EMU posturing provides no durable solution

Today I have been looking over documents from the EMU which emerged from last week’s summit in Brussels. Within the plush environs of their meeting halls and probably over very sumptuous dinners the best they could come up with was a half-baked plan to stop the daily headlines which have been indicating impending Greek default. Such a default would damage the Eurozone monetary system and probably show the way for other nations, which are being similarly bullied by the EU bosses into impoverishing their nations. Given some reporting today they may have succeeded … in stopping the headlines … for the moment. But the approach of the EMU leaders will do nothing to address the fundamental structural flaws in the their whole system. With the prospect of an extended period of austerity throughout the zone, they are really just making it more certain that the next major global downturn sinks them for good. That is, if social instability doesn’t do it beforehand.

Despite all the posturing by the Germans and other bullies within the EMU, the EU summit in Brussels last week decided on a so-called “rescue package” for Greece, which, in theory, will permit bi-lateral loans from other member states and also allow the IMF to get their grubby fingers involved in the mess – the proportions of the bailout would be 2/3 (EMU) 1/3 (IMF). The latter move, alone, will make the prospects for the Greek people worse than otherwise.

You can read the final statement of the Euro government leaders HERE.

The President of the European Council was fairly categorical in his quoted press comments:

We hope that it will reassure all the holders of Greek bonds that the eurozone will never let Greece fail … If there were any danger, the other members of the eurozone would intervene

You can see his Press Conference (in French) – HERE. You can also read the statement of the President of the European Commission – HERE.

But the fact is that the EMU bosses have no intention of following through on this plan. They are just buying time and trying to appease the bond markets. The plan in itself is nonsensical as we will see.

The EU summit also said:

Furthermore, we commit to promote a strong coordination of economic policies in Europe. We consider that the European Council must improve the economic governance of the European Union and we propose to increase its role in economic coordination and the definition of the European Union growth strategy.

Originally, the wording sought by France and Germany used to term “economic government” but, apparently, the UK prime minister persuaded the summit participants into changing to “economic governance” (Source) because he “feared a backlash from the eurosceptic press if such an inflammatory phrase entered the final communique”. The FT article quoted a British diplomat as saying “There’s no question of powers being ceded to Brussels or sovereignty being affected whatsoever.”

Well they don’t have any sovereignty anyway so what is the difference?

Further examination of the final statement of the heads says:

The current situation demonstrates the need to strengthen and complement the existing framework to ensure fiscal sustainability in the euro zone and enhance its capacity to act in times of crises. For the future, surveillance of economic and budgetary risks and the instruments for their prevention, including the Excessive Deficit Procedure, must be strengthened. Moreover, we need a robust framework for crisis resolution respecting the principle of member states’ own budgetary responsibility.

This is the German agenda to make the Stability and Growth Pact conditions even more onerous. It reinforces the fact that they want to hamstring fiscal policy which means that only nations with strong export positions (read: Germany) have any chance of sustained growth. But even Germany had trashed the wages and conditions of their industrial workforce to ensure they can make beggars of the other EMU member nations via trade superiority.

So a Pyrrhic victory? Who ultimately in Germany is benefiting from all of this? Comments from those who know the nation better than I do are welcome.

What this proposal for increased “governance” is really about is making sure they don’t get embarrassed again by nations that breach their ridiculous fiscal rules. They are prepared to impoverish millions of European citizens just so they can hang onto some ill-conceived neo-liberal rules that make no sense in a complex economic world subject to major demand and supply shocks – which, in turn, are asymmetric in their regional impacts.

Given the diversity of the EMU member nations this asymmetry is lethal to the weaker nations. It beggars belief that the citizenry in those weaker countries would ever tolerate this entrenched austerity for very long.

What benefits do the workers in these nations gain from being subjected to a significantly higher risk of unemployment, declining real wages and working conditions; and diminished access to public infrastructure?

