Michael Cembalest’s note explaining the EU Mess with lego seems to have touched a nerve, and while a part of that is due to the lego, I like to think that some of it is due to the fact that actually the diagram does very well what few other explanations have done — which is explain just how messy and multipolar the euro crisis really is.
Cembalest’s diagram includes a dozen different stakeholders, each trying to fob off the burden of the euro crisis onto someone else. (The single noble exception here are the opposition parties — the Social Democrats and the Greens — in Germany.) It’s all too easy, looking at Europe from across the pond, to divide the entire continent into two halves: a profligate south, spending beyond its means, piggybacking on the rich north, which doesn’t want to bail them out.
But of course it’s a lot more complicated than that. For starters, there’s the fight between the ECB, which wants a fiscal solution to the crisis, and pretty much everybody else, who wants the ECB to grow up, stop worrying about nonexistent inflation, and help save the euro zone by printing euros. There’s the question of whether and how much shareholders in banks should help pay for the bailout; a separate question about banks’ bondholders; and yet another question about sovereign bondholders. Within the northern countries, Finland has staked out a particularly extreme stance, saying that it won’t lend any money to anyone unless it’s collateralized. And then there’s the Bundesbank, which is particularly keen on imposing a painful regimen of austerity and structural reforms on countries which desperately need growth.
Or, to put it another way: European economic union has failed because European political union doesn’t exist. There’s no political body empowered to make decisions on behalf of the whole, and nor is there an executive able to issue debt on behalf of the whole. Hence the EFSF — a special purpose vehicle partially guaranteed by 16 different states including both Malta and Cyprus, incorporated under Luxembourgish law, and funded by the German Finanzagentur, in a structure which makes CDOs look downright simple. I’m sure it seemed like a good idea at the time, but you can hardly blame Europeans for being suspicious of such a creature.
As a result of all this politics, one thing is certain: we won’t get the best solution, as dreamed up by technocrats. Mark Dow, for instance, a former Treasury and IMF technocrat turned hedge-fund manager, has a solution to the problem that I like a lot: it’s far from painless, but it addresses the issue rather than doing any of the proverbial can-kicking, and it’s aimed at jumpstarting growth rather than trying to rely on austerity measures to do anything but make the situation worse.
Dow’s solution involves cutting loose Greece and Portugal, and probably Ireland too. The first two, certainly, need a devaluation if they’re going to regain economic growth — and so they should be allowed to devalue and default. Depositors in domestic banks would of course need to be kept whole; this might be reasonably expensive. And other European banks would lose a lot of money on the default, upon being forced to accept a hefty haircut on their holdings. So concurrently with cutting loose Greece and Portugal, there would need to be a massive recapitalization of the entire European banking sector — probably something on the order of a trillion euros or more. That would hurt bank shareholders, but keep the bondholders pretty much intact. “Shock and awe, writes Dow, “tired though this cliché has become, needs to be the overarching inspiration.”
As for Spain and Italy, they’re big industrial countries and can regain growth while remaining part of the euro — just so long as they can borrow relatively cheaply. Enter the ECB, committing to lend unlimited amounts of money to them, so long as they implement structural reforms, at a low rate of about 5%. Inflation risk, right now, is the least of our worries; if even the Swiss are happy to print unlimited amounts of money, then the ECB, in a much bigger crisis, should be too.
Now this isn’t the only possible solution; others exist. But something has to be done, and urgently. “Europe has to leapfrog the phase of thinking the unthinkable,” writes Dow, “and start doing the unthinkable”:
Orderly beats disorderly. Plan beats no plan. Proactive beats reactive. The time for the quantum leap in mindset is now.
And this is where Dow, or anybody else with a clever plan, runs straight into political reality. Any plan is going to be unacceptable to some European entity or government with veto power over the whole thing. And while Christine Lagarde, leading from the front, is surely trying to corral Europe’s elected politicians into something approaching a unified stance, her chances of success are slim.
Just look at where we are in the US, a single country with a single central bank and a strong federal executive. Look at the House Republicans during the debt ceiling debate; look at what all the Republican presidential candidates are saying about Ben Bernanke (a Republican originally nominated by a Republican candidate); look at the way that they increasingly don’t even bother to try to find economists willing to defend their stated positions. This is one of the reasons I pretty much want to pull a Rip van Winkle and wake up on November 7, 2012: by the conventions of journalism, there are going to be endless debates about whether or not certain economic-policy proposals make sense or are a good idea, as judged by economists and technocrats and pundits. And all those debates are going to make no difference whatsoever to the outcome of the election.
The principle of e pluribus unum, then, is looking pretty tattered even in its natural home of the US; it never stood a chance in Europe. Ideally, the population would elect a government; the government, duly elected, and with the backing of the people, would put together and enact a plan; and the plan would carry us through the crisis and out the other side. But that kind of thing is looking improbable even in the US; it’s impossible in Europe, not least because there is no European government. (And central bank independence, in this context, doesn’t help much either.)
Instead, we’re likely to end up doing as close to nothing as is economically possible. The slump in growth will accelerate, and probably result in another recession; the opportunity cost, in terms of wealth that might have been, will rapidly run into the trillions and won’t stop growing for a decade or more. Unemployment will savage the European welfare state and the US economy, and the entire global economy will stall. I don’t know or even particularly care what will happen to asset markets; they’re almost the least important part of the whole equation. It’s the real economy which matters, and as it remains stagnant, politics around the world will get ever more poisonous and unhelpful.
It’s a vicious circle, this situation that we entered with the advent of the global financial crisis, and neither the EU nor the US has the political will or ability to get us out of it. This is a test not only of capitalism but also of federalism and democracy. And right now neither of them are scoring very well.