of Italy or Greece, there would be riots. Spain is another story – but Greece is known as fiscally profligate in Germany – so bailing them out is unacceptable politically. Let’s not forget that Germany has its own problems in banking as well.
Here’s the problem. Yes, it was electoral suicide for the German coalition to do as they did. But Merkel did it anyway. The CDU and the FDP have repeatedly been destroyed in every single regional election since the fateful bailout decision. The FDP probably won’t make the 5% hurdle in next year’s elections to even be represented in next Bundestag. And this is exactly why Angela Merkel has been forced to bargain with the SPD and the Greens over the fiscal pact she has championed. In order to get the sign off in the Bundesrat, she needs a two-thirds majority and that means she needs to get the SPD and Greens on side as their regional electoral strength gets represented in the Bundesrat. Of course, she also wants to make nice just in case she has to enter a Grand Coalition when her FDP partners fail to make it in 2013.
Moreover, when I wrote, "Let’s not forget that Germany has its own problems in banking as well," that was an error. Actually, it is exactly because Germany had its own banking problems that the bailouts have happened. As Wyplosz puts it:
As we know, poor bank supervision is what drove Ireland and Spain into the camp of guilty countries. Here again, the story is not over and several countries may soon be found guilty of forbearance.
- Top of the list are France and Germany.
- Had Greece not been rescued then some large French and German banks, already fragilised by the subprime crisis, could well have been ripe for costly bailouts.
The lack of democracy is troubling
So, to sum up here: German elites entered a monetary union in what many Germans perceive as a very undemocratic way, hiding behind their representative democracy to allow German politicians to railroad Germany into the euro despite fierce domestic opposition to this move. German banks then went on a speculative binge in Euroland, in effect giving the eurozone periphery vendor financing to fund Germany’s export boom which replaced Germany’s anaemic domestic demand. You see, Germany was in a soft depression after re-unification, demographic challenges, and the low wage growth that resulted from structural reforms killed domestic consumer demand growth.
Then, suddenly the whole euro experiment ran into trouble. And so, even after the German government increased its debt to GDP to well above 80% in violation of the Maastricht Treaty to bail out its reckless banks which binged on American subprime debt, a sceptical German public was told more bailouts were coming with Greece, Portugal, Ireland and now Spain. Ostensibly this was because of the desire to maintain "European solidarity". But everyone knows it’s to protect the undercapitalised German banks again. Meanwhile 59% of Germans polled say they are struggling or suffering.
The German government is attempting to use ‘the representative democracy’ excuse with the ESM, the new European bailout fund, and with the new fiscal compact to make "more Europe, not less". They have received a free pass on the ESM but the second one is running into problems in the Bundesrat.
I hope you sense the indignation in this summary because, if you are a German voter, this is the problem with Euroland.
I’ll repeat my tweet here: "Chancellor Angela Merkel has sent word that Germany cannot save the euro. She is right."
Let’s hope she acts on this information.
What should Europe do then?
Charles Wyplosz does a good job of outlining a reasonable approach to the euro zone crisis. There are a number of ways to achieve the desired outcome but what should be clear here is that Germany’s hot-cold on-off approach to Europe is very passive aggressive in both tone and implementation. It sows the seeds of a resurgent economic nationalism. The German government has maintained the no-bailout mentality which is behind the euro zone’s strictures. Yet, out of fear of having to recapitalise its banks and to contend with economic depression, the German government has been forced to violate the no-bailout clause repeatedly. And so, you get this strange mix of aid packages to peripheral governments as the crisis flares again and again combined with austerity to show adherence to the no-bailout mentality that German voters demand. It won’t work.
Germany cannot save the euro. It does not have the financial resources to do so, even with the ESM and IMF in tow. Many of us have been warning for some time that the strategic approach of bailouts and austerity is all wrong. If German politicians want the euro to survive, they must recognise that defaults, credit writedowns and bank recapitalisations will be inevitable. The sooner this occurs, the better. But, if Europe is to survive, we will also need to change the European institutional architecture to integrate Europe in a way that smoothes business cycles with supranational automatic stabilizers instead of exacerbating them with procyclical austerity. The ECB will be a big part of the transition to this approach. And so the ECB will be the subject of the second part of my weekly column.
It’s long been my view that what’s “operationally” possible will ultimately have to succumb to what’s politically sustainable.
On related note https://larspsyll.wordpress.com/2012/06/21/why-the-euro-is-doomed/ (HT Lars P Syll’s blog)
^ meant to point to original https://blogs.telegraph.co.uk/finance/timworstall/100017007/why-the-euro-is-doomed-to-fall-apart-it-was-an-incredibly-stupid-idea-in-the-first-place/
Yep. The euro won’t make it in intact in all likelihood. I do try to spell out what needs to be done to keep it going though.
Yes, it’s in fact good to read informed opinion on the political realities within Germany.
Just to be clear, I never supported the euro as a project because Europeans simply do not want a United States of Europe.
The question is whether trying to shoehorn seventeen nations into a United States of Europe will fail. While I think it will, it’s feasible it could work but only under specific pre-conditions.
