The EMU reform ruse – Part 3

This is the third part of my mini-series which have been evaluating one so-called progressive reform approach to the Eurozone disaster. Part 2 provided essential background, given that one of the proposals being circulated by progressives involves the weaker Eurozone nations re-establishing their own currencies and then pegging them against the Euro. I showed that attempts to maintain any form of fixed parities among the core European states has been chaotic and led to breakdown. Along the way, the weaker trading nations were subject to austerity biases and elevated levels of unemployment. Given the scope of the topic, it will take me two more parts to finalise the discussion. In this part and the final part 4 I will discuss the second proposal from German academic Fritz Sharpf, which appears to have gained some traction with the Europhile Left, much to my disappointment. Here we commence the analysis of Sharpf’s “Two-tiered European Community” proposal.

In considering the options available to reform the failed Eurozone, Fritz Sharpf rejects calls from some commentators to strictly enforce the Maastricht rules, which would prevent the ECB from funding fiscal deficits (even if they are doing it in a roundabout manner) and force Member States governments to take full responsibility for their fiscal funding.

This would surely result in insolvency for several Member States almost immediately (Greece, Spain, Italy, Portugal, and probably others).

He considers a proposal to create a more “solidaristic North-South burden sharing” under a “transfer union” to have more hope of achieving political support.

But he realises that this would run counter to the “justifying purpose of the present euro regime” and “the enforced structural transformation of Southern political economies”.

Despite his assessment that Germany might be persuaded by solidarity elsewhere to relax its opposition to such a move, my view is that Germany will never agree to a truly federal Europe with a common currency, where it would have to take the major brunt of fiscal transfers.

And, his proposal basically discloses his implicit view that Germany would not concede in this area.

He considers a range of other options such as increased wages in external surplus nations to raise unit labour costs, increased deficit spending, more relaxed consumer credit, all aimed at boosting domestic demand in the Northern nations and stimulating the weaker economies.

He concludes that instability would increase (for reasons I don’t have time to explain) if these policies were followed under the current European Commission ideology and practices.

His overall conclusion in this regard is that:

… that the EMU can only be stabilized by maintaining the present asymmetrical euro regime and the compulsory structural transformation of Southern political economies. In other words, the EMU and the sacralized principles of the Internal Market can only be saved jointly by intentionally destroying the democratic legitimacy, the social cohesion, and the life chances of the younger generation in Southern polities.

That is a dire conclusion and motivates his second major reform proposal.

His use of the term ‘sacrilized’ indicates he believes we are dealing with a ‘religious’ organisation here (EC and its dogma) rather than anything rational.

His alternative proposal is thus predicated on:

1. The desire to retain the Monetary Union for “those Northern and Eastern political economies whose interests and political preferences are well-served by it, or for member states that are politically committed to continue on a course of structural transformation under external supervision”

2. To avoid isolating “countries that might otherwise be better off outside of the EMU”.

The proposal in summary is this:

1. A “European Currency Community” (ECC) would be created with “two types of member states – those belonging to the EMU and those whose currencies are related to the euro through the ERM II.”

2. “All of its member currencies would form a large “euro block” with the euro itself at the center and ERM II currencies connected to it by agreed-upon exchange rates and commitments to mutual support against external attack.”

3. “the common currency for those Northern and Eastern political economies whose interests and political preferences are well-served by it, or for member states that are politically committed to continue on a course of structural transformation under external supervision” would continue. This would be the ‘hard currency’ blog within the EMU. Not a lot would change for them.

4. The ‘Southern’ (read: peripheral) Member States would reintroduce their own currencies but peg them under agreed parities with the euro – that is, join the ERM II, where Denmark is currently the only member.

So the weaker nations could exit but not establish full currency sovereignty because they would have pegged currencies, and hence their monetary policy would be dominated by the ECB.

He does suggest that the ECB would help these nations stabilise their exchange rates within the agreed bands.