If there is a convincing argument which says that the average person gains from having their national governments tied up in a straitjacket like this then I haven’t seen it. I have read a lot over the last 20 odd years about “fiscal sustainability”, “restoring fiscal discipline”, “reigning in rogue spending” and all the rest of the catch-cries but never has there been a convincing case to explain why the stagnant Eurozone growth and persistently high unemployment is beneficial to the workers.

So my current assessment is that the Eurozone leaders haven’t really learned anything from the crisis at all. Their system has failed to meet the first crisis it faced. Some might say that it succeeded because no government has defaulted. That is so far true and probably will not happen now – but they have breached the strict intent of the “no bailout” rules as an ad hoc response and are prepared to allow access to the IMF – which is typically a sign of failure to govern.

It is now forgotten but the ECB also took advantage of hundreds of billions of US dollars provided by the Federal Reserve via swap lines which helped prevent an entire collapse of the European banking system.

Further, the only sustained fiscal response to the crisis by the EMU has been to pressure member governments to employ pro-cyclical policies to get back within the “rules” even though the rise in the budget deficits was driven significantly by the automatic stabilisers. Pro-cyclical fiscal policy is the exemplar of bad policy practice and defies the concept of sustainable fiscal intervention.

Please read my suite of blogs on fiscal sustainability for more on this issue – Fiscal sustainability 101 – Part 1 – Fiscal sustainability 101 – Part 2 – Fiscal sustainability 101 – Part 3.

Thus, it is for all these reasons that I consider the EMU system to have failed to withstand the crisis – pragmatic bailout agreement or not.

Wolfgang Münchau’s column in the Financial Times yesterday (March 28, 2010) suggests that Europe has resolved nothing over Greece.

He says:

Another knife-edge summit in Brussels, another late-night agreement, followed by self-congratulatory poses from European leaders: the “emergency funding agreement” for Greece sounded like a significant deal on Thursday night. But then you wake on Friday morning, examine the details and realise it was mostly smoke and mirrors. They had you fooled for a minute.

The aspect that puzzled me most was the announcement that a rescue would come in the form of a loan at market interest rates. This surely must imply that the market would not be willing to lend money to Greece at market interest rates. That is an absurd proposition.

The point is that if the bailout was invoked it would mean that market interest rates had risen so much that the Greek government could no longer fund itself. So what use will a non-subsidised “bailout” be anyway.

Münchau rightly considers the announcement to be a con job to give “psychological support for the market” which he thinks is “a dangerous confidence trick” and “will backfire, perhaps not right away, but at some point”.

I also agree with him that the immediate problem for the Greeks is that its funding rate is “too high given the likely trajectory of its economy”. As noted above, the only way the Greeks can stay in the EMU is by engineering a very severe and protracted recession. That sort of future provides no growth funds (the automatic stabiliser reversals) which allow a nation to pay down outstanding government debt and service existing debt obligations without default.

I am talking here about a non-sovereign government. For a sovereign government like Japan or Australia or the UK or the US insolvency is never an issue in relation to obligations in their own currency.

Münchau considers that, given this harsh trajectory:

… there may come a point when the Greek government concludes that default is the financially superior option, especially since 70 per cent of Greek debt is held by foreigners. If they are smart, they will take the EU money and then default. In any case, default is still the true backstop, not the emergency loan. Bond market investors should be well aware of that.

As regular readers will know I advocate Greece leaving the EMU immediately. Please read my blog – A Greek tragedy … – for more discussion on this point.

That would require a default on all Euro-denominated obligations. I outline some of these issues in this blog – Exiting the Euro?. But given the foreign exposure the defaulting strategy puts all the balls in the court of the Greek government.

Münchau is correct in his conclusion that:

the combination of no bail-out, no default and no debt monetisation is logically inconsistent.

