Sunday, 27 May 2012

Superstate or separate

Europe’s choice

That is the main message of the leading article in this week's ECONOMIST.

And it is right.    Europe has arrived at a fork in the road ahead.   It must either choose the Superstate road leading to further integration beyond the monetary stage achieved so far and upgrading it to a fiscal, banking, economic and finally to a political dimension where the citizen is more intensely involved in the election of EU leaders and not just national leaders or ineffective parliaments, or it must roll back the progress achieved so far and follow the road to Separatism.

The real choice is not really whether to have a Euro with Greece or without Greece but whether to have a Euro backed with fiscal and banking integration or not to have a Euro at all.

There is no doubt in my mind that the choice of a Superstate is much much preferable to the choice of Separatism.    We have had ample evidence in the last century that the separatist road leads to conflagration and human tragedy whilst the co-operative internationalist devotion lead to peace, stability, eradication of poverty and economic growth.

But it is absolutely necessary to define what a Superstate means.     If it means that we all become German and the Mediterranean would become a German model with better weather,  than that it is just not on.

Just see this link of Der Spiegel to see how for all their economic success the Germans simply can't learn how to enjoy life.

Spiegel - study-finds-germans-incapable-of-enjoying-life-

Superstate must allow for diversity and for making the best of economic models based on German style seriousness and efficiency and Mediterranean way of enjoying life.

To solve the current Euro crisis there are temporary measures that have to be taken to put out the fire but there are also important structural changes to be made to the Euro house structure once the fire has been put out; structural changes needed to ensure that the house is equipped with precautionary and safety measures so it does not catch fire again.

When a house is on fire you don't need a fire consultant telling you what fire safety precautions are needed.  You need a fire engine with an abundance of water and a big hose pipe.

In the current Euro crisis there is only one institution that can provide the fire engine with abundant water and a big hose pipe.   That institution is the European Central Bank (ECB).   

The ECB has to be ready to do three things to avoid the Euro house being completely gutted by fire irrespective of whether Greece stays or goes.

  • Huge, may be unlimited, liquidity injection initiatives to ensure that banks in all Euro countries  have all the necessary liquidity to meet and nip in the bud any loss of confidence by depositors  because of events in Greece.    This has to be on the same lines of the recent LTRO may be renamed LerTRO meaning Longer Term Refinance Operation as the term gets increased from three to five years and the collateral requirement relaxed even further. 

  • Display of readiness to intervene directly in the bond markets through its Securities Market Programme (SMP)  to keep within serviceable limits yields on bonds of countries undergoing and adhering to austerity programmes. No country can stay on course with austerity and restructuring if the savings made through austerity have to be paid out in higher borrowing costs.

  • Launch of a huge fund (sourced by government contributions from fiscally strong countries  and through monetisation by the ECB) whereby the EIB or the ESM will supply fresh capital to EU banks that are judged insolvent not merely illiquid. This especially applies to Cyprus, given its exposure to Greece, and to Spain given the bad assets still lying on its banks’ books.
These measures are so unconventional that they will most certainly meet resistance from the German Central Bank (BuBa).     The latter remain locked in a anti-inflation mind-set with scant realisation that the price stability threat is more from the downside rather than the upside, more from deflation rather than inflation, and that there is an existential threat to the Euro project, indeed to the whole European integration and peace with stability project.

Something has to give.   BuBa will have to break out of their mind-set and consider what the economic consequences for Germany would be if the Euro breaks up and Germany would have to revert to the Deutsche Mark.

BuBa strict monetarist approach that monetisation will lead to inflation is a fallacy out of tune with current realities.    The monetisation incurred through these non-conventional measures will not lead to increased spending in the economy where the velocity of circulation of money has dropped dramatically and the normal banking system is not creating money through the normal lending process.  Banks in distress are no longer in the business of lending money.

Furthermore all these measures are reversible.   Just as in the US the TARP measures were reversed with little or no cost to the taxpayer and with clear positive impact on the recovery, the non-conventional measures explained above can be reversed when we get to post-crisis mode.   The SMP and LTRO programmes can be reversed.   The recapitalisation fund can be wound down when circumstances permit banks to repay their extraordinary funding ( through redemption of Preference Shares) or through privatisation ( through sale of ordinary capital).

Once the fire has been put out through these measures than we have to install better security systems so it does not recur.   These security measures must deliver balanced growth through the whole EU and Euro area.   We must not have the north and south divide.    We must not have surplus and deficit countries.   We must not have countries like Germany capable of borrowing at zero interest rates and other countries either shut out of the borrowing markets or having to pay atrocious interest rates.

What sense does it make for Italy and Spain to pursue painful austerity if the economic gains achieved through such austerity have to be paid out in higher interest rates rather than re-invested for growth in their economy?

To achieve such balanced growth Germany has to become a bit more like Mediterranean countries and start enjoying life not just economic benefits.    At the same time Mediterranean countries have to become a bit more like Germany in rendering their economy more flexible and efficient.

Just as Ireland, Spain, Portugal, Ireland and Cyprus are undergoing a prolonged internal devaluation process, cutting wages and benefits to become internationally competitive again,  Germany should immediately undertake an internal revaluation process.

Germany should tolerate domestically a higher level of inflation, encourage private sector wage settlement at a higher level to compensate for the wage freeze suffered during the prolonged integration of the East to the West,  and consequently encourage a shift of demand from domestic brands to imported brands and shift of production to relocate to other Euro area countries with comparative cost advantages.

Such moves are totally within Germany's own jurisdiction, need little parliamentary intervention, are perfectly in line with the German Constitution and are far more effective for promoting growth than Euro bonds or Fiscal Union.   They may even be politically popular for Mrs Merkel's re-election ambitions.

Euro bonds and Fiscal Union may come later.

1 comment:

  1. We've certainly been here before Alfredo. Much depends on the ability of Merkel & Hollande to find common ground on the future of the euro. Whether that happens before June 17 (e-day in Greece) or after, I simply do not know.