Wednesday, April 20, 2011
Well well, it looks like Finland is going to throw a spanner into the works about that Portugal bailout, and by extension the whole Euro stability mechanism. Who'd've thunk. Anyway, here's the deal in brief, with my thoughts about it.
The slow-motion train wreck we've been seeing in Europe is due to reality catching up with a structural problem that was inherent in the Euro to start with. The Euro is a currency that has a monetary policy but no associated fiscal policy. That means that the money supply is controlled by the European Central Bank, but bonds are issued by sovereign governments, who also set taxes and control government spending. It also spans a much wider range of different kinds of economies than, say, the dollar.
A number of Eurozone economies—Portugal, Ireland, Italy, Greece, and Spain—have gotten their public finances into trouble. The reasons for this vary. Greece is just a structurally unsound economy, with a corrupt, bloated public sector; Ireland was seduced by the neo-liberal chimera and went from a massive debt-fueled boom into an equally massive bust; Spain and Portugal had a property bubble driven by plentiful foreign money, and Italy is... well, Italy. Each in their own way fell victim to hot money and the illusion of stability provided by the euro.
At the same time, the export-driven economies of North and Central Europe are well into recovery.
Now, if each of these countries had their own currency, things would be relatively straightforward. They'd still be in a mess of trouble, but they could export their way out of it. They could simply float their currencies, which would drop, make their economies internationally competitive again, and jump-start their economies. The downside is that imports would get a lot more expensive, which would make a nasty hit in the standard of living, but at least the shock would be distributed more evenly than having that adjustment through massive unemployment. That wouldn't obviate the need for structural reforms, of course, and those countries with foreign liabilities would see the burden increase relative to the domestic currency; the worst case is that they'd have to default partially on their debts, but that ain't the end of the world either. Portugal has been in default a number of times over past decades, and it's still hanging there on the edge of the Atlantic. Nice place too. We went there for our honeymoon nearly eleven years ago.
However, the countries are stuck with the Euro, for now anyway. The currency is too strong for their own good. That means that the only way out of trouble is through internal devaluation—i.e., cutting wages across the board. That's much more painful and slow and difficult than accomplishing the same by devaluing the currency. Nobody wants a pay cut.
This situation is a nasty cocktail of related problems, each of which makes solving the others more difficult.
The Euro is too strong for the problem economies. They need low interest rates and a weaker currency to restore competitiveness and stimulate spending.
Interest rates are too low for the strong economies. I'm currently paying a negative real rate on my mortgage: my interest rate is less than the inflation. The bank is paying me for lending me money. Of course, I personally ain't complaining, but that kind of situation is a recipe for trouble in the big picture: it's what asset bubbles are made of. The other Northern export economies are in a similar situation. The over-strong euro is counteracting this to an extent and preventing a totally nutty bubble, for now anyway.
The problem economies are still in dire shape fiscally. Simply put, it's unclear if they'll be able to raise enough taxes to service their debts.
The bailout is precisely about preventing default by these governments. There are pretty good reasons to avoid that scenario, if it's at all possible. The debt of these governments is mostly held by European banks. If they do default, that'll be a punch in the gut into the banking system—and it's already been severely weakened by the 2008 crash and subsequent crisis. A credit crisis on the European scale would be very nasty, and lots of innocent bystanders would be hit by the shrapnel. It would certainly cause another global recession in the same scale if not worse than the one that's just winding down. If there's a way of avoiding that, I'm all for it.
The brute-force way of avoiding a default is dead simple: just pass the risk onto taxpayers of countries that aren't in bad shape. If the EU as a whole agrees to guarantee the debts of the problem countries, default is as good as avoided, and everyone can sleep easy. That, in fact, is pretty much what the current deal states.
Except that it assumes that Germans, Finns, and Dutch will happily pay off the debts of Spaniards, Greeks, and Portuguese, while the bankers who took on that risk to start with walk off with their cushy bonuses.
We're not happy about it. It just ain't fair. Wherefore the success of the True Finns.
Or, in pundit-ese, "such a solution may prove politically impossible."
If that turns out to be the case, the stability mechanism will unravel, and we're right back to where we started—looking at the possibility of sovereign defaults causing a collapse of the European banking system and another worldwide recession. Fuck.
Thing is, the brute-force stability mechanism we have now isn't the only way to address this problem, not by a long shot. I still think breaking up the Euro isn't practically doable, and it would very likely trigger that very crisis it's trying to avoid... even though I am starting to think it may have been a stupid idea to start with.
The main problem with the bailout is the injustice and the moral hazard, as well as the general sleaziness of the whole affair—the back-room deal with Greeks buying German tanks with their money, for example. Now we're not only bankrolling a corrupt government and fat-cat bankers, but the fucking German military-industrial complex! How could we possibly make it any more sleazy?
The bottom line is, I don't think this goose will fly. Whether it's Soini's gang or somebody else, the stability mechanism as it currently exists isn't... stable. We'll have to think of something else.
For example, we could do this the old-fashioned way. Let the governments go into default, but not in full-on panic mode. Decide that they pay back, say, eighty cents on the euro, or whatever it takes to get them on a stable footing. Then back up the banks with the usual guarantee mechanisms scaled up: if the hit is too big for a bank to handle, nationalize it, re-capitalize it with public money, and then sell it once the crisis is over.
Obviously this is going to cost money, which we need to raise somehow. I would suggest a transaction tax on capital transfers—something like the Tobin tax—which would have the additional benefit of reducing volatility due to hot money flows. If we simultaneously shut down tax havens like the Cayman Islands and slapped a nice big tax on executive bonuses and capital gains, we could raise the revenue in no time flat, and the burden would be borne mostly by the people who benefited most from the bubble.
So yeah, let's bail out Greece and Portugal, and Ireland and Spain if they need it. We are all in this together after all. Just not this way. Let's not socialize the risks and privatize the profits anymore. The money should come out of the pockets of those who made out like bandits during the boom.
The crisis of the stability mechanism is also an opportunity. Let's do this right this time. And if it works out, we'll all owe the True Finns.