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Dealing with a terrible marriage

Posted on September 27, 2014 by Tom Healy

Tom Healy, Director NERI
Tom Healy, Director NERI

They were tall, elegant, famous, beautiful and affluent. It was a fairy-tale marriage deemed to last forever …. until the gales of crisis struck and deep cracks were exposed.  In 2002 and in the run-up to the introduction of the Euro most commentators and policy makers imagined that peace, stability and growth were here to stay. Governments in Europe and across the Western economies thought they could regulate the business cycle through a prudent mix of fiscal and monetary policy allied to that most ambiguous of terms ‘structural reform’ (read flexibility downwards and outwards of labour and social conditions and terms).

In Euroland, Member States, by giving up their own currencies, would adhere to the discipline and rules of a single market and currency union. Security, progress and ease of transfer and commerce were seen as the fruits of this marriage.  Then the crisis of 2008 came and the world changed. The full implications of the crisis for the Eurozone did not become apparent until, in 2010, a series of disastrous decisions were made by member states and the European Central Bank in relation to the cutting off of a fiscal stimulus prematurely and driving Greece further into debt unsustainability and a spiral of fiscal austerity.

Suddenly, the marriage turned into a nightmare as some members of the union were compelled to undertake what economists call a severe internal devaluation. Countries such as Latvia (which was pegged to the Euro prior to joining the common currency), Portugal, Greece and Ireland slashed public spending, cut wages and maintained the gradual sell-off of public assets. Private vultures, bondholders and other creditors had a feast. Betting on a haircut in 2011 bond yields on Irish government debt first rose as the price of bonds fell. When the new Irish Government, in 2011, didn’t do what some had said they would do (burn the bondholders and not pay ‘a red cent’) bond yields started to fall and, therefore, bond prices rose while some people made a handsome killing through sales of bonds after a period of time.

It’s no fun being locked into a currency union with a single-track central bank dedicated to a narrow set of goals – price stability, financial stability and low inflation. In the absence of any single progressive anti-cyclical fiscal authority at European level its like living under a version of the Gold Standard in the 21st century.  Since the option of national currency depreciation (or appreciation) is not present, countries have to adjust the prices of their goods and services traded through cost cuts (usually wages) or public spending cuts/tax increases partly as a way of cutting back on imports. It is a slow death through austerity, embedded long-term unemployment, especially among the young, and hardly any reduction in debt. Normally it takes many years to bring debt down either through inflation or real economic growth – neither of which is on offer in most European countries now. 

When, eventually, the economy turns around (whatever falls must eventually rise and vice versa) as it must, the austerians are jubilant: ‘austerity works, it had to be done, the pay-back is now being seen, confidence has been restored, the markets will lend to us again and we are the best shining example in Europe for other small nations struggling with debt and problems of competitiveness’. So the story goes. Read the official line from Ireland and ask any foreign delegation coming to our shores what they have heard – and only what they have heard.  Una voce and one message.

But, the process of stagnation, wealth transfer (from debtor to creditor, from labour to capital, from rich to poor) and the slow painful unwinding of the Irish property bubble while another bubble is waiting in the current supply-shortage is the outcome of what has been foisted on European taxpayers. 

Given the financial interests and stakes of US, UK, German and French banks in having lent to Irish banks during the years of crazy credit boom (2001-2006) political ears were bent (one might assume in rough proportion to the extent of national foreign bank exposure to Irish banks), first in the Autumn of 2008 and then again following February 2011. The result was that large bondholders (which included big name banks and finance houses among the aforementioned countries) got paid back in full. No haircuts for them. Plenty of hair and skin-cutting for the taxpayers, welfare recipients, small businesses and workers of Ireland and other parts of Europe. To sum up: the senior bondholders got bailed out while the citizens got bailed in. The implicit official line from European institutions and the national agencies is familiar:

Very tragic, Mr citizen, but that’s the way the world and the markets go. Move on, get over it, next time better with regulation and single European banking union… you should count yourself lucky – it could have been worse.  And a bit of austerity is no harm to regulate labour markets, restore competiveness and put order on public finances. 

The formula of ‘in riches and poverty, in sickness and health, till death do us part’ begins to ring hollow in the villages of Longford, the suburbs of Athens and the ageing communities of Latvia. Somehow the ‘punishment’ was deemed to be deserved and, in any case, entirely unavoidable. Is this a form of European ‘Stockholm Syndrome’ a policy of accelerated sales of Anglo-Irish bonds is presented as good news?

Martin Wolf, journalist with the Financial Times and an astute observer and writer on international finance, has recently published a book entitled ‘The Shifts and the Shocks’. Wolf contrasts Ireland with the other ‘PIGS’ (Portugal, Italy, Greece and Spain):

Ireland, on the other hand, suffered no loss in competitiveness, because of fast productivity growth in its output of tradeable goods and services. Ireland has a flexible labour market and relies for exports on foreign companies, mostly American, with access to state-of-the-art technology.

