Thursday, August 18, 2011

This is an EU Special. Today's normal post will be along tonight, fate permitting. If this bores you, click out now . . .

I've decided to do this because the Two-Euro solution appears to be gaining traction and merits the citation of three recent relevant articles.

Firstly, though, here's a paragraph from a Guardian leader, giving their view as to what should be done now it's clear (to that paper at least) that the enforced austerity programs can't solve the debt crisis but certainly can provoke a growth crisis:-

The European Financial Stability Facility (EFSF) is not the right mechanism to deal with the debt crisis, as it is based on direct guarantees from richer to poorer countries and such a system has clear political and economic limits. We need to issue eurobonds backed by the European Central Bank as lender of last resort to put an end to the ongoing erosion of the eurozone – and we need a new European growth strategy. This is the task, but the doubts of whether Europe's political leaders are up to the challenge are growing by the day.

Meanwhile, over on the other side of the political divide, in the Daily Telegraph Jeremy Warner also excoriates the EU's political leaders and endorses the calls for the two-currency solution, recognising this would hit Germany hard at first. The following is the entire article, so there's no need to go to it, unless you want to see the comments:-

Beneath the grandiose rhetoric of this week’s mini-summit in Paris between Angela Merkel and Nicolas Sarkozy, a rather more important story was breaking. This was the news that the German economic recovery has comprehensively stalled, causing growth across Europe as a whole to come to a virtual standstill. Amid the storm clouds of the single currency crisis, the apparent buoyancy of the German economy had been one of the few remaining rays of sunshine. Now that, too, has flickered out.

All the warning signs of another economic catastrophe have been there for a long time now, but with policy-makers fretting over how to save the euro, they have been ignored. Rather than attempting to stave off a double-dip recession by loosening monetary policy – and fiscal policy, too, among those member states that can still afford it – Europe has gone careening off in the opposite direction. Interest rates have been raised, and member states have been forced into self-defeating austerity programmes which, by destroying growth, have made underlying debt dynamics even worse. It is hard to imagine a more perversely inappropriate set of policies.

As the US economist Paul Krugman observed this week, American and European leaders sometimes seem to be engaged in a contest to see who can make the worst of a bad situation. The recent suggestion by Rick Perry, the Republican presidential hopeful, that Federal Reserve chairman Ben Bernanke should be roughed up and put on trial for treason, suggested that the US might still be in with a chance in this race to the bottom. Yet, despite the willingness of America’s political class to put naked self-interest before national economic wellbeing, they will always struggle to match Europe in the bad policy stakes.

Every one of the eurozone’s 17 states must bear some responsibility for this multiple pile-up – I’m not about to excuse the profligacies of the southern states – but it is clear that the main mischief is coming from that great engine room of the European economy, Germany. It is rigid German adherence to the principles of sound money that has both driven the European Central Bank’s decision to raise interest rates and prevented the ECB from applying the “unconventional measures” used in Britain and the US to stimulate economic activity. The same thinking underlies the fiscal austerity measures that all eurozone states are being obliged to commit themselves to.

These principles are, in themselves, wholly admirable – would they had been more in evidence in the UK over the past 10 years! It is also obvious that in order to regain competitiveness, most European economies need root-and-branch reform. The opportunity to grasp the nettle when times were good was squandered; it seems reasonable that, in crisis, such reforms should now be imposed. But what is right for Germany is not necessarily right for others. And with the German economy now stagnating, too, it looks ever more questionable that the current policy mix is even appropriate there.

This is not to denigrate Germans as bad Europeans, or accuse them – as some have, ridiculously – of attempting to recreate the Third Reich in modern form by pressing their own policies on others. A more reluctant nation of conquerors there has never been. Germany’s unwillingness to accept joint responsibility for Europe’s debts without corresponding fiscal harmonisation and common governance has nothing to do with wishing to subject the rest of Europe to servitude and mercantilist exploitation. Rather, it is about protecting its own taxpayers and sovereignty from southern profligacy.

The mistake that Berlin is making is to believe that, somehow or other, everyone else can be made as economically virtuous as itself: that Greeks can, via austerity, be transformed into Germans. Yet it doesn’t take a degree in economics to figure out that if everyone is scrimping and saving, there won’t be any demand in the economy. Not everyone can be a surplus nation, yet this logical impossibility is what German policy seems to be trying to create.

The natural remedy for the sort of trade and capital imbalances we have seen build up within Europe is currency adjustment. When a currency devalues, it both makes the goods and services of the deficit nation more competitive, and reduces the burden of external indebtedness.

