Push for European integration is politics, not economics

Throughout the European debt crises, Germany and its allies in the austerity camp have been urged by financial commentators, particularly in the United Kingdom and the United States, to show more “flexibility” to help the high-debt countries in the periphery of the single currency union.

Such flexibility first took the form of a bailout for Greece when it teetered on the brink of sovereign default in 2010. When that failed to stem the crisis, European leaders were urged to create a bailout fund for in case other nations would find it difficult to borrow on financial markets as well. They did. Ireland and Portugal subsequently tapped into that bailout fund, the European Financial Stability Facility.

When that failed to stem the crisis, the prevailing wisdom became that the bailout fund was too small and only temporary, raising concern about Germany’s willingness to bankroll peripheral eurozone nations in the long term. So Europe’s leaders devised a bigger, permanent bailout fund, the European Stability Mechanism.

Yet the crisis goes on and the new solution floated by commentators is the pooling of sovereign debt in the eurozone in the form of eurobonds. As with the Greek bailout and the erection of the bailout funds, Germany is hesitant. It fears that financial support for troubled eurozone economies removes the incentive on their part to improve their competitiveness relative to stronger European economies which Germany sees as the way to ensure long term stability in the euro area.

Moreover, there has been growing weariness in core eurozone countries like Germany and the Netherlands to bailing out weaker euro states. The political leaders of these countries can ill afford electorally to advance schemes for further European integration, which is increasingly unpopular.

This has been seized upon by those favouring, for instance, eurobonds as proof that their solutions to Europe’s debt woes are perfectly valid. The only reason they aren’t implemented—even if, so far, they usually have been, only maybe not very fast—is that Europe’s leaders are afraid of their voters who stop them from doing what’s right.

It turns out, the proponents of further European integration are quite afraid of the European electorate as well. Writes Martin Wolf, the Financial Times‘ chief economics commentator, in a recent blog post:

I fear that austerity without end will bring about a return to the unstable populist politics the European Union was designed to prevent. That could shatter the eurozone and, with it, the EU, thereby ending the most successful attempt to build peace and prosperity in Europe since the fall of the Roman Empire.

Wolf even invokes the rise of Adolf Hitler which he claims had nothing to do with hyperinflation during the Weimar Republic but was entirely due to the economic hardships of the 1930s Depression. “Deep economic collapses are dangerous.”

Indeed they are, as they often lead policy makers to experiment with unconventional economic policies because they haven’t the patience to let the market correct itself, which is exactly what should have happened after the credit crunch of 2008. Instead, by repeated government interventions in the private economy, the recession has been prolonged and the sort of creative destruction that has to take place before there can be a true and sustainable recovery has not been allowed to occur.

Notice the panic that arises whenever a single bank is about to go under. Tens of billions of euros doled out to Spain so the country can save its troubled banks. There can be no failures because the financial industry is so interconnected — it is feared that the collapse of one bank will drag others down with it, resulting in widespread financial panic.

So we have malaise instead until Germany pulls out the “bazooka” and makes clear that it will pay everyone’s bills. That is what Wolf means when he writes that “the creditworthy country has to lend freely if a fixed exchange rate system (or in this case a currency union) is to survive.”

If Chancellor Angela Merkel announces next week that she wants to quadruple the bailout fund, that she’s willing to underwrite every bad loan both German and peripheral banks ever made, will it end the crisis?

Maybe. Or maybe markets will come to their senses soon thereafter and wonder whether the German voters wouldn’t tear up such a commitment in the next election?

Maybe they’ll even realize that it doesn’t matter as long as Greece, Italy and Spain don’t change their ways and implement the sort of regulatory, labour market and entitlement reforms that are needed to move their economies away from clientalism and protectionism toward entrepreneurship and free trade.

Wolf doesn’t seem to particularly care about the longer term imperatives. He ominously writes of “populist politics” unless a short term solution is found. Without one, he believes, “the eurozone may never reach the long term”. It’s not so much an argument as it is a threat — integrate now or the “populists” win!

In fact, the push for European integration in spite of the clear wishes of voters in core eurozone countries is exactly what fuels the anti-European sentiment that Wolf despises.

But what’s more concerning is that Wolf apparently seeks deeper European integration for political reasons, not economic ones. Which raises the question: does he want want an even bigger bailout fund, does he want eurobonds and does he want to keep the euro together because it makes economic sense for Germany and the other countries in the euro, or because he wants this political project to succeed?

This article was previously published at Atlantic Sentinel.


The two-edged stimulus Britain can’t afford

Britain’s economy is on the brink of recession after barely growing in the last year and it faces acute risks from the debt crisis in the eurozone, its biggest trading partner. Critics of the ruling coalition say budget restraint is to blame for the malaise but just how much spending has been cut?

Opposition leader Ed Miliband, suddenly concerned about the deficit, urged the government to change direction “for the sake of the country” last week. “Austerity at home, collective austerity abroad is no solution to the problems of jobs, growth or the deficit,” he said. To stir job creation, the socialist urged immediate stimulus measures, including tax cuts. Imagine that.

The reality is that Britain can’t afford it. Its deficit it still as big as Greece’s while government spending accounts for half of gross domestic product. Total public sector spending, in real terms, is almost 4 percent higher this year than it was in 2009, Labour’s final full year in power.

