Greece keeps pushing the currency union envelope. Mr. Tsipras, the socialist prime minister, is driven by his ideological convictions and therefore plays a different game than the leaders in Brussels with whom he is negotiating to keep his country afloat. The problem for the European leadership is that it seems incapable of understanding what role Tsipras’s ideology plays for his actions – Tsipras wants full independence for Greece so he can build his version of the socialist dreamland that now-defunct Venezuelan president Hugo Chavez created.
Rational arguments such as “property rights no longer exist in Venezuela” or “they have 60 percent inflation” and “crime is rampant and there is a shortage of almost every daily necessity” do not work on ideologues like Tsipras. That is the very problem with them. Therefore, you cannot reason with them as though they were swayed by the same type of “sensible” arguments that you are. But more importantly: so long as the EU leadership does not understand that politicians like Tsipras are ideologically opposed to everything that the EU stands for, they will not be able to have a rational conversation. There will be constant discords, where the EU leaders try to set goals that will help Greece stay inside the euro zone – and ultimately the EU – while Tsipras and others like him (think euro skeptics in Italy and Spain) will try to create circumstances that allow them to get what they want, namely out of the euro zone (and eventually the EU).
The biggest danger with this discord is that once the euro zone starts breaking apart, the retreat from the common currency will be disorderly. There is no doubt that the Bundesbank in Germany has a contingency plan for that disorderly dissolution, but it is far from certain that their plan will work. There are so many uncertain factors in this game that an even reasonably confident prediction is out of the question.
That said, there are some fixed points that can be put in the context of macroeconomic reasoning. That in turn should at least provide some insight into the best and worst case scenarios.
Before we get there, though, an update on the Greek situation, as reported by the EU Observer:
The stand-off between Greece and its lenders deepened over the weekend ahead of a meeting of euro finance ministers on Friday (24 April), with both sides exchanging barbs over the risk of a Greek default and its consequences for the eurozone. On Friday, Eurogroup president Jeroen Dijsselbloem said both parties should avoid “a game of chicken to see who can stick it out longer. We have a joint interest to reach an agreement quickly”.
An agreement about what? If Greece secedes from the euro it can, at least theoretically, run away from its bailout-related deals. In practice, the EU would still want to enforce loan contract, but it is much more difficult with a country that has a currency of its own – a currency that in all likelihood will be depreciating rapidly.
As for the IMF, Greece would have to deal with them separately, but it could do so much more so on its own terms once outside of the euro zone.
In fairness, though, it looks like the full extent of the Greek situation is beginning to dawn on at least some EU leaders. The EU Observer again:
EU and International Monetary Fund (IMF) leaders warned that Greece had to make quick progress to finalise a list of reforms that would enable it to receive a €7.2 billion loan. But they hinted that a Greek default could be managed by the eurozone. “More work, I say much more work is needed now. And it’s urgent,” said European Central Bank (ECB) chief Mario Draghi in Washington, where he was attending the IMF’s Spring meeting. “We are better equipped than we were in 2012, 2011, and 2010,” he added, referring to the years when fears of a eurozone break-up were at a high. “Having said that, we are certainly entering into uncharted waters if the crisis were to precipitate, and it is very premature to make any speculation about it,” Draghi also said.
So what would happen if Greece seceded from the euro? Well, the EU Observer article brushes on that subject:
Greek finance minister Yanis Varaoufakis, for his part, warned that his country’s exit would cause major problems for the rest of the region. “Some claim that the rest of Europe has been ring-fenced from Greece and that the ECB has tools at its disposal to amputate Greece, if need be, cauterize the wound and allow the rest of the eurozone to carry on,” he said on Spain’s La Sexta channel “Once the idea enters peoples’ minds that monetary union is not forever, speculation begins … who’s next? That question is the solvent of any monetary union. Sooner or later it’s going to start raising interest rates, political tensions, capital flight.”
This is a key statement. Some would interpret it as Greek leverage in negotiations with Brussels. However, the correct way to read it is as a blunt warning of what is to come: sooner or later Greece will leave the currency union, and it will do so like the men who escaped Alcatraz in 1962. Once someone has done what everyone thought was impossible, then just as Mr. Varaoufakis says, the only question on everyone’s mind will be: who’s next?
British Member of the European Parliament for the UKIP, Mr. Nigel Farage, made a great point recently when appearing on BBC (at about 2:25 into the video): the initial effect of a Greek currency secession is going to be a boost in growth as the currency depreciates. This growth spurt will inspire other struggling euro-zone states to consider a return to their national currency. Once the secession movement gets off ground, it is uncertain how many states will actually reintroduce their national currency, but it would be reasonable to expect a first round of secession to sweep from Athens to Lisbon.
The short-term financial turmoil aside, the most likely effect will be a southern European currency war. The four countries that have historically had weak currencies will find themselves returning to that position, only with an even deeper macroeconomic ditch to climb out of. The only moving part of their economies is, actually, exports, which will get a boost from a rapid currency depreciation. At the same time, that depreciation will be a major conduit for imported inflation, which in turn will eat its way into the economy a bit after the exports boom has gained momentum. The more the currency depreciates, the stronger the imported-inflation effect will be.
Inflation will have major consequences for the government budget. Depending on what type of inflation indexation is built into the welfare state’s entitlement programs, the cost of government spending will rise more or less with inflation. While inflation can also be beneficial to the revenue side of the state budget, it negatively influences the purchasing power of households and generally (but not always) depresses business profitability. As a result, domestic economic activity slows down, causing the tax base to stagnate.
And this is where the major test comes for currency secessionists: how will they handle their budget problems? With weak currencies they will have a hard time selling their treasury bonds on the international market; they can load up their banks – a likely scenario in Greece where a Syriza government could even go as far as to nationalize banks – but as the Great Recession demonstrated, leaning on banks for funding a government deficit is a particularly bad idea. When banks are overloaded with bad government debt in the midst of a macroeconomic crisis, then suddenly it is 2009 again.
Very briefly, then: once the euro zone starts falling apart the first ones to leave will face very difficult challenges. That is not to say that the remaining euro zone countries will have a better life – it is very likely that the euro zone itself won’t survive the 2017 French presidential election – but once the Southern Rim has left the euro zone the remaining countries will have a somewhat easier time following an orderly retreat plan. In fact, it would not be surprising if Germany, Austria and the BeNeLux countries remained in a “core” currency union – a Gross-Deutsch Mark, if you will. That currency could actually become a stabilizing point for a post-euro EU.
Still, even with an anchor currency in the heart of the EU, an implosion of the euro will have major negative effects for the European economy. What will those effects look like? That is a subject for another article.
When the Chavista socialists in Syriza won the Greek election many forecasters raised the concern that Greece might leave the euro. However, most of them quickly subsided and joined the ranks of the non-confrontation opinion. The prevailing view over the past couple of months seems to have been that the Greek government will eventually cave in, stick to agreed austerity programs and honor its debt payments to the IMF.
I have refused to join the choir of consensus. On February 9 I explained (emphasis added):
There have been many attempts at predicting which way Greece is going to go under the new socialist government. Most of the voices heard thus far seem to agree that Prime Minister Tsipras will not seek a confrontational course against the EU. That is, however, a mistake. This is a man who considers now-defunct Venezuelan president Hugo Chavez a political hero. Tsipras is also a former communist (though being a former communist and at the same time a fan of now-defunct Hugo Chavez is a matter of political semantics) whose training in politics and – to the extent it exists – in economics is fully governed by those ideological roots. It is only logical that he continues to raise the volume vs. Brussels.