But within a currency union, such adjustment becomes impossible. There is no mechanism for the sort of burden-sharing that must occur to put economic activity back on a sustainable footing. There are no market disciplines to ensure the corrective action that will improve competitiveness. All these things have to be centrally imposed, leading to erosion of fiscal and democratic sovereignty.

Most of these problems were foreseen when monetary union was established, but they were swept under the carpet. Everyone wanted to believe in Neverland. Throughout Europe, politicians were dishonest about what the union could and would deliver.

If Germany cannot be persuaded into bailing the other nations out, either by agreeing joint-liability “eurobonds” or through massive European Central Bank purchases of sovereign debt – quantitative easing – what options are left? We are way past the stage where expelling a few miscreants would cure the eurozone’s crisis – so the obvious solution is for the single currency to reconstitute itself on an different basis. What’s required is a wider separation of surplus and deficit nations, so that the natural corrective of currency adjustment can establish an appropriate carve-up of the debt overhang between creditors and debtors.

Almost any such solution is bound to be hugely disruptive. But, by common agreement, the approach most likely to produce an orderly rebalancing would be for Germany and its satellite economies to exit the single currency, leaving all the paraphernalia of the euro to the Mediterranean nations, newly liberated from the shackles of German discipline.

Unfortunately, the economically optimal tends to be politically unacceptable. For Germany to recreate the Deutsche mark and float against the euro would plunge the economy into recession overnight, as industry scrambled to cut costs to regain lost competitiveness. It would also require massive recapitalisation of the banking system, whose euro loans would be correspondingly impaired. This is, in a sense, what needs to happen, but don’t expect Germany to accept it without a fight. A creditor will never lightly forgive his debtors.

Watching Angela Merkel and Nicolas Sarkozy at their press conference on Tuesday, it was clear that the two are still a million miles away from recognising the enormity of the choices their nations face – and that the crisis will need to escalate at least another couple of notches before they will even consider the solutions that are required. The idea that Europe might solve its problems simply by putting Herman Van Rompuy in charge of budgetary co-ordination and slapping a tax on financial transactions was little short of laughable.

The truth is that a project meant to tame Germany and integrate her into the heart of Europe has backfired spectacularly. Far from making economies converge, it has succeeded only in driving them ever further apart. From Britain’s island haven, we can only look on in horror as Europe once again stares into the abyss. The combination of tight fiscal and loose monetary policy that our free-floating, sovereign currency has allowed means that, in relative terms at least, we ought to fare better than our neighbours. But when the storm breaks, it will be small consolation to have the sturdiest raft.

Secondly, here's AEP on Tuesday's meeting and its aftermath:-

There was no deal. It was a vacuous restatement of clauses that already exist in the Lisbon Treaty, or an attempt to pass off retreads such as the Tobin Tax and harmonization of the corporate tax base as if they were new. No eurobonds, no fiscal union, no boost to the EFSF rescue fund, no change of policy on the ECB’s mandate. Zilch. More fiscal austerity for laggards, without even the Marshall Plan we had on July 21. It is all a step backwards into the black hole.

AEP feels that, if Germany continues to bar sensible fiscal-union solutions, then the option of Germany being shown the door should be taken up. For more, see here.

Finally, Edward Hugh has gone (very) extensively into print. You can see everything here but below are the relevant paragraphs on the two-euro option:-

There is a third alternative, even if it is one that at first appears no more appetising than either of the other two: the Eurozone could be split in two, creating two different euro currencies. Naturally the composition of the groups would be a matter of negotiation, since some countries do not easily belong in either one group or the other. The broad outline is, however, clear enough. Germany would form the heart of one group, along with Finland, Holland and Austria.

In addition Estonians have been making it pretty that they would also be up for the ride. Spain, Italy and Portugal would naturally form the nucleus of the second group, with Slovenia and Slovakia being possible candidates. Some countries, Ireland and Greece for example, might simply choose to opt out.

The big unknown is what France would do. In many ways it belongs with the first group, but cultural ties with Southern Europe and political ambitions across the Mediterranean could well mean the country would decide to lead the second group. Naturally if what was involved were not ultimate divorce but temporary separation, then French participation with the South would also have a lot of political rationale. The term Franco-German axis would gain a whole new meaning.

Naturally the technical challenge would be enormous, but it would not be insurmountable. The great advantage of such a move would be that two of the major burdens under which the monetary union is labouring – the lack of price competitiveness on the periphery and the lack of cultural consensus between the participants - would be resolved at a stroke.

No one knows the values at which the two new currencies would initially operate, but for the purpose of a thought experiment let’s assume a Euro1 at around U.S. $1.80 (the euro/USD is currently around US$ 1.40), and a Euro2, at around $1. Obviously, in the short term the winners of this operation would be the members of Euro2, who would get the devaluation their economies have been yearning for. Why would this be? At a time when the countries concerned are loaded down with debt and domestic demand is correspondingly weak, export growth is the only way for their economies to move forward, and the change would allow cheaper labor and production costs, giving them an enormous push in this direction.