As noted in earlier Parts of this series, Sharpf rehearses the standard line that EMU:

… membership is irrevocable … under the present rules … it is not a policy option that could be chosen by responsible governments as a lesser evil, no matter how devastating the euro regime’s impact is on its economy or society.

That is the Europhile orthodoxy. More religious doctrine. It is just a mantra that they think if it is repeated enough will become truth.

It is a lie. A nation could exit and reestablish its own currency if it had the political will and Brussels could do very little about it.

The reason the “irrevocable” mantra is repeated is that the technocrats know that nations such as Greece would immediately begin to reverse the damage if it had its own currency and used it properly.

They do not want that reality to become a norm for other nations (for example, Spain, Italy, Portugal) to follow. Then the game would be up.

But it is true – within the current set up, there are no processes in place to facilitate an orderly exit.

Currently, a unilateral exit, for example, would have to be a ‘brute force’ action and aimed at maximising the benefits for the departing nation without much regard for the impacts on the other Member States.

While the European Commission has created a public sentiment that such a unilateral exit would bring “horrendous transition costs and unresolvable uncertainties”, the reality is, in my view different.

The elites want everyone to think this is a fact because they have so much riding on the ‘success’ of their plan for neoliberal domination and the destruction of democratic choices.

Sharpf’s idea that “no matter how devastating the euro regime’s impact” is on an “economy or society” the system must be tolerated is a staggering statement for a so-called progressive to make.

Surrender to the neoliberal slaughter of prosperity takes many dimensions. But in concluding that a democracy has to tolerate “devastating” consequences from the design and operation of the monetary system, when, in fact, the alternative monetary system, enjoyed by most nations is available, is an astounding example of surrender.

Even the Europhile Left has bought into this myth. They should hang their heads in shame for mouthing the same tired and false claims.

As I have explained in my 2015 book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale – the costs are unlikely to be larger over the extended period than the current costs imposed by the convergence to the Northern model approach.

In fact, I consider the costs to be ephemeral and would fade quickly as growth returned on the back of a return to currency sovereignty and the freedom to stimulate.

After all, sovereignty gives the nation state privileges that no current Member State enjoys – the rights to issue its own currency, set interest rates, float its currency, and control capital flows.

I plan to write an updated blog outlining an Exit Blueprint soon to further develop an awareness of just how easy it would be – technically – for a nation to exit the disastrous Eurozone.

For now, we are considering Sharpf’s approach.

As you will read, there is a major tension between his “horrendous transition costs” scenario from an exit and the fact that he is proposing a broad exit but with ties that would prevent that exit delivering policy freedom.

He makes a point I have made often – “that leaving the EMU does not conflict with continuing membership in the European Union”.

Which can be extrapolated further to recognise geographic realities – leaving the European Union does not mean you leave Europe.

That is an important insight. The Europhiles all try to claim that if a nation leaves the Eurozone (or the EU, in Britain’s case), it automatically ceases to be part of Europe.

Well markets don’t work that way for a start. Transport costs, in part, determine where things can be produced and sold. For Britain, its geographic proximity, will ensure it remains an essential player in the European economy (particularly in Ireland’s case, which bears on the farcical hard-soft border debate – which I will write about presently).

Many Southern Europeans feel that if they were to exit the disastrous Eurozone they would be expelled from Europe. Clearly that cannot happen.

Greece, for example, has huge market potential given its natural resources and its proximity to very high income neighbours.

The Brexit debates obsess about whether Britain will have access to the Single Market or not. But it would be madness for Germany manufacturers to agree with its government to enforce restrictions on trade with Britain.

While Germany might be trying to nurture more trade with China, that will not replace the surplus anytime soon that Germany enjoys with Britain. For example, in 2016, the German Statistics Agency reported that Germany exports are worth 85,938,694 thousand euros to the UK and 76,045,836 thousand euros to China. In other words, Germany runs a trade surplus with Britain of 50,284,783 thousand euros (ranked No. 1) while it runs a deficit against China of 18,126, 075 thousand euros (its largest deficit nation).