This ideological foundation for the Greek attitude toward the EU and the IMF has continued to elude international analysts. One reason is that most of those analysts have a business background or are otherwise trained in strictly quantitative methods such as econometrics; another reason is that most analysts are American, and Americans in general have a shallow – even non-existent – understanding of what role political ideologies play in European politics.
Related to this, it is important to keep in mind that Syriza is governing with coalition support from a small nationalist party whose feelings for the EU are perhaps even more unfriendly than those in Syriza.
Since my February 9 prediction I have steadfastly said that while the Greek future in the euro zone is more uncertain than most economic and political events, it is more likely that they leave the euro than that they stay in.
Today, The Telegraph reports:
Greece is drawing up drastic plans to nationalise the country’s banking system and introduce a parallel currency to pay bills unless the eurozone takes steps to defuse the simmering crisis and soften its demands. Sources close to the ruling Syriza party said the government is determined to keep public services running and pay pensions as funds run critically low. It may be forced to take the unprecedented step of missing a payment to the International Monetary Fund next week.
This is not the place to re-hash all the reasons why Greece is in this situation in the first place. Suffice it to mention one point, though, namely that ever since the end of the military government in 1974 democratically elected governments have emphasized welfare-state spending over a sound, working economy. Slowly but inevitably this has eaten away at the private sector. Eventually, the Greek economy collapsed into a deep recession, government tried to fix its enormous budget problems with austerity patches, the result was an even deeper recession – and here we are.
In other words, the origin of this fiscal crisis is in the welfare state. Now Greece has a government that by ideological conviction stands by, and wants to restore and even grow, that same welfare state. The only way they can do this – they believe – is if they leave the euro zone. While most Greeks have been against a currency secession, the Syriza government has now manipulated the circumstances to exactly where they need them to be, namely where they look like they care more about the Greek people while the evil global capitalist IMF does not.
Prime Minister Tsipras will be considered a national hero for as long as the drachma has some value vs. the euro. Which will probably be 3-6 months. Then the global market will have deemed the drachma worth little more than Monopoly money and Tsipras will have to resort to the kind of currency trickery they use in Venezuela (his vision of Greece’s future). Of course, with such reckless exchange-rate manipulation and money printing comes 40-50 percent inflation.
That is literally where Greece could be in two years, maybe less, if they leave the euro zone.
The Telegraph again:
Greece no longer has enough money to pay the IMF €458m on April 9 and also to cover payments for salaries and social security on April 14, unless the eurozone agrees to disburse the next tranche of its interim bail-out deal in time. “We are a Left-wing government. If we have to choose between a default to the IMF or a default to our own people, it is a no-brainer,” said a senior official.
Again, the circumstances that fit the Syriza agenda for euro secession. And, as the Telegraph emphasizes, one has to look at this from a political, ideological perspective more than strict macroeconomics:
The view in Athens is that the EU creditor powers have yet to grasp that the political landscape has changed dramatically since the election of Syriza in January and that they will have to make real concessions if they wish to prevent a disastrous rupture of monetary union, an outcome they have ruled out repeatedly as unthinkable. “They want to put us through the ritual of humiliation and force us into sequestration. They are trying to put us in a position where we either have to default to our own people or sign up to a deal that is politically toxic for us. If that is their objective, they will have to do it without us,” [a Greek government] source said. … Syriza sources say are they fully aware that a tough line with creditors risks setting off an unstoppable chain-reaction. They insist that they are willing to contemplate the worst rather than abandon their electoral pledges to the Greek people.
Prior to the election of the French socialists to both the presidency and the parliamentary majority in 2012 there was not a single government within the euro zone that even grumbled about the tough austerity measures imposed by the EU-ECB-IMF troika. President Hollande wanted to part with some of the measures that the troika thought would bring France into compliance with the EU’s Stability and Growth Pact. (This is the EU’s constitutional budget balancing measure.)
France is still not in compliance with the Pact, and the alternative policies that the socialists imposed on the French people have not made any notable difference in terms of growth and job creation. But their balking at compliance with EU-imposed austerity measures sparked a movement of dissent through much of the European left. The idea of simply telling the troika that “we care more about our people than about you” eventually brought Syriza to power in Greece – and will now bring Greece out of the euro zone.
In fact, as the Telegraph explains, the Greek government has already drawn up the plans for it:
An emergency fall-back plan is already in the works. “We will shut down the banks and nationalise them, and then issue IOUs if we have to, and we all know what this means. What we will not do is become a protectorate of the EU,” said one source. It is well understood in Athens such action is tantamount to a return to the drachma, even though Syriza would rather reach an amicable accord within EMU.
The effects for the Greek economy would be devastating. For starters, their Treasury bonds, which are denominated in euros, would become even more toxic than they already are. The only way they could continue to honor their payments on those bonds is if they would peg the drachma to the euro. But that would hold up if and only if they locked the borders and prevented people from taking their money out of Greece.
Which is why they propose a nationalization of the banks. Thereby they can lock in people’s money and force them to keep it in the country. But such draconian measures would of course be tantamount to declaring war on the global financial markets. Not that a Chavista socialist government would care, but it would force them to take counter-measures to prevent a complete meltdown of the currency within the first few months.
One such measure is a double-currency system, which is in operation both in China and in Venezuela. That shields the “real” currency from massive depreciation, but it also creates liquidity problems in the economy. The Chinese government escaped those problems thanks to many years of massive trade surpluses that – by means of currency sterilization – flooded he economy with liquidity and cheap credit. (They are now paying the price for that exchange-rate policy.) The Venezuelan government has simply taken to the monetary printing presses to do away with their liquidity problems. One of the many effects is 40-50 percent inflation.
A Greek secession will have serious consequences for the euro zone. Keep a close eye on Spain this year, then France in 2016 and 2017. More than likely the euro zone will be dead by the end of 2018.
It looks like Greek Prime Minister Tsipras is finally getting the country to where he was heading all the time: out of the euro. After winning an extension in February of current bailout conditions, the Syriza-led government has made practically no progress toward accommodating the demands from its creditors. On the contrary, it is increasingly obvious that Tsipras is trying to manipulate the circumstances to where he has no choice but to declare a Greek euro exit.
Yesterday the Greek blog MacroPolis explained:
The Greek government faces a dire financial situation in the coming weeks, especially as lenders are unlikely to relent on the conditions of last month’s loan extension. In fact, Tsipras’ insistence on of pushing for a “political deal” is going nowhere: German Chancellor Angela Merkel, who he will meet in Berlin next Monday, 23 March, is unlikely to deviate from her preference for technical, rule-based solutions. Therefore, the risk of an internal default due to the inability to pay salaries and pensions is not negligible.
Tsipras knows that he has no leverage. If he wanted to keep Greece in the euro zone he would never have run the negotiations to this point. But he has, which strongly suggests that I was correct when I wrote on March 1:
Prime minister Tsipras wants Greece to secede from the euro zone so he can pursue his Chavista socialist agenda on his own. He cannot do that without a national currency, but so long as a large majority of Greeks want to keep the euro he cannot outright declare currency independence. He needs to build momentum and create the right kind of political circumstances. This extension of status quo gives him four more months to do so.
