This essay is from the book Euro
or Not?, which was published on June 5 in Helsinki,
Finland, by the think
tank Suomen Perusta. Authors of the
book include current and previous members of the European Parliament, Finnish
Parliament, a previous minister, economists and bloggers.Suomen Perusta is operated by The Finns Party and the full document (in Finnish only) can be downloaded from the think tank’s website in PDF format – along with the previous publication How the euro area develops?.
“For political
reasons”
The European common currency is a failed project by any
objective measure, but admitting the truth is politically difficult. [1,2] In the participating countries, whole
institutional chains from banks to politicians and from corporate management to
intellectuals have bet their credibility — and even their existence — on the
euro. When one understands this background, understanding the present, and what
is still ahead, is much easier. I will begin with a description of the euro’s
first crisis in the early nineties, followed by Finland’s
final decision to join during the government of prime minister Lipponen; then
detail the inconvenient truth of the current situation and finally, I will list
possible future developments.
The horrors of the
90s – lessons not learned
In Finland
the main problem was the liberalisation of the financial markets, combined with
the need to break out from the Soviet Union’s circle of
influence and a clear need to end the repeating inflation-devaluation cycle.
These factors led the country to apply to and join the so-called power cores
and the currency union as one of the first adopters. The Finnish media was
largely pro-Europe and pro-euro, thanks to the late media magnate Mr Aatos
Erkko, who approached all the major newspapers and television channels to
entice them to join in on pro-EU and pro-euro campaigning. [3,4]
Germany’s
domestic political motives destroyed the Exchange Rate Mechanism (ERM) project.
When the two Germanies were united, chancellor Helmut Kohl decided to unify the
currencies of West and East Germany
at an exchange rate ratio of 1:1. This led to higher inflation and forced Germany’s
central bank, the Bundesbank, to raise interest rates. Together with the
bursting of the bubble of the eighties and the ensuing global recession, this
put the other ERM member nations in a difficult position: they were forced to
raise their own interest rates in the footsteps of Germany
in order to maintain their fixed exchange rates. This led to a self-inflicted
recession in most of the ERM countries. Only when on the brink of total
destruction did most of the members finally float, devalue or expand their ERM
exchange rate corridor to such a degree that they in effect devalued their
domestic currencies.
For the elite in Finland
it was practical that the deepest recession of any OECD country since WWII
could be blamed on the collapse of the Soviet Union,
debt-fueled consumerism, banks’ risk taking and international currency
speculators. The downside of this was that the real culprit was neither named
nor discussed, which gave even more reasons to continue on the selected track.
Nobody wanted to admit that fixing the exchange rate was a major reason for the
troubles. The myth of the Finnish currency’s fragility was born: the sky-high
interest rates, the exchange rates manipulated by the speculators and the
exodus of foreign investors.
In most of the ERM countries the situation was similar, and
further analysis would have provided politically awkward results. Members of
the elite probably started to believe the fairy tale themselves. The
alternative of being wrong and having made a mistake was too discomforting.
Even Germany’s
monetary solo flight was not publicly condemned. [5-10]
More “medicine”
Mr Lipponen had made up his mind and with support from the
corporate elite decided to continue on the euro train. Even a small accounting
trick was used to make sure that the Maastricht criteria would surely be met.11
Belgium’s and Greece’s numbers were so bad that they could not have even been
forged to meet the criteria, but they were still admitted. Also Italy
was known not to meet the requirements. [12]
In the background, experts warned that by giving up monetary
policy there would be no balancing mechanisms left, especially as fiscal policy
too was locked up by the Maastricht
treaty. If the exchange rate, interest rate or fiscal spending are not
flexible, the only remaining adjustment tool would be aggregate demand – in
practice, unemployment. If one adds to this the suboptimal currency area, the
potential problems increase further. This is elementary macroeconomics and was
widely known at the time – but all this was disregarded. [13,14,15]
Glimpse behind closed
doors
An anonymous observer provides a glimpse into the darkness.
My apologies for the strong language. (Lipponen was at the time the Social
Democratic Party prime minister and Niinistö the National Coalition Party
finance minister.)
I was at an event where P. Lipponen the Great cursed as ignorant clowns all those people who warned that given Finland’s industrial profile a mutual currency with Germany and France was not a good idea. And such stupid monkeys could be bought cheaper at a local zoo. Unfortunately I do not have video or audio recordings. In modern times someone would surely have recorded the best bits with their mobile phones.Mr Lipponen was pissed off that none of the paid experts were able to come up with measures that could take the place of devaluation and other monetary policy measures. Behind the closed doors there was plenty of yelling and threatening, in the best tradition of the social democrats. Mr. Niinistö was more controlled, but he also thought that people talking about the problems were simply stupid.Messieurs Lipponen and Niinistö had simply decided with their European friends that the euro was the best thing that could ever happen to Finland. In both of their political parties there were no members able to do the math; they were either too old or too young. The pair overwhelmed any resistance. There were many more events where Lipponen sounded like a klaxon and Niinistö heavily harassed.They never redeemed their promises to industry on measures to address the removal of the devaluation option. The promises were immediately forgotten after they got the euro decision. If bad deeds done to other people have an effect on the afterlife, they will both burn for a long time.For the social democrats the euro crisis is a major pain because Mr Lipponen drove Finland’s membership. Now we see the laws of economics and especially the common currency fatally wounding the social democrats’ traditional voters, or rather their employers. If Lipponen, together with Niinistö, had not been the main architects of euro membership, the social democrats would be demanding an exit from the euro so loudly that their tonsils would show.Urpilainen [Finland’s current finance minister from the Social Democratic Party] is in an odd spot. She must somehow find a way to cope with the “achievements” of the party’s still-living prime minister. Also, many of the people from those times are still active and in powerful positions. Because of this, statements ranging from pathetic to ridiculous will continue in the future.
