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Looking ahead to see the new shape of Europe

22 November 2011

Summary:  The slow fire in Europe slowly moves to a conclusion.  From America we cannot foresee what will happen because the news media paints it as a morality play, obscuring the dynamics at work.  While we cannot predict which path the peoples of Europe will choose, we can at least understand the causes of the crisis (it’s not a morality play) and the two alternatives.  See the comments for updates.

European elites still hope the current crisis drives Europe to unification.  The slow-building deterioration since August might result from a conscious decision, allowing events to spiral down, so that the eventual crisis (coming soon) provides the political conditions for bold policy action.  Unification amidst mass panic.

Prime Minister Merkel tours Europe advocating unification, requiring large changes to the treaties defining the Union.  It’s easy to see why German’s elites support unification.  Germany used the European Monetary Union to impose interest rates optimal for Germany — with terrible effects on Europe’s periphery.

  • Germany got strong growth and low inflation — at the cost of large loans to the periphery.
  • The periphery enjoyed strong consumption facilitated by low interest rates — at the cost of large debts to the core EU nations.

That regime crashed, forcing either fragmentation or unification.  Unification looks easier for the periphery, with fewer uncertainties compared to the leap into the darkness outside the EU.  Plus Germany and France (desperate to save its banks) exert fierce pressure.  The combination of bullying and fear might produce some form of unification.

The next step:  a fiscal union

The news media acts as a mouthpiece for the financial industry, so we hear little but the wonderfullness of unification.  Understandably so, since the banks see unification as another bailout of their potentially lethal loans to the periphery.  Sometimes they explain the perspective of anti-unification German, and of the “technocrats” in the periphery who do the bidding of Germany.

The banks want immediate monetization by the EMU of sovereign debts.  That’s not going to happen.  A limited monetary union before political union was a bold gamble (now failed).   A full central bank — able to directly finance national spending — without central fiscal control would be deranged.

The next step towards unification means central control (in effect, German control) of individual nations’ fiscal affairs.  Since Germany used the EMU to rape the periphery (albeit with their ignorant consent), they should expect Germany to do it to them again in a fiscal union.  As the AA teaches, insanity is repeating ones actions but expecting a different outcome.

The people of the periphery might as well be Martians, so invisible are they to American journalists.  For variety we see the occasional description of venial politicians and photos of rioting unions.  One seeks in vain in the US media for any facts and logic supporting their views.  In fact leaving the union — devaluation and default — offers not just immediate pain (as does unification) but the prospect of future growth (instead of neo-colonization by Germany).  If instead some of the periphery nations choose to leave (or are kicked out), here’s a roadmap:  “On Technical Barriers to Leaving the Euro and Learning from Others’ Experience“, Ed Dolan, 20 November 2011.

What about those lazy profligate Mediterranean people?

The news media tell a simple story, a morality play fit for children (as our rulers see us).  The victims in the periphery brought their troubles down on themselves.  Weak characters, taking advantage of the thrifty hard-working Germans.  It’s mostly nonsense.  As so often the case, the underestimated power of monetary policy is the key factor.

For some simple facts blowing up the approved narrative, we turn to the estimable Michael Pettis (Prof Economics, Peking U): “Germany Must Do It, Not China“, 7 November 2011.

Germany has benefitted tremendously from the euro. Nearly all of its growth in the past decade can be explained by its rising trade surplus which, given monetary policy driven almost exclusively by the needs of slow-growing and consumption-repressed Germany, came at the expense of the rest of Europe.

And why do I say that Germany benefitted from the euro at the expense of peripheral Europe?  For one thing, take a look at the table below provided to me by Chen Long.  It shows the top ten trade deficit countries for each of the indicated years.  I have colored each of the spendthrift, deficit-loving countries of peripheral Europe red, and all the thrifty, deficit-hating countries green.

Notice that peripheral Europe in red shows up quite a lot – mainly thanks to Spain and Portugal and to a lesser extent Italy, in 1991 and 1992.  In total they show up around twelve times during the decade, with an average rank of roughly six.