It is very likely that the Germans have called Syriza’s game. As a counter-strategy they refuse to concede anything more, but are instead doubling down on their demands and conditions for a bailout. Reports the Telegraph:
Greece’s hard-Left government has been told to redouble its reform efforts in a bid to begin rebuilding the trust of its eurozone partners after a marathon four-hour meeting of European leaders in the early hours of Friday morning. With the clock ticking on securing the country’s future in the eurozone, Athens was urged to speed up its commitment to raising revenues and overhauling its economy by Germany’s chancellor.
Apparently, Chancellor Merkel has decided to play the chicken race that Alex Tsipras has been begging for ever since he was elected. According to the EU Observer, Merkel’s allies in the EU leadership have de facto made Tsipras an ultimatum:
Give us a list of reforms, and you might get the money you need, Alexis Tsipras was told at a three-hour meeting with select EU leaders on Thursday (19 March). The Greek prime minister met with German chancellor Angela Merkel and French president Francois Hollande. The heads of the EU Council and European Commission, Donald Tusk and Jean-Claude Juncker were also present, as well as European Central Bank chief Mario Draghi and Eurogroup chairman Jeroen Dijsselbloem. Tsipras was reminded that his government must stick to the Eurogroup’s previous, 20 February agreement. He was also told his partners are waiting for precise figures about the state of Greece’s finances and for a set of detailed reform proposals.
Merkel would not push Prime Minister Tsipras for the sake of saving him. She could not care less for a political half-wit from a broke-and-beaten Mediterranean outlier. No, her motives are at a much higher level. She has realized that the days are numbered for the common currency project. Greece is tugging away at its corner of the European currency; a party similar to Syriza is rapidly rising in Spanish politics, opening the possibility for Spain to eventually follow Greece toward currency secession; and then there is the constantly present threat of a President Le Pen in France whose first executive order would be to revive the franc.
On top of this Chancellor Merkel is looking at the exceptional depreciation of the euro over the past year. While this is good for exports, it has had no visible effect on domestic economic activity in the EU, especially not in the euro zone. The ECB has emptied out all its conventional monetary-policy measures and even resorted to unconventional stupidities like negative interest rates on bank overnight deposits. Yet none of this has helped get the European economy out of its state of stagnation.
Whichever way the chancellor looks, the euro is a lost cause. The remaining question then is: who is going to write the script for the end of the common currency? Is it going to be the rogues in Athens (and Madrid) or is it going to be the Germans? By being at least as principled as Tsipras, Angela Merkel is taking charge of the euro dissolution process. Her goal is to guarantee an orderly return to national currencies – and when that return will happen.
Prime Minister Tsipras can look wobbly and indecisive next to Merkel, but nobody should make the mistake of believing that the Syriza-led government eventually wants to stay in the euro. As Euractiv reports, the secessionist attitudes that characterize Syriza are not limited to economic issues:
The Syriza-led government will be against an Energy Union that undermines Greece’s national interests, including in its relations with Russia, said Greek energy minister Panagiotis Lafazanis, who also ruled out any privatisation schemes for the country’s energy sector.
So there you have it. The journey toward “Grexit” continues. The only question is who will blink first – i.e., who is going to be the first to give up on the Greek euro membership? Will Merkel say “I’m firing you” or will Tsipras say “You can’t fire me, I quit”?
The fiscal stress on the euro-zone continues. Last week the EU non-solved the Greek problem:
Eurozone finance ministers on Tuesday (24 February) approved a list of reforms submitted by Athens and cleared the path for national parliaments to endorse a four-month extension of the Greek bailout, which otherwise would have run out on 28 February. “We call on the Greek authorities to further develop and broaden the list of reform measures, based on the current arrangement, in close coordination with the institutions,” the Eurogroup of finance ministers said in a press statement.
Don’t expect that to happen. Prime minister Tsipras wants Greece to secede from the euro zone so he can pursue his Chavista socialist agenda on his own. He cannot do that without a national currency, but so long as a large majority of Greeks want to keep the euro he cannot outright declare currency independence. He needs to build momentum and create the right kind of political circumstances. This extension of status quo gives him four more months to do so.
The question is what those circumstances will look like. The EU Observer article provides a hint:
[The] IMF, while saying it can support the conclusion that the reforms plan is “sufficiently comprehensive”, criticised the plan for lacking details particularly in key areas. “We note in particular that there are neither clear commitments to design and implement the envisaged comprehensive pension and VAT policy reforms, nor unequivocal undertakings to continue already-agreed policies for opening up closed sectors, for administrative reforms, for privatisation, and for labour market reforms,” IMF chief Christine Lagarde wrote in a letter to Eurogroup chief Jeroen Dijsselbloem.
These are reforms that the new socialist government in Athens would not want to carry out. It is a good guess that they will be punting on the reforms to provoke the IMF into making an ultimatum. At that point Tsipras can tell the Greek people that he will not subject them to any more IMF-imposed austerity, and the only way he can protect them is to re-introduce the drakhma.
Will this happen in four months? It remains to be seen. But there is no way that Tsipras is going to tow the line dictated by the IMF, the ECB and the EU. His very rise to political stardom is driven by unrelenting opposition to such fiscal subordination.
In other words, the Greek crisis is far from over and will continue to be a sore spot on the euro-zone map. If it were the only one, the euro zone and the entire EU political project might still have a future. That is not the case, however:
The European Commission on Wednesday (25 February) gave France another two years to bring its budget within EU rules – the third extension in a row – saying that sanctions represent a “failure”. France has until 2017, having already missed a 2015 deadline, to reduce its budget from the projected 4.1 percent of GDP this year to below 3 percent. “Sanctions are always a failure,” said economic affairs commissioner Pierre Moscovici adding that “if we can convince and encourage, it is better”.
This is a non-solution similar to the Greek one, though for somewhat different reasons. In the Greek case the EU does not want to provoke an imminent Greek currency secession; in France they do not want to give anti-EU politicians more gasoline to pour on the European crisis fire.
What the European leadership does not seem to realize, or at least will not admit, is that the euro will lose either way. By pushing Greece too hard the EU Commission will give Tsipras his excuse to reintroduce the drakhma; by treating France with silk gloves the Commission hollows out the enforcement backbone of the currency union. Known as the Stability and Growth Pact – the balanced-budget requirement built into the EU constitution – it was supposed to hold sanctions as a sword over member states to minimize budget deficits. Now the EU Commission has effectively neutered the Pact and created an ad-hoc environment where austerity is forced upon some countries but not others.
With no sanctions there are no incentives for the states to comply. On the contrary: compliance means austerity, which comes with a big political price tag for the member states; non-compliance, on the other hand, comes with no price tag whatsoever.
To be blunt, the silk-glove treatment of France has put the final nail in the coffin of the Stability and Growth Pact. Aside from its consequences for the inherent strength of the euro, this silk glove stands in sharp contrast to the iron fist that the Commission presented Greece with already in 2010. The EU Observer again:
Valdis Dombrovskis, a commission vice-president dealing with euro issues, admitted that France is the “most complicated” case discussed on Wednesday. Paris is in theory in line for a fine for persistent breaching of the euro rules. However the politics of outright punishing a founding member of the EU, a large member state, and a country where the economically populist far-right is riding high in the polls, has always made it unlikely that the commission would go down this route.