But the inconsistency lies in the very essence of the Eurozone monetary system structure. It can only be healed by a fundamental abandonment of that almost moronic structure. They either have to abandon national sovereignty and cede fiscal responsibilities to a European government or exit. Under the first option, the resulting supra-national government would have the capacity to engage in fiscal redistributions to offset the impact of asymmetric shocks on different member nations.

The chances of this happening are zero.

So the only other option is to break up the whole system and re-align monetary (and currency) power with the fiscal power and allow exchange rates to float. Then each nation would be sovereign and responsible to its citizens for the economic fortunes it finds itself in. The Greeks would have to then take measures – such as reforming their tax base to ensure stable growth was achievable.

The latter reform, by the way, would have nothing to do with “raising funds” because as a sovereign government there would be no revenue-constraints on public spending. Rather, the tax reforms would give it more flexibility to control aggregate demand and align it better with real output capacity. As noted below, the flexible exchange rate would also allow it to realign its traded-goods sector with those of its trading partners without having to scorch the domestic economy and impoverish its workforce.

On the choices facing Greece, the four German academics who took their own government to court in 1998 challenging the Germany’s entry into the EMU wrote in the Financial Times last week (March 25, 2010) that – A euro exit is the only way out for Greece.

Writing before the bailout offer the four said:

Greece faces the threat of state bankruptcy. No longer is there any illusion that membership of Europe’s economic and monetary union provides protection from harsh realities. Since it entered the euro area in 2001, Greece has sacrificed competitiveness and amassed enormous trade deficits. Theoretically, to make up the economic ground lost in less than a decade, the Greeks would need to devalue by 40 per cent. But in a monetary union, that is impossible.

There is no shortage of proposals to help the Greeks, including assistance from other eurozone governments – a move that would contravene the “no bail-out” rule enshrined in the treaty setting up monetary union. There is, sadly, only one way to escape this vicious circle. The Greeks will have to leave the euro, recreate the drachma and re-enter the still-existing exchange rate mechanism of the European Monetary System, the so-called ERM-II, which they departed in 2001.

Well, first, the esteemed leaders have now violated that rule (by intent). But more importantly it is the Greeks that are being blamed for their own dilemma which in substance is a systemic failure.

I am not absolving the Greek government (or past governments) here. But the terminology “sacrificed competitiveness and amassed enormous trade deficits” gives away the lack of insight of these commentators.

A better way of putting it is that within the EMU (which has a fixed exchange rate and single monetary policy) the Greeks did not systematically erode the living standards of its industrial workers by introducing punitive anti-people policies like the Hartz reforms in Germany. As a result their real exchange rate fell against Germany.

Germany has had a long record of managing the DM (keeping it artificially low) to ensure it remained export-competitive which has increased the costs of imports to its citizens. Once that avenue was denied to them upon entry to the single currency they just shifted tack a little and attacked wage costs while maintaining work intensity (thereby reducing unit labour costs growth relative to their trading partners).

Further, as we have reported in previous blogs the Germans haven’t been backward in pushing millions of euros of military sales onto Greece, knowing that the latter is a trifle paranoid about Turkey. Please read my blog – The bullies and the bullied – for more discussion on this point.

The view of the German Four is that the bailout to Greece (now agreed) “contravenes the no bail-out rule” and they plan further legal action “to enjoin Germany to depart from monetary union”. So that will be a bit of fun.

But while their German-centric view is apparent they make the following sensible point:

It is reasonably clear that Greece has run out of options. The country has adopted an austerity programme of near-unprecedented severity, cutting government spending, raising taxes and depressing salaries. This programme completely ignores Keynes’ dictum that states must face crises with counter-measures to support demand. The Greek action is painfully reminiscent of Germany’s ill-fated moves to slash spending in the 1930s slump, which taught the world that cutting budgets to appease creditors in a downturn generates mass unemployment and radicalises society.

The fact is that the austerity programs in Greece, Ireland, Portugal and elsewhere will make things worse for an extended period. As I noted above, to impose pro-cyclical fiscal policy onto a nation in the midst of the largest crisis since the 1930s is plain madness and is an abuse of economic policy.

