November 16, 2011
We're at euro crossroads but every route looks grimPosted in Irish Independent · 260 comments ·
In the past few days I have bumped into many people on the street who are so confused by what they are hearing and they want to know what happens next. I have no inside knowledge, but my instinct tells me that the EU can’t go on like this, limping from one crisis to another. Yesterday, the crisis became more acute with the financial markets selling the bonds of Italy, Spain and even France. This is what happens in crises, the contagion becomes too much and everyone is engulfed.
The financial markets are no angels in this story. Those who believe that the markets are not trying to make money betting against the European elite are naive. In fact, any solution to this mess must have an element of capital controls embedded in it to control the excesses of the markets. It is simply not sustainable to have hedge fund managers in Greenwich Connecticut, who only pay 15% of their income in tax to the US government, dictating what happens in Europe – particularly as many of these people couldn’t locate Berlin on a map.
However, it is crucial to accept that while the financial markets are no angels, they did not cause the crisis and up until recently were happy to finance the governments of Italy and Spain, as well as France.
Notwithstanding the power of the markets (which can be controlled), the core of the problem is an enormous inconsistency at the heart of the EU. This inconsistency centres on how the Euro works in 17 different countries.
The credibility of the Euro – as a functioning currency within which countries and people can go about their business and prosper – is now in tatters. And people are moving their deposits because they are petrified.
Angela Merkel says that if the Euro fails, Europe fails.
This doesn’t look like a fair assessment of today’s economic reality. In fact the opposite is the case. Preserving the Euro seems to demand that banks will be protected for their stupidity, while taxpayers will be billed. At the same time, borrowers in certain European countries who need credit have no assess to credit, while borrowers in other countries that don’t want credit, have all the credit they like. And it seems to involve one large game of pass the parcel where the bill for more and more individual and institutional debts are being passed onto more and more people who had nothing to do with the debt in the first place.
When you look at what happens to money within the Eurozone over the economic cycle, a worrying pattern emerges. At the heart of the Euro is a self-reinforcing negative dynamic, which amplifies booms and exacerbates busts. This is the nub of the issue. In good times, when perceptions of risk are small, too much money flows from the core countries to the peripheral countries via bank loans either to the governments of the periphery or the private sector of the periphery. This means that anything can be financed at the top of the boom with other people’s money. The Greeks built Olympic Stadiums and we built Ghost Estates. Now they both lie empty and the bill remains unpaid because there is no money around to pay for them.
But where has the money gone?
Back to the core is the answer. According to the ECB, â‚¬122 billion of private money has left Ireland since January 2008. This has gone back to the core, it is no longer here and that is the reason we can’t pay for anything; the money is all gone.
If you think about this movement of money using the basic rules of economics, you will see there is something wrong with the picture.
In basic economics, when there is a recession the demand for money falls. This is because you don’t go out to spend or to invest and therefore, your demand for money falls. This should lead to lots of surplus money sloshing around and thus the “availability” of money increases. Eventually, with all this money sloshing about, the banks begin to “throw money at people” and confidence emerges again, people begin to spend and the cycle kicks off again.
But what happens if the downturn in the periphery is matched by a flight of money out of that country? In this circumstance the “normal” rules of economics do not pertain. The flight of cash from periphery to core leads to less money or credit being available for the peripheral recovery and therefore the normal recovery stalls and stutters, before stagnating.
This is the structural fault in the Euro. To use a Bertism, the Euro makes “the boom boomier and the bust bustier”.
So what’s the way out? Obviously the way out is for the central bank of the Euro, the ECB, to prevent that cyclical flow of cash. But how would it do that?
It could do that by turning on the taps and buying up all the debt that is being held in peripheral banks, injecting liquidity and making sure that there is loads of money sloshing about. It can do this easily, after all it prints the stuff.
But we are not seeing that from the ECB. Instead we are being pushed either in the direction of fiscal union or bust. But fiscal union, without an active central bank, won’t fix the problem. And a messy implosion of the Euro would cause massive dislocation as savings are debased with huge social and emotional consequences.
So what is on the cards? Either we will see a big bang move to political union through another referendum or the Euro will split in two with the core moving towards greater union and the periphery, with a new weaker euro, taking more time.
The first will be almost impossible to achieve politically as referendums have a habit of slapping elites around the head. The second will be all but impossible to achieve technically because with 17 different countries and banking systems, the first sniff of a two-speed Europe will cause massive capital flight.
So we are stuck. Yesterday, we saw the beginning of a run on the French government as French bond yields spiked. This won’t end here.
Meanwhile, the leadership in Germany warns of the biggest threat since the 2nd World War, yet is doing nothing to halt this. And all the while the economies of the periphery grind to a halt. Something has to give and, without real political leadership, we are looking at chaos.