This is of course a major mistake. The only mitigating circumstance is that France is not yet in a situation where it requires loans from the EU-ECB-IMF troika to pay its bills. But if the socialist government generally continues with its current entitlement-friendly, tax-to-the-max policies it will not see its budget problems go away.
Down the road there is at least a theoretical possibility that France could be sucked into the bailout hole. More likely, though, is that Marine Le Pen will be elected president in 2017 and pull France out of the euro. That will, so to speak, solve the problem for both parties.
I have said this before and I will maintain it ad nauseam: so long as Europe’s political leaders persist in their fervent defense of the welfare state, they will continue to drive their continent deeper and deeper into the macroeconomic quagmire called industrial poverty.
There have been many attempts at predicting which way Greece is going to go under the new socialist government. Most of the voices heard thus far seem to agree that Prime Minister Tsipras will not seek a confrontational course against the EU. That is, however, a mistake. This is a man who considers now-defunct Venezuelan president Hugo Chavez a political hero. Tsipras is also a former communist (though being a former communist and at the same time a fan of now-defunct Hugo Chavez is a matter of political semantics) whose training in politics and – to the extent it exists – in economics is fully governed by those ideological roots.
It is only logical that he continues to raise the volume vs. Brussels. Alas, from Euractiv:
Greek Prime Minister Alexis Tsipras laid out plans on Sunday (8 February) to dismantle Greece’s “cruel” austerity programme, ruling out any extension of its international bailout and setting himself on a collision course with his European partners at a summit in Brussels later this week. In his first major speech to parliament since storming to power last month, Tsipras rattled off a list of moves to reverse reforms imposed by European and International Monetary Fund lenders; from reinstating pension bonuses and cancelling a property tax to ending mass layoffs and raising the mininum wage back to pre-crisis levels.
There are two reasons to take this man seriously. The first has to do with his admiration of now-defunct Hugo Chavez. Fans of so called Bolivarian socialism – the ideological niche Chavez carved out for himself and his project to destroy Venezuela – truly believe in the idea of socialism in one country. They are not ideologically or intellectually opposed to “going at it alone”: on the contrary, it would be entirely in line with their thinking to try to repeat in Greece what now-defunct Hugo Chavez did in Venezuela. This means, as I have explained several times before, that Tsipras and his party, Syriza, would be more than happy to try to turn Greece into a European Venezuela.
In addition to terrible economic consequences, this would mean cutting some key economic and political ties between Greece and the EU. A termination of EU-imposed austerity and a reintroduction of the drachma are high on that list.
The second reason to take Tsipras seriously will be revealed in just a moment. First, back to Euractiv:
Showing little intent to heed warnings from EU partners to stick to commitments in the €240 billion bailout, Tsipras said he intended to fully respect campaign pledges to heal the “wounds” of the austerity that was a condition of the money. Greece would achieve balanced budgets but would no longer produce unrealistic primary budget surpluses, he said, a reference to requirements to be in the black excluding debt repayments. “The bailout failed,” the 40-year-old leader told parliament to applause. “We want to make clear in every direction what we are not negotiating. We are not negotiating our national sovereignty.” In a symbolic move that appeared to take direct aim at Greece’s biggest creditor, Tsipras finished off his speech with a pledge to seek World War II reparations from Germany.
In effect, that means writing off German loans. But wait – there is more. Let’s continue with the Euractiv article and listen to the political arrogance of Prime Minister Tsipras:
Tsipras ruled out an extending the bailout beyond 28 February when it is due to end. But he said he believed a deal with European partners could be struck on a so-called “bridge” agreement within the next 15 days to keep Greece afloat. “The new government is not justified in asking for an extension,” he said. “Because it cannot ask for an extension of mistakes.” Athens – which is shut out of bond markets and will struggle to finance itself without more aid quickly – plans to service its debt, Tsipras said. “The Greek people gave a strong and clear mandate to immediately end austerity and change policies,” he said. “Therefore the bailout was first cancelled by its very own failure and its destructive results.”
This is quite a high-pitch rhetoric to come from a man whose country cannot function without foreign aid. But herein lies the second reason why it is important to take Tsipras seriously and assume that he means every word he says. From EU Business:
A Greek exit from the euro would see the euro collapse like a house of cards, Finance Minister Yanis Varoufakis warned in comments that triggered a spat with Italy. “Greece’s exit from the euro is not something that is part of our plans, simply because we believe it is like building a house of cards. If you take out the Greek card, the others will collapse,” Varoufakis said in an interview with Italian public broadcaster RAI that was aired on Sunday.
Here is the strategy behind the Greek finance minister’s rant. As PM Tsipras tells the EU, the ECB and the IMF that austerity is over, he flags up that Greece will now begin its long walk out on the left flank. he is now at a point where he can start implementing his long-held dream of a communist, or at least Bolivarian socialist, paradise in Greece. The EU-ECB-IMF troika has very limited resources to put up against the Greeks unilaterally ending austerity – their most formidable weapon would be to kick Greece out of the euro.
Theoretically, the Greek government would not mind that, but they want it to happen on their terms. They want to tell Europe that “you can’t kick us out, because we quit”. That is a risky strategy – they can only push Brussels and Berlin that far – so to increase the likelihood that Greece holds the aces here, finance minister Varoufakis reminds the European leadership what chaos would erupt if they kicked Greece out.
This is a very high-stakes game, for both parties. The first skirmish will be over Greece’s participation in the currency union, with my bets being on Tsipras unilaterally pulling Greece out. That may make him look strong, but in the end Greece will lose. It is their economy and their people who will be subjected to a European version of the Bolivarian socialist paradise that now-defunct Hugo Chavez created.
When the euro was introduced more than 15 years ago it was marketed as the rock-solid currency that would beat the sterling, the U.S. dollar and the Swiss franc as the world’s safe haven for investors.
Part of the foundation for that ambitious, but not unattainable, goal was the convergence criteria that were supposed to align fiscal policy in all euro-zone countries. Those criteria, which went into effect in 1993, were elevated to constitutional status and still guide fiscal policy in the form of the Stability and Growth Pact. One of the three pillars of the pact was a ban on deficit monetization: the European Central Bank was not allowed to print money to buy up treasury bonds.
During the Great Recession the first two pillars of the Pact have crumbled; now the third one is about to fall apart as well. From the EU Observer:
The euro has begun 2015 at its lowest level in more than eight years, as markets expect the European Central Bank to present plans to buy government bonds in the coming weeks. The single currency was trading at $1.19 on Monday (5 January), its lowest rate since 2006, after ECB president Mario Draghi gave an interview stating that the bank was preparing a programme to buy up government securities in its latest bid to stimulate greater consumer demand and avoid deflation.
Unless the ECB is planning to buy bonds directly from European consumers, there is no direct connection between Draghi’s bond purchases and consumer spending. If he is hoping to depress interest rates even further and thereby stimulate consumption, then he has very little to play with. In most euro-zone countries interest rates are plunging toward zero – credit is practically available for free.
The problem is not lack of liquidity. The problem is lack of faith in the future. More on that in a moment. Now back to the EU Observer:
Speaking to German daily Handelsblatt on Friday (2 January), Draghi said the ECB was preparing to expand its stimulus programmes beyond offering cheap loans to banks and buying private sector bonds. “We are in technical preparations to adjust the size, speed and compositions of our measures in early 2015,” said Draghi, who will convene the next meeting of the bank’s Governing Council, where the support of a majority of its 25 members would be needed for a decision to be taken, on 22 January.
