A Eurozone Crisis or a Global Crisis?
Is the euro crisis just a European crisis — or is it a global crisis in search of a global governance solution?
- It isn't just the eurozone crisis that has important global linkages. Indeed, all of the world's real challenges are global in scope.
- Blaming the failure of Lehman Brothers on the "subprime mortgage crisis" was a cynical maneuver to deflect blame from the financial establishment.
- The common understanding among eurozone governments is clear: increasing public debt (and indirectly private debt) is no way to cope with a debt crisis.
- In a step-by-step fashion — sometimes too small, often too slow — the eurozone's leaders have actually moved in the right direction.
- The misguided effort to see the eurozone crisis as the central reason for the world's economic woes may have had an unexpected and lasting benefit.
The present European debt crisis finds its main roots in the United States: First, in the U.S. model of development that has spread to much of the rest of the world since the end of World War II, and second in the benign neglect with which the United States has managed its leadership with the rest of the world.
Thus, it is not just, as then-U.S. Treasury Secretary John Connally told European finance ministers in 1971, that the U.S. dollar was “our currency, but your problem.”
The logic of this blunt statement can be extended to the entire U.S. growth model. Benign neglect was merely an elegant way of rationalizing policies mainly driven by the United States’s own — and sometimes blind — interests.
Three main factors stand out in this regard:
1. Debt as an instrument for growth
This generalized model — based on the uncontrolled growth of internal (private and public) debt as well as external debt — would have been completely unsustainable in the United States if not for the highly accommodative stance of the U.S. leadership at the Federal Reserve on down, buttressed by the goodwill of the Chinese central bank. It has now become globally unsustainable in many countries, not just in Europe.
One of the results of such an economic growth model was to permit an excess of debt among consumers (mainly in the form of long-term housing credit, but not limited to that).
This model could have worked in a world of constant and stable growth and low unemployment. But it could never work in a globalized and economically instable environment in which indebted people don’t have stable incomes over the long term.
2. Deregulation as a new propellant
An excessive stance on deregulation of financial markets, mainly during the 1990s, further fuelled these debt-driven economic growth policies.
It took two main forms: The first was the Gramm-Leach-Bliley Act, which in 1999 repealed the Glass-Steagall Act of 1933. Glass-Steagall had sensibly keep commercial banking separate from investment banking and pure financial market activities for more than six decades.
The second key measure of deregulation was the Commodities Futures Modernization Act of 2000, which legalized so-called over-the-counter (OTC) operations. This act unleashed an insufficiently regulated — not to say unregulated — market of $600 trillion.
These measures created a nontransparent financial casino. The only surprise, as Lynn A. Stout, a professor of securities law at the UCLA, has stated, was that “the newly unleashed OTC derivatives market didn’t lead to economic disaster even sooner.”
3. Ideological fuel on the fire
All of the systemic mismanagement on the part of big-time financial market operators and legislators was made even worse — and more dangerous — because of a highly ideological approach to managing the fallout from the U.S.-induced financial turmoil in 2007-08.
Regulators should have known financial houses-of-cards such as Lehman Brothers, Bear Sterns and AIG should have never been left unmonitored and unregulated. It is no wonder they failed. The idea that these institutions operated on the basis of anything that could be considered manageable risks was mere hypocrisy (or worse, willful ignorance).
That the failure of Lehman Brothers and other institutions came to be blamed on the “subprime mortgage crisis” — and, by association, politically weak and unsophisticated U.S. consumer groups — was a highly cynical maneuver to deflect blame from the real culprits: the financial and economic establishment.
The mixture of laxness and short-term, ideologically-oriented actions by the regulators enabled the oncoming calamity. The misunderstanding — to put it mildly — of the risks so created spread all over the world in no time at all.
And so most the European Union and the eurozone countries were caught in a dragnet. This was because their banks and financial institutions were among the biggest of the world (as in the case of France, Germany and the UK), or because they were experiencing housing bubbles (like Ireland, Spain and Portugal).
In either case, because they had not taken proper care to follow their own regulatory and supervisory rules, and instead blindly followed the example of the Americans and British, they all had to pay a very high price.
Don’t get me wrong. These institutions and countries ultimately have nobody to blame but themselves. But it is still very important that we don’t forget the true causality of the eurozone’s debt crisis.
Whatever the deficiencies of the eurozone’s governance, the crisis occurred solely because of the fact that European institutions and countries failed to adopt policies different from the Americans and British.
Saving Europe’s weakened banks imposed great costs on European budgets. Altogether, it has amounted to €4.5 trillion ($5.85 trillion). In one fell swoop, the crisis drove the debt-to-GDP ratios of countries like France and Germany from about 60% to 80% — and much higher for Spain, Ireland or Portugal.
