Europe after the Global Minotaur

21/11/2012 by

This post follows up from an earlier one entitled America after the Global Minotaur. Both posts are extracts from the forthcoming new edition of The Global Minotaur.

Bankruptocracy, as I have argued in Chapter 8 of my Global Minotaur, is as much of a European predicament as it is an American ‘invention’. The difference between the experience of the two continents is that, at least, Americans did not have to labour under the enormous design faults of the Eurozone. Imagine their chagrin if the citizens of hard-hit states (e.g. Nevada or Ohio) had to worry about a death embrace between the debt of their state and the losses of the banks who happened to operate within the state! Additionally, Americans were spared of the need to contend with a Central Bank utterly shackled by inner divisions and the Bundesbank’s (nb. the German Central Bank’s) penchant for treating the worst-hit parts of the Union (the Eurozone, that is) as alien lands that had to be fiscally waterboarded until they ceased to obey the laws of macroeconomics![1]

In the past two years, the debate in Europe has focused exclusively on issues that sound technical and minor, especially when projected against the background of Europe’s extraordinarily rich history. Will there be ‘conditionality’ attached to the recently announced purchases of Italian and Spanish bonds by the European Central Bank? Will the bonds that the ECB purchases be treated on something financiers refer to as a pari passu basis (in relation to bonds held by private institutions)? Will the ECB supervise all of Europe’s banks, or just the ‘systemic’ ones?

These are questions that ought to be of no genuine interest to anyone other than those with a morbid interest in the interface between public finance and monetary policy. And yet, these questions (and the manner in which they will be answered) will probably prove as important for the future of Europe as the Treaties of Westphalia, of Versailles, of Rome even. For these are the issues that will determine whether Europe holds together or succumbs to the vicious centrifugal forces that were unleashed by the Crash of 2008.

And yet they are not issues that are worth expounding upon here. All they do is to reflect a tragic, underlying reality that can be described in simple lay terms without the use of any jargon whatsoever: Europe is disintegrating because its architecture was simply not sound enough to sustain the shockwaves caused by our Minotaur’s death throes. The previous chapter has dedicated several sections that described the Eurozone’s construction and all its faults; the manner in which Europe’s version of Bankruptocracy sprang up. In particular, the section on Europe’s ‘tumbling mountaineers’ captures nicely the domino effect which began with Greece and ended up (after this book’s first edition saw the light of day) engulfing two proud and immensely productive large European nations: Spain and Italy.

On the basis of Chapter 8’s analysis, it is quite obvious that the insolvency of Madrid and Rome had nothing to do with fiscal profligacy (recall that Spain had a lower debt than Germany in 2008 and Italy has consistently smaller budget deficits) and everything to do with the way in which the Eurozone’s macroeconomy relied significantly for the demand of its net exports on the Global Minotaur. Once the latter keeled over in 2008, and Wall Street’s private cash disappeared, two effects brought Europe to its knees:

One was the sequential death-embrace of bankrupt banks and insolvent states (beginning with Greece, moving to Ireland, to Portugal and continuing until Italy and Spain were torn asunder). The other was the Minotaur’s Simulacrum (see the previous chapter for this metaphorical sketch of the German economy) and its determination to hang on to its option of exiting the Eurozone at will, therefore denying each and every rational plan for mending the currency union in a sustainable manner.

Has anything of analytical significance occurred in Europe since Chapter 8 was penned two years ago? I can think of three moves that Europe’s leadership made that are worth a mention as they prevented the Eurozone’s final collapse, keeping it in a state of slow burning disintegration:

(1)           The European Central Bank’s decision, between December 2011 and February 2012, to print around one trillion euros and lend it to the Eurozone’s insolvent banks in exchange for worthless collateral. In so doing, some of that money (no more than 30%) was then lent by the banks to the fiscally-stricken member-states (e.g. to Italy). This operation (known as LTRO) bought the Eurozone another eight to nine months.

