Euro Crisis: A critical assessment of where we stand

2011-09-06

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The longer European leaders cling to their failing policies and their vaunted beliefs that have so far utterly failed to contain the crisis, the more suffering they will cause to European citizens.Image Source: Spiegel Online

The systemic crisis of the euro continues to spread. Contrary to the calm situation European officials wish to project, a number of threats exist in numerous fronts, ranging from the deep and downwardly spiraling recession in Greece, to the worsening of the crisis in Italy and Spain, to the increasing possibilities that the credit rating of France will be downgraded, to the increase in the banking risk of the quasi-bankrupt European banking system, to the fact that the ECB might have to put an end to its bond-purchasing programme, to the possibility that the German Constitutional Court will decide that European bailouts are not in line with existing legislation. The situation is very volatile and things can only get worse if European leaders fail to calm down the markets by finally producing a rational plan to save the euro and put an end to the crisis (such a plan has been proposed by Yanis Varoufakis and Stuart Holland in the Modest Proposal for Overcoming the Euro Crisis).

The current economic environment is quite bleak simply because European leaders allowed it to become as such (I have explained in detail The real reasons EU delays a solution to the Euro crisis. Check that article so that I do not have to repeat myself here). It is an undeniable fact, regardless of its reasons, that European leaders seriously misunderstand the structure of the crisis. They have hitherto given birth to measures/mechanisms that produce adverse effects thus succeeding in making the crisis worse. The combination of bad politics and economic illiteracy that characterizes European action so far, is going to go down in history as the best example of irrationality for future generations of policy-makers to avoid.

European leaders want to believe (or prefer to preach) that the crisis is a debt crisis, caused by certain states who lack “fiscal discipline”. This prevailing idea conceals the other two dimensions of the crisis as well as the architectural flaws of the euro. The other two dimensions of the crisis apart from the debt crisis are the banking sector crisis and the under-investment crisis. The European banking sector is verging on insolvency as it was never cleansed of all the toxic paper that lies in its books (the pre-2008 financial derivatives and the government bonds of practically insolvent states). It acts as a black hole that absorbs all the liquidity that is thrown its way, therefore retarding growth.

As for the under-investment crisis, the eurozone experiences a general decline in investment and in many areas investment has completely stopped (not only in the European periphery but even in many parts of surplus countries). This is certainly not helping us out of the crisis, as without growth the crisis can only get worse.

The voluntary narrow-sightedness of European leaders to address only one of the three dimensions of the crisis (the debt crisis), is compounding the problem since no solutions are being proposed for the other two crises. No discussion is made on the fundamentally important issues of a healthy banking system and real economic growth. “Fiscal consolidation”, i.e healthy public finances, will only make sense once those other two issues are addressed as well.

Coming to the structural flaws of the euro, those can all be categorized under the lack of a fiscal union. The euro is a currency that binds together 17 states, without however having a centralized, homogenous way of dealing with fiscal issues. The architects of the euro, built a house that was never designed for rainy days. For the first years of its life it performed well simply because there was no rain, as the world economy was booming. But when the first storm came its way it simply flooded from all sides.

Greece, Portugal, Ireland the “PIIGS” can be blamed for the malignancies of their economies/societies/states. They can be blamed that their houses flooded first, however they cannot be blamed for causing the storm and the flood, nor can they be blamed for the lack of preemptive system-wide measures that would never allow them to be in that position. What I mean by this is not the need for a series of restrictive measures such as those that German Chancellor Merkel suggests (debt ceilings and any other constraints). What I am referring to is the structural flaws of the euro that must be identified and fixed otherwise the euro will never be a viable project.

Yet under today’s conditions and given the legal, practical, political and time constraints a fiscal union is unfeasible (for now). In practice what the euro architecture lacks and what it could get today, within the existing overall environment, is (a) a surplus recycling mechanism that would recycle the accumulated surpluses with profit across the euro area, in order to achieve balanced growth and convergence and (b) a banking sector supervisory authority that would have the responsibility to carry out objective stress tests and re-capitalize banks. Point (a) can be satisfied by mobilizing the European Investment Bank, which has two times the funding capacity of the World Bank. While point (b) can be achieved by redesigning the EFSF, giving to it a productive and non-degerative role (as it has today). [For more details on the matter see my articles 1) Questions and Answers on the Eurobond – Full analysis -2) The real reasons EU delays a solution to the Euro crisis -3) More on the insolvency of the European banking system]

It is clear, to me at least, that the longer European leaders cling to their failing policies and their vaunted beliefs that have so far utterly failed to contain the crisis, the more suffering they will cause to European citizens and the worse the situation will get, not only in the economy but also in the society. Time for a revision of approach is running out. I believe that now is their last chance to fundamentally revise their strategy vis a vis the crisis, otherwise the point of no return will be reached and then nothing will prevent the euro from collapsing (with all the catastrophic implications this will have in the overall life of the EU). European leaders must finally accept that the crisis is systemic and requires system-wide solutions. They must put an end to today’s ad hoc half-measures that waste taxpayer money by throwing it in the black holes of the system, that are ineffective in their cause and which often lack democratic legitimacy. The euro is not just a common currency, it most of all bears the idea of a common Europe. It is foolish to destroy in such a short time what took decades to build.