That will be four days before the Greek elections, which could bring the euro-secessionist Syriza to power. Syriza is a leftist hard-liner party with Venezuela’s defunct president Hugo Chavez as their political and economic role model. They would not think twice of reintroducing the drachma if they had enough political clout to do it.
By promising to buy up government bonds, the ECB could make a direct appeal to Greek voters – or at least to an incoming Syriza prime minister – that the ECB will buy all their government debt if only they choose to stay in the currency union. That, in turn, will basically give a new Syriza government the bargaining chip they need vs. Brussels to end austerity and return to the spending-as-usual policies that reigned before the Great Depression.
Precisely the situation the Stability and Growth Pact was supposed to prevent.
And again, as always, there is the change in tone among forecasters – the same kind of change that has become so frequent in recent years:
Draghi added that the risk of negative inflation had increased … Eurostat’s monthly inflation data to be published on Wednesday is likely to show that prices fell by 0.1 percent in December, the first decline since 2009. … Market analysts are forecasting another difficult year for the single currency bloc, predicting that the euro will continue to weaken against the dollar over the course of 2015, as a result of a combination of very low inflation and weak economic performance. … The eurozone economy is forecast to have grown by a mere 0.8 percent in 2014, and to grow by a meagre 1.2 percent in 2015, well below the US.
Unless there is a radical change in fiscal and welfare-state policies across the euro zone, its GDP won’t even grow by one percent for 2015.
A bond-buying program by the ECB won’t change that. All it will do is allow governments to return to deficit spending, which is not a desirable alternative to the austerity policies of the past few years. Europe needs structural reforms in the direction of free markets, limited government, low taxes and cheap energy. Nothing else will help.
Yankees baseball legend Yogi Berra coined the proverbial phrase “It ain’t over ’til it’s over”. That is certainly true about the European economic crisis. This past week saw a crop of bad news from the Old World. Nothing very dramatic – and certainly nothing that should surprise regular readers of this blog – but nevertheless bad news. In this first of two parts, let’s look at a report from the EU Observer:
The eurozone appears to have come back onto the markets’ radar amid low inflation, poor economic news from Germany, and Greece’s bailout exit plans. Greece’s long-term borrowing costs went above 8 percent on Thursday (16 October) – their highest for almost a year – as investors took fright at the fragile political situation in the country. The government in Athens has tried to shore up popular support by suggesting it will exit its bailout programme with the International Monetary fund more than a year early.
There is an important background here. The bailout program had three components:
1. The Greek government will do everything in its power to combine a balanced budget with protecting as much as possible of its welfare state against the economic depression;
2. In return for the Greek government’s tax increases and spending cuts, the International Monetary Fund, the European Union and the European Central Bank provided loans that kept the Greek government afloat cash-wise;
3. The only metric used to measure the success of bailout policies is the stability of a balanced government budget.
If GDP did not grow, if unemployment was at 30 percent, if more than half the young in Greece had no job to go to… none of that mattered. As a result, there has been no structural improvement of the Greek economy; government has not reduced its burden on the private sector – quite the contrary, in fact. Welfare systems have been reduced, but higher taxes have prevented welfare recipients from transitioning into self sufficiency.
As a result, the social situation in Greece is almost unbearable. The political reaction has come in the form of a surge for parties on the extreme flanks of the political spectrum. In my book Industrial Poverty I explain in detail what happened in Greece, what brought the country down from the heights of European prosperity to permanent stagnation. Today, sadly, the country is little more than a macroeconomic wasteland.
It is with this in mind that one should approach the news that Greece is considering leaving the bailout program. The coalition government is under enormous pressure to save the nation itself, to keep parliamentary democracy in place and to inject some sort of life into the economy. If they fail either of two extreme political movements will take over – the Chavista communists in Syriza or the Nazis in Golden Dawn.
International investors know this and are understandably scared. In their mind the bailout is the least of available evils; in reality, as I explain in my book, the attempts at balancing the budget and saving the welfare state in the midst of the crisis are the very policies that keep Greece from recovering; weak signs of a minor recovery earlier this year have yet to materialize into anything other than the “beaten dog” syndrome often following protracted periods of austertiy.
This is the very reason why Greece is now considering leaving the bailout program. They cannot continue forever to try to muddle through with an economy deadlocked in depression and a democracy so fragile that it has brought the first Nazis into a parliament in Europe for the first time since World War II.
However, as the EU Observer explains, the Greek government is caught between a rock and a hard place – as are other hard-hit euro zone economies:
But the recent announcement spooked investors, unconvinced that Greece can stand alone. Long-term borrowing costs also jumped in the weak periphery states, Spain, Italy, and Portugal. The market jitters – while not comparable to the height of the eurozone crisis in 2011 and 2012 – come as the eurozone’s main economies are once again at odds over policy responses.
France also belongs on that list, primarily for its typically European attempt at leaving the bailout program. Its government tried to leave the bailout path for a left turn into the quagmire of government expansionism. Thinking that more government spending, on top of the largest government spending in the world, could in fact bring about a recovery, the French socialists who won the 2012 elections scoffed at the EU balanced-budget rules and went full speed ahead with their government-expansionist agenda.
Two years later that agenda has hit a brick wall. Massive tax increases, supposed to pay for some of the new government spending, have only resulted in an exodus of brain power and entrepreneurship. The French GDP is standing more still than the Eiffel Tower.
In fact, the EU Observer notes,
France and Italy are fighting a rearguard action for more flexibility saying budget slashing will condemn them to further low growth. Paris is on collision course with both Berlin and the European Commission after having indicated that it wants an extra two years to bring its budget deficit to below 3 percent of GDP. Italy, meanwhile, has submitted a national budget for 2015 which brings the country to the edge of breaking the rules.
The French challenge to the budget-balance rules compounds the uncertainty emanating from the talks in Athens about a Greek bailout exit. It is more than a theoretical possibility that at least one of these countries leaves the euro zone in the next two years, and does so for a combination of political and economic reasons. That would be an institutional change to the European economy – and really the global economy – of such proportions that no traditional quantitative analysis can render justice to a forecast of its effects. It is therefore entirely logical that global investors are growing more uncertain and as a result demand higher risk premiums.
As the icing on the uncertainty cake, informed investors know that Marine Le Pen may very well become France’s next president. If she wins in 2017 her first order of business is in all likelihood going to be to exit the euro zone and reintroduce the franc. On the one hand that could be an “orderly” exit; on the other hand it would have ripple effects throughout the southern rim of the euro zone to the point where the very future of the common currency is in grave danger.
In summary: mounting uncertainty about the future of the euro is being mixed with growing uncertainty about the macroeconomic performance of the member states of the currency union.
Stay tuned for the second part about the bad news out of Europe.
The economic problems in Europe make themselves known in many different ways. Among them, a weakening of the euro. TorFX reports, via EUBusiness.com:
While the Euro recovered losses sustained in the wake of Portugal’s mini-banking crisis earlier in the month, the common currency put on a fairly lacklustre performance last week. The Euro dropped to a fresh 22-month low against the Pound and struggled against the US Dollar as investors speculated on the prospect of the European Central Bank bringing in additional stimulus measures.
