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Epilogue: The Euro as Historical Hubris

10. February 2014, von Alexandre Abreu, Comments (0)

The euro is many things at once. Like all other currencies, it is a means of payment, a unit of account and a store of value. Since its inception, it is an attempt to challenge the hegemony of the US dollar as world currency. Insofar as it embodies the transfer of monetary and exchange rate policy from the national to the European level, it is a major step in the process of European integration – albeit one increasingly regarded as ill-advised and out of sequence. But it is also, and somewhat more prosaically, an especially fixed fixed-exchange-rate system – and in that sense, it is also an exercise in historical hubris.

During the course of the 20th century, there have been three major attempts at setting up fixed exchange rate regimes involving significant portions of the advanced capitalist world. The first one was the gold standard of the late 19th and early 20th centuries, which fell apart as a consequence of the outbreak of World War I (as the warring parties felt compelled to adopt expansionary policies in order to finance the cost of war), was resurrected in the mid-1920s, and finally collapsed again as it confronted the structural crisis of the late 1920s and 1930s (otherwise known as the Great Depression). This final undoing of the gold standard was a protracted affair: while Britain and the countries of the so-called ‘sterling bloc’ left as early as 1931, others lingered on until 1938. In historical hindsight, we now know that those countries that abandoned the fixed-exchange-rate regime earlier did a much better job at overcoming the Great Depression (see Figure below, taken from here). Little wonder, then, that the experiment was doomed to fail sooner or later.

Figure

The second major experiment in fixed-exchange rates was the one adopted in the context of the post-1944 Bretton Woods system, in the context of which currencies were pegged to the US dollar, which in its turn was convertible into gold at a fixed rate of US$35 per ounce. It remained in place until the Nixon shock of 1971, whereby the suspension of the convertibility of the US dollar did away with the Bretton Woods fixed-exchange rate system and replaced it with a freely floating currency regime. The proximate cause of its downfall was the US government’s need to finance the Vietnam War, but the deeper underlying cause was the structural crisis of the 1970s (which in fact began to make itself manifest in the late 1960s) and its constraining effect upon profitability, output and fiscal revenue.

And so we get to the third major experiment in fixed exchange rates of the 20th century: the euro, with its predecessor the EMS. The predecessor itself came undone as it confronted the minor crisis of the early 1990s, but still the experiment was carried forward, in a sense through raising the stakes and pressing ahead, in the form of the euro. Then followed the structural crisis of the late 2000s and 2010s – and the rest, well, the rest is history being made as we speak.

Each major fixed-exchange-rate regime experiment of the past 150 years has been undone by each of the structural crises which swept advanced capitalism. Expecting the euro to resist the current structural crisis, at a time when that crisis has scarcely begun to be overcome, while reacting through ever-more-deflationary policies that only exacerbate that crisis, is what I call a fair amount of hubris. A Greek tragedy, as it were.

Europe For Citizens

“This project has been funded with support from the European Commission. This publication reflects the views only of the author, and the Commission cannot be held responsible for any use which may be made of the information contained therein.”

2013: A Year in the Crisis

15. January 2014, von Alexandre Abreu, Comments (0)

So here we are in 2014. As this edition of the Euro Crisis blog draws to a close, it is time to say farewell to the readers and greet the new contributors who will take over and comment on the Euro zone crisis as it develops from here on in. Farewells are also an appropriate time for stock-taking exercises, however, so I think it is appropriate to end my contribution by reviewing what the latest year has meant for the bigger picture of the Euro crisis – at least the way I see it. What progress has been made in the various fronts? And how much closer are we to a resolution of the crisis?

Perhaps not surprisingly, my views are considerably less optimistic than those of most other analysts, many of whom seem to consider that the worse of the crisis is largely behind us. I, on the contrary, believe that we are still far from hitting the bottom, let alone from a resolution. And I also believe that we end the year 2013 in a worse position that we started it.

First, take the superficial element of the crisis: the sovereign debt levels of the eurozone countries. (Superficial in the sense that, as I and many others have argued before, they are a consequence, not a cause, of the crisis.) Between the second quarter of 2012 and the same quarter of 2013 (the latest for which Eurostat has available comparable data), in a context of widespread austerity, absolute public debt levels increased in Austria, Belgium, Cyprus, Estonia, Finland, France, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovenia, Slovakia and Spain. That is to say, in every single eurozone country except for Germany and Latvia. As a percentage of GDP, government debt increased in all 18 eurozone countries except for Austria, Germany and Latvia – including to such remarkable levels as Greece’s 169%, Portugal’s 131%, Ireland’s 126% and Spain’s 92%. Not quite unexpected given the obviously recessive consequences of austerity, but certainly not a sign of progress towards a resolution: greater debt levels mean a greater burden constraining the possibility of counter-cyclical fiscal policy (particularly with the Fiscal Compact in place) and, at least in the Portuguese and Greek cases, a greater amount which will not, for it cannot, be repaid (whether this be through haircuts or sovereign defaults).