On YouTube one can easily see how classy the discussions in
parliament were – even in public. I wouldn’t award any points for artistic
style, as a certain amount of nagging and complaining is part of politics, but
it looks like decisions were not based on analytical merits when the parliament
voted on euro membership in 1998. [16] At least in this respect little has
changed.
Damage done: the
inflating bubble…
Because of several factors working together (low capital
ratios of banks, many banks already being publicly owned, banks holding
government debt, The Basel regulators and the European Central Bank
miscalculating risk and thus misallocating capital, convergence of interest
rates, the need for current “core” countries to find customers for their industries
and lenders for their banks), a huge flow of private capital went to countries
where no money should have been sent.
While the internal current account imbalances of the euro
area grew, everyone was happy and criticism and warnings were ignored. It is
still being ignored, as one country’s deficit is another’s surplus. The German
trade surplus would not be what it is today without the deficits in the
periphery. There were warnings – Ireland’s
unsustainable real estate boom was clear to outside observers – but there were
no possible measures to take against single member’s credit growth or wage
increases.
…deflates and hurts
In some countries debt growth started directly in the public
sector but in most cases the culprit was high debt levels in the private
sector. When economic troubles began, the private sector’s problems became the
public sector’s problems. Lower tax income, higher social security payments and
maintaining the banking system crippled the public finances of several
countries.
This turned into a problem for the large banking countries
of Europe: Germany,
France and Netherlands.
These countries’ banks had loaned money to the governments and the finance
sectors of the crisis countries, and there was a risk of defaults and thus
credit losses. This was unacceptable to France
and Germany as
they were preparing for the coming elections. As many of the banks were already
largely owned by the state a Swedish-style capital injection in the form of a
directed stock issue would not have been possible, or at least not large
enough. Politically, the only option was to find new guarantors with high
credit ratings and new lenders. This is why the crisis was called a euro crisis
– to make all the euro area countries responsible for the potential losses of a
few.
British and American banks also had large receivables from
the crisis countries. The participation of these two countries in
crisis-fighting costs was minimal compared to their original risk because of
the crisis being defined as a euro area problem. This also meant that Finland,
which had no banks with large positions in the crisis countries, was drawn into
ever-growing debt mutualisation. Others benefit, Finland
pays – because “the jobs of mothers and fathers have to be protected”. I assume
that behind the scenes something else happened as well: threats,
scaremongering, outright bribery and extortion – or perhaps just stupidity,
vanity and “political reasons”.
Loss transfer to
taxpayers
Without the possibility of exchange rate adjustments and the
avoidance of debt restructuring, especially with the private sector
involvement, there are only limited tools to solve this multidimensional
crisis. The common currency rules out the usual solution of weakening one’s
currency or adjusting interest rates, and no country has so far been prepared
to jump ship and leave the euro area, not even Greece. The private sector
involvement has been avoided because of the possibility of a domino effect that
would topple all shaky countries and eventually even the solid ones that are
the current creditors.
Private sector involvement is also hindered by the fact that
there is less private capital left. Almost all of the most uncertain
receivables have already been mutualised. Bilateral loans, indirect loans
through special purpose vehicles like the European Financial Stability Facility
and the European Stability Mechanism, the European Central Bank’s SMP-asset
purchase programme, very lax LTRO-loans and recently the “unlimited”
conditional OMT-program, and the less well-known and not public ELA.
In two years’ time the bad loans made by the European banks
have been transferred to taxpayers even
though the whole project was sold to the voters as supporting the crisis
countries. Follow the money, said the original investigative journalist. When
there are no private sector loans left to cut, officials started to move the
losses to bank depositors, like what happened in Cyprus.
It is worth noting that although debt levels have continued rising during the
past years the real economies are in recession. In a way, the solution has
moved further down the road and has become more difficult despite apparently
temporary steps of progress. The current round of internal devaluations and
mass unemployment hardly equate with the success story that the euro was seen
to be. Worryingly, the more bitter the medicine, and the less it works, the
easier it will be to push the eventual agenda of full federalisation.
Rotten fruit
The euro crisis has thoroughly ruined transnational
organisations. The International Monetary Fund's reputation as the most neutral
and credible player in the international economy has been spoilt by its
political actions. By transferring the excessive debts of the crisis countries
to the IMF, the European states have in effect decided to finance the crisis
countries outside the democratic process. Now the IMF’s resources are tied up.
