We all know how the Euro crisis began: with Greece and lies about its public deficit. Then over the next two and a half years, the drama expanded to include Portugal, Ireland, Italy and Spain. Now the Spanish banking system threatens to collapse and take with it the Euro. But what is really causing the Euro crisis?
Is it “just” a problem of sovereign debt and speculative attacks fed by the bond markets conviction that the Euro is not defended by credible institutions and financial power the way the US dollar is? Or are other factors at work here, in particular cultural divergences and globalization?
Let’s take them in turn.
1. Financial Factors
On June 2nd 2012, Soros, in a memorable and much-discussed speech in Trento (Italy) has made the point that Angela Merkel is responsible for the way the crisis has unfolded: she put a stop to Germany in its traditional role as the engine of a federated Europe. How did she do this? It seems that after the fall of Lehman Brothers in 2008 she declared that “the virtual guarantee extended to other financial institutions should come from each country acting separately, not by Europe acting jointly. (italics added)”
Bizarre as it may seem, if you read Soros’ speech as presented now on his website you won’t find this particular reference to Ms. Merkel’s declaration – undoubtedly taken down under diplomatic pressure. Mr. Soros may have cleaned up his speech to please the Germans but the fact remains that if Ms. Merkel and Germany had moved immediately to quell the speculative attacks on Greece, we would not have a Euro crisis now.
Mr. Soros made two further important points: we have just three months to stem the Euro crisis before it destroys the European Union and only the Germans can do it. This three month’s window is a consequence of the next government election in Greece (June 17): one may expect the Greeks to be ready to accept the bailout agreement but unable to meet the conditions. So the crisis will come to a climax in the fall just when the German economy will be weakening as its major exports markets slow down. Under the circumstances, “Chancellor Merkel will find it even more difficult than today to persuade the German public to accept any additional European responsibilities.”
How did we get into this situation? Because the Maastricht Treaty created a common currency without prior political union: it took a step that was too big to be sustainable. As long the economic winds were favorable, the instability was not perceived. The common currency threw together countries at very different levels of development: for Germany, i.e. “the center” that includes other northern European countries like Finland or the Netherlands, the Euro was an opportunity to expand exports. The Euro was cheaper than the national currencies had been and all the necessary measures to improve competitiveness were taken, chief among them restraint on salary increases. For Southern European economies, i.e. “the periphery”, the Euro became a source of cheap credit feeding a dangerous consumption and housing boom. Commercial banks, allowed to accumulate government bonds without having to set aside equity capital, gobbled up bonds of the weaker euro members to make an extra profit.
When the 2008 Wall Street crash came, European governments engaged in massive deficit spending and the “periphery” found itself in the position of a third world country that has become heavily indebted in a currency that it does not control. Financial markets discovered that such government debt was no longer sovereign. Banks loaded with these bonds found themselves insolvent. Result: a closely interlinked banking and sovereign debt crisis.
In the spring of 2012 the Bundesbank, with claims of some 660 billion euros against the central banks of the Eurozone periphery, began to shed them off, in order to limit the losses it would sustain in case of a Eurozone breakup. Furthermore, it has always been against expanding the money supply or adopting any financial fix, most notably Euro-bonds, even though they would be an instant solution. Why? Because since the Bundesbank is in the driver seat, it would find itself having to guarantee them.
This is a self-fulfilling prophecy: once the Bundesbank does it, all banks do it. They are reordering their exposure along national lines: the “center” is shedding bonds from the “periphery” and conversely there’s a capital flight from the periphery towards the stronger Euro countries. Towards Germany in primis – indeed German bond yields are near zero! As a result, credit to enterprises, especially the medium and small ones that are a major source of employment, becomes less available and unemployment soars in the periphery.
Hence a deeper crisis. A wider divergence between Germany and the rest of the Eurozone. Moreover, an orderly break-up is not in the cards because the current re-ordering of Euro financial exposure within national boundaries is not completed (it would take several years).
Yet those who would suffer the most from the break-up would be the Germans themselves. They’ve benefited the most from the Euro so far – a cheap Euro has been the source of Germany’s success in exports – but a restoration of the Deutschmark would be very painful since it would be valued much higher than the Euro ever was.
By end June, a European Summit should come up with proposals to avoid a Euro break up. So far, it appears that the following financial measures are under discussion:
a form of European banking union, with perhaps as a first step a European Bank Deposit Insurance scheme to stem capital flight;
a functioning bailout fund, strengthening the already approved European Stability Mechanism so that it is capable of providing sufficient financial support to the eurozone banking system;
Eurozone-wide supervision and regulation.
It is probable that Germany will do whatever is needed to preserve the Euro but no more, allowing the internal divergences between the center and periphery to grow, thus preventing the European Union of ever achieving a federal union like the United States.
What is needed is to convince the Germans to do more? For a real political change, Ms. Merkel will need to leave and that won’t happen before 2013. Only then, and assuming a more pro-Europe party emerges, might Germany be more amenable to sustain the Euro and solve the euro management problems.
Problem solved? Not if some other negative factors are at work in Europe, in particular on the social/cultural front.
2. Cultural Factors
Cultural divergences could well be the forces that will overturn the boat.
