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Whatever happens to Greece, the euro is unsustainable
Alan Kohler
The latest Greek crisis should end next week after the people surrender
this weekend, but Europe’s foundations will continue to weaken: this
won’t be the last existential crisis for the euro.
Unless greater fiscal and political union accompanies the monetary
union, it will eventually, noisily, fall apart.
But this crisis, at least, is almost over. The Greeks would vote ‘yes’
on Sunday to almost any question they are asked to get access to what’s
left of their euros.
Prime Minister Alexis Tsipras will then agree to Germany’s demands for
reform against the overruled objections from his party, German cash will
start flowing again through the ECB, and Greece’s banks will reopen to
sighs of relief all round. Most importantly, funds will be released to
repay the IMF.
The eurozone’s mistake was letting the IMF get involved in 2010. The
incompetence, or negligence, of its then managing director Dominique
Strauss-Kahn, who acted against the advice of many of his member
countries (including Australia) and half of its staff, set up Greece for
failure.
The IMF’s refusal to restructure Greece’s debt in 2010, and instead to
insist on crushing austerity in return for more cash, was a terrible
mistake. The Eurogroup attempted to repair the situation in 2012 with
the restructure that replaced almost all of the private lenders, but the
damage to the Greek economy had been done.
Ironically, the IMF has changed its mind and is now arguing that Greece
needs some debt relief.
Greek Finance Minister Yanis Varoufakis declared this week that he would
rather cut off his arm than sign another “pretend and extend” agreement
that did not include debt relief, and that he’d resign if the people
voted ‘Yes’. Meanwhile the IMF issued this review of Greece’s debt and
commented that it needs €60 billion over three years, plus debt relief.
The IMF’s central position in the 2010 bailout inserted a hard-line
outsider into what had been a cosy arrangement -- the 15-year-old
European Monetary Union, in which Germany props up the southern
countries with loans and they stagger on, burdened with debt, propping
up Germany’s export machine.
Greece’s failure to make its IMF loan repayment on Tuesday was a
disaster for everyone: the IMF, Greece, Germany and the ECB. It is a
mistake that should never have happened.
The IMF now has the largest and most prominent delinquent debtor in its
history; Greece sits on the edge of catastrophe and Germany, the ECB and
the EU are complicit in the threat to the euro itself. They accepted the
IMF’s money and conditions in 2010 and now, in reality, it is they who
are refusing to repay.
The remote prospect that the IMF might formally have defaulted Greece on
Wednesday morning meant two things happened that dramatically raised the
temperature:
Tsipras called a referendum, ostensibly to get popular support for his
position, but maybe to quell the revolt within his party so he could
cave in to the Germans while keeping his job
Then the ECB took the drastic step of closing the banks, presumably to
pressure the Greeks into voting ‘Yes’.
The Greek people really have no choice but to vote ‘Yes’ and they will
be rewarded for their obedience with cash. The euro ship will sail on …
until the next iceberg.
The fundamental problem will remain: Germany’s surpluses are someone
else’s deficits, specifically Italy’s, Spain’s, Portugal’s, France’s
and, of course, Greece’s.
Since the introduction of the euro in 1999, Germany has run cumulative
trade surpluses versus the rest of Europe of well over a trillion euros.
That has been financed by Germany lending the money back to the
Mediterranean countries, either to finance budget deficits in the case
of Greece and Italy or property bubbles in the case of Spain and Ireland.
So there are two reasons why Germany is desperate to maintain the status
quo: it is now a colossal creditor of those countries as well as the
beneficiary of a weaker currency than would otherwise be the case.
The exchange rate is the most important price in any economy.
In March it seemed that the euro would hit the holy grail of parity with
the US dollar, when it got as low as $US1.0463, but since then the
unfolding crisis has seen it rise back to $US1.10 (note that it hasn’t
fallen with the rising prospect of Grexit).
But the US dollar exchange rate is less important to Germany than the
internal currency lock-in. In the same way that China built its economy
on exports to the US by locking its currency to America’s, Germany’s
economy has been built on trade surpluses to countries to which it has
shackled its currency so they are no longer able to devalue.
