Friday, July 24, 2015

Don't blame Germany or Greece. Blame the Euro

Published by CapX

Writing for CapX, Iain Martin writes that “the financial and political elite has behaved appallingly towards the Greeks”, noting that “it seems to be forgotten that Germany’s revival after the Second World War was underpinned by massive American aid while victors such as the UK were crippled for decades by the cost of defeating the Nazis”. 

The historical comparison is tricky. After the second World War, newly democratic Germany only enjoyed – conditional – debt relief after it had burned bank depositors. Also, much of Germany’s post-War economic miracle is thanks to measures like eliminating all price controls at once, against the wishes of the US army. This was underpinned by hard money policies which had started in 1948 with a 93% contraction in the money supply, all driven by men such as “ordoliberal” Economy Minister Ludwig Erhard. Perhaps Syriza, which often invokes Germany’s post-war debt situation, should read up on German economic history to get inspiration on how to fire up an economy.

We shouldn’t overlook how the massive transfers made to prop up Greece after 2010 haven’t exactly led to positive economic outcomes for reasons not completely unrelated to the clientelist Greek state. These were transfers, not loans, given that a “loan” with an artificially low interest rate partly counts as a “gift”. These transfers really already started since Greece entered the Eurozone, in 2001, and perhaps before. The prospect for the country to enter the Eurozone resulted in a drastic reduction of its borrowing rate from almost 20% in 1995 to around 3% in 2005. The reason was two-fold: investors considered investing in Greece less risky, given how its banking system would soon enjoy access to the ECB’s cheap money. When the cash started flowing, a lot of it was passed on to the Greek government. Greek politicians were able to burden their citizens with more debt than would ever have been possible outside of the Eurozone. The country would have defaulted long before. Also private debt levels have almost tripled between 2000 and 2010.

It is correct that the billions of euros in bailout funds - estimated at 240 billion euro - have partly served to prop up exposed major European and US banks, which may explain US President Obama’s sudden interest in Europe after the eurocrisis broke out in 2010. This was a mistake made by Germany, but also by all the other Eurozone states. In 2011, private investors agreed to take a haircut of 50% worth 100 billion euro on their claims towards Greece, but in order to convince these investors to do that, they were allowed to dump of a lot of their remaining exposure to taxpayers. With Open Europe, we've warned for this at the time, while we estimate that taxpayers now hold around 75% of claims to Greece, up from 36% in 2012.
Bail-ins and restructuring of the whole European banking system would have been the desirable thing to do, but this would have risked driving up interest rates. Europe’s cash-strapped welfare states would have been forced to impose draconic spending cuts, disturbing an ageing population which is awaiting all the promises made by their politicians for decades. How many voters in Europe would have gone for this, if presented the option? We can blame politicians, but at the end of the day, they are merely executing the electorate’s desires, which can be often summarized in a very simple manner: kick the can down the road, send the bill to the grandchildren. 

The common currency itself is largely a means of bailing out struggling member states. A country like Belgium increased the number of its civil servants with 15% between 2000 and 2010, but saw its borrowing rate drop nevertheless, just like Italy and France. In Spain and Ireland, the easy money mainly went into unsustainable private investment, causing a monstrous real estate boom and bust which badly damaged their banking systems. 

The individual European states had witnessed their borrowing rates going up until 1995. This indicated that the game was soon going to be up. In 1995, the euro was announced, overriding German public opinion. The prospect of having access to a central bank backed by Germany’s creditworthiness and presiding over a very large economy drove borrowing rates down after 1995.
Would this have happened without the euro? Certainly to an extent. The UK, outside of the euro, also saw its borrowing rates drop over the same period, largely driven by central bank activism. Given that investment happens at a worldwide level, also the US Federal Reserve’s low interest policies were influential, having contributed to the fall in borrowing costs for Italy and Spain after 2012, given how the Fed’s balance sheet has ballooned since the Summer of 2012, unlike the ECB’s.

The smaller a monetary union, the more quickly investors will punish its central bank for having excessively increased the stock of money in a bid to lower borrowing rates – primarily to allow governments to refinance more cheaply. Lots of other factors also play a role, of course, but access to the ECB’s “cheap money canal” has been the necessary condition for countries like Greece, Ireland or Spain to get in trouble so deeply. 

The euro hasn’t been a good thing for Greece. The country’s GDP is now lower than before the entered the Eurozone. Also for Germany, however, the euro wasn’t a good thing, although it has been less damaging than for Greece. As one of Germany’s most prominent economists, Hans-Werner Sinn, who built his economic institute IFO into a world player, remarked: “When the euro was announced in 1995, Germany’s gross domestic product per capita was the second-highest among the current euro countries. [In 2013,] it is seventh. That’s not exactly the performance of a “euro winner”. 

Too often the focus has been on Germany’s export success. But there are also importers, consumers, savers, insurers and pensioners. They are all being hit badly by the euro which is artificially weak for Germany. Sinn has estimated that therefore, the benefits of a German “revaluation”, through the introduction of the D-Mark, would be three times as big as the benefits certain parts of the German economy enjoy thanks to the undervalued euro. Obviously German politicians and politically well-connected major exporters are the benefactors of the ECB’s low interest rates, given how it has driven down the German federal government’s borrowing costs. Meanwhile, German pensioners who were assuming to enjoy at least 5% annual returns on their life savings are biting the bullet. And German insurers are facing deep trouble.

To sum up: Greek corruption and the leftwing populist economic mindset of Greek voters certainly has helped to drive the country to where it is today and German – and French - elites certainly could have allowed Greece to default hard on reckless banks in 2010. Then banks could have been bailed out directly, if one wanted to avoid deposit haircuts, which on its turn would have destabilized a system whereby all deposits are not available all the time. This story is much bigger than the recklessness of a Greek Finance Minister or the short term - focus of a Northern European politician. This is the result of the creation of a monetary union serving to paper over decades of irresponsible welfare state spending.

 Pieter Cleppe represents independent think tank Open Europe in Brussels

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