It is important to keep in mind that exchange rates swing very frequently and sometimes violently, only to return to long-term stability. However, there is more than a short-term message in a 22-month low for the euro. Four variables are aligning to make the euro’s future difficult:
1. The negative interest rate. The ECB is penalizing banks for depositing excess liquidity with the bank’s overnight accounts. Even the moderately skilled speculator knows that a negative interest rate means he will have less money on Friday than he had on Monday, which of course drives investors to other currencies. The British pound comes to mind, as does the U.S. dollar. The problem for Europe is that once it has dug itself into a hole with the negative interest rate, it is mighty hard for the ECB to get out of there without any macroeconomic gains to show for it. The argument for the negative interest rate is that it will “encourage” more lending to non-financial corporations – business investments, for short. But businesses do not want to invest unless they have credible reasons to believe they will be able to pay back the loans. That really does not change because interest rates drop from almost zero to zero.
Bottom line: the ECB has entered the liquidity trap and will be stuck there for a long time to come, negative interest rate and all. This weakens the currency, especially over the short term.
2. Deflation. Part of the reason for the ECB’s move into negative interest territory is the spreading fear of deflation. The past few years have shown that a rapid expansion of the money supply has no effect on inflation, either in Europe or in the United States. Therefore, the ECB cannot reasonably be hoping to cause monetary inflation with a desperate move like negative interest rates. Its hope is instead hitched to a rise in business investments which would cause inflation through traditional, Phillips-curve style excess-demand effects.
Bottom line: not gonna happen. As mentioned earlier, businesses are not borrowing at almost-zero interest rates – why would they borrow at zero rates? There is no profit-promising activity in other parts of the economy, and there won’t be, as our next point explains.
3. Austerity and government debt. Ever since the Great Recession began, Europe has used austerity not to reduce the size of government, but to preserve the welfare state. This has led to perennially slow or non-existent GDP growth and high, perennial unemployment. This has two consequences that spell trouble for the euro over the longer term. The first is that persistent lack of economic activity discourages business investments per se. Austerity, European style, includes tax hikes which constitute further government incursions into the private sector. The perpetuation of European austerity therefore means the perpetuation of low levels of business activity. The second consequence is that even if economic activity picks up, because, e.g., a long-term rise in exports (unlikely to happen) there is so much excess capacity in the economy that there will be no excess-demand driven inflation for a year, maybe even two. The excess supply, of course, consists of massive amounts of un-demanded liquidity slushing around in the European economy, and perennially high unemployment, including 20+ percent youth unemployment in a majority of EU member states.
Bottom line: political preferences to preserve the welfare state will keep macroeconomic activity low. Long-term outlook is continued stagnation. No support for a return to interest rates above liquidity-trap levels.
4. Continued recovery in the United States. Despite dismal growth numbers for the first quarter, the long-term outlook for the U.S. economy is moderately positive. We have not applied the destructive European version of austerity, even though its tax-hiking component makes it a wet dream for many statists. Furthermore, Obama has been surprisingly restrained on the spending side of the federal budget, being far more fiscally conservative than, e.g., Ronald Reagan. This has created reasonably good space for U.S. businesses to grow. There are caveats, though, such as the implementation of Obamacare, which in all likelihood contributed to the negative GDP number in the first quarter of this year. There has also been a regulatory barrage from the Obama administration that has stifled a lot of business activity, although it has subsided somewhat in the last year and a half. But even a moderately positive business climate makes the U.S. economy notably stronger than its European competitor.
Bottom line: a slowly strengthening dollar will attract investments that otherwise would have gone to the euro zone, putting further downward pressure on the euro.
There is actually a fifth variable, which is entirely political. If Marine Le Pen gets elected president in France in 2017 she will pull her country out of the euro. That means goodnight and farewell for the common currency. Long-term minded investors would be wise to keep this in mind.
All in all, the case for the euro is not good. Stagnation at best, weakening more likely, with the probability of its demise slowly gaining strength.
In last week’s elections, did Europe’s voters plant the seeds of a post-EU Europe? The question has surfaced in response to the strong showing of Euroskeptics and outright anti-EU parties across the continent. While most observers of European politics are still at loss trying to comprehend the fact that some of their fellow citizens actually don’t like the EU, some sharp-minded analysts see the writing on the wall for what it actually is. In addition to Yours Truly, you can always trust Daily Telegraph columnist Ambrose Evans-Pritchard. Again, he has elevated himself above the murmur. Starting with Britain, he gradually expands his perspective, laying out a credible scenario for Europe’s future:
If Europe’s policy elites could not quite believe it before, they must now know beyond much doubt that they have lost Britain. This island is no longer part of the European project in any meaningful sense. British defenders of the status quo were knouted on Sunday. UKIP won 27.5pc of the vote … Margaret Thatcher’s Tory children are scarcely more friendly to the EU enterprise.
This is an important observation. The British vote shows two things: first, that British democracy, unlike continental Europe’s, still has not succumbed to Europhoristic centralism – on the contrary, Brits still believe in their traditions and their way of governing themselves; secondly, classical Anglo-Saxian liberalism still has a voice in Britain.
The second point carries more weight than perhaps even the Brits themselves realize. Deep down, UKIP’s ideology is a mild version of what we here in America refer to as “libertarianism”, namely a solid refutation of all government beyond a small set of strictly contained and enumerated core functions. A UKIP prime minister would never pursue the termination of the British welfare state, but he would most likely revive some of Thatcher’s legacy, a legacy that has been carefully squandered by the Conservatives.
Britain needs more Thatcherism. Europe could use a big dose of it as well. Hopefully, an invigorated UKIP can deliver that, with the right cooperation in the European Parliament.
Back to Evans-Pritchard:
Britain’s decision to stay out of monetary union at Maastricht sowed the seeds of separation, as pro-Europeans fully understood at the time, though almost nobody expected EMU officialdom to clinch the argument so emphatically by running the currency bloc into the ground with 1930s Gold Standard policies and youth unemployment levels above 50pc in Spain and Greece, and above 40pc in Italy. European leaders must henceforth calculate that the British people will vote to leave the EU altogether unless offered an entirely new dispensation: tariff-free access to the single market along the lines already enjoyed by Turkey or Tunisia; and deliverance from half the Acquis Communautaire, that 170,000-page edifice of directives and regulations that drains away sovereignty, and is never repealed.
In a nutshell, Evans-Pritchard is saying that the euro was doomed without Britain’s participation – a statement that is only partially correct. The structural imbalance of the euro project goes deeper than that. But more on that later. Evans-Pritchard refers to reckless austerity policies as having removed the fiscal and, especially, monetary policy foundations for a sound, strong common currency. He is right about austerity, as regular readers of this blog know; the Liberty Bullhorn contains more analysis of Europe’s austerity policies and their consequences than any other website in the world.
But even if we disregard the structural imbalances built into the euro project, it is important to note that the ECB has exacerbated the crisis by frivolously printing money right, left, up and down to save credit-crashing welfare states from fiscal ruin. If there is one single policy move that really drove the pole through the heart of the euro, it was the ECB’s decision to bail out its worst-rated welfare states. That open-ended commitment to print money reduced the euro from Deutsch Mark status to something of a business-class Drakhma.
Evans-Pritchard also makes a note of the ever-growing regulatory burden on EU’s member states. In this category, the EU is competing with the Obama administration, though in the latter case things have slowed down considerably in the last couple of years. Also, it is increasingly likely that the next president of the United States will have libertarian roots – probably stronger than those of UKIP leader Nigel Farage – which will vouch for a historic regulatory rollback. For that to happen in Britain, the country has to leave the EU.
