Europe’s Rough Seas
by Steven Hill, IP Journal, June 22, 2012
Europe’s latest Y2K has passed. The Greek elections are over with no “Grexit” in sight and Europe did not fall apart. The screaming Cassandras were wrong once again. Indeed, French president François Hollande, the leader of efforts for a new economic strategy in Europe, led his Socialist Party to a solid win in France’s legislative elections on the same day, which further strengthens his hand.
Yet the eurozone’s perplexing challenges are not even close to over, as Spain’s escalating bond spreads show. And so now the ball shifts back to German Chancellor Angela Merkel’s court.
Merkel is in danger of being overtaken by a surging tide of events. She has been a cautious yet steady pilot, ably keeping the ship afloat in rough seas. But recently the winds have shifted and Ms. Merkel is failing to tack fast enough so that her sails can catch the new headwinds. If she is not careful, she is going to wreck the ship, which in this case will mean the fortunes of Germany, Europe, and herself.
Chancellor Merkel, to her credit, has been the strongest voice calling for the development of a new, sustainable economics in the aftermath of the global economic collapse. In 2010, she lectured President Barack Obama and other world leaders about the need for the global economy to return to a sustainable growth path. In Merkel’s view, that would be one that is not built on “debt and speculative bubbles,” as she called it. What Merkel was saying—and it was boldly revolutionary in its ramifications—is that the era of US-style, Wall Street capitalism must end. The world needs to figure out how advanced economies can provide for their people without having roaring growth rates driven by hyper-consumerism, financial industry casinos, and asset bubbles that eventually burst, and how to develop in a way that is ecologically sustainable.
Merkel’s vision is as valid in 2012 as it was in 2010—but it is a long-term one in which the route to get there is filled with obstacles, some hidden just beneath the surface, that can sink the whole project. In the short term, the focus must be on how to keep the European project afloat and sailing forward. But it is becoming increasingly clear that Chancellor Merkel may not have the necessary skill set to go the distance.
She is already losing the confidence of many of her fellow European leaders, as well as President Barack Obama. François Hollande’s arrival on the scene has given new impetus to calls for fostering growth and job creation in addition to Merkel’s insistence on fiscal responsibility. But these calls are not only coming from the left; prominent conservatives such as Italian Prime Minister Mario Monti, ECB president Mario Draghi, European Commission president José Manuel Barroso, as well as the IMF, OECD, and British weekly The Economist have also signaled that it is time for a tactical shift. At the G-8 summit on May 18 and again at this week’s G-20 conference, most of the leaders in attendance pressured Ms. Merkel to enlist Germany’s considerable resources to save the European project, not least because Germany has been the biggest beneficiary of it.
If the eurozone crisis has made one thing clear, it is that a monetary union has a much different set of needs than a simple loose confederation. The eurozone has become quite distinct from the European Union, as Europe evolves into de facto two speeds. Everyone now knows—though some are still in denial—that a more integrated economic union must have three foundations: first, a fiscal stability union, in which important decisions on levels of government spending, debt, tax rates, and the like are harmonized across member states (just as Social Security, income taxes, and debt levels are mostly the same across all 50 US states). This realization has resulted in the controversial “debt break” agreement that Merkel herself engineered, and which 25 member states are in the process of ratifying.
Second, a monetary union must have a European Central Bank or other continent-wide financial body with enough firepower and policy tools (such as Eurobonds) at its disposal to act as a financial backstop of last resort and guarantor of member states’ debt and everyday people’s bank deposits. Much talk is now focused on creating a Europe-wide banking system rather than the current collection of national systems. These powerful financial institutions would best ensure that Europe as a whole cannot be ravaged by corrupt rating agencies and greedy bond traders speculating on national economies.
And finally, the end result of this integration process must be a transfer union, in which the better-off member states (usually those with trade surpluses) financially assist the lesser-off member states (those with debt/deficits), whether through ongoing federalized appropriations that spread the wealth around, or a conscious policy of rebalancing trade within the union among deficit and surplus states, or both. If you are going to ask member states to give up their own currency, and to forsake their ability to depreciate their currency to make their economies more competitive, then there must be a mechanism like “solidarity transfers,” much like West Germany has done for East Germany and western Europe for eastern and central Europe.
