In my previous report, "Bankrolling the Incontinent Subcontinent," I discussed the basics of the European crisis. The mess was predictable. The experts did not predict it.
The Northern bankers did not predict it. They have lent gigantic sums to the Mediterranean governments. Their solvency is at risk. On the extent of the loans, click here.
They should have seen this coming. Over a decade ago, I had a discussion with an Austrian banker. He is still in the banking business, though in Central America. I will let him remain anonymous. He told me that the European Monetary Union would pay a heavy price for bringing the governments of Spain, Greece, and Italy into the European Monetary Union (EMU), which was proposing the euro and the European Central Bank (ECB).
He said that the citizens of the Mediterranean countries would prove unwilling to save money, that their governments would never balance their national budgets, and that at some point they would either default on their debts or have to be bailed out by the EU or the European Central Bank or both. He was correct.
He said that the northern European taxpayers would wind up footing the bill for the spendthrift southern European nontaxpayers.
This is how the crisis of the European Union and EMU is playing out. The politicians want the public to believe that there is a workable arrangement possible that voters in Greece will accept. They are not sure exactly what Greece owes to whom and how soon, but they assure the voters that an arrangement will be worked out that will maintain the purchasing power of the euro, forestall a banking crisis because of Greece's default on its debt, and not cause price inflation due to huge increases in the money supply.
They assure the public that Greece's politicians are willing to impose spending cuts and tax increases that will push the ratio of the deficit to the Gross Domestic Product from 12.7% in 2009 to 8.7% this year and 3% in 2012. This is the promise of Greece's Prime Minister, George Papandreau. He is the leader of the Panhellenic Socialist Movement. He has been the President of the Socialist International since 2006. He was born in Minnesota. He has a masters degree in sociology. Trust him!
Here is a country that cannot balance its budget. It refuses to cut wages of its union-protected government employees. Its public sector workers rioted last week to protest the minimal austerity measures announced by the government. Yet, we are assured by a commissioner of the Economic and Monetary Affairs Commission, that "We expect that in due course the Greek government will take the necessary additional measures." In due course. One of these days. Real Soon Now.
On Friday, February 12, news from Europe came that there would be a bailout of some kind. Now we are told that Greece must jump through some very tight fiscal hoops to get aid. Greece's government must stop looking only to the interests of Greek voters. Bloomberg reported:
Austrian Finance Minister Josef Proell said the region had to "act in the interest" of the euro currency and it was up to Greece to cut its deficit before the EU offers help.
"Nobody can spare Greece the task of cleaning up its own house, Proell said in Brussels. "Only then will we decide whether financial signals have to be sent," he said. Germany's Wolfgang Schaeuble also said additional measures that Greece should take will be considered.
Wait a minute! It will take months for the Greek government to produce fiscal results. In the meantime, how will Greece's government borrow more money to stay afloat? How much will it pay to borrow? How will the crisis be deferred while the Eurocrats are waiting to see the official figures — from a government that has misled the banks from the beginning?
TOUGH LOVE AND SOFT MONEY
This charade reminds me of one of those reality shows where the friends and family of some alcoholic stage an intervention. They gather together and bring in the target. The target wants a drink. He is not interested in lectures. No matter. The group lectures to him. The members tell him he must become responsible. He will either agree to sober up or else.
In this case, the intervention group is made up of his drinking buddies. Throughout the entire intervention, they keep passing around bottles of 100-proof vodka. They are swigging it down like soda pop. But they are telling the target that he has got to sober up. Well, not exactly sober up, but at least cut back on his intake of alcohol.
Here are members of the EU whose nations are all in violation of the EU rule of a maximum deficit of 3% of GDP. There is not one of them even close to this percentage.
These people are telling the #1 boozer of the group that he must stop drinking so much. He will not have to go cold Turkey (sorry; I could not resist). But he will have to show good faith. He is going to have to cut back.
The target readily agrees. He is sweating. His hands are shaking. He sees the bottle being passed around. "I will agree to whatever you say, only could I have just one swig?" They answer yes, and pass him the bottle.
They then report to the press that they see hope. The target has agreed with all their requests. He will cut back on his alcohol consumption in due course.
The trouble is, the members of the intervention group are not allowed to give any more booze to the target.
EU treaties bar the ECB or national central banks from bailing out members countries through buying their debt or offering loans, while rules on government-to-government support are more ambiguous. One clause in the Lisbon Treaty, which came into power last year, permits EU financial aid for a nation in "severe difficulties caused by natural disasters or exceptional occurrences beyond its control."
On paper, this sounds like tough love to me. No aid except in cases of a natural disaster or exceptional occurrences beyond a government's control.
Let's drink to that!
THIS IS A CHARADE
Greece is not going to cut the deficit in 2010 to 8.5% of its GDP. It is not going to cut it in 2011 and 2012 to reach that 3% figure that no member of the EU met in 2009.
As to aid, the ECB cannot lend Greece money. Oh, no. Of course, it can lend money to other governments. What they do with the money is their business.