For Wolf the genesis of the crisis globally and within the Eurozone stemmed from trade imbalances together with associated large-scale capital flows from the ‘surplus’ account countries to the ‘deficit account countries. It was not fiscal imbalances that triggered the crisis (with the exception of Greece). However, fiscal deficits did emerge due to a combination of cyclical and bank bail-out forces.

Ordo-liberalism argues, on the other hand, that the fault is with those countries that over-spent, over-borrowed and declined the necessary structural reforms to regain competiveness. The solution, according to this view is fiscal austerity in the short-run (and possibly longer if necessary) combined with tight fiscal rules.

The trouble according to Wolf with the current policy of Germany and, therefore, the Eurozone/Europe is that we have a ‘discipline union’ but no ‘collective insurance union’.

If the current common currency union of the Euro is to survive there are, in my view, only two possibilities ultimately:

  1. Movement to a full political and transfer union where a United States of Europe operates more or else on the same internal solidarity principle as a single federal union such as Canada, Germany or the USA itself.
  2. Break the Eurozone into at least two currency blocks

Muddling through from one crisis to another will not work. The first option may be seen as the most desirable especially if it were accompanied by a new age of European social enlightenment (which withered from the 1980s onwards). The prospects of this happening politically, culturally and popularly are about as likely as the fall of the Berlin Wall in 1989 (but yet it did happen!).

Restoration of national currencies with the right to devalue as a tool of public policy is not a silver bullet. Devaluations are disruptive and can often by accompanied by inflation, erosion in living standards and wages and high interest rates. Devaluation can also be beneficial (as it was in Ireland in 1986 and 1993). However, when devaluation is accompanied by a sovereign default the results can be rapid, traumatic for a while and socially destructive.

I think that Wolfgang Streeck (Buying Time – the delayed crisis of democratic capitalism) is probably right to say that “The European Monetary Union” was a mistake (even if we are not sure what the alternative might have looked like both before and after the Great Recession of 2008-2009). However, it is too late now to break up the Euro currency union without dramatic impacts on member states. While the threat of the unknown and the very financial instability implied in a costly and contested European currency ‘divorce’ can be exaggerated and used as a means of imposing further austerity discipline on the weaker countries these risks cannot be dismissed (there are perhaps small echoes, here, of the recent debates in the UK in regards to Scottish independence and the question of a currency union involving Scotland). Streeck argues in defence of a breaking up of the Euro currency union and reinstitution of national currencies:

Such a system, which would recognise the differences among European societies instead of trying to reform them out of existence along neoliberal lines, would be politically and economically far less demanding than monetary union. (page 185)

I am not so sure.

The reform ‘along neoliberal lines’ was well in place long before the advent of the Euro or, for that matter the arrival of the Troika. Successive governments, in Ireland, are committed to a gradual diminution in profitable state enterprise activity, maintenance of a low tax economy and, therefore, an impoverished social wage by European standards. Moreover, a small, open economy such as Ireland (albeit still a member of the European Union but not, hypothetically, of the Eurozone) would continue to be subject to the ‘discipline’ of borrowing money on international markets and warding off speculative attack on its national currency if it were free-floating.  In any case, the prospect of Ireland deciding on its own or with others to exit the Eurozone any time in the immediate foreseeable future is about zero. If it ever did happen it would be as a result of a major European crisis and break-up in which Ireland had no option except to align with some new currency union or go it alone (or peg to Sterling).  All of these options may be described as no-fun scenarios along with the current no-fun scenario of staying in the Eurozone.

It could still be the case that this terrible marriage that the Euro has revealed itself to be is better than some awful, untested and unknown alternative. If that is the case, policy makers and the elected representatives of the people at home and abroad should at least try to bring trade, investment, monetary policy and fiscal policy back under more social control – this time at the international level having surrendered so much of it at the national level. The secrecy with which the Transatlantic Trade and Investment Partnership (TTIP) is being conducted does not offer much short-term hope that happening. TTIP looks like a corporate charter to lower European social and environmental standards).

Just because the existential crisis of 2010/12 has greatly abated partly due to the promise of ‘whatever it takes’ by way of bond purchases in mid-2012, does not mean the seep underlying problems have gone away. All it would take is another sovereign debt crisis in the one of the weaker links in the Eurozone chain or a combination of political or market instability in one or more members to cause a fresh crisis.  Global money has flown to government bonds including those of the Irish Government. Funds in the new emerging economies are hungry for European Government bonds. Interest rates are abnormally low right now. This will not last.

Putting it altogether we have a deadly combination of:

  •  ‘structural reform’ in countries such as France, Greece, Portugal, Italy and Ireland (privitisation, downward adjustment in the share of labour in GDP and the removal of social controls to trade, investment and the employment of labour);
  • Secretive, costly and very unfair bank bailouts (or small depositor bail-ins in the case of Cyprus);
  • A lack of engagement, openness and democratic oversight in regards to discretionary fiscal, monetary and social policy
  • A lack of a coherent and socially progressive policy at the European level

European citizens deserve better. To save the Euro we need to save social and economic Europe. Otherwise I suggest that the Euro will not last in its current configuration and membership.

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