In considering the exit proposal, Sharpf identifies “three bodies of rules” that would deal with:

… state insolvency, with exit procedures, and with subsequent relations between exiting states and the EMU.

Sharpf’s logic is clear. While he thinks membership of the EMU is irrevocable under current rules, the Member States could agree on a process which would allow his proposed bi-furcation to take place.

It remains obscure why such an agreement could not allow a nation to exit with the same sorts of “rules”. I will return to that.

He wants some “exit models” created which would:

… need to include procedures for the transition to a national (or parallel) currency, for the treatment of public and private debts defined in euros, and for financial, legal, and procedural support during the transition period … I am encouraged to see that knowledgeable economists of very different theoretical and political persuasions appear to be quite sanguine about the avail- ability and effectiveness of practicable options that would reduce the transition costs of a country’s exit from the EMU through a cooperatively managed “amicable divorce” …

Which begs the question: Are the current rules which he thinks would impose “horrendous transition costs” just threats?

Are they the posturing of politicians who want to preserve their ‘system’ (and repute) rather than make the lives of all Europeans better?

If such “options” are identifiable and available, why wouldn’t the European Commission deploy them for a nation such as Greece who clearly cannot prosper within the EMU?

Are they so wedded to the idea that ‘no one leaves’ that they are willing to impose these horrendous costs as payback? It seems so.

But the point is that if a nation, even under current rules chooses to exit, then the balance of power shifts quite dramatically, as I outlined in my 2015 book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale.

The exiting state has legal cover to redenominate all liabilities in its own currency. It can default on all euro liabilities if it chooses.

It can run parallel currencies and allow the non-government sector to transition over time. It can offer 1 for 1 exchanges for bank deposits currently in euros. It can do a lot more into the bargain. That will be discussed in my Blueprint Exit blog(s).

The EMS again …

Sharpf thinks that the “members of ERM II … would not be required to be economically coherent and structurally convergent”.

But the exiting nations would peg their currencies against the euro, which he thinks would be a good thing.

He argues that the ECB would protect these states from “speculative currency fluctuations” and their nominal exchange rates would reflect “the underlying fundamentals of their respective economies”.

Well not quite.

This brings us back to the EMS (and the ERM).

His proposal informs readers that Europe can learn “from the faults of the EMS”, which I considered in The EMU reform ruse – Part 2.

He acknowledges that these exiting nations:

… might suddenly have to cope on their own with turbulent capital markets and with speculative exchange-rate fluctuations that could wreak havoc on the viability of economically interdependent national industries and that might also trigger vicious price-wage-devaluation spirals that could overwhelm all national efforts at stabilization.

He claims the ERM, which I discussed in – The EMU reform ruse – Part 2:

… protected member currencies against short-term imbalances and speculative attacks by (symmetrically!) obliging central banks to intervene in currency markets in order to maintain the upper and the lower limits of their respective exchange-rate corridors.

Therein lies a revision of history.

First, the symmetry was agreed. Second, the Bundesbank reneged. Result: the adjustment was borne by external deficit nations and forced them into recessions with high interest rates and elevated levels of unemployment.

Further, there was constant speculative attacks that were only largely thwarted by capital controls.

While Sharpf claims the “the EMS worked reasonably well” a better memory tells us it was chaotic and exchange rates were only vaguely stable while capital controls were in place.

A few paragraphs on, he basically contradicted his earlier praise of the EMS by admitting that the “famous ‘Emminger letter'”, which I discussed in Part 2, meant that Germany “would not have to engage in monetary policies and currency interventions that might conflict with its basic commitment to price stability in Germany.”

So the “the symmetry of interventions was incomplete, and currency realignments were more frequent than they otherwise would have been” and the system was falling apart as Europe agreed on Maastricht.

He also acknowledges that Germany’s behaviour in the early 1990s “in fact destroyed the EMS”.