But notice that Germany shows up every single year among the leading deficit countries – with an average rank of around four, which makes it worse than the average for Spain, Italy and Portugal.  Toss in Austria, a country with policies that mirror that of Germany, and the “virtuous” countries of Europe turn out in the 1990s not to have been much more  virtuous than the vicious ones.  They turn up fourteen times instead of twelve and have bigger deficits on average.

… Now take a look at what happened in the next decade to the top ten leading deficit countries.  Once again the spendthrift, deficit-loving countries of Europe are colored red.

Pretty surprising, right?  First off, notice that there is no green.  It turns out that Germany and the thrifty Europeans largely learned to love thrift only after the euro was established.

Red countries, on the other hand, are everywhere.  Although I am sure to be excoriated by some, not least by my French mother and her family, for including France among the spendthrifts, altogether they show up 42 times, with an average rank of around five.  Their performance in the decade after 2000 turns out to have been abysmal compared to their  performance in the decade before 2000.

The data for leading trade-surplus nations tell a similar story.  In the decade before 2000, Germany shows up in the top twenty trade surplus  countries only once, in 1990.  But in the decade after 2000, Germany is the second biggest trade surplus country every single year except in 2001, and again in 2010, when it ranked third.

Among the spendthrift countries, on the other hand, France shows up in the top ten trade surplus countries every single year from 1992 to 2003, after which it drops off forever to become one of the major deficit countries after 2005.  Meanwhile, surprisingly, presumed wastrels like Italy are actually in the top ten trade surplus countries every year from 1993 to 1999, while little Ireland managed to put in four showings in the top twenty trade surplus countries in the 1990s.  In the decade after 2000, however, they too became major deficit countries.

So how do we explain the European crisis?  One theory is that the European crisis was caused by the moral turpitude and spendthrift habits of lazy Europeans along the periphery, in sharp contrast to the hard-working and thrifty countries of the center.  According to this theory it is unfair to demand that Germans clean up the mess.

If you believe this theory, you are going to have to explain what happened in 2000 that turned thrifty Italians, French and Irish into , and that turned ordinary Greeks, Portuguese and Spaniards into even worse spendthrifts.  You will also have to explain why spendthrift Germans in the 1990s suddenly morphed into the stolid, thrifty creatures of legend.

An alternative theory is that the imbalances were caused by internal policies – perhaps the creation of the euro and the gearing of monetary policy to German needs at the expense of the periphery? – which led to the severe internal imbalances.  These imbalances created employment growth in the countries that suppressed consumption, and forced the  countries that didn’t to choose between debt and unemployment.  Of course since the latter countries had no control over monetary policy, the choice was largely made for them by the ECB with its excessively low interest rates, and their debt levels surged.

I find this alternative theory a lot easier to understand, and if it is true it places responsibility for saving the euro squarely in Germany’s hands.</

Recent articles about the crisis of Europe

  1. Neo-Calvinists and the Euro-Crsis“, Paul Krugman, New York Times, 22 November 2011 — Click through to the study by the Centre for European Reform.
  2. Austrian Economics, the Real Kind, Paul Krugman, New York Times, 21 November 2011

Other posts about the crisis of Europe

  1. The post-WWII geopolitical regime is dying. Chapter One , 21 November 2007 — Why the current geopolitical order is unstable, describing the policy choices that brought us here.
  2. Can the European Monetary Union survive the next recession?, 11 July 2008
  3. The periphery of Europe – a flashpoint to the global economy, 8 February 2010
  4. A great speech by the PM of Greece. How soon until an American President says similar words?, 3 March 2010
  5. Governments cannot go bankrupt, 2 April 2010
  6. Our government’s finances are broken. How do we compare with our peers?, 8 April 2010
  7. The EU does Kabuki for Greece. Is it the next domino to fall?, 14 April 2010
  8. About the Euro crisis: the experts are wrong; the German people are right., 7 May 2010
  9. Former Central Bank Head Karl Otto Pöhl says bailout plan is all about ‘rescuing banks and rich Greeks’, 20 May 2010
  10. The Fate of Europe, nearing the point of decision, 13 September 2011
  11. Europe drifts towards the brink of a cataclysm, 26 September 2011
  12. Delusions about easy fixes for Europe, dreaming during the calm before the storm, 30 September 2011
  13. Every day the new world emerges, yet we see it not.  Like today, as Europe begs China for loans, 15 September 2011
  14. Is Europe primed for chaos, as it was in July 1914?, 7 October 2011
  15. We see the outlines of the next cure for Europe.  Will it work?, 14 October 2011
  16. Today Europe’s leaders took another step towards the edge of the cliff, 27 October 2011
  17. Where to from here, Europe?  Some experts share their views., 8 November 2011
  18. Status report on Europe’s slow re-birth (first, the current system must die), 10 November 2011
  19. Europe begins its endgame.  Watch and learn, for Europe’s problems are the world’s., 11 November 2011
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9 Comments leave one →
  1. 22 November 2011 12:52 pm