Which, again, is probably going to happen in the next few years. Now for the broader perspective, and Evans-Pritchard’s analysis of where France is heading:
It is a fair bet that EU leaders would search for an amicable formula, letting Britain go its own way while remaining a semi-detached or merely titular member of the EU. Let us call it the Holy Roman Empire solution. Yet Britain is the least of their problems. The much greater shock is the “Seisme” in France, as Le Figaro calls it, where Marine Le Pen’s Front National swept 73 electoral departments, while President Francois Hollande’s socialists were reduced to two. … It is widely claimed that the Front is eurosceptic only on the surface. Perhaps, but when I asked Mrs. Le Pen what she would do no her first day in office if she ever reached the Elysee Palace, her reply was trenchant. She would instruct the French Treasury to draft plans for the immediate restoration of the franc… She vowed to confront Europe’s leaders with a stark choice at their first meeting: either to work with France for a “sortie concertee” or coordinated EMU break-up, or resist and let “financial Armageddon” run its course. … She said there can be no compromise with monetary union, deeming it impossible to remain a self-governing nation within the structures of EMU, and impossible to carry out the reflation policies necessary to defeat the economic slump.
Given that the Front National has suffered no notable setback in national voter support over the past decade, but instead gradually grown stronger, the prospect of a Madame President Le Pen is one that both Europe and the United States should get used to. Therefore, as Evans-Pritchard rightly explains, it is also time to get used to the prospect of Europe returning to national currencies.
The one point in this that I disagree with is that reflation is the way out of the recession. More on that in a moment. First, one more point from Evans-Pritchard, this one about the future of the euro with rising Euro-skepticism among voters:
The euro will inevitably lurch from crisis to crisis without some form of fiscal union and debt pooling. Yet voters have just let forth a primordial scream against any further transfers of power.
Indeed. So long as there is any form of government involved in the economy, there has to be a fiscal policy tied to that currency. Furthermore, so long as there is a welfare state there will be government deficits, either in recessions or on a structural basis as has been the case in Europe and the United States for decades now. Such deficits will be denominated in a currency, and that currency has to be the same that the government accepts for, e.g., tax payments, as well as the same currency that they use to pay out entitlements. In other words, there has to be a jurisdictional overlap between a currency and a fiscal government, or else the currency inevitably becomes unstable.
Some of these points were made by economists, among them Robert Mundell, already 15 years ago, before the euro was minted. However, they were drowned out by the Europhoria that dominated most of the ’90s in Europe, leaving the continent with a fundamentally unsustainable imbalance between monetary and fiscal policy.
So long as national government deficits were of manageable levels the imbalance did not have any notable political or macroeconomic consequences. As I describe in my forthcoming book Industrial Poverty, this was the case between the Millennium and Great Recessions. However, as soon as budgetary sink holes opened up around Europe from 2008 and on, the imbalance became a true problem.
The full explanation of this requires an intricate but fascinating macroeconomic analysis. I am working on it separately, hoping to share it later this year. In the meantime, let’s acknowledge that Evans-Pritchard hits it right on the nail: the mounting voter resistance to more EU power is a game changer for both the EU and the future of the euro currency. What is missing from his column is the right economic conclusion, namely that dismantling the welfare state – not reflation – is the way forward for Europe. But that is a minor point. Do take a moment and read the rest of his entertaining yet sharply analytical column.
Never bark at the big dog. The big dog is always right.
To begin with, I have said all the way that the European crisis is a welfare-state crisis, not a financial crisis. The blow to the banks from the financial-market problems of 2008 would never have caused the ripple effects it did, had it not been for the fact that banks in Europe had invested so heavily in government treasury bonds.
The banks thought – for obvious reasons – that those bonds were the safest investment they could make, that large investments in treasury bonds would provide them with a rock-solid low-risk platform for their portfolio management. But then the welfare states in Europe kept on spending on their entitlements, despite the fact that scores of taxpayers were either unemployed or earning fractions of what they would in a strong economy. They started having problems paying their creditors – i.e., the banks.
Low-risk treasury bonds became high-risk assets. Bank portfolios were totally upset, leaving them with much more of mid-to-high risk assets than was healthy for them.
Today the British news site The Commentator confirms my analysis, using Cyprus as an example:
When the European Union (with German money) mounted its most recent bailout of Greece, one of the conditions was a 75 percent write down of Greek government debt. For the Cypriot banks, which had made loans to the Greek government totalling 160 percent of Cyprus’s GDP, this was disastrous.
I was also right about the true purpose behind the Cyprus bank heist. Yesterday I explained that the plan to confiscate bank deposits was not going to be a one-time exceptional event, but was instead intended to set a new precedent for future bank-deposit confiscation raids:
Again, the two-fold goal of the Cyprus bank heist is to secure the euro zone as it is and to cause a long-term depreciation of the euro. In order to accomplish the latter, the Eurotarians have to create a certain, calculated level of capital flight from the euro zone. There are several ways to do this, but the instrument they have chosen – seizing bank deposits above a certain level – is devious enough to work. However, to cause a “right-sized” exodus you cannot limit the scheme to one country. You need others to follow.
British daily newspaper The Guardian has a story that confirms my analysis:
Fears that bank accounts could be raided in any future eurozone bailouts spooked markets on Monday, as Cypriots prepared for their banks to reopen for the first time in over a week on Thursday following a deal to secure a €10bn lifeline. Markets took fright after the head of the group of eurozone finance ministers indicated that the Cyprus rescue could be a template for similar situations.
And then the question is: what is a similar situation? Again, the Cyprus bank heist was not about taking deposits from individuals to rescue the banks where they had their money. The purpose was instead to take depositors’ money to give to government, which then used it to prop up ailing and failing banks.
The difference may seem like a technicality, but it is not. The fact that government is the middle man is crucial: it is right there that you find the precedent in this confiscation scheme. Government took money from large-balance accounts because it did not have enough cash for very important expenditures. Next time the very important expenditure does not have to be a bank, or even a financial institution. It could just as well be an urgently needed but financially strapped income-security system (Americans, think TANF or even Social Security).
The purpose behind the Cyprus bank heist was not primarily to save the banks – that could have been handled in a much different way by, e.g., the ECB printing another five billion euros – but instead to establish that government can raid the bank accounts of private citizens under the auspices of some kind of fiscal emergency.
It is not far-fetched to guess that many governments in small EU member states are now salivating over the opportunity to raid the bank accounts of their own wealthy citizens. The fact that the Cypriot government appears to be ready to take 40 percent above 100,000 euros makes this an even more attractive “revenue tool” for Europe’s cash-strapped welfare states.
It is this realization that is now setting in on investors all across the euro zone. The Guardian again:
[All] markets erased their early gains to close down on the day. The FTSE 100 index lost 0.2% and the German stock market fell 0.5%. Bank shares fell across Europe while the euro, which had nudged up through $1.30 initially, fell back to below $1.29. US markets, which had largely shrugged off the Cypriot problem, were also lower, with the Dow Jones Industrial Average down over 70 points, 0.5%.
The decline in Dow Jones is temporary, while the decline in Europe is the beginning of a permanent downward adjustment. Again: one of the ideas behind the Cyprus bank heist is to start a process that stokes fear in financial investors, resulting in a moderate outflow of funds from the euro zone. This will in turn cause a depreciation of the euro.
Germany needs this downward adjustment to compensate its export industries for the ridiculous shift to a much more expensive system for producing power.