Some researchers and most recently NYT columnist David Brooks (see his excellent article here ) have argued that the European union project makes no historical sense in the face of deep-set cultural divergences. Brooks reminds us how the world, after the disasters of World War II, yearned for peace and harmony: it was in this favorable setting that multicultural and supranational entities like the United Nations were created and with it all the international organizations still with us, chief among them the World Bank and the IMF. Those were also the years of the birth of the European Union project that began with the creation of the Coal and Steel Community, an optimistic effort by Germany and France to bridge their differences and “never” go to war against each other again.
Now, the pendulum has swung the other way: cultural divergences are increasing, not diminishing. There is a “failure of convergence” not just between countries but also within countries.
Consider the United States: a single country with a single currency, but as Brooks points out: “the country has become more polarized, not less. The country has become more difficult to govern, not less.” This is why the 21st century will be, as he puts it, “the segmentation century”. With the rise of modern communication technologies and Internet, “people’s tastes have become more parochial, not less.”
Brooks argues convincingly that the failure of convergence is most striking in Europe. While “a tiny sliver of European society”, as he puts it, is becoming more transnational, only “only 2 percent of Europeans live in a different European nation than their country of citizenship.” Habits, values and opinions differ from country to country. For example, 40% of Danes believe that work is a “very important” part of their lives, compared with roughly 65 percent of the French. According to Pew Research surveys, 73 percent of Germans think that economic conditions are good right now. In France, 19 percent think that, and in Spain only 6 percent. Europe means different things to different people. There is not even an understanding that Germans are closer to Greeks than they are to Chinese or Iranians.
Add to that the fact that there’s been a resurgence of local regionalism: the Basques in Spain, the Flemish-Walloon rift in Belgium, the Lombards’ Northern League in Italy etc. Not to mention the remarkable success of nationalistic, anti-immigrant parties like Marine Le Pen’s Front National in France, a veritable throwback to 19th century chauvinism.
In this environment, it should come as no surprise that the European Union project has a hard time surviving…
To make matters worse, there is another negative factor at work here, the one which underlies the other two: globalization.
3. The Impact of Globalization
Over the past decade, globalization has progressively impacted developed countries, and in particular the Eurozone, in the following ways:
governments are progressively losing control over their tax revenues: it becomes ever easier for big, global corporations and the ultra-rich to escape taxation. To illustrate, two examples will suffice: the Greek shipping industry is not taxed by the government, the theory being that if shipping magnates were taxed, they’d move elsewhere, hence it’s useless to even attempt to tax them. General Electric, the American corporate giant, has over one thousand staff dedicated to exploiting tax loopholes with the result that GE pays one of the lowest corporate taxes in America: last year, despite $14.2 billion in worldwide profits including more than $5 billion from U.S. operations, GE did not owe the US Government any taxes in 2010;
competitiveness in the industrial sector is threatened by emerging economies (the BRICS) and outsourcing is eliminating jobs, particularly in manufacturing, causing increasing unemployment;
the IT sector and other advanced technologies such a green energy have not so far created enough jobs to cover the losses in industry; as a result, unemployment is not only sticky, it has grown especially large for new entrants in the labor market, in particular the young.
Conclusion: Quo Vadis Europe, Can you Reform?
This is the general backdrop against which the Euro drama is unfolding: a financial mess, cultural diversity and globalization. Which means that even if a “financial fix” is found to shore up the Euro, the long term downward economic trends due to globalization will continue as Eurozone governments find it hard to raise adequate revenues; as European industry finds it hard to compete with cheap imports produced in the BRICS; as the loss of jobs in manufacturing is not compensated by gains in other newer sectors.
Over time, this means the Eurozone as a whole is growing poorer (even if the Germans still feel rich!) And obviously less able to afford its expensive welfare system. Austerity is the catchword. Cuts into pensions and health care benefits appear inevitable. The alternative is to make the management of the welfare system more efficient. But that implies reforming the state bureaucracy, cutting out red tape and unnecessary duplicative jobs, streamlining management processes, suppressing clientelism etc. This concerns in particular the euro “periphery” though even the “center” is not immune to the need for administrative reform.
Are Europeans even capable of reform? The Germans demand it. But will the cultural divergences stop reform in its tracks? Very possibly. People in the periphery are already rebelling against austerity: from there it’s but a small step to rebel against any kind of reform, however much needed.
The only way to move forward would be to believe once again in something BIGGER: the “fantastic project” of the European Union, as Mr. Soros calls it. You need dreams to overcome the grim reality of chauvinistic retrenchment, each country behind its own borders.
Is the European dream dead? Can it be revived? What is surely lacking in Europe is a leader with a European vision. Ms. Merkel often talks about wanting “more Europe” but she doesn’t seem to be aware that time has run out on her. The Euro financial mess has to be fixed now and cannot wait the decades necessary to overcome cultural divergences and achieve reform, step by step the way Ms. Merkel wants to do it.
What is needed is a European leader with the courage to push for European federation now. Someone charismatic.
Can Mr. Hollande, the new French President do it? Can he be considered charismatic? I doubt it. Certainly his heart is in the right place: he talks about the need for growth and that is a step in the right direction. But it doesn’t address the fundamental issue, which is a lack of European cooperation.
Europeans need to understand that they are in this together because they’ve adopted a single currency. Now they need to take that final step and complete the process to sustain the Euro.
If not, the Euro will drop dead, and Europe with it. The tsunami will be enormous, the shock waves will hit the American continent as well as the BRICS. It is in everyone’s interest to see Europe solve its Euro problem.