Union Européenne: Non, l’euro ne survivra pas la sortie de la Grèce

No Mr. Wolfgang Schäuble, the euro won’t survive Greece’s exit

The German minister of Finance, Wolfgang Schäuble, stated in an interview with the “Rheinische Post” on 11 May 2012 that Europe has the capacities to cope with a Greek euro area exit. He went on to say that Germany and its partners have learned a lot during the last two years and have put in place several protection mechanisms. Basically, this is a strong signal from one of the highest German officials stating that the euro can survive without Greece.  Let me say this upfront: No, the euro—and probably the whole European Union project–cannot survive Greece’s exit from the Eurozone. Schäuble’s statement could have been correct if it was given 2 years ago. But now, his statement is tantamount to a Eurozone suicide. And this is why.

However, before we get to why Greece’s exit from the Eurozone would lead to the total collapse of the euro as a currency and probably to the collapse of the European Union as an ambitious yet salutary political project, we need to briefly remember how we got to this point.

The project of the European Union started or was imagined as a purely political project by its founding fathers.  On the ruins of the disastrous and destructive second World War, Robert Shumann, Jean Monet, Alcide De Gasperi, Paul Henri Spaak and Konrad Adenauer (two Frenchmen, an Italian, a Belgium, and a German respectively) began imagining a political project that would knit together the different European countries and make the prospect of another destructive war between European countries an impossible endeavor. Of course, this started with a closer economic cooperation limited to a certain number of goods and services and just between a small numbers of countries, which would later on represent the core countries of the European Union. This limited economic cooperation created a spillover effect, and over time, more goods and services were included and more countries wished to join. Long story short, this economic cooperation spilled over into a political cooperation and led to the necessity of creating a common currency—i.e., the euro.

After the Maastricht Treaty (also know as the Treaty on the European Union) was adopted and ratified by most of the countries, the euro was introduced.  It was first introduced to the financial markets as an accounting currency in 1999 (it replaced the old ECU) and then introduced in circulation in 17 of the 27 EU member states replacing their national currencies in 2002.  The introduction of the euro caused a certain euphoria in the financial markets. Suddenly, countries that were deemed risky for investment saw a drastic influx of cheap capital—i.e., loans. Basically, cheap money started pouring in southern European countries like Greece, Italy, Spain, and even in Ireland and Austria. Belonging to the Eurozone made these countries safe places, though some of them had deep structural flaws (as we came to discover that later on). This influx of cheap capital financed huge housing boom-like bubbles and increased trade deficits.  And then, the 2007-2008 financial crisis hit. It started in the U.S., but soon migrated to the European continent. The influx of cheap money dried up. This caused severe economic slowdowns and downturns in almost all of the Eurozone.

Since the European Union is an unfinished economic integration project topped by an even more unfinished political integration, countries like Greece, Spain, and Italy were literally up the creek without a paddle.  The economic crisis of 2008 led to a huge fiscal crisis in these countries since they had no control over their monetary policies, and they were obliged to keep their budgetary spending within the 3% allowed by the EU agreements.  However, in a time of severe economic crisis, one needs to engage in fiscal deficit spending in order to get out of the hole. The last thing a country needs is drastic cut in public spending. Why? Because drastic cuts in public spending lowers consumption, which lowers demand, which leads to less investments, which leads to less revenues.  And the more austerity measure a given country adopts, the more it reinforces this infernal downward spiral. But what did the EU leaders do? They did exactly what they should not have done.

Germany and France (Sarkozy’s France) forced most of the EU members to engage in drastic public spending cuts hoping that fiscal discipline would calm financial markets and stop speculations. However, these EU leaders misread completely the message that most financial markets have been sending. They were not looking for strict fiscal discipline, though some discipline doesn’t hurt. They were looking for serious economic growth prospects.  Since spending cuts depress economic growth (just look at the economic growth in the Eurozone countries in the last 2 years and you notice that cuts caused economic stagnation and recession in France, Spain, the UK, Italy, Greece, and so forth), investors and bond markets lost confidence in the Eurozone, and that led to higher interest rates on short term borrowing. Not only are these countries killing their economic growth with all those drastic cuts, but also they can’t even find cheap capital to fund short-term operations. Consequence: 3 European countries—Greece, Spain, and Italy—are on the verge of total economic collapse and serious political turmoil.

