European integration was a grand plan, perhaps driven by lofty motives. I don’t take a position on that since I’m not European. But as we have argued from the very beginning, the set-up of the EMU was fatally flawed. At the very least, they “put the cart before the horse”—adopting the euro before they achieved fiscal integration under a fiscal authority with sufficient sovereignty to protect the member nations. For references to our early work, see here, here and here.
Indeed, the whole set-up seemed to have been flawed by design and desire. The idea was that permanent austerity is the path to growth. You see, since none of the EMU members was sovereign in the currency sense (each adopted a foreign currency), they’d have to adopt austerity individually. And then the European Parliament was not given a proper Treasury, so its spending required contributions from the nonsovereign states.
It would be like asking Uncle Sam to operate solely on hand-outs from Mississippi. And then if Mississippi got in trouble they’d be deep in the soup since Uncle Sam would not be able to help out. Good luck with that.
The only way any individual state could relieve the austerity would be by operating a beggar-thy-neighbor mercantilist policy to suck demand out of the other states. Germany excelled at that.
So while the whole idea behind unification was to prevent the un-neighborly behavior that had led to two World Wars within Europe, the construction of the EMU was guaranteed to promote it. The EMU promoted self-interested behavior by any member willing to pursue it, and Germany reaped most of the rewards.
Add on top of that the wisdom of unleashing the depravity that modern financial institutions are known for with free “capital” movements and you had the makings of a guaranteed financial crisis. The icing on the cake was to make individual nations fully responsible for their own out-sized financial institutions.
Without fiscal sovereignty the first serious financial crisis would blow up the budget of some member nation. Ireland? You betcha. The rest would be history, as the rest fell like dominoes.
And so it is wrong, now, to point the finger at Troika-imposed austerity for problems on the periphery. Permanent austerity was always the plan. This is not new. It is the way that nonsovereign governments must operate in the absence of a sovereign center.
And there is still no sign that the fundamental flaw of the EMU will be resolved.
So, how’s that Euro thingy working out? Not so good. And it won’t get better.
The problem was never one of profligate Mediterraneans with lax fiscal policy. No Euro nation should ever have run chronic deficits of any size; none should have run up any significant debt ratio. By design, these are not sovereign countries in the currency sense—they abandoned their own sovereign currencies years ago in favor of a foreign currency. And like any nation that gives up its sovereign currency, every one of them lost the ability to run chronic budget deficits.
What is a bit surprising is that it lasted as long as it did. Part of the answer is that financial institutions run amuck were able to bubble up economies for quite a while—just as they did in the USA. Further, there was the “confidence” fairy—a belief by markets that if the you-know-what hits the fan, the ECB will violate its mandate and bail-out. Finally, there is the rather high probability that creditors were fools—unable to understand the difference between a sovereign currency issuer and a government that uses a foreign currency.
The final act will play out over some period of time. First the PIIGS, then France, Austria, Finland and the Netherlands. But it will get to Germany. Germany! Yes, the mother of all fiscal rectitude. Its own debt ratio is orders of magnitude too high for a country that gave up its currency. (Remember Argentina? Adopted the currency board—essentially the same thing as adopting the euro. It always met the Maastricht criteria—unlike Germany—and collapsed into crisis all the same.) And Germany’s success depends on demand from the rest of Euroland—demand that is quickly collapsing.
The EMU can be saved. But saving it will require that the ECB do something that goes against its DNA. The EMU was set up with its restrictions precisely to ensure that there would never be a rescue by the ECB. The separation of Euro-wide monetary policy (interest rate setting) from fiscal finances was to be inviolable. The ECB has done more than I thought likely. However, you cannot run a monetary union without fiscal authority relying on a reluctant central banker to go against its programming.
Hence, it is not at all clear that the EMU will be saved.
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