martedì 14 marzo 2017
Why does the US need to get rid of the euro
(...the last time I accessed this document was on October 19th, 2016. I had been asked to write it by a think-tank, under a tight time constraint. I had been told that the text would be published before the US Presidential election. It was not. Therefore, I offer it to my blog's readers. At least, someone will read it...)
Seventy-one years ago, the Axis powers lost WWII, leaving the US with the demanding task of managing its victory and defining a new global architecture. The US did this by setting up ambitious institutions, such as the Bretton Woods system and NATO, and by supporting the European integration project. Institutions have much inertia, which while favoring stability, may prevent vital change in response to evolving situations. This explains both the success of many political projects, and their ultimate fall. The same applies to European integration.
NATO and European integration shared the strategic goal of creating a cohesive alliance that could withstand what was at the time perceived as a credible threat: the Soviet Union. They were successful. NATO (not the EU) secured almost six decades of peace in Europe, while economic integration was a key to prosperity in the former world leader, Europe.
Then something happened. The Soviet system collapsed, which among many other things, brought back to the fore what had for centuries been the root cause of much suffering: the difficult relationship between France and Germany. Berlin-wall panic suggested the nonsensical and impossible goal of European political union. The worst possible way was chosen to pursue it, namely by forcing it through establishment of a European monetary union. No democratic or even meaningful political process can take place in an area which does not share a language or national identity. Yet, despite advice to the contrary from prominent US economists (ranging from Feldstein to Krugman), a hasty marriage of convenience between France and Germany, with the single currency as wedding ring, was seen as necessary in Europe in order to avoid intra-European conflict. Much has been written about whether building a political house starting from a monetary roof was actually a mistake. Like any economic choice, the euro affected the distribution of income, creating losers and winners. The latter of course cannot bring themselves to consider it a mistake. While opinions on this point may differ, everybody agrees that as of today the euro is failing.
The reason for its failure is the same that put the Bretton Woods system out of its misery: both institutions fostered external imbalances, though for different reasons. The original sin of the Bretton Woods system was to adopt the currency of a state as the world currency. The euro’s original sin was to adopt the currency of no state as a regional currency. Their common flaw is fixed exchange rates, that prevent balance-of-payments adjustment. If, for whatever reason, this mechanism is hindered, it must be replaced by something else. The relatively long life of the Bretton Woods system was secured by financial market regulation and by the vision of its leader, the US. These two things are missing in the Eurozone, where unfettered capital movement is fostered in the absence of any regional supervising institution, and where the regional leader, Germany, is patently obsessed by the very short-sighted aim of increasing its external surplus as much as possible.
This Wille zur Macht is now backfiring. Keynes’s proposal at the Bretton Woods conference gives us good insights into what is happening. Keynes proposed to settle international trade in a supranational currency, the Bancor, issued by a world bank, which would charge an interest rate on negative and positive Bancor balances. The rationale for this apparently unfair symmetry (why force a creditor to pay interest, rather than earning it?) is that international debtors and creditors both benefit from international finance: thanks to international lending, the former can buy goods they otherwise could not afford, while the latter are able to sell goods that would otherwise remain in stock. By proposing such perishable money, a currency that by design could not be a store of value, Keynes aimed to discourage mercantilism, i.e. the temptation to hoard international assets rather than reinvesting them in the world economy, thus mitigating the potentially destabilizing properties of fixed exchange rates. The euro obtained the opposite result. Its rigidity fostered mercantilism both by helping redirect trade to the benefit of core countries, whose currency is undervalued in real terms, and by preserving the value of their net foreign assets.
But the supposed winner of the euro game, Germany, is now at a dead end. If it wants to keep the Eurozone alive, Germany must accept the very loose monetary policies run by the ECB. Ironically, Keynes’s negative rates are coming back in disguise, putting strain on the Eurozone banking and pension systems, especially in Germany. On the other hand, a tighter monetary policy would give relief to the creditors, but for the very same reason would lead the debtor countries to immediate collapse by making it difficult to service the debt. Any illusion that fiscal expansion could solve this conundrum must reckon with the fact that the countries needing fiscal stimulus, i.e. the Eurozone peripheral countries, are the very same countries where an increase in income would bring about external deficits, again fostering the imbalances that caused the crisis.
Germany romped to victory by manipulating the forex market (as the US Treasury recently recognised), but must now choose between losing everything at once (through the collapse of its debtors) or little by little (through zero or negative interest rates). In the long run, irrational economic choices have no winners: bad economics cannot be good politics. What should have united Europe is now dividing it. The United Kingdom is going, and continental Europe must now choose between increasing confrontation or surrender to German hegemony. The US, like any global player, must reckon with the evidence that the euro has unnecessarily revived the German question, which it was meant to prevent.
If the US decides that it is in its best interest to deal with a politically divided, economically failing, socially unstable Europe, then supporting the euro is the best option. After all, the divide et impera (divide and rule) principle secured a former Empire some five centuries of existence. If instead the US feels that a politically and economically healthy Europe could be a key partner on the global stage, then it should promote a controlled end to the euro. Undoing the euro will be costly, though less costly than its alternative, which is protracted stagnation of the European and hence the world economy, and the growing risk of a major financial collapse. Secular stagnation and zero interest rates are not a result of some remote astrological circumstance: they are mostly the effect on the global economy of using wrong European rules to manage huge imbalances accumulated due to flawed European institutions. Although Europe is declining, it is still too big to fail without causing great trouble in the global economy.
No matter how much political capital is invested in it, the euro will fall, as top US economists predicted. The most likely cause will be a collapse of the Italian banking system, which will take the German one with it. It is in the interest of any political power, certainly of the declining European leaders, and probably also of the US, to manage this event rather than passively await it.