In Finland
there is plenty of talk about the IMF as an independent and outside party,
whose blessings and participation turn any bailout package into a credible one.
This is exactly why France
and Germany had
pressured the IMF, and successfully did so. [17,18]
* * *
ALTERNATIVES
Euro area breakup
There are only a limited number of future paths. A return to
national currencies (some or all of the countries) would even out the
competitive differences between the countries, and history has proven it is
both a market economy-based and efficient solution. It would also amount to a
confession that the euro project has been a failure, and lead to difficult
negotiations over the euro system’s balance sheet and debt redenominations. It
would certainly create at least a temporary shock, and the credibility of the
“new” national central banks would be difficult to establish, especially during
and immediately after the shock. [19]
Federal union
Another option would be a full federal union that would
include at least a mutual debt and joint budget and thus fiscal transfers
between the member countries. In practice this would mean that the EU would
have a right of veto over national budgets and taxation rights either directly
or indirectly, and these tax receipts would be used to transfer funds from the
better-performing countries to the poorer-performing countries. Because the
euro area is not an optimal currency area and the competitive differences
between the member nations are large, the federal elements would have to be
larger than in e.g. the United States.
[20] With the track record of the European decision-making and the often
opposing interests, we can already guess how well designed, honest, fair and
functioning a federal union would be.[21,22]
Muddle through to
semi-federal union
After playing for time, extending loan maturities and
promising reforms, while at the same time keeping growth minimal and
unemployment high, sooner or later the competitive differences will narrow. It
could take a very long time, and the narrowing might be too small to make a
difference, with the price being a lost generation. Internal devaluations are
slow, cruel and ineffective, and someone who has been unemployed for 10 years
in Greece will
definitely not return to the job market and compete against Germany
like nothing ever happened. A muddle through would allow slow and opaque
haircuts by maturity extensions and interest payment reliefs, and this would be
enough to fool the electorate of the creditor countries. This rudderless
semi-federal union would lead to a long but shallow recession in the creditor
countries and an utter disaster in the crisis countries [23, 24]. As a bonus,
economic performance might wear down the electorate and the opposition to a
full federal union and eventually make possible a full Brussels-led command
economy.
Monetary diaspora
The European Central Bank could design monetary measures
that would target only certain countries in the euro area. Past measures have
already included such features. Fragmented monetary policy could need
restrictions on the free mobility of capital – like the ones already in use in Cyprus.
The elite would save face as the euro would survive in name, although its core
idea would have been destroyed.
Wild cards
Finland
earlier had the choice of exiting and not participating in this mess. Either
the courage or the intelligence to do this was lacking. After the already
completed debt mutualisations, leaving would be a much more difficult process.
But it is not impossible. There could be other willing leavers as well. The
world after the German elections will surely be an interesting one.
My wish
Instead of the current muddle-through towards a federal
union and continuous burdening of the Finnish government with others’ losses,
it would be preferable to have a decent, fact-based discussion about what Finland’s
options and goals are and the ways to reach such goals. Voters will understand
if explanations are provided. Parties that still believe that the euro is a
success story, that Greece
will pay its debts and that the burden will have to be shared, are not credible
or rational. Statements like that are in a hideous way populistic and are
contrary to the available facts. Honesty instead would be a good foundation for
co-operation and a new era. And a confession that mistakes are made – even by
social democrats.
Footnotes/Links:
[1] When Can We All Admit the Euro is an Economic Failure?
[2] Europe in Brief
[3]
Lehdistöneuvos: Erkko käänsi Hesarin EU-myönteiseksi
[4] Pekka
Karhuvaara pitää lähtöä lehtitalojen yhteiseen EU-kampanjaan virheenä, joka
haisi pahalle
[5] ERM at 'breaking point'
[6] Black Wednesday
[7] Krugman: Currency Crises
[8] Interpreting the ERM Crisis: Country-Specific and
Systemic Issues
[9] The EMS Crisis in Retrospect
[10]
Talouspolitiikan virheet laman taustalla. Suomen 1990-luvun kriisin syyt ja
seuraukset lamatutkimuksen valossa
[11] Nolo totuus
Suomen ehdottamista kriisilääkkeistä
[12] Operation Self-Deceit: New Documents Shine Light on
Euro Birth Defects
[13]"Emua
mahdoton perustella taloudellisilla hyödyillä"
[14] Revenge of the Optimum Currency Area
[15] Impossible trinity
[16] Euroon vai
ei? Kiihkeää sanavaihtoa vuonna 1998
[17] The IMF needs to overcome its bipolar personality
[18] Time for a transparency revolution at the IMF
[19] Exit Special
[20]
Euroliittovaltio ja suomalainen veronmaksaja
[21] Eurokriisi
on monin eri tavoin luottamuskriisi
[22]
Dokumenttiprojekti: Harmaa eminenssi
[23] How Europe Can Muddle Through
Its Crisis
[24] Muddling through means deepening crisis for the euro
zone