WHITHER EUROPE?

 

 

I’M A ‘PIG’ TOO

As a descendant from PIGS parents and born in Dublin, I am keenly following events, and associated credit-events in the European Union. Only two years ago, I was travelling with my brother (who lives in Derry) through Southern Ireland towards Achill Island in County Mayo. Throughout the journey, I noticed the intense, postered scepticism regarding the Lisbon Treaty and the perceived threat to democratic continuity in the Irish Free State. I returned downunder to all the horror of unfolding spreads in Irish, Greek and now Portugese debt. One of my favourite investors, Warren Buffet will tell you, don’t get emotional about business (or lack thereof). Clearly, however, there are the seeds in Europe of a global systemic problem. In this blog, I will be drawing on the work of Farrell, Quiggin, Eichengreen and Krugman. And so I ask, whither now the EU and the Euro??

PREACHING IN A CRISIS: ‘HOW TO SAVE THE EURO – AND THE EU’

Given my PIGS heritage, Henry Farrell and John Quiggin’s article, ‘How Keynes can Save Europe’ in the May/June edition 2011 of Foreign Affairs got me closely thinking about the future of Europe. In some respects, Farrell and Quiggin have the bully pulpit. In light of recent Australian, Asian and US market events, it’s safe to say the ‘peripheral’ countries are very much in our global peripheral vision. Indeed, Farrell (an Irishman) and Quiggin mention Michael Noonan, the incumbent Irish Minister for Finance in regard to his opposition to the Union and specifically German intransigence in the face of Ireland’s budgetary malaise. (Many Irish are not all too keen, I previously discovered, about transfer payments to Brussels for the EU Parliament and Commission).

According to Farrell and Quiggin themselves, moreover, the EU was never that great for the ‘core’ economy, Germany nor was the EU unified in the face of budget difficulties and constraints on growth.

‘TO BE OR NOT TO BE’: UNITY OR DELUSION?

Originally a cognac salesman, Jean Monnet travelled through Europe and the United States. Later, he served as Deputy to the League of Nations but is remembered as founding father of the European Steel Community, forerunner to the European Economic Community and ultimately the Union. In Monnet’s words,

‘There will be no peace in Europe, if the states are reconstituted on the basis of national sovereignty... The countries of Europe are too small to guarantee their peoples the necessary prosperity and social development. The European states must constitute themselves into a federation...’

Together with Robert Schuman and his announcement of the Schuman Declaration, Monnet and Schuman urged Germany to commit to a reunited and mutually beneficial, strengthened Europe. The key to ESC and later the EEC and now EU’s future prosperity was, and, to many commentators, is Germany. As Schuman claimed before the United Nations,

‘Our hope is that Germany will commit itself on a road that will allow it to find again its place in the community of free nations, commencing with that European Community of which the Council of Europe is a herald’.

MONNETARISM

Accepting the Karlspreis in Aachen in commemoration of that great ‘European’ conqueror, Charlemagne, European Central Bank President Jean-Claude Trichet wore his central banker’s heart on his sleeve in support of deepening fiscal and financial union. The speech was entitled ‘Building Europe, Building Institutions’. In common with Monnet and Schuman, Trichet focussed not on widening bond yields and interbank spreads, but rather on the mental divagations and metaphysical fancies of Erasmus, Victor Hugo and Immanuel Kant toward a cosmopolitan, ‘supra-nationalist’ continent.

Amidst this grandiosity, however, Trichet remains a hard-headed monetarist. Principle-bound to the M in EMU, Trichet insisted that monetary union and fiscal responsibility were the primary determinants of a lasting political union for Europe. In order to build Monnet’s inter-generational cultural synthesis, Trichet enjoined fellow ‘true Europeans’ to disregard any talk of crisis surrounding the Euro and to commit to strict anti-inflationary targets below 2%.

Channelling political theorist Max Weber (interestingly, an expert on puritan ethics), Trichet stated that conviction and responsibility dictate that the ECB ought to be granted additional ‘non-standard’ restructuring powers to expel non-performing actors if they did not permit increased vigilance and monitoring by the ECB over fiscal policy and public debt levels. In Trichet’s view, what are otherwise peripheral sovereign debt concerns will have to translate into a ‘quantum leap’ in EU economic governance. Yet strangely for one so sanguine, Trichet concluded his speech with an enigmatic quote from Monnet:

‘And Jean Monnet in his memoirs 35 years ago wrote: “Nobody can say today what will be the institutional framework of Europe tomorrow because the future changes, which will be fostered by today’s changes, are unpredictable.”