More significantly, though, the more fundamental economic variables which encapsulate the nature of the crisis have either deteriorated or remained unaltered during the course of 2013: the massively negative external debt, or international investment position, of the peripheral Euro zone countries (the ‘divergence’ component of the crisis) remained basically unaltered, save for some marginal improvement in the case of Ireland. As for the overall economic performance (the ‘stagnation’ element of the crisis), the outlook also continues to be profoundly depressing: annual GDP growth in the euro area as a whole in 2013 is estimated at -0.4%, while euro area unemployment remains at a record 12.1%. At the same time, the constraints weighing down on that performance have not alleviated: the deleveraging of the private (household and corporate) sector remains to be done, while the spectrum of deflation is an ever-more-present possibility, further worsening the debt overhang and giving rise to recessive debt-deflation dynamics.

At the political and institutional levels, we now have a Fiscal Compact in place which has basically banned counter-cyclical fiscal policy at a time when monetary policy has become well-nigh ineffective; a ‘banking union’ which has not broken the vicious links between troubled banks and troubled sovereigns; a minuscule EU budget slashing all hopes of a recovery led by counter-cyclical policy at the European level; unrelenting insistence on austerity as supposed way out; discontent with the European project growing steadily across the EU; the far right increasingly showing its ugly head as it takes advantage of the European leaders’ incapacity or unwillingness to address the real root causes of the crisis; and a full-fledged humanitarian crisis in large swathes of the European periphery. Hardly grounds for optimism.

Having said this, it is no doubt true that the eurozone crisis has changed its character during the course of 2013: in contrast to earlier on in the year, we no longer experience the crisis as a series of acute episodes, in which the possibility of a dénouement is just around the corner. Instead, we have entered a largely chronic stage, with neither collapse nor improvement in sight. A significant indicator in this respect consists of the interest rate levels on sovereign debt throughout the eurozone: even though the economic outlook has continued to worsen, interest rates, particularly in the eurozone periphery, have fallen significantly over the course of 2013, thus alleviating one of the most acute dimensions of the crisis. By and large a continuation of the ‘Draghi effect’ (the ECB’s manifest willingness to do whatever it takes to prevent defaults in the Euro zone, provided that austerity remains in place), but unintelligible without taking into account the extent to which resistance to austerity has so far failed to materialise at the political level (thus rendering this deleterious low-level political-economic equilibrium much more stable than it seemed 12 months ago).

But this equilibrium will not last, for austerity and deflation are exactly the key ingredients of permanent recession in our current debt overhang situation – and sooner or later the electorate, in at least one of the more chastised countries, will prefer default and the possibility of a euro exit, for all their risks, to the certainty of perpetual impoverishment. In 2013 the crisis turned into chronic stagnation, but we should not let ourselves be fooled by this apparent calm: it only takes one card to bring the house down.

May you have a happy 2014, dear reader – and in these times of crisis, may Europe and its peoples live up to the lofty democratic ideals which the continent has spawned throughout its history.

Europe For Citizens

“This project has been funded with support from the European Commission. This publication reflects the views only of the author, and the Commission cannot be held responsible for any use which may be made of the information contained therein.”

Too Much Trust in EU Institutions

9. January 2014, von Adriaan Schout, Comments (0)

The general impression is that the EMU zone (which gathers countries belonging to, or potentially belonging to, the euro) suffers from a crisis of trust. How can we move forward with European integration when people lack trust in EU institutions? The facts may however be quite different: there is too much trust in the EU institutions and too much trust in the reform capacities in the EMU countries.

The guiding rule for EU-leaders has been to restore trust in the EMU and to get economic growth in the EU back on track. Many steps are being taken to rebuild trust ranging from fiscal compact and banking union, to measures to increase the relevance of subsidiarity. Overall, these measures and the fight for trust will – optimistically – lead to deeper integration.

However, the EMU zone may not suffer from a lack of trust. Paradoxically, this is bad news. First of all, there is generally more trust in EU institutions than in national institutions. Over the past few weeks, I sat in meetings with senior officials and politicians from different parts of the EU. On the question whether they would like to see the EU institutions take over economic tasks and develop into an EU economic government, the answer was decidedly ‘yes’. According to the responses, national institutions (including central banks), have been the cause of the economic and banking problems.