And eventually there will also have to be a redesign of European-level political institutions to make them more representative and directly accountable to the voters, and more suitable for an integrated monetary union instead of a loose confederation. So significant institution making is in the cards for Europe if it wants to have a monetary union. Europe—as well as Germany and Ms. Merkel—are at a crossroads, and the question that has to be answered is quite simple: do you want a monetary union or not? If you do, there are certain things, certain evolutions that must occur at this point.
In a way, Merkel and the Germans have been as bad as the Greeks because they all want to have their cake and eat it too. The Greeks want to stay on the euro but also want to renegotiate many of their previous agreements; they want to enjoy “western” European living standards despite having “eastern” European habits (corruption, tax evasion, low productivity, and public employee patronage machines). Whereas Merkel and the Germans also want to retain the euro, but they do not want to put in place the institutions that are necessary to maintain a monetary union, especially if it involves mixing Germany’s highly valued creditworthiness with that of its neighbors. But they cannot have it both ways.
Chancellor Merkel faces a dilemma as she weighs all this. She makes a valid point when she expresses fears that debt-pooling (such as Eurobonds) will simply recreate the conditions that allowed the governments in Greece, Portugal, and Italy, as well as private sector actors in Spain and Ireland, to over-borrow at cheap interest rates to the point where, following a global economic collapse, they suddenly found themselves drowning in debt. Merkel has argued that the main problem in the eurozone is the difference in competitiveness across member states—every state and nation, whether China, the United States, Germany, Spain, or Greece, is faced with the unrelenting dilemma of figuring out what they can produce that the rest of the world wants to buy. Merkel says that it “makes no sense to patch this up with Eurobonds or similar supportive instruments” since that might result in a renewed piling on of unaffordable debt by some states.
On the other hand, that is what the other institutions of a monetary union are supposed to be designed to prevent, including the fiscal debt brake and solidarity transfers, as well as the necessary (democratically elected) political institutions to oversee and legitimize it all. Merkel appears to realize this, occasionally hinting that it is not a matter of “if” but “when” to launch the various institutions that will result in “more Europe.” But it is a dangerous game of cat and mouse she is playing, as the system—and public confidence—may begin eroding amid signs of fatigue and fragility.
Indeed, the greatest failure of Merkel’s leadership is that she has failed to make the case to her fellow Germans about how Germany has been the greatest beneficiary of the euro. She needs to tell Germans that because of its membership in the euro zone, Germany’s exports have boomed and unemployment has declined to its lowest level in two decades. If Germany were still using the old deutsche mark, its currency exchange rate would have been much higher and made German exports more expensive and less attractive. And most of those exports have been purchased by other European states, many of whom are currently running large deficits. In certain cases, like Greece, Spain, and Portugal, German banks loaned the private and/or public sectors lots of money that boosted their economies and resulted in them buying more German products. It is literally true that Italian, Spanish, and Greek overspending was Germany’s income.
At the time, this arrangement seemed like a virtuous circle where the rising tide floated all boats. But without the institutions to maintain a monetary union, the virtuous circle has become a vicious whirlpool threatening to engulf Europe. In the future, who will buy German exports if many other European states are suffering? And given Europe’s history, in which weaker regions of the continent have become the epicenters of conflict, is it likely that Germany could thrive in a sea of failing member states? The answer is most certainly no.
Chancellor Merkel also has made a point of lecturing the rest of Europe about the “German model” of competitiveness that resulted from labor market reforms begun by her predecessor, Social Democrat Chancellor Gerhard Schroeder in 2003-04. But she neglects to mention that there was an important difference between then and now: those reforms, which held down German wages relative to Europe’s, were launched during a time when the European and global economies were on the upswing and could easily absorb Germany’s depressed demand and allow the country breathing space to complete its reforms. But given the fragile nature of the European and global economies today, if too many member states are engaged in German-style reforms at the same time it will only result in collapsed aggregate demand and ongoing recession. Indeed, the current sinking tide is lowering all boats, and that will eventually rebound against even Germany’s robust economy, as reduced demand will result in fewer German exports.
Merkel’s longer-term vision of developing sustainable economies and ecologies is the correct one, but in the short term sometimes being right is not enough. Sometimes you have to bend to the inevitable and have the skill to make that work for your broader vision. Is Merkel up to this task? The next few months are likely to be the most difficult of her seven years in office, as she stands on the bow of her ship and decides which direction to tack in the face of some mighty blustery headwinds.