The real reasons EU delays a solution to the Euro crisis

2011-09-03

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The irrationality that is made manifest in just about every European decision vis a vis the crisis, is based on some very sensible real world facts

European elites have been dithering for long now and have not yet delivered any rational solution to the systemic crisis of the euro. In fact the irrationality they have projected so far is legendary and will go down in history as a perfect example for future generations to avoid. They have been kicking the can forward since from summit after summit they have been coming up with half-measures that only succeed in buying time, not in addressing the fundamentals of the crisis. This practice has so far massively failed to contain the crisis and has in fact transformed a problem that could have been solved with minimal losses into an existential crisis that threatens to destroy the euro. I have explained in previous articles why that is the case and you can find them by viewing the list of my articles relating to the Euro Crisis. My purpose today is to assess the reasons that lead European elites to the decisions that they make and the reasons why they are trying to buy as much time as possible.

Buying time only makes sense when you have something else in mind that needs to be completed in prior to other things. So what are these issues? Quite a few actually that can be separated into two categories (which are overlapping but for the sake of understanding them, it is better to treat them separately): those are technical and political.

The technical issues are the following:

1. The need to accept that the European banking sector is walking on the verge of insolvency. This is a really tough task to accomplish under the current conditions, since there is no European authority that would carry out objective stress tests to evaluate the health of Europe’s private banks, nor is there an authority/mechanism that would have the power to re-capitalize the banks that are in need of capital, in exchange for shares. The latter understandably implies a partial or in some cases full nationalization/europeanization of private banks and a restructuring of their debt together with a restructuring of sovereign debt. This role can ideally be given to the EFSF, which now has a very degenerative role that is caused by its toxic foundations. So in that way the European banking sector is brought under a single European authority and the EFSF (which will soon be replaced by the permanent ESM) will finally have a useful task in hand. As things currently stand we are confronted with the preposterous situation in which European banks, which share the same currency, are subject to different legislations from different member-states, while we also have an EFSF that does more harm than good.
2. To set up a much needed surplus recycling mechanism that would take the accumulated surpluses from the European core and recycle them with profit in the deficit regions of the European periphery (and not only) so as to achieve balanced growth and convergence in the constituent economies of the Euro. This role can ideally be given to the European Investment Bank (EIB), which has two times the funding capacity of the World Bank but which remains dormant currently due to a clause in its charter which requires a 50% funding for any project by nation-states. As things currently stand no state has the capacity to fund any project, since all have followed the path of fiscal consolidation, i.e. strict austerity to minimize government expenditures and bring public finances under control. This obstacle can be circumvented by issuing eurobonds (which is the third technical issue) that would take the place of the 50% national participation clause.
3. Issuing of eurobonds. There have been quite a few proposals regarding eurobonds, with the most prevailing idea being that of issuing jointly guaranteed bonds, in a similar fashion the EFSF is guaranteed by all participating member-states. I have said quite a few times that this sort of eurobonds is highly toxic and will in the end succeed in making things worse, something that is accurately pointed out by many experts including Otmar Issing, a former member of the ECB’s executive board and one of the architects of the euro. I personally am in favor of eurobonds but only if those are issued in a very rational way such as that proposed by the Modest Proposal of Yanis Varoufakis and Stuart Holland (see my full analysis of the eurobond concept).

The technical issues alone would not pose a real problem if there was the necessary political determination to overcome them. So here are the political reasons that lead European leaders to the decisions that they make and the reasons why they are trying to buy as much time as possible.

1. The EU is not a political union, where a central authority (government) would take control and full responsibility of the situation in a homogenous way. The EU as it is currently structured is a “political UFO” where heterogeneity prevails and where decision-making is cumbersome, bureaucratic and often lacks democratic legitimacy. This alone would have been enough to justify the delay and the need to buy time, so as to find a homogenous solution to the crisis.
2. The power of Germany and France have always been dominant in EU and Eurozone decision-making. Amid the crisis Germany’s positions has been reinforced, because she is the greatest contributor to all funds and therefore has a de facto greater say. Germany uses this advantage to its benefit to gain immense bargaining power over France (which is not in the best of economic situations) and especially over the European periphery that is in desperate need of money, in this case German money (and other surplus countries’ money of course, just Germany is by far the biggest of them). In that way Germany can push for the reforms she considers necessary. The other important advantage for Germany and France is that they achieve to keep their debt perfectly separable (at least by law) from the volatile public debt of the partners in the periphery.
3. Political courage to challenge private banks and to force them to accept haircuts and a restructuring of their own debts. European banks were never forced to be cleansed from their pre-2008 toxic waste (derivatives), they have ever since accumulated more toxic paper as they also hold much of the public debt of practically insolvent states and they largely depend on the liquidity of the ECB and the money from the “generous” taxpayer. European banks act like black holes in the system that absorb all the money that is thrown their way. The only way to stop that is to be decisive and to take advantage of the need for capital these banks have to impose rules and conditions. This of course is not easy to do, from a political perspective since no national agency will ever take that step on its own, unless there is coordinated, Euro-wide action, which is hard to agree upon, for obvious reasons (why should Germany accept that Deutsche bank should write off a large portion of the periphery’s debt, or France do the same with Societe Generale etc.).

The above-mentioned are the primary reasons that make European leaders delay on deciding on a solution to the systemic crisis of the euro. There are of course other issues of secondary importance that need not be included here, since those obstacles can be transcended with ease if the above are dealt with. Out of this analysis it becomes clear, to me at least, that the irrationality that is made manifest in just about every European decision vis a vis the crisis, is based on some very sensible real world facts. We are now able to see what are the reasons that make European leaders delay a tangible, rational solution to the systemic crisis of the euro. The point now is how much time can they continue to buy and for how long will they be allowed to delay decisions? When will the point of no return be reached?