This trust in EU institutions is in accordance with the Eurobarometer which indicates that the people in 17 euro countries have (much) more trust in EU institutions than in their national governments. The bottom of the list with trust in national governments shows euro countries Spain (8% trust national government), Greece (9%), Slovenia (10%), Portugal (10%) and Italy (11%). Other countries with low national trust and higher trust in EU institutions include France (only 24% trust national government) and Ireland (18%).

The consequence of this situation is that there is not so much a lack of trust in the EU (and the related euro institutions) but a national trust crisis – and EU institutions are trusted to manage national economies. If the discussions of the past week are anything to go by, there is a majority of countries in the EU that would like to see the development of stronger European economic governance because they are themselves too weak to run their own economies. In the words of a minister from a country preparing for joining the euro: “the Commission can better decide what is good for us”.

The second reason why there is not a lack of trust in EU institutions is that the EU seems to suffer from traditional over-optimism. Judging by the hope that the EU is better in taking economic governance decisions than national governments closer to their voters, this over-optimism still exists. Greece, Portugal and East European countries were allowed into the EEC/EU. Similarly, accession into Schengen also proved quite easy. Membership was assumed to lead to reforms. In the same vein, despite an argument between monetarist and economic governance economists, euro membership was granted ahead of economic reforms, trusting that membership would do the trick. Hence, the EU has been gambling with economic history based on naïve trust in EU reform mechanisms.

Thirdly, countries have been trusted to be flexible and to develop. However, the French competitiveness index fell from 15th position in 2000 to 22nd in 2013. Italy’s competitiveness eroded as underlined by the drop from 24th position to 49th. Greece managed a slight but hugely painful improvement from 33rd to the 31st position.

Deeper integration is on the agenda. The EU Council meeting of December 2013 concluded additional steps towards banking union and economic contracts. The basis of the economic governance, however, remains a collection of mostly week states; states that seem to have given up managing their own economies and that place their hope in the EU. The EU might as well be doomed with this trust in the EU to solve national reform problems.

Europe For Citizens

“This project has been funded with support from the European Commission. This publication reflects the views only of the author, and the Commission cannot be held responsible for any use which may be made of the information contained therein.”

The Eurozone Crisis: Finance 2 – Society 0

24. September 2013, von Alexandre Abreu, Comments (0)

An interesting and crucial feature of the eurozone crisis, which hardly ever gets mentioned, is the extent to which it corresponds to a massive, lengthy, disguised and undemocratic process of socialisation of debt relations. What started out as a massive build-up of debt/credit relations between private debtors and private creditors has been gradually converted into debt/credit relations between state debtors and state creditors, with the implication that those who will ultimately foot the bill for the inevitable restructuring of the massive ‘debt overhang’ holding the European economy back will be European taxpayers and peripheral-country citizens, rather than the financial sector and its shareholders. The aim of this post is to show why and how this is so, and to highlight the two main phases that have characterised this process.

By way of background, it is worth recalling that the 2007-2008 Global Financial Crisis and the ensuing Great Stagnation are very much akin to the 1929 Crisis and the ensuing Great Depression: in the build-up to both crises, capital-friendly growth regimes ensured the profitability of investments through direct and indirect wage compression; gave rise to increasing inequality and an increasingly central role of finance; and made up for the detrimental effect (upon aggregate demand) of this rising inequality through a massive increase in private debt. The expansion of credit served as a mechanism not only for recycling profits, but also for households to make up for their relatively stagnant incomes and for firms to expand, merge and modernise. The resulting credit-fuelled demand, again in the build-up to both 1929 and 2007, allowed for ‘roaring’ growth, but sooner or later it had to come up against its limits. And so it did when over-indebtedness reached its ceiling and surfaced as a ‘financial’ crisis, originally emerging in the system’s weakest links (in the first instance, the subprime housing credit market in the US), but ultimately exposing the unsustainable basis on which the entire growth regime was built.

In this sense, the current crisis is indeed global (or at least a crisis of advanced, mature economies as a whole), and it is indeed systemic (for it signals the unsustainability of the neoliberal growth regime). Another aspect to be noticed is the radically different character of this systemic crisis (and the one of the 1930s) vis-à-vis the crisis of the late ‘60s and ‘70s, which was the systemic crisis of a labour-friendly growth regime, brought about by the discouraging effect of declining profitability (in its turn arising out of the workers’ increasing bargaining power) upon investment. And the final background commentary concerns the key difference between the crisis of the 1930s and the current one: while they share the same underlying causes, the crisis of the 1930s took the form of the “Great Depression” because the process of deleveraging was relatively rapid, violent and uncurbed by government action; the current crisis, by contrast, has taken the form of a “Great Stagnation” (after the initial shock in 2007-09) because governments stepped in and halted the process of debt deflation (although the consequence is that there can be no sustained growth, absent inflation or major write-offs, because the ‘debt overhang’ remains in place).

