April 24, 2012
There is a famous scene in the 1976 film, The Outlaw Josey Wales, starring Clint Eastwood as the eponymous hero. During a particularly brilliant exchange, the bounty hunter Fletcher, hot on the heels of Wales, comes out with an inspired put-down to the cowardly senator who is trying to pull the wool over his eyes.
Squinting into the sun, saloon door at his back, chewing tobacco, Fletcher disdainfully hisses: “Don’t piss down my back and tell me it’s raining.”
The expression, which is originally from South Carolina, beautifully captures the moment when someone who is being lied to turns the tables on the person who is lying to him.
When it comes to the fiscal compact, the EU is pissing down our backs and telling us that it is raining. And the fact that the government is also going with this line implies that it is party to this falsehood.
Brussels is pretending that the fiscal compact is necessary to strengthen the euro. This is nonsense. The fiscal compact has nothing to do with solving the eurozone’s problems. Let’s be clear about that. It has everything to do with reassuring the German electorate that they will not be on the hook for the internal inconsistencies of a currency union, which they were bounced into a few years ago.
When I say ‘bounced into’, I mean the Germans never wanted the euro. They were more than happy with the Deutsche Mark but the French demanded that the price of German unification in 1991 be greater EU integration. A new currency would anchor Germany into western Europe, just in case the newly-unified Germany got itchy feet again and lurched eastwards.
Throughout the 1990s, the German public was kept in the dark about what all this meant for them. In the past few years, they have woken up. But they are now told that they are on the hook. However, this is only half the story.
Germans should know that there are no free lunches, and the greatest free lunch of all was the belief that Germany could lock in a permanently cheaper exchange rate off which to export without a price. Of course, the quid pro quo of their huge trade surplus was massive inflows of money to Germany, which has to be spent somewhere.
Had they their own currency, it would have risen in response to these inflows and German exports would have become very expensive. This didn’t happen, so Germany got turbo-charged export conditions, a massive current account surplus and huge financial exposure to its neighbours because German banks re-lent this cash to the periphery of Europe.
Unfortunately, no one told the Germans this bit of the story. As a result, they have misdiagnosed the ailment and they claim every problem begins and ends with free-spending governments.
But the financial panic wasn’t caused by budget deficits. Ireland and Spain entered the crisis with budget surpluses. The problem in Europe is driven by capital flooding from the north to the south and west.
At its core, it is a problem of capital flows rather than budget deficits. Ireland and Spain’s budgetary problems are the consequence of capital flows, not the cause of the crisis.
It is important to remember in Ireland that the reason we are in the clutches of the troika is not because we threatened to default on our debts, but because we didn’t. It was when we said we could pay everything that investors panicked.
So the problem for the euro is the capital flows between the creditor nations and the debtor nations.
What caused the problem? The culprit is the current account imbalances. Ours has reversed dramatically, providing the evidence for the idea that our budget deficit is simply a reflection of a massive increase in domestic saving, rather than explicit government spending.
The turnabout in our current account position reveals the massive domestic swing to saving over investment.
It also suggests that, when the eurozone breaks up, as I expect it to, Ireland will be able to finance itself. In fact, in the coming era of capital controls, this country will be in a better position than most. Far from being dependent on foreigners for financing, the ludicrous reality today is that this country is actually exporting capital – capital, which could be much more effectively deployed at home.
The real story of the past five years is that government spending was driven to replace the increased savings of the private sector. If the government hadn’t spent in the past five years, how deep do you think the recession would be now?
When we look at the entire eurozone debacle, we see an example of a monumental misdiagnosis to suit German political opinion.
Doctors will tell you that sometimes misdiagnosing the aliment is as dangerous as no diagnosis at all.
By focusing on budget deficits as the ‘fiscal compact’ does – which is not the root of the problem – the Germans are pissing down our backs and telling us it is raining.
And while they might be able to fool the insecure Irish people into voting for the ‘fiscal compact’, they are not fooling investors.
In the past few days, investors have taken flight from the bond markets of Spain and Italy and now, interestingly France. After all the cash injected by the ECB, investors are heading out of Spain and into Germany. They realise that the euro is a currency primed to explode.
Many years ago, this column argued that the euro would break up. Back then, I thought the break-up would be the likely upshot of a dramatic eurozone debt crisis. Now I am certain that this will come to pass.
A bit like Ireland with the bailouts, the flight from Spain happened, not because Spain said it wouldn’t meet its tighter budget targets, but because it said that it would! Investors know this is not politically possible.
We have yet another summit this weekend, while today we have an election in France in which the people are set to give Nicolas Sarkozy his marching orders. The world knows that the fiscal compact is not credible. Eventually, the people of Spain and Italy will get fed up of austerity, and the people of Germany and the Netherlands will get sick of bailouts.
The currency will go the way of most monetary unions; it will break up.
Remember there have been plenty of examples of countries leaving monetary unions in the past 100 years. It’s not unusual at all.
In these weeks of April showers as we go into the campaign season, remember that sensation of dampness you are feeling down your back is a bit too pungent to be water.
David McWilliams will be speaking at NUI Maynooth on Tuesday April 24.