(2)           The partial write-off of Greece’s debt, in March of 2012. Alas, this write off, a formal default by any standards, was unique in economic history in that it left the indebted nation with a heavier debt burden at the end of 2012 than that which it was shouldering at the end of 2011![2]

(3)           Following an admission, in August 2012, by the President of the European Central Bank that the Eurozone was disintegrating,[3] the ECB announced that it would be prepared to buy unspecified Italian and Spanish second hand bonds in order to keep the interest rates paid by these two countries manageable. However, as the price for carrying the German government with him, the ECB’s President, Mr Mario Draghi, also announced that these ‘operations’ (which are now known as Outright Monetary Operations, or OMT for short) would be conditional on further, vouched for by inspectors, austerity. Thus, surreptitiously, Europe’s Central Bank sacrificed, on the altar of keeping on Germany’s ‘right side’, its most prized principle: Central Bank independence.[4]

Many a reader may protest that I left out of my short list of significant changes the June of 2012 Summit Agreement according to which Europe’s leaders, at the insistence of the Italian and Spanish prime ministers, agreed to separate the continent’s banking crisis from the debt crisis. How would that separation be achieved? By unifying the banking systems of the Eurozone countries, infusing them with capital from the ‘centre’ and desisting from counting these capital injections as part of the national debt of the countries in which the banks are domiciled. This agreement, if it were implemented fully, would have been an important step toward arresting the Euro Crisis’ triumphant march. But it will not be! Days after it was reached, Germany’s leadership began a clever and determined campaign at pulling the plug. I have no doubt that this, the most significant agreement to date, is dead in the water. –and thus not worthy of much ink.

The telling question thus becomes: Why such resistance, particularly from Germany, to every single idea that would end the Euro Crisis? The standard answer is that Germany does not wish to pay for the debts of the Periphery and will resist all federal-like moves (e.g. a banking or a fiscal union) until it is convinced that its partners behave responsibly with their German-backed finances. While this captures well the mindset of many Northern Europeans, it is besides the point. Consider the following mental experiment which, I believe, helps us unveil a deeper motive.

Picture the scene when a sheepish Finance Minister enters the Chancellor’s Berlin office bearing a control panel featuring one yellow and one red button, and telling her that she must choose to press one or the other. This is how he explains what each button will do

The Red Button: “If you press it Chancellor the Euro Crisis ends immediately, with a general rise in growth throughout Europe, a sudden collapse of debt for each member-state to below its Maastricht limit, no pain for Greek citizens (or for Italians, Portuguese, etc.), no guarantees for the Periphery’s debts (states or banks) to be provided by German and Dutch taxpayers, interest rate spreads below 3% throughout the Eurozone, a diminution in the Eurozone’s internal imbalances, and a wholesale rise in aggregate investment.”

The Yellow Button: “If you press it Chancellor the situation in the Eurozone remains more or less as is for a decade. The Euro Crisis continues to bubble along albeit in a controlled fashion. While the probability of a breakup, which will be a calamity for Germany, remains non-trivial, the chances are that, if you push the yellow button, the Eurozone will not break up (with a little help from the European Central Bank), German interest rates will remain extremely low, the euro will be nicely depressed (‘nicely’ from the perspective of German exporters), the Periphery’s spreads will be sky-high (but not explosive), Italy and Spain will enter deeper into a debt-deflationary spiral that sees to a reduction of their national income by 15% over the next three years, France shall slip steadily into quasi-insolvency, GDP per capita will rise slowly in the surplus countries and fall precipitously in the Periphery. As for the first ‘fallen’ nations (Greece, Ireland and Portugal), they shall become little Latvias, or indeed Kosovos: devastated lands (after the loss of between 25% and 40% of national income, a massive exodus of their skilled labour) on which our people will holiday and buy cheap real estate. In aggregate, if you choose the yellow button Chancellor, Eurozone unemployment will remain well above UK and US levels, investment will be anaemic, growth negative and poverty on the up and up.”

Which button do you think dear reader the Chancellor would want to push? And, quite a separate question, which of the two buttons would the median German voter want her (or him, in years to come) to push?

Of course, this is both an hypothetical and an empirical question and no one can answer definitively. However, the answer is not as straightforward as it would in America or Britain. Whereas the yellow buttons would hold no attraction for the American President Obama or the British Prime Minister, the German Chancellor’s yellow button is a far more powerful option. Even if the Chancellor wanted to opt for the red button, she would be terrorised by the reaction of the German electorate were she to do so. Letting the Greeks and the Italians, the Spaniards and the Portuguese, off the hook of their Great Depression so ‘easily’ is unlikely to win many votes east of the Rhine and north of the Alps.

