Wednesday, August 22, 2012

“A Canary in the European Coal Mine?”

Sydney M. Williams

Thought of the Day
“A Canary in the European Coal Mine?”
August 22, 2012

August is the traditional month when Europe shuts down and the powerful (and even the not so powerful) retreat to shores or mountains. The problems left behind do not dissipate. They are simply ignored, while they continue to fester. Chancellor Angela Merkel returned from her holiday to quash rumors that the European Central Bank (ECB) would be setting caps on government yields in Spain, Italy and other debt-burdened nations. Investors Business Daily reported on Tuesday that the ECB downplayed the report, “but did not deny it.” Nevertheless, it seems highly improbable they would do so, as it would mean a commitment to unlimited purchases of debt. The ECB has been buying short-dated government notes, but the Bundesbank, according to yesterday’s Wall Street Journal, considers even those purchases by the central bank “a dangerous move into the realm of fiscal policy.” And therein lies the rub. The euro, as a currency, may be at risk, but any risk to the euro should not extend to the sanctity of the European Union.

The world, as we know it, can live with a failed currency. It cannot live with a failed European Union. Guy Sorman, the French economist was quoted in the weekend edition of the Wall Street Journal. “Europe was not built for economic reasons, but to bring peace between European countries.” Amartya Sen, a Nobel economist from India, expressed similar sentiments in a recent piece in The New Republic: “…the movement for European unification began as a crusade for political union, rather than for financial unification and a common currency.”

While the currency is not the cause of Europe’s problems, it has become symptomatic. Everybody is looking for the canary in the coal mine. Perhaps “Spiegel on Line” has discovered one. On August 13th they reported that, according to the ECB, cross-border lending among euro-zone banks has been steadily declining, especially since the summer of 2011. In June such lending hit its lowest level since the financial crisis first broke out five years ago. It may signal that lending institutions are fearful that the common currency may fail.

The problem, as I see it, is the sense that many people feel that both the EU and the euro are inextricably linked. Such feelings have created confusion between the desire for eternal peace among European nations that caused these countries to form a common political union in the post War years, and the more recent felt need for a common currency. Two wars over a thirty year period (1914–1945) devastated the continent, caused tens of millions of deaths, reduced cities to rubble and destroyed their industrial base. Despite rebuilding, the fear of repetition has haunted European leaders for sixty-seven years.

War has been a constant presence in Europe from time immemorial. The Holy Roman Empire, with its constant battles, dominated central Europe from 962 to 1802. The Hundred Years War pitted England against France from 1337 to 1453. The Thirty Years War, fought mostly in Central Europe, lasted from 1618 to 1648. The Napoleonic Wars (1803–1815) were fought against Napoleon’s aggression from Spain to Russia. The Franco-Prussian War (1870–1871) established Germany as a continental power. And then, forty-three years later, came the Great War. Establishing a common political base was seen as a way to eliminate (or, at least, greatly reduce) the prospect of another war. For a continent that had been racked by such devastation over more than a thousand years, nothing could be as important.

Europe is like a manic depressive that vacillates between periods of abhorrence and times of reconciliation. The dream of European unification is ancient. But so is the hatred. On the eve of World War II, in 1939, the poet W.H Auden wrote:

In the nightmare of the dark
All the dogs of Europe bark,
And the living nations wait,
Each sequestered in its hate.

In the aftermath of World War II, in 1952, seven countries – Belgium, France, Germany, Italy, Luxembourg and the Netherlands, former enemies and allies – joined to form the European Defence Community. From that beginning, the European Union, conceived as a federation of states, was formed. Today it consists of 27 member states, with a population of a little over 500 million people and a GDP of about $16.5 trillion, making it the largest economy in the world. In 1957, the Treaty of Rome created the European Common Market. Thirty-five years later the Maastricht Treaty allowed for the European Union as we know it today, and seven years later, on January 1, 1999, the euro began trading.

The crisis Europe faces now, as M. Sorman notes in his interview, was not caused by the currency; it was a function of demographics and promises made to welfare recipients that were unaffordable and which created a culture of dependency. The Keynesian stimulus spending in 2008-2009 only added to the problem. Declining economic growth has further exacerbated the situation. So, today the economies of the Mediterranean nations are faced with the herculean task of ratcheting down spending and expectations, but without sending their economies into a death spiral. It will require a Clark Kent in the guise of free markets and less regulation.

Among the questions with which Europe should be wrestling include: What steps must be taken so that the euro can be dissolved with the least disruption? How to preserve and strengthen the political Union should the euro unravel? How to wean people from a culture of dependency to the practice of personal responsibility? When to recognize that monetary policy alone is not sufficient to handle the problems Europe (and the United States) faces? How to address what Victor Davis Hanson calls the pernicious cycle “in which the perceived medicine [less regulation and freer markets] seems worse than the known disease?” When to acknowledge that the statement “growth versus austerity”, as it is used by politicians, applies to government, not the private sector?

Democracies are difficult to form and easy to lose. Many of Europe’s are young and untested. If we accept the hypotheses that democracies are fragile in their infancy, but that they are critical to long term financial health and political stability, then it is important to understand that other than France and England, most of Europe is relatively new to the concept. While some democracies were created in the aftermath of World War I, it has only been in the post-World War II period that democracies began to thrive. Even Greece (the fountain from which all democracies flowed) has a current democracy that dates back only three decades, and the former Soviet satellites extend back just over twenty years. Europe’s currency, in my opinion, arrived betimes, before a fiscal and political union. As such, I fear it may not survive. If Europe can handle its dismantlement while strengthening its political and fiscal union then the 21st Century could well be Europe’s.

Is the euro finished, as Niall Ferguson seems to believe and as Milton Friedman expected upon its introduction thirteen years ago? Again, I don’t know, but declining cross-border lending by banks does not bode well. It could be the canary in the coal mine. But the end of the euro does not mean the end of the European Union.

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I will be out until Tuesday September 4, part of the time out of the country. That will provide a respite from my ramblings, and perhaps an opportunity to unclog your in-box. However, should events or personalities prove irresistible, I may not be able to restrain myself.

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