So I ask, yet again, whither Europe?

FARRELL AND QUIGGIN’S DEMANDS FOR ‘DEMAND’ SPENDING: IS THE EURO WORTH ITS WEIGHT IN GOLD?

According to Farrell and Quiggin, austerity economics has not worked and the solution is hence entirely ‘clear’. In the authors words: ‘Hard Keynesianism would not solve all of the EU’s economic and political problems. But it would steer the union away from the disaster toward which it is now sleepwalking’.

In this vein, Farrell and Quiggin point to the fact that the 750 billion euro European Financial Stability Facility is under pressure - under a scenario involving risk of Spanish default, the authors project the necessity of a bailout to the tune of a cool 600 billion euros taken directly out of the EFSF. (The BIS estimates current PIGS exposure at more than 1 trillion euros). 

Anticipating a reverse Golden Age for Europe, Farrell and Quiggin liken the current ECB and domestic austerity measures to the bad old days of fixed-exchange rates backed by the Gold Standard and that age’s recurrent slumps in economic output. Following this attack on the ‘bad old’ gold standard, they advert to probably the leading authority on the subject, Professor Barry Eichengreen and his celebrated tome, ‘Golden Fetters’. Indeed, it is worth quoting a recent Eichengreen paper, 'Fetters of Gold and Paper' to obtain the flavour of Farrell and Quiggin’s scathing critique of current ECB and European sovereign debt policy:

‘As in the Great Depression, this second round of problems stems from the prevalence of fixed exchange rates. Fixed exchange rates facilitate business and communication in good times but intensify problems when times are bad.

We argue that the gold standard and the euro share the attributes of the young lady described by Henry Wadsworth Longfellow (American, 1807-82):

There was a little girl, who had a little curl Right in the middle of her forehead, And when she was good, she was very, very good, But when she was bad she was horrid’.

Thus, Eichengreen shares the assumption that the Euro, akin to the previous Gold Standard, is an ‘extreme’ form of exchange rate backed by an extreme regard for supra-national solidarity. Eichengreen attributes both outbreaks of economic extremism to a nineteenth century mentalite, redolent of Trichet, Schuman and Monnet’s most perfumed writings. Mindful of my recent encounter with Irish sentiment toward Brussels, I note that Eichengreen explicitly reproaches the lack of flexibility in the Lisbon Treaty. There is no scope for reintroduction and depreciation of a Euro member’s national currency in a time of recession.

And it is doubtful, Farrell and Quiggin remind us, that the EMU is actually an ‘optimal currency area’ (Cf Mundell). Via contagion, peripheral damage is becoming collateral damage for the Eurozone herself. On this subject, Farrell and Quiggin vituperate Angela Merkel’s plan to institute ‘Debt Brakes’ which would place additional pressure on public spending and reduce aggregate demand. With deficits set to rise as growth slows and the output gap widens, Quiggin, in a posted rejoinder to Paul Krugman on his Blog, ‘Crooked Timber’, states: 

‘Krugman has long criticised the eurozone on the grounds that it is not an optimal currency area and that the European Central Bank must therefore pursue an unsatisfactory “one size fits all” policy, too contractionary for economies that are doing badly and too expansionary for those that are doing well. Back in February, I argued that in fact ECB policy was “One size fits nobody” and that even Germany was vulnerable to its contractionary effects’.

Proposing a Keynesian surplus – not a minimal deficit – in good times, Farrell and Quiggin advocate a combination of deficit spending, quantitative easing, ECB intervention/purchase of impaired assets, inflationary policy and resort to capital markets. Specifically, Farrell and Quiggin advise Euro members to abolish Growth and Stability Pact bye-laws mandating budget deficits below 3% and Debt-to-GDP ratios lower than 60%.

By far their most interesting suggestion, I think, is for issuance of a new Eurobond..   

A LITTLE RESTRUCTURING NEVER HURT ANYONE: THE CONCEPT OF A ‘EUROBOND’

I must confess the Eurobond was an idea I liked before I heard it officially introduced in the press and in Farrell and Quiggin’s article. For some time, I have believed that a Brady-bond style restructuring will be essential to calm investors while committing the core to sustainable backing of the Eurozone. After all, the ECB is already intervening to stabilise the Italian and Spanish bond markets pushing their yields, at least temporarily, below 6%.