For two years now, the German public has become convinced that Germany has escaped the worst of the Crisis because of the German people’s virtuous embracement of thriftiness and hard work; in contrast to the spendthrift Southerners who, like the fickle grasshopper, made no provisions for when the winds of finance would turn cold and nasty. This mindset goes hand in hand with a moral righteousness which implants into good people’s hearts and minds a penchant for exacting punishment on the grasshoppers – even if punishing them also punishes themselves (to some extent). It also goes hand-in-hand with a radical misunderstanding of what kept the Eurozone healthy and Germany in surplus prior to 2008; i.e. the Global Minotaur whose demand-generation antics were for decades allowing countries like Germany and the Netherlands to remain net exporters of capital and consumer goods within and without the Eurozone (while importing… US-sourced demand for their goods from the Eurozone’s Periphery).

Interestingly, one of the great secrets of the post-2008 period is that the Minotaur’s death affected adversely aggregate demand in the Eurozone’s surplus countries (Germany, Holland, Austria and Finland) more adversely than it did the deficit member-states (like Italy, Spain, Ireland, Portugal and Greece) – see Figure 6 below. While the sudden withdrawal of capital from the deficit countries brought about their insolvency, countries like Germany saw their ‘fundamentals’ more grievously affected by the Crash of 2008. This fact, in conjunction with the terrible squeeze on German wages (that was discussed in the previous chapter), explains the deeper causes of the animosity in places like Germany that so very easily translate into anger against the Greeks and assorted Mediterraneans – feelings that are then reciprocated, thus giving the wheel of intra-European animosities another spin, favouring the rise of xenophobia, even Nazism (in countries like Greece quite incredibly), and thus leading to a wholesale readiness to push all the yellow, as opposed to the red, buttons in sight.

Figure 6 – US goods trade deficit with the Eurozone’s Periphery (Italy, Spain, Ireland, Greece and Portugal) and with the Eurozone’s Surplus Countries (Germany, Austria, The Netherlands and Finland) – Source: US Bureau of Economic Analysis

To recap, the Minotaur’s surplus recycling was essential to the maintenance of the Eurozone’s faulty edifice. Once it vanished from the scene, the European common currency area would either be re-designed or it would enter a long, painful period of disintegration. An unwillingness by the surplus countries to accept that, in the post-Minotaur world, some other form of surplus recycling is necessary (and that some of their own surpluses must also be subject to such recycling) is the reason why Europe is looking like a case of alchemy-in-reverse: for whereas the alchemist strove to turn lead into gold, Europe’s reverse alchemists began with gold (an integration project that was the pride of its elites) but will soon end up with the institutional equivalent of lead.

[1] My assertion here is that the unqualified demand that countries like Greece and Portugal eliminate their deficits through deep public sector cuts, at a time of a debt-deflationary depression, is to ask for the macroecomically impossible – especially when these countries lack a currency whose devaluation would yield some respite.

[2] While almost 100 billion euros was written off, Greece was forced to take on new loans to repay its ‘official lenders’ (the trio made up of European Union countries, the European Central Bank and the International Monetary Fund) plus the remaining private lenders. With a savage recession raging, the Greek government was made to accept public expenditure cuts and appalling new taxes that, between them, caused national income to shrink so much that the nation’s debt to national income ratio rose to levels it had never scaled before.

[3] Naturally, no central banker worth his salt will speak such blunt words. Mr Mario Draghi’s choice of words, by which to signal unambiguously that he was talking about the Eurozone’s dismantling, was there was now a serious “convertibility risk”; by which he meant that there was a risk that all prices in the Eurozone would be ‘converted’ to other, new, national one presumes, currencies!

[4] This loss becomes clear the moment one realises that the ECB has chosen to conduct monetary operations that will stop not when the ECB judges it must but when Brussels or the IMF say it should cease and desist. This is, if nothing else, ample proof that the fabled central bank independence was never a real principle but, rather, a pretext for never financing anyone other than ‘needy’ bankers.

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