So, what if we let Greece out of the Eurozone like Wolfgang Schäuble wants? What would happen to the rest of the Eurozone?

Let us game this scenario for a second.

As we speak, Greece is under a slow-moving financial blitzkrieg.  There is a slow moving bank-run on the Greek banks (or what the bankers call a bank-jog). What does that mean? It means that depositors are pulling out their capital to anticipate a possible Greek default or an exit from the Eurozone.  This bank-jog has been going on at a very low rate for the last 2 or 3 months, but it has accelerated since the last legislative elections.  However, the ECB is backstopping, or for the lack of a better word, financing this bank-jog through lending to Greek banks the necessary capital. More accurately, the Greek banks are using the emergency liquidity assistance until the EFSF (European Financial Stability Facility) agrees to release its bonds, so they can use them as collateral.

However, when the ECB decides to stop financing Greek banks (and that’s what the German minister of Finance, Wolfgang Schäuble, means), Greece would effectively be forced to leave the Eurozone and abandon the euro as a currency, and revert to issuing again its own national currency, the drachma.

The first fallout of such a move is that financial markets would lose total confidence in every Eurozone countries. Greece leaving the Eurozone means that the euro is reversible, and any country could decide to abandon it.  Do you remember that bank-jog we just talked about in the previous paragraph? Well, that bank-job would turn into a bank-run on Spanish, Italian, Irish, and possibly French banks. All investors and all financial markets would pull out all of their money at once. Ladies and gentlemen, no bank in the world and in the history of banking has had enough cash or securities in its vaults to face a cataclysmic event like this one. This means that most banks in Spain and Italy would collapse overnight.  A large numbers of banks in France, Germany, Austria, Netherlands, and Belgium would also collapse. This would trigger a worldwide chain reaction and some U.S, Japanese, and Russian banks exposed to Eurozone debts would also be severally affected.

What we would be looking at is a total blow-up of the European Union and a severe global depression.

This is what it means to let Greece leave the Eurozone now. On top of the financial and economic global calamity, we would also have a political one. The rise of extreme right and left political parties in Europe and elsewhere would surely be the most likely political outcome. Mainstream parties would be blamed for the catastrophe and would be completely discredited in the eyes of most voters, which would directly benefit the extreme right and extreme left political leaders.

What to do then to avoid such a calamity? Not only must Greece stay in the Eurozone, but also a more encompassing political economy must be devised. First, the mutualization of the debt must be organized. Second, the ECB must be restructured to issue euro-bonds so member states can directly borrow from the ECB at low rate instead of borrowing from banks. Third, a serious economic growth agenda must be considered so countries like Spain, Italy and others could trigger decent economic growth rates and emerge from the infernal cycle of austerity and depression.

Finally, the ECB must increase the Eurozone inflation rate to at least 4%. Why?  In a recession, you expect average wages to adjust to a lower level. As the unemployment rate increases, workers are willing to accept lower wages, and as wages decrease, employers become more willing to hire more workers. If this does not occur, the recessionary cycle deepens and becomes persistent.  There are several ways to fix this problem, but let us concentrate on the one most suited for the Eurozone. One of the problems in Spain, Italy, Greece and most of Europe is that their workers have become increasingly uncompetitive over the past decade—higher wages, high unemployment rates, and low investments leading to a highly uncompetitive Eurozone worker. One way to correct this is by devaluing the currency, which would effectively reduce wages in a country compared to the rest of Europe. But this solution is not available to most Eurozone member states because they do not have control over their monetary policies. The Eurozone monetary policy is dictated by the ECB.  So how do you reduce wages in those countries when you can’t manipulate your currency? Well keep wages constant, but allow a higher inflation rate. If the ECB allows the inflation rate to run at a 4% level, you effectively get no wage increase, but an effective drop by 4%. This would increase the competitive edge of the European worker.

This is the only way out. But to reach these set of solutions, the ECB and the Germans need to get over their obsession about spending, inflation, price stability, and moral hazard. If Angela Merkel keeps on doing what she has been doing and keeps on bullying the rest of the Eurozone member states into these suicidal austerity programs, she would literally cause the collapse of the European Union. Lastly, the ECB needs to embrace its function as an independent central bank facing drastic economic crisis with a possible political and economic collapse of the whole area. The ECB needs to get over its rigid ideology of price stability and face  reality. Otherwise, there will not be an ECB in a couple of years.