“A specter is haunting Europe” – Karl Marx (Communist Manifesto, 1848)
Marx may well be proven to be right on this count – though with the craziest of irony. While Marx was speaking of the specter of an imminent Communist Revolution, something truly strange has happened in the 160 years since he made those remarks. Today the specter is not that of Communist Revolution, but of serious national bankruptcy and debt default. This specter looms large across the continent, and it is going to cost A LOT to fix. In fact, there may very well be no easy solution.
A recent NYT Editorial touches on these issues:
http://www.nytimes.com/2010/01/18/opinion/18mon1.html?adxnnl=1&hpw=&adxnnlx=1263841266-/bypFYbIFT9V4aScBY6H/g
While not Marx’s Communism, a form of communal sharing has in fact spread across Europe in the form of a common monetary policy. With the adoption of the Euro ~10 years ago, individual countries gave up their sovereign right to issue currency. This control was given to a central, and in theory non-political, authority known as the European Central Bank.
There were very good reasons to do this. The use of a common currency immeasurably simplifies cross border trading, for example, the sale of oranges from Spanish farms to supermarkets in Finland, or the selling of German cars in Spain. Further, companies can more effectively invest in people and infrastructure across Europe with confidence that their investments will retain stable value. This is a giant win, and a non-trivial accomplishment. Hurray for the Euro!
However there is a darker side to this communal coin, and this is the ability to issue debt in Euros and the responsibility to pay those debts back in Euros. Think about this carefully… in the past we had Germans issuing national bonds in Deutschmarks, Italians in Lira, Greece in Drachma, etc, etc, etc. A bit chaotic, but basically you could trust that the Germans would not allow their Deutschmarks to drop in value (the acts leading to World War II brought on a huge fear of inflation, see http://en.wikipedia.org/wiki/German_hyperinflation_of_the_1920s). You could also pretty well count on the fact that the Italians and the Greeks would periodically run the presses to devalue their currency. For this reason, investors demanded a much higher rate of return on a Lira denominated bond vs. a D-Mark bond from Germany.
Q: Why did the Greeks, Italians, Spanish periodically run the currency presses?
A: Inefficient labor markets. Because the local working classes continually and effectively demanded higher pay (money that the countries did not have), they basically said “yes, we’ll raise your pay” and then printed money to do this. Classic wage infation.
The advent of the Euro changed all this. Countries like Greece, Italy, Portugal and Spain agreed to give up their ability to run the currency presses and basically handed currency control over to the Germans and French. In one sense, this is very good; because the risk of currency inflation has been removed, these countries can borrow at a much lower rate of interest vs. before. On the other hand, it required that these same countries “just say no” to large deficits and the wage-inflation stoking demands of their unions. They have failed miserably in doing this. Having sold lots of Euro denominated bonds at lower interest rates than they were able to get before adopting the Euro, they turned around and spent the money on, you guessed it, a bloated civil service and higher wages. Now the day of reckoning has come.
People who have not spent time in these countries will have difficulty appreciating how very different the labor force is from that in North America; they strike, they burn cars, they really, really protest hard. Civil unrest is a very real concern when any kind of austerity program is tried by a fiscally cornered government. Inevitably the governments relent, and things lurch forward to the next crisis. You can only do this for so long before people stop buying your next set of Euro denominated bonds.
We are rapidly approaching that day, and it would appear the Greece will be the first country to go through a real crises where a massive Euro debt default is not only possible, but seemingly probable.
So what happens when Greece announces that it simply cannot pay its Euro debts? There are several possibilities…
#1 They ask Germany and France for help, in the form of long term loans. They might ask, but why would Germany and France agree? Greece cooked the books (really!) to get into the Euro, and there is little reason to believe they will be able to make good on any bailout. I have a novel solution to propose…but it will never work: Germany and/or France should actually insist on having some Greek islands offered as collateral for their loans (at say, €10 Billion, per island)…should Greece fail to pay them back, the islands would be foreclosed on and transferred to the country who offered the loan. (classic bankruptcy, debt holders become asset holders). This has a nice logical feel to it….but really, will the Greek populace accept losing territory to another country? There would be war (perhaps one involving a large wooden horse rolled into town; precedent exists ;-). So sadly, while I like the idea, and Germany would doubtless enjoy owning a few sunny islands, it is a bust.
#2 They simply default on their Euro debts. “Sorry, we’re bankrupt! We’ll only pay bondholders 10% of face value on our debts. Problem solved!” The obvious problem here is that no one will ever lend them money again, and without those loans their economy will go into a terrible spiral.
#3 They withdraw from the Euro, declare all their debts to actually be in a new currency (the neo-Drachma), and promptly devalue that currency. This is the “quit the Euro” scenario…the problem is that it is basically identical to #2, it is a total debt default.
#4 Some continuing half-measures where the ECB (Euro Central Bank) and member countries pretend that Greece (and the other countries) are getting their house in order in exchange for a series of bridge-loans intended to get them past the crises. This is really just a delaying action, hoping against hope that the economy will pick up fast enough to let the countries scrape by. The problem here is that is does nothing to actually solve the wage/competitiveness problems of these countries; fundamentally the populace and civil servants will need to accept large reductions in their (falsely funded) standard of living. This gets us back to the civil unrest problem.
It’s going to be a messy, painful, and possibly unstable year for the poorer Euro-zone countries…. Marx was right, there is indeed a specter haunting Europe.
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