Moreover, I don’t think that a fiscal union of seventeen different nations can work the way the United States or the UK or Canada do. But clearly, we are politically a long way from trying to back out of the euro. Doing so would be an economic catastrophe.
I’m sure you agree.
Edward while I agree that it is folly to believe that the bailout will work, the Euro would be equally doomed without a bailout. Its a catch 22 situation with no clear way out – the bailouts at least offer the politicians the chance to kick the can down the road.
Also your remedy of defaults , credit writedowns and bank recaps would simply cause too many social problems in Europe for it to be acceptable politically. And the question remains where would the money for bank recaps come from anyway – presumably would be more public money? Either way you look at it the Euro is doomed its only the timing thats in question.
Meanwhile the European political class are trying to tinker around the edges by messing around with the ratings agencies. https://tailevents.com/europe-2/eu-credit-ratings-farce/
PS – Do you not allow comments on your G+ posts?
There is one policy move that would have prevented the balance of payments problem and the bank problem. That is credit controls. With such measures Greece would have struggled to buy Mercede and Porsche cars without corresponding exports. It would have meant that the German banks would not have binged on US Sub Prime Debt and its banks would also not have lent to the periphery. Ireland would have found it much harder to finance the bubbles, but if they had financed a bubble domestically it would not have had any contagious effects. The solutions are out there but no one is looking at them.
The euro can survive if it allows the banks to crash. Start again with a new financial sector and tough regulations, such as capital controls. On some private ratings agencies I have seen most of the big European banks are rated as junk already.
Curious, you propose doubling down on more of the solutions/goals (European fiscal union) that caused the problems in the first place. I’m reminded of the undemocratic ratification of the new American constitution, written by a runaway convention, dominated by anglophile lawyers and rich planters, and that mono-cultural American event of fiscal union resulted in a civil war a half century later (wars between states were supposed to be precluded by the constitution, or so it was argued at the time): curious, but major wars and economic cycles seem to coincide with that same time scale in multicultural settings too. You really expect less rancor and conflict in a European multicultural fiscal union with a liberal soft core welfare state of free riders?
The only way to save the euro is to create a sort of United States of Europe. That’s the reality. Will it work. I doubt it. But if Europe wants the euro that’s what it will take.
P.S. – I don’t see Ireland, Spain or Italy as free riders in the least. I don’t know who you’re talking about but when you say free rider, it evokes the sort of moralism that is part of the problem and not part of the solution.
I’m sorry, I should have been more specific regarding “free riders.” I had in mind the sort of “moralism” implied in “moral hazzards.” I suppose the classic example of such moralism was the northern abolutionists disdain for the southern slave system in the south: I wonder if the slaves thought that Northern moralism was the problem? I suspect the German folks today have similar feelings regarding the Greek’s and their proclivity for early retirements and tax avoidence at the German taxpayer’s expense. I suppose the modern American fiscal union does make it easier to divy out the moral hazzards for the taxpayer to subsidize the “systemic risk” of too big to fail banks. I hope that clears it up.
what does American slavery have too do with the euro? you’re reaching and it is not productive on this thread. stay on point or go away.
I think it is still too early for fiscal union. That will now only come a serious democratic set back.
There are rumours that Germany want Greece to suffer badly after exit, because it will encourage the other PIIGS nations to try harder to avoid a similar fate. What they have not factored in is the unintended consequences. The problem is that I suspect that Greece will fall to a revolt at some stage in the near future. Especially if the new Greek government cannot get any flexibility from the Germans. This is only what Syriza wanted anyway, yet the Germans framed a Syriza election as exit. All the New Democracy victory gains is a few months leeway before possible exit. So after this government falls a revolt could be likely. Even diehard conservatives voted for Syriza last time.
This could have the perverse effect of actually making the risks of revolt even higher in Portugal Ireland and even Spain. Much like the Arab spring toppled government after government in North Africa. We could have a Mediterranean Spring at some point. This might all have a catastrophic impact on the markets. It is similar to the talk of a Greek exit massively increasing the chances of a Spanish exit, which is something that the Germans definitely do not want. This is all the fault of the Germans.
A general comment here. I wrote the following remarks last August that I stand 100% behind. Personally, I think a lot of people who are just negative, haters, trolls will scream and shout how terrible the euro is and that they should just abandon it now. That’s politically unrealistic and useless drivel.
The euro is here now, like it or not.
Here’s what I said in August:
Yes, I am a eurosceptic and have always been. But we are here now. The euro exists. And that does change things.
It would easy for me to say something like, “see I told you so. The euro is an abomination and the peripherals should simply leave or be tossed out of the euro zone.” I even remember suggesting the Irish should threaten this to get the most leverage before their banking sector imploded
But, again, we are here now. The political imperatives for closer European ties that created the single currency are still with us. And the negatives of abandoning it are many, both politically and economically – in the periphery and the core. I recognize this.So when I talk about the euro zone these days, despite my euroscepticism, I am not pushing an anti-Euro line. It is just the opposite; I am suggesting ways the euro zone can best remain intact despite the political and economic impediments.
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