In the eurozone context, this otherwise ‘merely’ socioeconomic process (which is the form it has taken in the US, for example) has taken on an especially serious and international character because of the inherently faulty features of the EMU (the inability on the part of deficit countries to undertake currency devaluations; the requirement that the burden of adjustment falls exclusively upon deficit countries, as opposed to being shared by deficit and surplus countries; the interwoven character of national financial systems and national public finances; and the ‘constitutional’ ban on inflation, which would otherwise provide the means for addressing the ‘debt overhang’).

From this perspective, the story of the eurozone crisis may be summed up in two main phases. Phase 1 corresponded to the socialisation of the debt relation on the debtors’ side: economies whose private sectors were up against the limits of unsustainable indebtedness when the process of debt deflation was triggered in 2007-08 (including Portugal, Greece and Spain) very quickly saw that private debt morph into public debt through two main mechanisms – the direct effect of financial sector bail-outs and the indirect effect of so-called ‘automatic stabilisers’ (declining government receipts and rising expenditures due to economic contraction). Recall that the eurozone’s peripheral economies currently being affected by the so-called ‘sovereign debt crisis’ include countries with vastly different public debt/GDP ratios as of 2007 (36% in Spain, 68% in Portugal, 107% in Greece); what they had in common was the unsustainable levels of net external indebtedness of their economies as a whole by 2007 (78% of GDP in Spain, 87% in Portugal, 115% in Greece). The escalation of peripheral countries’ public debt levels was a consequence, not the cause, of the crisis – and reflected the socialisation of the process of debt deflation on the debtors’ side.

Phase 2 is the one that we’re currently going through: it consists of the process of socialisation of the debt relation on the creditors’ side, as private creditors (particularly banks and other financial institutions in the European ‘core’) are gradually replaced by official lenders as the holders of peripheral countries’ ‘sovereign’ debt. After this debt was socialised on the debtors’ side as of phase 1, the impending inability on the part of the governments in question to service it meant that there were only two options on the table: either those governments defaulted, which would have meant losses for the private creditors, or official lenders like the EC-IMF-ECB troika stepped in (as indeed they did), lending just enough to support the continuing servicing of the debt while private creditors gradually rid themselves of these bonds (as indeed they have been doing over the course of the last 2-3 years).

Given that the public debt/GDP ratios in the crisis countries keeps escalating precisely because of the lethal combination of the dynamics of debt deflation and public-sector austerity (i.e. simultaneous deleveraging across all sectors of these economies, implying recession and decreasing ability to pay), it is increasingly obvious that the sovereign debt of peripheral eurozone countries will eventually and inevitably require a default or serious write-down (not like the Greek one in 2012, which did next to nothing to overcome these structural barriers). This is not a “whether-or-not” question; it’s a ‘when’ question. And when it is that this takes place is important for two reasons: (i) the later the default or write-down occurs, the more the burden will fall upon European taxpayers as a whole as opposed to private creditors; and (ii) the later it takes place, the more time peripheral country governments will have to hold their constituencies to ransom in order to undertake the neoliberal restructuring of their societies in a way which otherwise would never have been possible.

In sum, regardless of the uproar in 2008 against the financial sector, its reckless behaviour and the need to rein it in, the story of the eurozone crisis is a re-run of 2008 in a different, protracted and more subtle form: once again, finance tramples society and forces it to bear the burden of its losses.

 

Europe For Citizens

“This project has been funded with support from the European Commission. This publication reflects the views only of the author, and the Commission cannot be held responsible for any use which may be made of the information contained therein.”

Blog Authors

Adriaan SchoutAdriaan Schout

Dr Adriaan Schout is Deputy Director Research/Europe at Clingendael, Netherlands Institute of International relations. (read more...)

Alexandre AbreuAlexandre Abreu

Dr Alexandre Abreu is a 33-year-old Portuguese economist with a PhD from the University of London. Currently he is a lecturer in Development Economics at the Institute of Economics and Business Administration, Technical University of Lisbon, and a Researcher at the Centre for African and Development Studies of the same University.

Almut MöllerAlmut Möller

Almut Möller is a political analyst in European integration and European foreign policy. She is currently the head of the Alfred von Oppenheim Centre for European Policy Studies at the German Council on Foreign Relations (DGAP) in Berlin. (read more...)

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