The ECB has been accepting Greece's debt as collateral submitted by European commercial banks — at 1% no less. Why, without warning, is this going to stop? If it stops, Greece may default. That is the #1 threat. That will take down banks all over northern Europe. Greece is holding the trump card.
Greece may have to pay higher interest rates to sell its debt. That hurts existing owners of older Greek bonds. But banks are not being asked by the ECB to repay the ECB the money they borrowed from it at 1% to buy all those high-interest Greek bonds.
So, what will be the sanction for Greece's obvious inability to meet the deficit-to-GDP ratio? No one in the EU is saying. It's "or else," but the question arises: "Or else what?"
Investors bought stocks in Europe as soon as the market opened on Monday. But then it fell back all day. The euphoria at the announced bailout on Friday was based on some public statements about good intentions. Now the Eurocrats must decide what, exactly, they are able to do about Greece's looming default. There were no specific promises of public funds.
OTHER SQUEAKY WHEELS
The Eurocrats know that if Greece gets financial grease, Spain and Portugal are waiting in the wings. Greece will not be a one-time bailout. It will establish a precedent.
On February 15, Otmar Issing wrote an essay for London's Financial Times. Issing is a former member of the ECB's executive board. He reminded readers that for days, the cries have gone up from the EU that Greece must be rescued in order to save the European Monetary Union, meaning the ECB and the euro. He announced the opposite.
It is certainly true that this is a decisive moment for Emu — but for the opposite reason. Greece will continue to receive support from several European Union funds. But financial aid from other EU countries or institutions that amounted, directly or indirectly, to a bail-out would violate EU treaties and undermine the foundations of Emu. Such principles do not allow for compromise. Once Greece was helped, the dam would be broken. A bail-out for the country that broke the rules would make it impossible to deny aid to others.
The dam will break. That is one way of putting it. I prefer a less apocalyptic analogy: squeaky wheels. The other squeaky wheels will squeak much louder. The voters in Spain and Portugal will see that Greece got the grease. How? By a cry of despair. "Bail us out, or we just don't know what might happen!" Two can play that game. So can three.
Issing went on.
The monetary union is based on two pillars. One is the stability of the euro, guaranteed by an independent central bank with a clear mandate to maintain price stability. The other is fiscal solidity, which has to be delivered by individual member states. Member countries are still sovereign. Emu does not represent a state; it is an institutional arrangement unique in history.
So, if the ECB publicly creates new money to buy Greek bonds directly, this will send a signal: the EMU is gone. As for fiscal stability, this has not existed in Europe for two years. Massive Keynesian deficits have become a way of political life for the West.
This is surely true: "Emu does not represent a state; it is an institutional arrangement unique in history." This is why Milton Friedman thought the experiment would fail. There has never been a central bank issuing money in the name of more than one nation. There is no institutional arrangement to bring international sanctions against a member of the EU.
Now the question is whether monetary union can survive without such a political union. The current crisis must be handled in such a way as to produce a positive answer. The viability of the whole framework — nothing less — is at stake.
Issing said that it is the responsibility of each country to adjust its fiscal policies to the central monetary policy. As he said, "one size fits all."
Then all the nations broke the 3% limit. Greece merely broke it more flagrantly.
Thanks to the euro, Greece has enjoyed long-term interest rates at a record low. But instead of delivering on its commitment at the time of entry to reduce public debt levels, the country has wasted potential savings in a spending frenzy.
The Greek government saw no need to say no to the voters, who want their own personal bailouts. Why should anyone have expected Greek politicians to show restraint? These Eurocrats were either completely naïve or else they did not really believe that Keynesianism leads to national bankruptcy. They were wrong.
In this context, one conclusion becomes obvious: financial assistance for countries that violated the terms of their participation in Emu would be a major blow for the credibility of the whole framework.
He continued. "This moment is a turning point for Emu, and for the future of Europe." He is correct. "For Emu, the crisis represents a final test of whether such an institutional arrangement — a monetary union without a political union — is viable for an extended period of time." Also correct.
Now what? A bailout. Why? Because the European banks bought Greek debt. Then other squeaky wheels will get Greeced. Why? Because the banks also bought Spain's debt and Portugal's debt. They have placed their solvency on the line.
Greece is about to get bailed out. If it does, the other debt-ridden national governments are likely to follow. How will these politicians explain the need for austerity measures if Greece gets bailed out just because of promises from Greek politicians?
I think the euro is a lost cause. I think the rules governing fiscal policies are already broken. They no longer are taken seriously. Now it is the ECB's turn to break the rules. Why not? It lent commercial banks money at 1% so they could buy Greek and other PIIG debt. To stop now could bust the banks. The ECB is the agent of these banks.
There is a lot of bobbing and weaving going on. The fact of the matter is this: the ECB failed to police the commercial banks. They lent to the PIIGs, and the ECB knew it. The ECB put up the money.
When you think of the bankers of the European Central Bank, who express shock at what has happened, think of Claude Rains in Casablanca when he discovers that Rick's has a gambling casino in the back.
February 18, 2010
Copyright © 2010 Gary North