Blanchard and Delong on the Greek endgame - and implications for Spain and the future of the Euro

After the crisis is before the crisis... Olivier Blanchard (via Brad Delong) has some simple home truths for those who think that Greece has now been "rescued" by cutting its privately-held debt by ~80%, a uniquely savage restructuring for any country except Ecuador and Argentina -- what great company for the Eurozone. It's really a gentle reminder that Merkel, Schäuble, and the rest of the German "Austerity Will Solve Everything" Muppet Show just failed Econ 101. The real underlying issue, as Blanchard points out, is the continued current account deficit - still 10% of GDP. Olivier points out that leaving the Eurozone would give Greece a chance to finally increase competitiveness, but with his IMF hat, seemingly rules this out as impractical. Brad Delong, probably remembering the experience of leaving the gold standard in the 1930s, strikes a different balance -- with quitting the Eurozone looking much better. And everything that we say about Greece also applies to Spain. Here is why "internal devaluation" (ie savage wage cuts), the only alternative route to make countries competitive, will never work in the Club Med:

• strong unions combined with an inclination to strike and raise hell. That will damage growth directly
• high private debt burdens. The average Spanish family carries so much debt thanks to consumer + mortgage lending that even a 10% wage cut translates into a 30% fall in disposable household income
• small export sector -- after years of post-industrial growth, there isn't enough of a manufacturing sector left that could benefit from a major increase in competitiveness

So, overall, I think Brad is right - for many countries in the South of Europe, the costs of staying in the Eurozone far outweigh the benefits. Responsible governments should prepare for the day after.

When you don't want to be this right...

(image via libcom.org)

Last year, Jacopo Ponticelli and I wrote a paper looking at the link between austerity measures and unrest. We found a close one. The dramatic images from yesterday - with wide-spread rioting in Athens, building burning, etc. could not bear out our thesis with more force. And there is no question that this was about austerity, either ... normally a tough nut to crack in this context is the question if the link is really causal. Of course, academics always enjoy being able to say "I told you so", but this time, I would have preferred it if the Greeks had proven us wrong.

While there is a lot of understandable frustration with Greece's unwillingness or inability to implement reforms, the riots illustrate that austerity is reaching its limit. How many more budget bills can the government and the troika push through parliament? And what is the implication for the rest of Europe? For the moment, bond markets are a bit calmer, and equity markets are in party mood. The pictures from Greece tell us that the cheer of markets thanks to more austerity is bought in an unsustainable fashion. It's not the most likely scenario, but we may very well see a rapid deterioration in the growth outlook in Spain and Portugal, thanks to all the cuts and tax hikes being implemented now. If this produces yet more deficits and another round of austerity, the Greek scenario is beginning to look much more likely; somewhere along the way, the bond market will panic, and the mother of all bailouts could be on the agenda by mid-summer. Let's hope I am wrong. Even Wolfgang Schaeuble, whose pleasure in forcing austerity on deadbeat ClubMed countries has a been a constant at EU summits, seemed to hint last week that he is starting to change his mind. 

RAC1 interview

You can listen to my words of wisdom about the future of the Euro (and about who is more useful - astrologers or economists) over at RAC1 [in Spanish - program intro is in Catalan].

As part of the media reaction to my Spiegel interview, there is also a bit more over at CNN's excellent background piece on the origins of the Euro crisis, and interviews with European news service EURACTIV with Austrian newspapers Kleine Zeitung and Salzburger Nachrichten. 

My CNN soapbox

A small op-ed piece of mine over at CNN, on whether true Finns, Dutch, or Austrians will break the Euro...

Europe after the End of the Euro

[this is the English original of my article published in Le Monde]:

Europe after the Death of the Euro

For years, countries struggled to defend the rigid link between their currencies. Speculators attacked; country after country implemented austerity programs to make debts sustainable, to win the trust of international investors. At the same time, the economic downturn deepened. Unrest became more common; political systems buckled under the strain of more cut-backs, surging unemployment, and unsustainable debts. And still, the common currency was widely regarded as the best way to assure stability. Without it, no trust in governments, in economic management, no end to economic turmoil, or so the refrain went. And then it all disappeared, almost overnight. Countries abandoned the common currency. And the earlier they did so, the faster their recovery. None of the terrible predictions about the end of the world as we know it actually turned out to be true.

            The time? The early 1930s. The common currency? The gold standard. What sounds like a description of modern-day Europe is actually very similar to the drama played out some 80 years earlier. Cutting the link with gold turned out to be the single best policy measure politicians could take. Britain left early – in 1931 – and only suffered a mild downturn, compared to the US which stuck with gold at the old parity until 1933, or France, which hung on even longer. Where the link with gold was severed, deflation and austerity measures came to an end, debts became more sustainable, growth recovered, unemployment fell. And when people looked back at the interwar gold standard, they soon asked – how could we be so wrong? Sacrifice so much for such a misguided policy?