When the Conservatives and Liberal-Democrats engaged in a coalition last year, accountants at PricewaterhouseCoopers estimated that “Britain would have to make across the board budget cuts of 5 percent a year to come close to cutting the deficit in half by 2014.” They even assumed a slight economic upturn that’s unlikely to materialize due to Britain’s high energy costs and the spiraling debt crisis in Europe.

Prime Minister David Cameron recognizes that too often, government is what’s standing in the way between entrepreneurs and wealth growth. He has vowed to fight the “enemies of enterprise” and cut regulations but one out of five Britons is still employed by his government. The top income tax rate is 50 percent and the level of government debt, though ambiguous, is eye watering.

Officially, Britain’s debt stands at roughly 62 percent of GDP or nearly £1 trillion but that doesn’t include its huge pension liabilities. When factored in, according to the Treasury, Britain’s actual debt equals 173 percent of GDP. According to independent analysis, it could be double that number.

Meanwhile, the Bank of England has been injecting some £275 billion into the economy, corresponding to nearly 20 percent of GDP, in monetary stimulus. This policy David Cameron has explicitly endorsed. He ruled out fiscal stimulus this summer, saying that no country can afford it anymore. “They have all run out of money.” So the answer is printing more of it?

The only sensible policy is for the central bank to stop the printing presses—which not only undo the very modest pay increases that Britons still enjoy but exacerbate the credit dislocations that were at the heart of the financial crisis—and for the government to start cutting red tape as well as future pension commitments to simultaneously encourage private sector investment and shore up public sector finances.

That’s what austerity would look like. The half-hearted “conservative” policy that Britain has now is not enough.

This article was originally published at the Atlantic Sentinel.


Bank recapitalization will make euro crisis worse

Eurozone leaders ordered their banks to raise additional capital last week to prepare for a partial Greek default. The continent’s banking industry didn’t yet receive a direct financial injection but will be allowed to appeal to national governments and the European bailout fund for assistance.

A recapitalization of Europe’s financial industry was championed by the International Monetary Fund and the United States as well as countries whose banks are excessively exposed to Greek debt, notably France. It is why President Nicolas Sarkozy liked to enable banks to tap into the European Financial Stability Facility that was set up last year to help countries, not companies, in financial distress so his fiscal challenges wouldn’t be aggravated. German Chancellor Angela Merkel insisted that banks raise capital from their own governments before raiding the bailout fund.

It’s a better plan, but one that will provide only temporary relief to Europe’s sovereign debt crises before making it worse.

Europe’s leaders agree that Greek debt levels have reached unsustainable heights. Its public debt is now worth 50 percent more than its entire economy and is projected to growth further in the coming years as Athens struggles to rein in spending substantially. Greek debt will be “restructured,” which means that roughly half won’t be paid back. European banks that have loaned to Greece could be in trouble. Even if they aren’t, other banks and investors might worry that they are, causing the market to tank. “Recapitalization” is designed to prevent that from happening.

In the short term, it could, but several weeks later markets would likely start wondering whether pumping billions of euros into a financial system that’s bloated with debt is really an intelligent strategy.

Western banks have been hesitant to loan money, to each other and to businesses, since the 2008 financial panic when the investment bank Lehman Brothers collapsed. American and European central banks lowered interest rates in response, allowing banks to borrow cheaply in the absence of private sector confidence.

The European Central Bank has been more prudent than its American counterpart, the Federal Reserve, and didn’t buy sovereign bonds, from Italy and Spain, until this summer. The Fed, by contrast, has been financing American deficit spending by printing trillions of dollars for more than two years. Both have supported banks in the expectation that they would continue to extend business loans and mortgages.

They haven’t really—not enough to stir an economic recovery, anyway, because they realize that the market is still full of dislocations and excesses.

If there weren’t central banks or if they hadn’t intervened, those dislocations and excesses, build up in an era of “cheap money” when financial institutions knew that they were “too big to fail,” would have been cleared out in 2008 when Lehman collapsed and threatened to sink half of Wall Street with it. Prices that did not reflect real demand, especially in housing, where government policy had encouraged people without sufficient income to apply for mortgages, would have deflated—considerably.

Default and deflation however, along with potentially huge losses in personal savings, are politically unacceptable. So instead of failing, the institutions that created the crisis are now on life support while the housing market in many Western countries, and construction with it, is stuck. Homeowners aren’t willing to lower their expectations while buyers aren’t able to purchase at the prices they charge.

Recapitalizing banks after they bought worthless Greek bonds when they should have known better isn’t just wrong; it’s not going to work. If writeoffs are also expected for Portugal and maybe Italy and Spain, investors will realize that no matter how big the EFSF is made to be, the solvent countries in the north of Europe can’t afford to compensate them for their losses indefinitely. If the ECB also turns on the printing presses (which it doesn’t want to), that will be the clarion call for investors to get out. Interest rates on peripheral bonds will skyrocket.

The political willingness to reform structurally rather than cut several billions of euros in annual spending is virtually nil in Greece and Italy. These states are already bankrupt and waiting for Germany to pull the plug. It is king in the land of the blind (or broke actually) but doesn’t have the cash on hand to bail out half of Europe. Some countries just won’t change until they’ve hit bottom. The sooner the better, for the longer banks have to wait for the inevitable, the longer they’ll avoid investing in enterprises and loaning to other banks — they don’t know which will survive the reckoning and which won’t. Recapitalization would thus make the problem worse by providing a false sense of security that cannot last.

This article is based on one previously published at Atlantic Sentinel