    Nice polemic :-)

    Could the author try to separate effects of Euro and German re-unification? It is not sound (at least in hard science) to change two variables at the same time and then attribute the observed effect to only one :-)

    German trade balance was positive in most years of the 1980-1989 decade (pre-unification) without the Euro. Does the changes after 2001, therfore, reflect the impact of the Euro – Germany is milking fellow Eupeans – or do they show that some aspects of the unification have been digested, i.e. would the effect also have been observed with a D-Mark?

    How did Switzerland with a similar industrial structure but without Euro and unification perform at the same time?

    Another issue is that the author completely fails to explain why many European countries let their pensions, salaries of state servants etc. grow much faster than their productivity? Which problems were really imposed by the low interest rate after introduction of the Euro, which were system immanent?

    Like

    • 22 November 2011 2:41 pm

      These are all good questions. Social sciences are dedeviled by the inability to run controlled experiements, and the difficulty of disstinguishing the effects of simultaneous changes. Real research, unlike the quick looks (such as the excerpt from Pettis’ article) will take years to perform.

      The tables provide a partial answer to your question by looking at the behavior of the EMU’s creditor-exporters as a group (eg, Germany, France, and Holland). It wasn’t just Germany. Looking at Swiss as a control is a good idea.

      Re: social spending

      The trade flows and productivity changes are the core problem of the EMU. There are other articles dealing with social spending (broadly defined). But this post was already insanely long and complex, as was Pettis article.

      Like

  2. whirlwind21 permalink
    22 November 2011 9:50 pm

    Will this Europe be German led? Its the Fourth Reich albiet a much more benevolent one.

    Like

    • 22 November 2011 10:18 pm

      Too many choices. They do not know the result, so we cannot reliably guess.

      Like

  3. 23 November 2011 11:43 am

    The German problem now is, that we have to lead but do not want to lead.
    And a guy like the former Bundeskanzler Helmut Schmidt, who was able to make really tough decisions and sell them to the people, is not available. Angela Merkel fails IMHO when it comes to communication with the voters. Euro bonds without a clear definition of responsibilities and proven willingness to change is political suicide in Germany and some other countries, however, without Eurobonds the situation may run even faster out of control.

    It is clear that Germany is to a large extent responsible for the low interest rates after introduction of the Euro and also allowed the admission of some problem countries into the Euro area. However, it is hard for me to understand when some contries used these low interest rates to borrowed money with Germany’s rating for a decade and only achieved to prolong or worsen a unsustainable economic culture.

    Like

  4. Duncan Kinder permalink
    24 November 2011 9:37 pm

    The London Review of Books has an article on Greece’s response to its debt crisis: “Diary” by James Meek, 1 December 2011. Read the whole thing. However, I highlight one part which is buried:

    “The time of political parties was over, she said. ‘We don’t believe in structure. All these years we had structure, and look at us now.’”

    Other points:

    1. The Greeks are now calling their taxes “kharatsi,” the hated head tax the Ottomans once levied on Christian Greeks.
    2. Lesbos, the Greek island which this article’s author visits, is larger and far more self-sufficient and less tourist-dependent than most Greek islands, such as the Cyclades. Therefore, Lesbos’ economic woes, as described in this article, should be less severe.

    Like

  5. Krugman explains "Mysterious Europe" permalink
    26 November 2011 11:11 pm

    An excellent summary of the cause of the euro-crisis: “Mysterious Europe“, Paul Krugman, New York Times, 26 November 2011 — Conclusion:

    So where is the story about how this is supposed to work?