            Europeans after the end of the Euro will ask the same questions. Why did they waste more than a decade with interest rate policies that were too high for some, too low for others, creating boom and bust as well as unsustainable debt burdens and banks that eventually implode? How did they stomach all these austerity programs and bailout packages, for so little gain? Presented to electorates as a policy without alternative, the Euro is actually a poorly designed currency arrangement that was always more about political symbolism than about sound economics. Today, member countries of the EU have eleven currencies – the euro and ten national ones of members states that have not joined EMU. The European Union will not fall apart if eleven currencies become twelve or fifteen. The Euro can only survive if the German, Austrian, Dutch and Finnish taxpayers are willing to sign a blank cheque; or if economic reforms and austerity packages on a truly frightening scale are implemented. Neither option is politically feasible. It may take a few more rescue packages and a few more years for politicians to finally realize this, but electorates in Europe are already growing restless. Once the true economic and political costs of “rescuing the Euro”, again and again, are fully understood, it will need to be abandoned.    

With the Euro gone, we will see a return to the currency world before 1999. Some countries will follow German monetary policy, either by sharing a currency or by copying everything that Frankfurt does. This is the future for Holland, Finnland, Austria, perhaps the Scandinavian countries. The southern European countries will probably stick with a rest-Euro. Interest rates will be set appropriately; growth recovers; unemployment falls; asset price bubbles become less likely. Some countries may default, and banks in several countries may need to be nationalized, as they were in Scandinavia in the early 1990s. The euro will devalue against the new Deutschmark; exports from Italy, France, and Spain will be more competitive, and German export surpluses will shrink, reducing economic imbalances in the European Union. At the same time, vacations by the Mediterranean, French wine and Italian cars become cheaper for the Dutch, the Danes, and the Germans. This is not a vision of economic apocalypse – it is the way rebalancing should work.

What does this mean for Europe’s political future? Surprisingly little. To be sure, many prominent European politicians will have a lot of egg on their faces. Megalomaniac fantasies about the “United States of Europe” will be laid to rest. The so-called bicycle theory – that Europe has to move ahead or crash – will be forgotten. We will have more pragmatic policy-making, with Brussels starting to look out for the things that actually matter, and trying much harder to make them work. What matters are the single market – free trade, freedom of movement, intellectual exchange, fair play for European companies trying to compete for government contracts elsewhere, or trying to buy another firm.

Instead of the grand visions and grand pronouncements, Brussels will have to focus on the hard, boring, beneficial nitty-gritty. Implementation of existing rules and schemes is important, and Europe currently leaves much to be desired. The single market works only in part; mutual recognition of degrees, for example, is often only a legal fiction. My dubious Oxford PhD cannot be validated in Spain, for “technical reasons”. Don’t ask why it needs to be “validated” at all. Germans are not allowed to buy holiday homes in Denmark; European governments often stop the sales of companies to foreign buyers for no good economic reason; and so on. European integration should be guided by what is good for its citizens and companies.

Sharing the same pieces of paper in the wallets of Europeans turned out to be a bad idea. It has failed at its only conceivable purpose, making the lives of Europeans better than they otherwise would be. Giving up the Euro now will do less damage to the European project than several “lost decades” of unemployment, stagnation, austerity, and riots. The European Union is much more than monetary union, and Europe is so much more than the EU. European citizens know this, but politicians need reminding that this prestige pet project is not the same as Europe’s future.

Just how great is the euro for Germany?

I am at a conference in Berlin on sovereign debt. Last night, at one of the many pleasant restaurants serving remarkably good food at reasonable prices, one of our German colleagues held forth with a view I read a lot in the newspapers - that Germany should just bear the cost of endless bailouts since its industry was "benefitting so much" from the euro. Wage and price inflation elsewhere in the Eurozone made countries uncompetitive; Germany's wage restraint paid off, at the expense of the free-spending peripheral countries. The NYT has a story on changes in export shares of European countries in the last 10 years. The allegedly unfair advantage of the euro for German exporters should matter much less with the ROW -- the exchange rate versus the dollar, the pound, the yen can still adjust. What does the chart show? Germany's export share (relative to the rest of the continent) is up -- but it grew no faster within the Eurozone than for exports to the rest of the world. This doesn't prove that exports to the Eurozone wouldn't be lower if we had the DM, and it had appreciated a lot; but it takes the wind out of the sail of those commentators who argue that swapping shiny cars for junk bonds is such a great deal for the Germans that they should happily carry on doing it forever...

Investment bankers discover solution to the Euro debt problems

The solutions spells M-O-N-E-Y. German money. Lots of it.