But having said all that, he thinks the “critical design fault that destroyed the Exchange Rate Mechanism (ERM) of the EMS has been corrected in its successor regime, the ERM II”, which began on January 1, 1999.

Of course, Denmark is the only current member of the ERM II – a Northern economy with a similar austerity bent to Germany, which means it is not a good model for evaluating whether ERM II would be any more effective than the failed ERM I.

Has such a correction been made?

Sure enough, in the ERM II there is only one central bank in the picture now – the ECB and the rates are pegged against one currency – the euro. That is different to the ERM I, where all the Member States central bank had to work together with multiple currencies.

But the reality was that the ERM I was dominated by the Bundesbank and the Deutsche mark.

And, as the currencies were collapsed into the euro, Germany’s domination has not changed. Further, the ECB has demonstrated, as part of its Troika membership, how far embedded it is in the politics of austerity and maintaining the euro at all costs.

Even to the point of abandoning its charter to maintain financial stability when it basically threatened to bankrupt the Greek banking system should Syriza not cower to the demands of further and deeper austerity in June 2015.

So how far the ECB can be trusted to provide liquidity and foreign exchange to exiting Member States who cannot maintain their currencies within the agreed parities via their own central bank reserves is a reasonable question?

Especially, when the next ECB boss is likely to be Bundesbank boss Jens Weidmann. If he takes over then the current ECB law-breaking is likely to end or at least be curtailed. Then all the Member States will see the deep design flaws in the monetary system reveal themselves again.

Sharpf does not mention any of that.

Instead he lauds the fact that ERM II rules allow a nation’s currency to “fluctuate up to 15 percent above and below their agreed-upon” parity against the euro.

But that was the same band as the ERM, which proved unworkable.

The 15 per cent plus or minus rule was introduced as a desperate attempt to deal with massive currency instability and showed how German intransigence forced dysfunctional outcomes on the other Member States – not much changes really in Europe.

When Italy was forced out of the ERM in 1992 as the Bundesbank refused to fulfill its obligations for symmetrical intervention, the financial markets turned next on Britain and Black Wednesday was the result.

The 1993 Northern Summer saw a replay of the currency chaos throughout Europe as recession became more entrenched and central banks around Europe were signalling a need to lower interest rates, to provide some stimulus support.

The constraint they faced was that the Bundesbank would not compromise on its tight monetary policy settings, which were addressing the domestic liquidity consequences of spending associated with reunification.

The two positions: high interest rates in Germany and reduced rates elsewhere to fight recession, on the one hand; and maintenance of the agreed exchange rate settings, on the other, were incompatible.

The French government also experienced major political instability over the Summer of 1993 and the currency market traders clearly believed the French government would succumb to the domestic pressure to cut rates and devalue the franc.

When the Bundesbank (on July 29, 1993) confirmed they would not cut German interest rates, the currency markets went crazy, selling the franc and other European currencies in huge volumes and making the 2.5 per cent fluctuation bands unsupportable.

The EMS was dead.

As a desperate move, the politicians widened the allowable fluctuation range for all currencies to plus or minus 15 per cent (a 30 per cent overall allowable fluctuation), which made a mockery of the claim that the EMS was maintaining currency stability.

The widening of the bands was called a ‘temporary measure’ by the politicians who accused the Italians and the British of being too lax in their anti-inflation fight or the Germans of being too lax in their spending on reunification.

The ± 15 per cent band has been retained despite it being seen as a temporary measure.

However, as Sharpf acknowledges, even with this wider band, many nations still had to realign their currencies when their underlying external fundamentals pushed their exchange rates outside the allowable bands.

And to make the point again, a 30 per cent overall range is hardly the statement of currency stability.

Conclusion

In the final Part 4 of this discussion we will see that the composition of the “Northern hard-currency” group is not without problems.

Further we will see that the Member States that do exit will not really be unleashed from the suffocating austerity bias that defines the current operation of the Eurozone.

That is enough for today!

(c) Copyright 2017 William Mitchell. All Rights Reserved.