by Frank Thomas and John Lawrence
Frank's remarks go first as he is living in the Euro zone and much more knowledgable than John. John's remarks, which are more speculative come later. Perhaps this can be an ongoing dialogue between our two correspondants.
Frank's Remarks:
The European Court of Justice will ultimately have central oversight of national budgets making sure that budget deficits do not exceed 3% of GDP and total overall debt does not exceed 60% of annual economic output. Debt brakes will be put into law or constitutions committing countries to these fiscal discipline measures. The 3% rule was put into effect in 1991, but it has been given scant attention and has never been enforced. Sound familiar? Politicians have a tendency of flouting, not standing behind, or resorting to subtle ways to shirk enforcement of their statutory legislative actions. But that behavior will be harder for EU members this time as serious sanctions face those who disobey the tough rules. Sanctions might include possible expulsion or willful withdrawal from EU membership.
Premier Cameron found the fiscal-budget oversight measures too much of a threat to UK sovereignty and an intrusion into the City's powerful financial trading services. Thus, his veto of the reinforced fiscal measures means the UK is stepping out of further discussions about the euro, deficits and debt reduction, and funding of the EU central bank. This is not surprising as Cameron has been under extreme pressure from party members who want no part of this development. The UK wants it both ways. They want to have influence but not pay the price of joining the eurozone. This veto means that only the EU 17 have formally or legally committed to accepted central fiscal oversight control and enforcement.
Once the detailed operating mechanisms are worked out, the next step will likely be a prudent, innovative plan to add liquidity to the financial system to restore confidence and put to rest any market panic. In the interim, the European Central Bank (ECB) will reduce the banks' benchmark interest rate from 1.25% to 1.00% to offset the current credit crunch. Also, the ECB will offer banks more long-term loans of up to 3 years versus current 13 months. This will make it easier for banks to lend money in the market place and will offset the flight of private investor capital from EU financial institutions.
To date the ECB has been modestly buying the distressed debt of Greece and Portugal. The ECB is strongly commited to intervene in the bond markets to keep interest rates under control for financially weak countries that are finding it more and more expensive to borrow money on the bond market. However, the ECB will do no more than that now and is not about to print money or buy a large amount of government bonds. The game is to keep the pressure on politicians of financially weak and strong countries to start carrying out tough fiscal measures and debt reduction to make sure this kind of crisis problem never happens again. The Netherlands, Finland and Germany have been the keen initiators of uniting on a policy of strictly enforced fiscal-budget discipline as a first step before exploring the role and funding of the ECB in bailing out insolvent governments, requiring a change to the Maastricht treaty. It's all about coming down hard on the financial recklessness of southern European countries while adhering to the original goal of European fiscal and monetary unification under the euro.
Another complication is that the ECB (unlike the U.S. Federal Bank) is prevented by treaty law from financially coming to the aid of EU member governments. The EU's single legal mandate is monetary stability. It can only aid companies/people by supporting the banks. And that's just what the Germans want and preferably no more. Bailing out and restructuring the bad debt of an insolvent government must be a very last resort action by the ECB after a country's belt-tightening actions have failed. The Germans and Dutch are uncompromising about this principle.
Europe does not want to get on the fast track of wholesale printing of money or selling of EU bonds (or buying up billions of bad debt) in the easy ways the U.S. money system works (e.g. trillions in quantitative easing and selling Treasury bonds). There are many reasons for this: first, the most obvious being the fear of inflation 3-5 years down the road -- a risk Paul Krugman and other economists erroneously consider as highly unlikely with very low inflation today --; secondly, there's the fear of exacerbated debt growth as some countries relax their controls thinking they will always be saved by the taxpayers of the finacially well-managed countries. It's called Moral Hazard.
Another concern is that printing euros on a large scale in Europe is far more inflation-risk intensive than in the U.S. This is because the euro is a relatively small regional currency while over the past 60 years the dollar is better protected against this kind of inflation-risk by being deeply distributed and planted in worldwide banking and transactions' systems. As stated, EU leadership is reluctant to open the money faucets until there is clear evidence of at least a "de facto" fiscal discipline in process. And in all cases the ECB should be the lender of last resort to governments. Presently, there is about €850 billion in the Euro Emergency Fund. Some are advocating this Fund should be increased to €1.5-2.0 trillion to scare the pants off the treacherous currency speculators. So far, EU officials are not buying this advice.