    As far as I can tell, European policy makers aren’t even thinking about scenarios. They’re just repeating the old slogans about stable prices and fiscal responsibility, with no narrative at all about how pursuing those virtues can be consistent with European recovery.

    Even a few months ago I regarded a complete euro crackup as highly implausible. Now I’m having trouble finding a plausible story about how the thing survives.

    Like

  6. "Prepare for riots in euro collapse, Foreign Office warns" permalink
    27 November 2011 12:39 am

    Prepare for riots in euro collapse, Foreign Office warns“, The Telegraph, 25 November 2011 — ” British embassies in the eurozone have been told to draw up plans to help British expats through the collapse of the single currency, amid new fears for Italy and Spain.”

    As the Italian government struggled to borrow and Spain considered seeking an international bail-out, British ministers privately warned that the break-up of the euro, once almost unthinkable, is now increasingly plausible.

    Diplomats are preparing to help Britons abroad through a banking collapse and even riots arising from the debt crisis. The Treasury confirmed earlier this month that contingency planning for a collapse is now under way.

    A senior minister has now revealed the extent of the Government’s concern, saying that Britain is now planning on the basis that a euro collapse is now just a matter of time. “It’s in our interests that they keep playing for time because that gives us more time to prepare,” the minister told the Daily Telegraph.

    … Diplomats have also been told to prepare to help tens of thousands of British citizens in eurozone countries with the consequences of a financial collapse that would leave them unable to access bank accounts or even withdraw cash.

    … If eurozone governments defaulted on their debts, the European banks that hold many of their bonds would risk collapse.

    Some analysts say the shock waves of such an event would risk the collapse of the entire financial system, leaving banks unable to return money to retail depositors and destroying companies dependent on bank credit.

    The Financial Services Authority this week issued a public warning to British banks to bolster their contingency plans for the break-up of the single currency. Some economists believe that at worst, the outright collapse of the euro could reduce GDP in its member-states by up to half and trigger mass unemployment.

    Analysts at UBS, an investment bank earlier this year warned that the most extreme consequences of a break-up include risks to basic property rights and the threat of civil disorder. “When the unemployment consequences are factored in, it is virtually impossible to consider a break-up scenario without some serious social consequences,” UBS said.

    Like

  7. david jones permalink
    27 November 2011 2:00 pm

    Great article, a perspective I hadn’t heard really.

    BUT- I have to agree with the comment about the German reunification. It really was the dominant economic event for them in the 1990s. I like Pettis a lot (just started reading his blog) but he should’ve mentioned it.

    I talked to a semi-retired German landscape gardener / carpenter while on vacation recently, over a beer. First of all, he was pretty well off. One thing Germans do is treat their workers well, strong union style protections there too, as much as southern Europe. So another way to attack the hard-worker-vs-lazy story.

    Anyhow he said he and he believes most other Germans aren’t really upset that the Greeks/Italians borrowed money they can’t repay- They’re upset that their system, I guess they believe you ought to have a lot of faith in the system , and the system totally let them down. Like Americans in the 2000’s , they weren’t paying attention to the flow of big money and credit bubbles and the like. (oh they don’t have a real estate bubble either… research that one). So its like one day they wake up and oops! Someone lent your pension funds to a Spanish developer so they could build the third shopping mall in a small town in the middle of nowhere. So I think they’re out to get the government. He was also dismayed that there isn’t as much of a difference between their 2 big political parties (Christian Democrats and Social Democrats) as there used to be, so its not like he can just switch parties and expect anything radically different.

    And anyway it’s too late. Personally being the cynic that I am, I predict the near-failure of 1 big German and French bank followed by a collosal kick-the-can-down-the-road operation involving a multi-country multi-bank compromise deal to have some banks eat as much of the bad paper as they can, nationalize them while it matures, then re-privatize when it’s done. Note the ample opportunity for insiders to score along the way. Also the ECB provides trillions in “emergency overnight credit” to all the other banks, every day, during the several years this goes on for. I think that is technically allowed for its mandate. This would buy enough time to negotiate some heavy EU treaty changes, but they’ll probably blow that opportunity.

    Like

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