According to Reuters, former ECB chief economist, Otmar Rissing acknowledged that the Central Bank has ‘crossed the rubicon’ away from ‘price stability’ by purchasing Irish, Greek and Portugese debt. Ironically, this has put Trichet at loggerheads with the Bundesbank. Nonetheless, the introduction of a Eurobond may be a less ad-hoc solution, delivering investor certainty. Further, it would reduce the risk of ECB intervention into overnight markets (Cf Brunetti, Fillipi and Harris).     

WHITHER THE WORLD?

In the Return of Depression Era Economics, to return to the issue, Paul Krugman admits candidly that our globalised world has entered the ‘Mother of all Crises’. We have experienced the convergence of mortgage, currency, capital market and public debt blowouts due to the increase in unregulated (or poorly regulated) international capital flows, which have magnified the damage. Even with a growing credit supply, there is little demand and banks are not on-lending. Instead of ‘singing the praises of financial innovation’, Krugman admonishes bank executives, central bankers and governments to embrace good old-fashioned Keynesian stimulus.

As Krugman observes, the Brady Plan allowed the Mexican government to impose a ‘haircut’ on investors in their high-yield Mexican debt by writing down the face-value of Mexican bonds. In turn, this periodised the crisis and restored confidence to bond markets. By marking a psychological turning point, Brady restructuring contained crisis spread and reduced the risk of capital flight. As a result, the primary deficit itself came down. By 1993, Krugman recalls, Mexico had raised $30 billion in foreign investment. This was helped by Mexico’s improved access to short-term debt. Krugman’s advice:  initiate an orderly restructure thereby reassuring investors, and see the process through.  

The ECB, Farrell and Quiggin assert, has been ‘possessive about its powers’. One-time cost inflation to Germany backed by a newly issued Eurobond would ‘shore up the euro long enough for further-reaching reforms down the road’. It may, also, save the Union.

A PRICE TO PAY: PRICING CULTURE INTO EUROPE’S RESURGENCE

I admire Trichet’s technocratic savoir-faire. But maybe he has the wrong mentalite.. So as to guarantee the future of the European socio-economic project, it is necessary for the core, able to bear the risk, to forgive the vices of the periphery. In so doing, Germany and the stronger countries of the 17 member union (including France, before she too is in trouble) to remove the plank in their own eye. A French and German push for debt brakes could instead be diverted to backing the Eurozone with concerted funding assistance and a new Eurobond.

As Trichet indicated, ‘Each generation needs to affirm its commitment to Europe’ faced by its own concerns. Whereas debates concerning global financialisation and fiscal responsibility can be left for another day, it is imperative to shore up a more legitimate, more stable Union, an EU that is economically and culturally sound. Sound Keynesian policy aiming toward surplus should be backed by the Eurobond.

REFERENCES

Henry Farrell and John Quiggin, ‘How to Save the Euro -- and the EU: Reading Keynes in Brussels’ in Foreign Affairs

Paul Krugman, The Return of Depression Economics and the Crisis of 2008,

Barry Eichengreen and Harold James, ‘Golden Fetters: The Gold Standard and the Great Depression’, 1919-1939, NBER Series on Long-Term Factors in Economic Development             

                                                

Barry Eichengreen and Peter Temin, ‘Fetters of Gold and Paper’, UC Berkeley, MIT and NBER

Brad De Long, blog ‘Are We Handcuffed by Golden Fetters?’, March 27, 2009 at http://delong.typepad.com/sdj/2009/03/are-we-handcuffed-by-golden-fetters.html

Jean-Claude Trichet, President of the ECB, ‘Building Europe, building institutions’, speech upon receiving the Karlspreis in Aachen, 2 June 2011 at ECB website  http://www.ecb.int/press/key/date/2011/html/sp110602.en.html

Rudiger Dornbusch et al, ‘Mexico: Stabilization, Reform, and No Growth’,

Brookings Papers on Economic Activity, Vol. 1994, No. 1. (1994)

Narayana Kocherlakota, ‘Modern Macroeconomic Models as Tools for Economic Policy’, Banking and Policy Issues Magazine, Federal Reserve Bank of Minneapolis, May 2010 at http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4428.

N Gregory Mankiw, ‘The Macroeconomist as Scientist and Engineer’, Harvard University, May 2006 at http://www.economics.harvard.edu/files/faculty/40_Macroeconomist_as_Scientist.pdf