Obviously, even this one event, staggering as it was in its scope, does not fully explain what followed in the eurozone. Its internal crisis could definitely have been better managed.
Deficiencies in proper surveillance mechanisms of eurozone economic and financial statistics allowed Greece to hide its true levels of public debt. There were many other impediments, including national egoism, electoral considerations, and a consensus-based decision-making process that was too slow in responding to the demands of markets.
Too often, the reactions of the eurozone governments that compose the European Council, despite their good intentions, were not prompt enough nor proportionate to the problems at hand. Worse, given the hostile environment, they created a domino effect, with mutually reinforcing negative interactions.
Nevertheless, in a step-by-step fashion — sometimes too small, often too slow — the eurozone’s leaders have actually moved in the right direction, reaffirming and giving flesh to principles already inscribed in the Maastricht Treaty, which created the Economic and Monetary Union.
In light of the crisis, it is now widely recognized that the union cannot be purely monetary — that it must be monetary and economic. That is to say that economic coordination cannot be left, as it has been in the past, to the goodwill of the individual member states.
The eurozone’s economic and fiscal governance needs to be greatly strengthened — and it has been, although further steps remain to be taken. One of the remaining questions is whether the eurozone should have its own budget, which would permit it to engage in globally relevant, countercyclical fiscal policy.
While that particular debate is ongoing, a consensus has been established on building sound public finances. And it is well understood that the prospects for long-term growth in the eurozone requires profound systemic reforms in many countries.
Thanks to pressure from external actors (e.g., the markets) and internal ones (the so-called troika of the IMF, the EC and the ECB), these national reform packages are all on track.
This also extends to proper solidarity being exercised among member states. This is the significance of the creation of the European Stability Mechanism, the action of the ECB and its OMT program, and the European package for an investment-oriented growth, through the so-called structural funds.
Good economic and fiscal management rules, as defined in the Maastricht Treaty — specifically in matters of public debt and public deficits — have to be respected. While this pivotal item had been treated more as a wink-wink manner — as in: let’s all pretend we’re tough — such carelessness is long gone.
The consequences of a severe lack in earnestness since the EMU came into existence in 1999 with regard to following the mutually-agreed upon rules are clear for all to see. And they have been very painful financially.
The idea that “an ounce of prevention is worth a pound of cure” has finally become the eurozone’s credo. And it is here to stay from now on, thanks to the modification of the national constitutions to include “the budgetary golden rule.” Members that accept this rule commit to maintaining a balanced budget.
It also requires that the structural deficit (which does not include one-off effects from debt repayments and business cycle downturns) should be capped at between 0.5% and 1% of GDP, depending on whether their debt-to-GDP ratio is over or under 60%.
The common understanding among eurozone governments is clear: increasing public debt (and indirectly private debt) is no way to cope with a debt crisis.
Any government that is still intent on doing so is bound to incur major risks — if not in the short run, then certainly over the medium term.
There is also agreement within the eurozone that financial and banking markets need to be regulated with more stringent rules that will be monitored at a eurozone-wide level.
This includes placing limits on purely speculative operations and requiring financial markets to contribute to the fiscal adjustment through a tax on financial transactions. (Obviously, this measure should be adopted on a worldwide basis to avoid competitive distortions between financial centers.)
In addition to these measures, Europe is creating several new authorities that have concrete regulatory aims and practical scopes of action, including:
— European Insurance and Occupational Pensions Authority (EIOPA)
— European Securities and market Authority (ESMA)
— European Banking Authority (EBA)
— European Banking Union (EBU)
A lot has moved in the right direction by the European Union — and much remains to be done. But the right tracks have clearly been designed by the “old” continent to evolve towards sustainable long-term growth.
To succeed will require responsible and courageous leaders — not just for Europe itself, but for the world as a whole. And it will require leaders who are able to operate in a purely non-nationalistic manner.
In the final analysis, the misguided effort to see the eurozone crisis as the central reason for the world’s economic woes, as many in the Untied States have tended to do, may have had an unexpected and lasting benefit.
It has made plain an even bigger aspect of “mis-leadership.” It isn’t just the eurozone crisis that has important global linkages. Indeed, all of the world’s real challenges — including climate change, energy security, access to food and water resources, and demographic pressures — are global in scope.
And yet, on these issues we are “invited” to a systematic effort to compartmentalize the proper response — not solely, but predominantly because powerful nations are incapable within their own borders of coming up with even the most basic of outlines for a reasonable compromise and plan of action.
In that manner, the eurozone crisis could merely be an “appetizer.” That ought to put the world community on proper notice.