The American journalist H.L. Mencken once joked that for every difficult problem, there was a solution that was simple, elegant, and wrong. That is what I was reminded of reading the increasingly hysterical comments being issued by various people in the I-banking community. Euro area debt problems? The end is nigh? Let's get a bailout. We have had three years of effective "blackmail" by the markets, where governments have caved in every single time, making bondholders whole at the expense of the public. The German government some weeks ago felt that enough was enough. Now the rise in bond yields is creating a crescendo of voices arguing that a "fiscal union" in the EU will solve this problem. Bloomberg ran a full story composed of nothing but London-based investment bankers sagely advising that this was the only solution. Among the more bizarre suggestions, the idea that some 350 billion of Greek, Portuguese and Irish debt gets transferred to the core countries to bring debt burdens down... I think these people are based in the wrong place.

Anyone with any knowledge of German politics will tell you that a gigantic bailout - much as our underpaid friends in the City would love it - will not happen. The whole Euro experiment was sold to the German public via a million holy oaths that this could not happen; the already weak consensus behind the euro will crumble before we see a fiscal transfer union or massive debt shifts. Some commentators are always advising that the Germans and French are just bailing out their own banks. True, in part. But that used to favor bailouts in the past; it is now becoming much harder as a political sell. Yet more money for bankers? Not the message you want to send as a politician. And don't forget -- Germany's export performance is largely built on selling to the rest of the world. While most of the EU mostly trades with the rest of the EU, Germany does sell in significant amounts to the US, Brazil, China, and the rest of Asia. Compared to that, exports to Portugal, Ireland, and Greece are miniscule. Germany needs Europe much less today than it did 20 years ago. The second mistake that people make when thinking about incentives for a bailout is to say that Germany is benefiting hugely from other EU countries not being able to devalue against a Deutschmark. True, but the point of Germany's export surpluses is to accumulate foreign assets for the day when the population is dominated by pensioners. A stronger Mark will facilitate buying up assets elsewhere, from factories and stocks to holiday homes in the sun. Bottom line - much of the current chatter about Germany having to step up to the plate for sure is, in my view, a bunch of I-bankers whistling in the dark, hoping that their trades will finally turn around...

a fist full of billions

So the EU finally tried to get "ahead of the curve", and announced the mother of all bailouts -- a cool 750 bn € or so, but who is counting? Speculators, so the official line, caused the markets for sovereign debt to be dysfunctional. That is why the EU offered massive credit lines to Southern Europe, and the ECB is now buying bonds by sovereigns whose debt wasn't worth a great deal a week ago. As a quid pro quo, the countries in question - Spain, Greece, Portugal - are making a big show of tightening their belts, including wage cuts for civil servants, etc. What do we make of this?

The first thing to note is the German reaction. It is a little hard to communicate to people who only speak English that the poor, naive Klutzes in former Deutschmarkland actually believed in the "rules" -- no bailouts, the Euro as stable as the DM, etc. The FT was recently making fun of Germans being a little literal-minded. That may be true, but is hard to overstate the consequences of last week's events. In the minds of many Germans, this is the beginning of the end of the Euro, nothing less. It is not what they were promised, it was a lousy deal in which they gave up something they cherished - the DM - for little more than empty promises of budgetary probity and worthless paper bonds. The idea that there is "no alternative" (Merkel's pitch to the German public re the bailout) is not convincing anyone. I expect that some parties are going to try and make hay of this, or that the constitutional court will actually declare the bailout package illegal.

The arch-conservative FAZ, a daily newspaper that is as close to the CDU as the Times of old used to be to the Queen, just published a fictitious retrospective about the demise of the Euro, with 2010 as the turning point. Their idea - it won't take beyond 2013 to get there. Is it going to happen? Nobody can be sure, but I would say that the probability of an exit of Greece, Spain, Portugal, Italy has gone from 2% to 20% within the next 10 years within a week. Current austerity measures will make the recessions there much more painful; and before long, governments will be tired of budget cuts, strikes, and general unhappiness. The Great Depression ended when countries cut the link with gold, and the earlier they did it, the better they fared. The same will be true -- getting out of the Euro will be a god-sent for these countries, provided they can escape with their banking systems intact.

The Mother of All Bailouts

I was just in Rome for a talk at Ente Einaudi (and some plain old tourism, enjoying Richard Meier's Ara Pacis Museum) when German TV asked me to comment on the mother of all bailouts and latest perturbations of the current sovereign debt crises. For German speakers, the link is here. I am trying to say nice things about speculators, and at the same time think we have to get serious about bank reform. They didn't ask me about the rescue package, which in scope and motivation seems singularly misguided. They do want to know about what to do, and I emphasize the need for financial sector regulation. How often do we want to live with this type of blackmail, where the financial sector asks for a bailout because otherwise, the rest of the economy might suffer.

Times of distress also create a demand for cranky ideas. The Germans from 3SAT found a "visionary" in Vienna that wants to replace the Euro with the Globo -- a single global currency. I think it's a spectacularly stupid idea, and if there is something stunning about it, it's that this kind of idea is given an airing at all. But hey, people discussed Federgeld at some point, money that would lose its value if not used in transactions -- a way to tax "dead capital". The party that pushed it? Just a bunch of freaks, on the very fringe, with no chance to enter office... until they did, in Berlin in January 1933.