One thing is certain. It's not a question of choosing between the euro falling or fiscal unity. The vast majority of European leaders realize that suggesting or even contemplating the fall of the euro is NOT an option -- it's a self-fulfilling DISASTER scenario affecting the entire world economy. The globalization and advanced data transfer technology processes have bound the financial world into a tight, supremely complex, irreversible interconnection like the attachment of early twins in the womb. Abandoning the euro would trigger a wave of financial collapses, negative growth and a duplication of the 1930s depression. Allowing the euro to fail with the hope of building the system up again with multiple currencies is, as one financial advisor lightly remarked, "like thinking an egg can be broken up and put back together again." Impossible! Furthemore, one currency versus multiple fluctuating currencies makes it far, far easier to undertake long-term investments, cross border transactions and to grow businesses. But of course this requires that fiscal policies of EU 17 are brought in line. A common currency without fiscal and monetary harmony is very problematic as Europe is learning the hard way.
I'm confident EU countries will resolve the loss of sovereignty pain and come up with the right emergency funding actions to calm financial markets and assure long-term fiscal stability and debt control. Already, general agreement is near to raise the banks' reserve requirement to 9% from 6% which could be further increased as a bank gets globally bigger. This responsible financial thinking is in contrast to the U.S. where compromised politicians continue playing the banks' casino games with a paltry 6% reserve requirement and massive bonus payments. The EU bank bonus system will also be sharply reformed. Meanwhile, U.S. authorities cowardly pussy-foot around this insidiously destructive practice. Another more aggressive step being considered is legislation that will allow a failed insolvent (as opposed to illiquid) government to declare bankruptcy or to willingly withdraw from eurozone membership. But, of course this idea, if feasible, must be structured in a highly regulated, orderly way
This is a complex serious matter. The EU mature countries, with the Netherlands as an excellent example, are already taking a tough but balanced, equitable austerity approach to the ongoing recession and to maintaining fiscal sanity. The Netherlands' approach involves four strategies: CUT (for example: waste, culture/social-net budgets, foreign aid, possibly mortgage interest deduction); REFORM (health care, social-nets, financial institutions/systems); INVEST (in sustainable job-producing projects, i.e., education, infrastructure, green energy, R&D, Innovation; and RAISE TAXES (but not on lower income earners).
When European leaders finally come together as they have and say they are fully behind the euro and fiscal discipline, I'm convinced they mean business.
Best,
Frank Thomas
The Netherlands
December 9, 2011
John's Remarks:
In a way Merkel is playing the role of conservative Republicans in the US who want fiscal problems solved by cutting expenses rather than raising revenues. While the Occupy movement in the US is calling for taxing the rich to solve the deficit/debt crisis, Republicans and Merkel seem to be calling for cutting spending. Why isn't their a greater call for taxing the European rich? I did notice, however, that Merkel has called for a Financial Transaction Tax (FTT) which is why Britain backed out of the agreement which all the other Euro zone countries have agreed to. Why does Britain, which doesn't even use the euro, have any say in the matter whatsoever, and does this mean that there will be a FTT in the euro zone sans Britain? If so, this could alleviate some of the austerity which is being advocated.
I also notice the parallel between the Republican war on government workers in the US and the fact that there is a large percentage of the Greek work force involved in government work. I assume that it is Merkel's intention to cut that government work force as part of her austerity measures. But what are those laid off workers supposed to do? I don't think Greece has much of an export economy or even much of a private sector. If the austerity measures are too severe, there will be rioting in the streets as if there hasn't been already. But there will be more.
I think Merkel's approach will probably bring the speculative markets under control and allow Greece, Italy, Spain and Portugal to get a handle on their debt problems. It's interesting that the ECB cannot loan money directly to governments but only (for all intents and purposes) to banks. That is similar to the US Federal Reserve which has offered extremely low interest loans to banks - over $7 trillion of quantitaive easing at an interest rate of .01% - while not dealing directly with the average middle class citizen whose lot is to deal with the banks which offer them no such advantageous deal. The ECB seems to be relying on the fact that bailing out the banks (in advance) will help Euro zone countries with their debt problems because the banks then will be able to loan to the countries involved at a lower interest rate than would otherwise be the case. This still leaves the problem of what to do with all the unemployed workers who will lose their jobs due to the belt tightening.