It is the classic mercantilist ruse of pegging your currency to that of
your customers, so that your surpluses don’t result in it appreciating,
as it should.
Unlike China’s yuan/US dollar peg, Germany’s was not designed for
economic purposes, but to cement what had been achieved in Maastricht
earlier that decade -- what may be seen as the hard cop/soft cop routine
of Adolf Hitler and Helmut Kohl.
Hitler was the horror that Kohl promised to expunge in 1992 with the
Maastricht Treaty that set up the EU rules, followed by monetary union
in 1999. It was pushed through by Kohl and Mitterrand not to profit
Germany but to contain it, but it has certainly done both.
Before the euro’s introduction, Greece had devalued the drachma by 96
per cent against the deutschmark between 1957 and 1999. The Italian lira
had devalued 85 per cent over the same period and the French franc 75
per cent.
After 1999, those countries suddenly had hard currencies, in effect tied
to the deutschmark. Lenders and investors no longer had to fear constant
devaluations. The money poured in, and it was good -- for a while.
Instead of devaluations periodically rebalancing Europe’s books, money
now flows from north to south through the ECB’s clearing system and
shows up in a ledger called Target 2.
Germany has the biggest credit balance in the Target 2 ledger, about
530bn euros, as shown in this chart:
If the system unravelled as a result of a Greek exit, Germany would be
the biggest loser: it would lose more than the entire capital of its
banking system.
In that event, it would be Germany with queues at ATMs, suffering a
liquidity crisis and asking the ECB for emergency liquidity assistance.
The fundamental cause of the imbalances is shown by the following chart:
The result has been that, even though they all share the same currency,
there has been a big divergence in real effective exchange rates since
the euro’s inception in 1999.
Normally that would be rebalanced by devaluations, and before 1999 it was.
The flaw in European Monetary Union was that a full fiscal union wasn’t
introduced at the same time, merely fiscal rules that could be broken --
and were. But fiscal union, which means political union, was impossible,
and still is.
Australia works fine as a monetary union because it also established a
fiscal and political union on January 1, 1901. It was possible because
all the members speak the same language and, in effect, the citizens
were happy to put the nation ahead of their own state.
Not so in Europe. Greeks are Greeks first, Europeans second; likewise
the Italians, French and Germans, and so on. The only common language is
English for goodness sake.
The architects of monetary union believed in the supremacy of money --
that it is a powerful enough force to overcome cultural and political
differences.
But they were suffering the same delusion as believers in a gold
standard. In fact, the euro is like a gold standard, which JM Keynes
famously described as a “barbarous relic”.
He wrote: “All of us … are now primarily interested in preserving the
stability of business, prices and employment, and are not likely, when
the choice is forced upon us, to deliberately sacrifice these to outworn
dogma. Advocates of the gold standard do not observe how remote it is
from the spirit and requirements of the age.”
The European Monetary Union is analogous to the Bretton Woods system
established in 1944, which set up the IMF and affirmed the gold standard.
In 1971 the United States was actually in a similar position to Greece
now -- suffering a huge and growing current account deficit and growing
public debt. The difference is that the US was powerful, Greece is not.
In August 1971, President Nixon was able to declare an end to the
‘monetary union’ of Bretton Woods by ending the dollar’s convertibility
into gold, in effect devaluing it, while at the same time imposing wage
and price controls and a 10 per cent tax on imports.
The result was that the US dollar became the new gold, replacing the
ancient yellow store of value as the world’s reserve currency. Not much
chance of Greece doing that with the drachma.
As Keynes said of gold, the euro is an outworn dogma remote from the
spirit and requirements of the age and unless it is now accompanied by
fiscal and cultural union, there will continue to be more crises until
it eventually falls apart. Italy will be next after Greece.
Germany simply cannot continue to plunder and fund the southern
countries at this rate. The imbalances and the reductions in real wages
and living standards required in Greece, Italy and Spain are too great.
In the end it comes down to the cliché attributed to J. Paul Getty: “If
you owe the bank $100 that’s your problem; if you owe the bank $100
million, that’s the bank’s problem.”
The imbalances and debt built up in Europe as a result of the
introduction of the euro are Germany’s problem.
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