Greece will make it through November without a default. That’s all we can say with certainty, however, as people around the world keep scratching their heads. They want to know why Europe just “doesn’t get it.”
There is one principal reason. Economic and political forces are pulling in different directions and they do so stronger in the European Union than elsewhere.
The late American economist Thomas Sowell summed up this dilemma, which is applicable everywhere, not just in Europe: “The first rule of economics is scarcity: everyone cannot have enough of everything that they want. The first rule of politics is to disregard the first rule of economics.”
Bad Policy Leads to Economic Problems
“There was this notion of one monetary policy fits all. I think it’s a completely absurd notion. And it was really at the center of [this policy], with countries at different stages of development that created a lot of the problems that we are living with now,” says Robert Sinche, a macroeconomic strategist with an extensive history in banking and investment management.
He and other panelists discussed the European Union crisis at an event co-hosted by the New School and the United Nations Association of the United States in New York on Nov. 12.
According to Sinche, this policy created an artificial environment of low interest rates for high-growth and high-risk countries, such as Ireland and Greece. Low rates led to excessive borrowing and investment in unproductive ventures, such as property in Ireland and Spain. “You borrow and you leverage and you continue to leverage, as long as your cost of levering is lower than your topline [GDP growth].”
I am still quite bullish on Europe because there is always another pillar. And the other pillar is the political will.
This was fine as long as the growth continued. However, when growth vaporized in the wake of the 2008 economic crisis, debt service became increasingly difficult and in the end impossible. This in effect led to delinquent banks and sovereigns in Ireland, Spain, Greece, and Portugal—a solvency crisis.
“The bottom line of all this is: We had excessive borrowing, excessive leverage, there are now massive wealth losses and the question is who pays,” says Sinche.
Debt Masked Deeper Structural Issues
The only way for the indebted periphery to get back on track and to repay the debt is to kick-start growth. Previously, the growth was funded by cheap debt. This option is no longer available. The only other option now is to increase output by gains in productivity. However, there is a sharp division between the highly productive Northern and the less productive Southern Europe.
Therefore, peripheral Europe imports more than it exports, leading to a large balance of payment deficits vis-à-vis the northern countries.
“The current account deficit is not being addressed by any of the policies that are being discussed,” says Carlos Abadi, emerging markets veteran and president of broker-dealer ACGM.
Abadi rules out the process of internal devaluation that would keep countries such as Greece in the euro. He thinks the process of cutting wages and prices in order to become competitive is not feasible. Historically, it has led to social unrest and the overthrowing of governments in other countries where it has been tried.
In order to help peripheral nations start again, he advocates debt relief, an exit from the euro and a devaluation of the new currency unit. This would free the troubled countries of debt service and restore competitiveness via a cheap currency.
“My base case scenario is that Europe will try to muddle through for a while longer until one or more countries exit,” says Abadi.
Political Forces Aim to Preserve the Euro
“The economic rationale for creating the European Union and the European Monetary Union was always a little iffy at best if not an ‘Alice in Wonderland’ scenario,” says Irene Finel-Honigman, adjunct professor of International Affairs at Columbia University and an expert on the European Union.
The scholar emphasized the other aspect of the European Union. “I am still quite bullish on Europe because there is always another pillar. And the other pillar is the political will,” she says.
Professor Finel-Honigman frames the discussion in terms of how deep the union needs to be in order to benefit the citizens of Europe. She concludes that the changing geopolitical environment after the Cold War made a deeper union necessary, despite the shortcomings in the economic planning of the eurozone. She ultimately thinks the political forces will be strong enough to overcome economic difficulties.
She also thinks that Greece and other troubled nations will stay in the eurozone: “Many of you may remember the American Rock song ‘Hotel California.’ You could check out anytime, but you can never leave.”
Dr. Christiane Lemke, professor of political science at Leibnitz University in Hanover agrees. “The discussion about the eurozone crisis of course is an economic debate, but at the same time we have to remember why the euro was introduced and what it means for the European Union and European countries.”
Dr. Lemke believes that the European Union has contributed greatly to a period of peace and prosperity since World War II. In her opinion, Germany’s decision to give up the Deutsche mark and join the euro was a commitment to lasting cooperation and peace and that Germany will not jeopardize the project. “The German government has changed its position. … From saying no bail-out to saying bail-out under certain conditions.”
She believes in policies put forward by ECB members to foster growth and mutual economic well-being and in getting away from the rigidity of thinking purely in terms of who is bailing out whom.
However large the political will though, time for European institutions and political leaders is running out, says Robert Sinche: “Changing structural policies is great. Come back in five or ten years to see if they had any impact. Markets aren’t going to wait for five or ten years to figure that out.”