Redistribution of wealth from the hardworking, thrifty and frugal northern Europeans to the "La Dolce Vita" loving Italians and the "Who me, pay taxes?" Greeks is something that Angela Merkel is adamant against just as in the US the Republicans are adamant that the "job creators" should not pay any more in taxes to help the poor. The rich, whether individuals in the US or countries in the EU, seem to think that they are entitled to keep what they perceive they have earned and not be forced to give it up to those who have squandered their resources. They have worked hard while the others have been lazy and goofed off so why should they have to bail them out?
However, redistribution from rich to poor, whether in terms of individuals as in the US or in terms of countries in the EU, might be the more preferable and humane solution compared to the prospect of rioting in the streets. In order to keep the wolves at bay, it might be desirable for the more conservative elements in both societies to give a little even as reforms are being implemented. It may be necessary for northern Europeans to "carry" their "little brothers" in the south for the sake of maintaining peace and harmony in the EU just as it may be necessary for the weathy in the US to give up some of their enormous gains in wealth and income over the last 30 years in order to stabilize society.
In the last 30 years average workers in the US have made hardly any wage gains while most of the gains have gone to the upper 5%. 30 years ago CEOs made about 30 times the wage of the average worker whereas today they make 300 times the average worker's wage. The middle class has only been able to keep its head above water by going into debt and participating in the bubble economy only to lose big time when the bubbles have burst - first the stock market bubble in 2000 and then the housing bubble in 2008. These two bubbles dropped the floor out from beneath the middle class. Since Europe, especially Britain, has followed the US in its fiscal and monetary policies to some extent over the last 30 years, I imagine that some of the maladies in the economy of the EU are similar to those in the US especially in banking.
In the final analysis, taxing the rich may be necessary in the interests of social stability as opposed to balancing budgets on the backs of the poor and middle class. Perhaps northern Europeans need to relax their work ethic while southern Europeans need to step up to the plate and strengthen theirs. All the countries of the EU need to pull together or it will come apart with disastrous consequences as has happened all too frequently in past history.
Frank's Further Remarks:
Your speculative analysis overall is excellent, but I feel goes way too far in equating EU country tough treatment of the weak nations to that of the Republicans treatment of "the losers" and poor in America. As noted in my writing, Europe will come to the aid of Spain, Greece, Italy, and Portugal eventually as a lender of last resort but only after they show evidence of their committment to get their debt and fiscal house in order. I have no doubt that the EU Emergency Fund will be increased in a sane manner. Don't forget that 26 of the EU 27 countries have just agreed to sacrifice some precious sovereignty in accepting central oversight control of national budgets that will be enforced by tough penalties. This is a major, major change! These 26 nations reflect a population base of over 400 million. It's totally unimaginable that 99% of all states in America with 300 million people would ever agree to such a concept of central budget oversight control. This would be immediately met with screams of a "communistic tyranny" and "down with the government" !!
John's Further Remarks:
Similar to the poor and gullible in the US who took on sub-prime loans which they didn't have a prayer of ever paying back especially after the ARMs reset, the Greek government took on debt that it couldn't pay back which, if the banks didn't actually force on them, they certainly used pursuasion and encouragement to get them to go in debt way over their heads. So in both situations it was the banks who "helped" the Greeks and individual would be mortgagees in the US take on more debt than they should have. Sure one can blame the debtor who wasn't exactly forced to sign on the bottom line, but the banks surely acted as pushers to the debt addition both in the EU and in the US. Unfortunately, the weaker countries such as Greece, Italy and Spain fell for the banks' ploys just as weaker persons in the US fell for the easily obtained credit without realizing what they were getting themselves into.
This is why I think both the Greeks and debtors in the US should be cut some slack. In the final analysis, if it weren't for the banks' policies of making credit easily available to unworthy debtors, crises in both countries could have been avoided. The big banks encouraged individuals and countries to go into debt way over their heads.
Frank's Further Further Remarks:
Improved bailout resources, ECB's support of the banking sector, and fiscal austerity and overhauls where budget deficit and debt limits will be incorporated in national constitutions all give governments time to prove they are serious about financial discipline as well as to finalize a new intergovernmental treaty. The EU's firm, unified commitment that the euro does not fall also means no one is about to let the weak countries go down the tubes providing they move on the financial pack agreed to by the Euro Zone core 17 and the 9 remaining EU states.