And it would encourage growth in other ways. Take Spain as an example. The country has at the present time a large pool of surplus property, on many estimates of around 1 million unsold new housing units. Many have criticised the banking sector for not dropping prices sharply to enable the market to clear, but the banks are understandably reluctant to do this due to the impact this would have on their balance sheets, and due to the knock-on effect on their existing mortgage books. The beauty of this solution is that no further drop in price would be needed, since for external buyers the real price of all this housing would suddenly become much cheaper.

The case of tourism would be somewhat similar, since not only would more tourists come to Spain, they would come for longer and they would spend more. The shopping bags would certainly not be empty on the plane home.

Spain’s troubled savings bank sector has been desperately looking for foreign investors to help them recapitalise, but while many have shown interest virtually none have participated to date. After the devaluation all this would change since they would be able to buy shareholding at attractive prices, and without having to worry about a sudden drop in prices and hence loss of capital.

Spain’s 4.5 million unemployed would gradually start to go back to work, new investment could steadily be attracted for other productive projects in manufacturing industry, no one would doubt the solvency of the Spanish state, and the private sector would be in a better position to start paying back its debts as the economy grew.

Anyway, my (very Catholic) sister who's lived in France for 40 years, tells me that Sarkozy's initiative-taking is going down well there. Even though we Anglos tend to see it as sub-Napoleon posturing, aimed at helping him win the imminent elections. So, not even national but just personal interests. 

That said, I wouldn't be surprised if the clever buggers from the Grandes Ecoles hadn't told him to ensure he falls out with Frau Merkel so that the  departure of Germany and her satellites could be engineered. Leaving France, once again, with the leadership of at least part of Continental Europe. And the Mediterranean.

Which all leaves the questions - Would The UK want to join the Nordic Union. And Would they let it?

BTW . . . My very Jewish sister lives in Liverpool. In Childwell, of course.


Ferrolano said...

OK Colin, I can understand what will be the value of a Euro held by a German bank and also the value of one held by a Spanish bank. Now, what would be the value of the Euros held by a bank outside of the Euro zone, for example by a British or a US bank?

I can also see problems with say a person from Spain or from Portugal, who while working in Germany has been remitting money back to the home country, to build up a retirement nest egg. The person retires back to Spain or to Portugal and later wants to visit old friends back in Germany. He arrives at Frankfurt, Berlin or wherever to find that his Euros are no longer worth the Euro that he worked for.

Colin said...

Life's unfair. Someone's got to suffer to sort out the mess. Or is there a suffer-free option?

Anyway, the clever Frogs will work something out, if there's a chance that La Gloire can be restored and the Anglo noses can be put out . . .

Colin said...

Or, as MacMillan once said "Detail, my boy. Detail."

Ferrolano said...

I can see (not necessarily understand) that in the case of the returning workers that yes, life is a bitch. Now, what about the first part of my question?? Because there you can have various international banks and governments with a vested interest – and will they accept that life is not always very fair? All of this in spite of MacMillan.

Azra said...

This has been interesting... thanks for sharing :)

Colin said...

Thanks, Azra. I'm so encouraged that at least one person read it that I'm about to do another . . .

Colin said...


Here, thanks to Chas Butler, is an interesting article on EU banks.

And here's a para from it suggesting fine minds will come up with fine solutions to everything. A least so far as it affects banks. Individuals with savings can go hang. Like Brits in Spain with a pound pension when the pound fell 25% or more against the euro. Whereas it would have risen against the peseta.

"It is possible to “sacrifice” Greece in the name of the “One Europe” project and maybe (although dropping this country is much less likely) Portugal. Yet Ireland is in the eurozone to stay. Every such kind of decision now requires “fine calculations”. Here France and Germany might reach an agreement as the banking sectors of both countries face similar challenges at the end."

Colin said...


Here, thanks to Chas Butler, is an interesting article on EU banks.

And here's a para from it suggesting fine minds will come up with fine solutions to everything. A least so far as it affects banks. Individuals with savings can go hang. Like Brits in Spain with a pound pension when the pound fell 25% or more against the euro. Whereas it would have risen against the peseta.

"It is possible to “sacrifice” Greece in the name of the “One Europe” project and maybe (although dropping this country is much less likely) Portugal. Yet Ireland is in the eurozone to stay. Every such kind of decision now requires “fine calculations”. Here France and Germany might reach an agreement as the banking sectors of both countries face similar challenges at the end."

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