Yes, politics can be that cynical. It is a risky strategy, but so is any high-end manipulation of the course of events, either in politics or in the economy.
In fact, if the Cyprus bank heist was repeated in a couple of more countries, it would give the desired financial outflow the boost that German leaders are calculating with.
And they may get exactly what they want. The Guardian again:
Malta’s finance minister wrote an article in the Malta Times expressing concern about what would happen if it encounters similar problems in the eurozone.
But this ill-intended, well-hatched plan also puts on full display the arrogance with which Europe’s political elite runs its new kingdom. They are either oblivious to, or dismissive of, the severity of the crisis that Europe has been stuck with for the better part of four years. This crisis only seems to get deeper and more entrenched for every move that this political elite makes. Der Spiegel has a good analysis:
It has been only four weeks since German Chancellor Angela Merkel had nothing but nice things to say about her “very esteemed” counterpart in Cyprus. In a telegram to newly elected President Nicos Anastasiades, she “warmly” congratulated him on his election victory and wrote that she looked forward to their “close and trusting cooperation.” That was then, as Merkel conceded last Friday in a speech to the parliamentary group of her center-right Christian Democratic Union (CDU) at the Reichstag in Berlin.
I could say something funny here about the fact that the German parliament is once again referred to as Reichstag – something about how it is easier to rule a continent by means of a common currency than by means of a common army. But let’s leave that aside. Back to Der Spiegel:
Although her intent was not to set an example, she said, Germany also would not “give in.” She added that there would be “no special treatment” for Cyprus. And over the weekend, she lived up to her word. … Since Cypriot parliament rejected the initial bailout plan, one crisis meeting followed the next in Berlin, Frankfurt and Brussels as concepts were presented, revised, rejected and resubmitted. In the end, the European Central Bank (ECB) imposed an ultimatum on the country. The message from ECB President Mario Draghi was that either Cyprus agree to the bailout conditions or it could be the first member of the euro zone to declare a national bankruptcy.
The technical meaning of that would be that Cyprus would have left the euro zone, reinstated its national currency and re-denominated all its debt in that new currency. Most analysts would contend that such a move would have led to a drastic depreciation which in turn would have caused foreign investors in Cypriot treasury bonds, as well as in private banks, to lose money.
However, there is a real possibility that the opposite would have happened: with Cyprus out of the euro zone the country could de facto have reinforced its position as a low-tax jurisdiction with high respect for bank privacy. That would have led to a new inflow of foreign money, and eventually the little nation could actually have come out more prosperous.
Now they are facing the exact opposite scenario, as Der Spiegel explains:
In the end, Nicosia agreed. The country’s oversized banking industry is to be radically downscaled, one of its biggest banks, Laiki, is going to be dissolved and those holding accounts there will see volumes over the €100,000 insured limit potentially vanish. A worsening economy will almost certainly be the result.
Not to mention the ramifications for the entire euro zone:
Smoldering and flaring for the last three years, the euro crisis has reached a new stage. For the first time, a parliament rebelled against the requirements of international creditors, and for the first time euro-zone taskmasters tried to take a slice of the savings of ordinary citizens, prompting people throughout the continent to wonder whether their money is still safe. The unprecedented showdown led many in Europe to speculate over the national character of the Cypriots, and wonder: Are they especially jaded, desperate or simply nuts? Finding the right answer was the perplexing task for leaders in Brussels, Paris and Berlin. How far can one bend to demands from a teetering country like Cyprus without losing one’s credibility?
Actually, the real question is: how far can the European political elite bend their member states before they start breaking apart – or breaking away from the common currency, and perhaps even the euro zone? The jury is still out on that question, but there is no doubt that the political elite that runs Europe completely lacks understanding of the art of government. They have eradicated hundreds of billions of euros worth of GDP in several EU member states, just to preserve their precious union and at the same time gradually centralize control over fiscal policy. They completely dismiss the will of voters, either as expressed in elections, in a referendum or in the form of parliamentary representation. Cyprus is only the latest example, and certainly won’t be the last.
They are Europe’s authoritarian leaders and deserve to be called Eurotarians. They rule with very little regard for the half-a-billion people whose tax money they live off. they use instruments of power, such as austerity policies, to close the ranks of member states and if necessary oppress public opinion.
These instruments of power have thus far allowed the elite to win and become seemingly stronger. But at the same time, each new victory they score erodes the very pillars upon which they build their power. Der Spiegel makes a good point on this:
But a monetary union, at its core, is not held together by budget figures or austerity programs, nor by the statements of finance ministers and the heads of central banks, no matter how well-received they are in the markets. The most important glue holding together a monetary union is the mutual confidence of its members, and that has declined drastically in recent months. While many in the north question the willingness of politicians in Rome and Athens to bring about reform, citizens in the south are increasingly furious over the austerity diktats from Berlin, Brussels and Frankfurt. There are predetermined breaking points all across the continent, but they are more apparent in Cyprus than anyplace else. … the debacle over the debt-ridden island nation is more than just another financial crisis along Europe’s southeastern edge. It is emblematic of the entire monetary union. If the euro zone collapses, it will be because of both its economic contradictions and its members’ inability to reach agreement.
In other words, the attempts at keeping the euro zone together, by means of austerity and anti-democratic thuggery, have created a backlash that will combine a persistent economic crisis with an accelerating democratic crisis. These two are now merging into a perfect storm of uncertainty, unemployment and deprivation. Italy offers a great example, as illustrated by this story from Corriere della Sera:
Time is running out for Italian industry. Business is in a “desperate” condition with companies “very close to the end”. This umpteenth warning came from Confindustria chair Giorgio Squinzi during talks with the mandated prime minister, Pier Luigi Bersani, in which Mr Squinzi appealed for a swift return to “a stable government”. Given the three million Italians out of work, with a spike of almost 40% for young people, Mr Squinzi pointed out that the employment issue “is becoming a tragedy”. Confindustria had no option but to be “extremely concerned about Italy’s real economy”, warned Mr Squinzi. The Confindustria leader said “intervention is needed with absolute priority”, starting with payment of the public sector’s outstanding debts to businesses and implementing what he described as a no-holds-barred “shock treatment” for the first hundred days of government.
In the recent election Italian voters responded negatively to the bone-crushing austerity measures forced upon the nation by the EU and the ECB. Their response created a stalemate in negotiations for a new prime minister and parliamentary majority, which in turn has led to a standstill in legislative activity. There is no identifiable course of fiscal policy, which means uncertainty as to taxes and government spending. (This includes the macroeconomically small but microeconomically important problem of government contractors not getting paid.)
This uncertainty, ultimately brought about by the relentless pressure from the EU and the ECB, is making life increasingly desperate for Italy’s businesses and citizens. The private sector’s faith in, and respect for, a parliamentary government will at some point start eroding. Once that process gains critical mass they will either leave the country in order to invest elsewhere…
…or support political forces that are much more hostile toward the EU than what we have seen thus far in Italy. We got a foretaste of what that means in the Greek election last summer.
It would be an exaggeration to say that the common currency and the European project of unity are unraveling. That said, though, there is no doubt that Europe is inching closer to the point where both the EU and the currency union start falling apart. The institutional uncertainty of the continent has increased, while the reasons to invest there have weakened significantly.
Therefore, I will say it again: If you have any investments in the euro zone, get the money out ASAP.