There is no doubt it will cause social unrest in Greece and probably Portugal. There is a view around that the Irish will tolerate their declining fortunes because they have typically been impoverished. Any Irish readers are invited to comment on what is going on in social terms as a result of the very harsh austerity program in place there.

But our German friends are right. The options for Greece (and the other struggling nations) is extended poverty or leaving the EMU and facing some medium-term uncertainties including a fairly substantial depreciation in the newly-introduced drachma.

Some people have been saying that the depreciation would be inflationary. It all depends. It would force a once-off adjustment to the terms of trade and so imported goods (like military equipment) would become more expensive. This doesn’t necessarily result in inflation if the consequences are sequestered from the distributional system and the nation takes the “real” cut in living standards that is implied. But the domestic non-traded goods suffer no impacts and form the majority of the consumption anyway.

Further, the real cut via the depreciation is likely to be of a much smaller magnitude than the austerity plan they have in place at present.

The Greek government would then be advised to cancel (default if need be) on all military purchases from Germany and France and redirect their public spending to welfare enhancing measures and enter dialogue with the US government to keep Turkey under control.

Finally, the improving terms of trade will make the Greek islands (and other exports) more attractive – although then they will be flooded with sun-burnt Germans.

The other point is that if the EMU does introduce its new “governance” scheme which will make it even harder for EMU member governments to run their economies, the next time a major negative demand shock occurs, things will be even worse (and more quickly worse) than they were in this crisis. So by muddling through and scorching the domestic economy, the Greek government is just prolonging the agony rather than taking out structural insurance that will protect its people from future ravages.

This applies to all the EMU nations. They are just shortening the plank that they have to walk down every time there is a crisis.

The four German academics conclude that:

… the Greeks have no way out but through the exit door. Restoring the drachma at a lower exchange rate would help exports and lift revenues from tourism. It would also send a message to other countries that they have to take serious steps to avoid landing in a similar predicament. Loss of confidence in Greek economics imperils all of Europe. Removing Greece from the euro provides a way of preventing a drama from becoming a tragedy – and of ensuring the survival of monetary union.

I agree but far from sending a message to the other EMU nations, a decision by the Greek government to leave the Eurozone provides a blueprint of leadership to the other nations and points them in the right direction. Then German can have the Euro to itself.

Digression: Tony Abbott finishes ironman

Many of you will know that I play a lot of sport (cycling and surfing). I wouldn’t say I have work-life balance (or whatever the buzz term is) but I value the physical side of things given I spend hours doing nothing but reading and tinkering in front of a computer which is wrecking my eyesight.

So while I have very little to agree with the Federal Leader of the Opposition in Australia Tony Abbott (who is a right-wing neo-liberal Catholic conservative) I admire his efforts yesterday to complete the Port Macquarie Ironman (3.8-kilometre swim, 180km cycle and 42km marathon) in just under 14 hours.

The point is that the leading government members, who themselves don’t look to be in the best of physical shape, have admonished Abbott for spending too much time training and not enough time working. Abbott says he trains about 10 hours a week which is hardly anything.

Australians face increasingly longer working hours (and an increasing portion of that are unpaid-bullied hours) as labour market deregulation has been introduced by successive governments. That is, the workers who are not underemployed – they are increasing too. So we have a bi-modal hours distribution here. Workers at both ends of the distributions are disadvantaged.

So where does the Labor government (which had origins as the political arm of the trade union movement – long forgotten) get off criticising Abbott when it is overseeing a child obesity problem (with rising incidence of diabetes and other related health issues) and workers are being coerced into ever longer working days. Where does the self-promoting pro-family government get off arguing against a person taking 10 hours of leisure per week!

I liked Abbott’s comment to ABC news where he said the “the most effective workers”:

… have a life If you’re chained to the desk eventually you go very, very stale …

Conclusion

Time to go and do something physical!