September 26, 2011
Over the past few weeks, one of the most perplexing positions taken by many of Ireland’s so-called ‘sensible’ commentators is that the euro is not workable in its present form, but that breaking from it would be inconceivable.
But where does that conundrum leave us? It means we are in a currency union which is tearing itself apart from the inside, yet is apparently unfixable. But this is plain silly. If the thing is broken, fix it; if it is unfixable, break it up and start afresh. The problem is that no one wants to pay the price of fixing the euro. No one except the ‘serial integrationists’ in the elites of Europe wants closer political or fiscal integration. Integration’s popular rejectionwas evidenced by the past three failed referendums here, in Holland and in France. So Europe is stuck.
Maybe because the generation that remembers the SecondWorldWar is now dying out, there is now no leader who can muster up a transnational sense of European solidarity,which is needed to drive the project forward.Or maybe it is because we have reached the limits of European integration and, without a credible external threat, there is no sense of urgency.
One thing is clear: Europe, unlike the US, can’t react as one with sufficient dexterity and force to address the major financial problems that are now emerging. The crisis has migrated fromthe much caricatured ‘Pigs’ to the haughty aristocrats at the core. France and French banks are now the battleground and, having worked for BNP/Paribas, I know how French banks are regarded in Paris as part and parcel of the French state’s prestige.
However, I also understand, from the same experience, how wedded the French establishment is to the status quo. In fact, it is one of the few countries where indignation can suffice as a policy and where concerns about prestige and ‘losing face’ can dominate, leading to stupid policies being followed long after they have outlived any usefulness. If Europe is putting all its faith in the ability of the French financial establishment to get it right,we are in big trouble.They always make a mess of things.French elite thinking on economics hasn’t changed much since the gold standard.
During the 1920s and 1930s, the French central bank hoarded gold, rather than injecting money into its ailing economy. It built up huge amounts of this useless commodity, believing that France was symbolically strong even though its economy remained manifestly weak.This behaviour can be put down to the narcissism of insecure prestige. Now we are at crossroads.Let’s be in no doubt: the next phase of this crisis is a run on the French banking system. In this regard, the developments in the Irish banking system where a problemof illiquiditymorphed quickly into a problem of insolvency may prove to be the blueprint.For France in the autumn of 2011, read Ireland in autumn 2009.
Clearly there are differences.The French banking system is not as dependenton foreign liquidity as ourswas, so the consequent deleveraging might not have to be as severe, but the pattern is similar. The first phase is the one where certain banks won’t lend to French banks because they are worried that the French have too muchGreek assets on their books.This forces up interbank rates.
The next phase is when large depositors get jittery.For example, Siemens reportedly withdrew e500 million last week fromone largeFrench bank and now has a total of e6 billion deposited with the ECB.The large depositor is not being ‘paid’ forFrenchbank risk, sowhy would it bother leaving its money there? The third phase is the denial phase, where the chief executives of the banks come out and say there is no need for fresh capital. As their noses strangely get bigger, the market sells French assets.The boss of BNP was out lastFriday wrapping himself in the tricolour and, though stopping short of singing La Marseillaise at Place de la Republique, he waxed indignant about attacks on France.
Meanwhile, the business class lounges of Air France at Charles deGaulle airport were full of French bankers flying to the Middle East, hoping that years of pan- Arabism might lead to a fat cheque from the oil-rich gulf.Put simply,the ‘chiens sur les rues’ know there is a problem and the elites’ fear is that the sans-culottes will twig it.
The liquidity issue should be containable by the ECB;a fter all, that is what a central bank should do in a crisis ^ it should provide liquidity.But all the while,the share capital of the bank is being wiped out as share prices collapse. Equally, the bonds of the banks tumble and large depositors move money out. In time, the average Jean Claude and Claudine begin to get worried and they take their money out too because, after all, the French government only a few months back said there was nothing toworry about.Now they are spooked.
In short order, a remote liquidity problemturns into a real insolvency catastrophe. Ultimately, the French government will need to inject capital into its banking system just as the Irish did.But where will it get the cash? Does anyone know howbig the hole in the banks is? After years of saying all was okay, can anyone trust anyone anymore?
So the banks will have to be ‘overcapitalised’. But where does the money come from? It will have to come fromthe French treasury. So the French government will have to set aside billions to cover bank losses. But thismeans the sovereign debt market becomes overloaded and the banking crisis contaminates the ‘sovereign’. If this happens, French bond yields decouple from Germany and then France finds itself in the same position as Italy and Spain.By this stage Greece has been give yet another e8 billion at the very last moment by the EU/ECB/IMF troika,but the crisis spreads everywhere.
German bond yields collapse as investors flock to German assets and the German newspapers side with those who say Germany should not pay for everyone. ‘France should pay’makes the headlines in Germany again for the first time in many years. Already, the leading indicators for the eurozone point downwards.This process is starting with manufacturing orders and the opinions of purchasing managers showing rapid reversals.
Now is this a currency union that can work? I don’t think so.Andwhat is the alternative?Well, as this column has argued again and again for many years, there has never been a recovery froma recession like ours without a huge drop in the value of the currency.Without this, austerity fails. But we are told this logical step is impossible, sowhat are we left with?We are left with the option of no other option at all.
Europe’s attitude now seems dreadfully reminiscent of the gold standard in the 1930s when central bankers made mistake after mistake and crushed the real economy, leading to social implosion.The world is on the verge of anotherGreat Depression.TheUS doesn’t have the resources to drag us out,China doesn’t want to and Europe hasboxed itself inover silly budgetary rules. All the while,money is fleeing, credit is tightening and unemployment rising.This is not a growth strategy;i t is debt strategy. And debt without growth leads to mass default ^ and what happens then to the euro?
David McWilliams has devised and will teach a new economics diploma, Economics Without Boundaries, from October 11. See www.independentcolleges.ie