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Guest Post: A Very European Financial Coup d’état

Our KTG-friend Cheshire Cat just submitted his latest post of ” A Very European Financial Coup d’état”. To tell you the truth, I’m glad to see more and more people speaking of a Coup d’ Etat triggered by the markets and facilitated by the inability of the EU leaders to cope with issues that in fact they cannot deal with… The more I read the more I realize, that nowadays the European Union considers its own citizens as annoying bugs. Should we remain silent? No, we shouldn’t.

Cheshire Cat:  Very European Financial Coup d’état


The attempt to create a monetary union before a political and fiscal union placed the cart before the horse. Or was it… an attempt to steal the cart?

To achieve a fiscal union and political union would have required the democratic consent of the voters of each member state. Such an acceptance of this might then have implied an acceptance of a monetary union and its consequences. ‘Acceptance’ should not be underestimated.

Hyman Minsky: “Anyone can create money; the problem lies in getting it accepted”

It was never likely that all Europeans would have accepted the idea of an United States of Europe. The European Monetary Union is increasingly becoming undemocratic, press-ganging euro members to make constitutional agreements with the use of financial force without the consent of their electorate.

School kids are told that democracy is about listening to the people. When they grow up they are told it is about listening to the markets. Now we are all told to listen to un-elected bank clerks who (in Greece) are then forced to sign another piece of paper for approval by another set of banking clerks residing in the head office. The argument being of course one of ‘trust’. Democracy, meanwhile, is forced to hide behind a tear gas mask.

In Greece there are now anti-semitic anti-islamic neo-nazies in the government. Is it surprising that people are feeling reluctant to pay their taxes to pay the wages of such men? Every day we witness a regime that marches, increasing taxation in one step and decreasing representation in the other, towards a some ugly reminder of the past. It’s like paying for your own firing squad.

Many People view this as the the fault of economists. It is not. There are many economic papers in journals (Monetarists, Keynesian, etc – choose your favourite school of economic thought) go back 50 years giving detailed reasons why a monetary union might not work out. To think of ‘internal devaluation’ and austerity as a way of adjusting to events that occur in the world that exist outside the EC borders is very naive. It is akin to a Napoleonic way of standardizing and metricizing economies into homogeneous diary products with fines on diary producers for failing to meeting these standards. Milton Friedman, the infamous monetarist, made the following observation in 1997:
“…Europe exemplifies a situation unfavourable to a common currency. It is composed of separate nations, speaking different languages, with different customs, and having citizens feeling far greater loyalty and attachment to their own country than to a common market or to the idea of Europe”. Milton Friedman The Times (19/11/97)

The Euro was a political exercise, but lets wipe the dust off more economic texts. As far back as 1972 another economist, M Corden warned that a monetary union would be heavily dependent
on labour mobility involving significant migration cost. This is what happens in the United States. In the Great recession during the 1930s this produced shanty towns (called ‘Hoovervilles’, after US president Hoover who thought that discipline would clean the economy). In the 1960s boom period more this was a more psychedelic experience, with some ‘tripping’ across states (remember the songs “Lets go to San Francisco” and “California Dreaming”).
In present day Europe, however, we see neo-nazism on the rise (even becoming members of the Greek government), Greeks emigrate to Australia and labour mobility tends to wear army boots ‘making war ‘not love’.

Instead, the European Commission’s “One Market, One Money” Report (1990) conjured up a flawed theory to construct the Euro. Politicians did not deny that crises would occur but some even looked forward to them.
“I am sure the euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible to propose that now. But some day there will be a crisis and new instruments will be created.” Romano Prodi, EU Commission President. Financial Times, 4 Dec 2001
And some even expressed a strong dislike of referendums and elections
“A true European cannot not want a referendum [on the European Constitution].”
Jean-Pierre Raffarin, French Prime Minister from 2002. Quoted in 2003.
The French and Dutch in 2005 voted against a European Constitution. When Ireland voted no, it was made to vote a second time to get it ‘right’. Now changes are being discussed to European Treaties based on the argument of economic necessity in a crisis.

The Ring that binds – the sovereignty debt entrapment

How did this Press Ganging of economies into the euro ship happen? Any country that can issue its own currency (and is not pegged to any other currency or precious metal) does not risk default solvency risk. It cannot be forced into debt. It controls its own currency and can always spend, by crediting bank accounts to create money.

Hence flexible exchange rate economies like Japan can run far higher debt to GDP ratios than Euro-zone members while still having low interest rates on their sovereign debt. Thus there is no default risk premium.

The design of the Euro destabilizes some governments with uncontrollable default risk. It achieves this in three ways by: (1) generating trading account deficits with other euro-zone economies without any automatic means (exchange rates) to adjust competitiveness; (2) restricting the controls to finance these deficits and (3) imposing external or self-imposed fiscal discipline that renders the economy helpless in times of crisis. With one global storm economies begin to capsize and sink.

When an economy is hit by a recession from an unexpected shock in the global economy there are automatic increases in government expenditures (social security and unemployment payments) and reductions in government’s tax revenues (as output falls). This part of the government budget deficit is ‘unplanned’. To reduce expenditures and/or raise taxes it will deepen or prolong the recession.

When an Euro-zone economy increases the size of its budget deficit ( due to the effect of the recession and also, as what happened in Europe, by bailing out banks) it will mean that reserves in its European Central Bank (ECB) Account are being depleted and will replacing. Individual Euro-zone governments are not monopoly issuers of currency and cannot create money (by crediting bank accounts) to finance the change in their budget deficits. So a Euro-zone government will need to recover this by selling bonds and this adds to its sovereign debt.

Thus, just by maintaining existing government plans, an adverse impact from the world economy will increase some Euro-zone government’s borrowings more than others. Sovereign indebtedness for an Euro-zone country is not a simple choice; it is often beyond its control. This exposes euro-zone economics to disastrous debt dynamics. Ponzi financing (named after a fraudster “pyramid scheme” in the 1920s) occurs when a debtor must borrow just to pay interest, which means debt grows – typically in an unsustainable manner. A government that controls its own currency can never be in this Ponzi position. A euro-zone member can.

Euro-zone members, with trading deficit accounts, are therefore exposed to debt dynamics. The more they borrow, the more the markets demand higher interest rates to compensate for the increasing risk of insolvency. The more the government attempts to solve its budget deficit, by cutting expenditure and raising its tax, the more it cuts it growth rate and its ability to repay its sovereign debt. Moral hazard by the government comes into play here as the covering up off statistics will aid it to obtain lower interest rates its bond issues.

At some point everything goes critical, as in Ireland and Greece when about bond rates reached about 7%, and the government spirals into a vicious circle of borrowing more and more to pay ever higher interest rates. The government finds itself locked out of the market. This leads the Euro nation at the mercy of the intervention of the ECB and the Euro-zone credit nations for bail outs. It is also an invitation for the vultures funds that normally hover around third world countries to scour for opportunities.

There is, however, one big problem. The ECB itself. To be effective, a central bank must act as a monopoly.”It, just like Sauron, must control all.” (@FTalphaville) but… The ECB not a real monopoly. There are no common Euro bonds and individual Euro-zone central banks issue their own. Before the 2007-8 global crisis sovereign default risk did not seem to matter. Those with greater dependency on ECB liquidity, as in the case of Greece, found more of their bonds ending up at the ECB. The less bonds available for the market, the smaller the market and the more vulnerable it becomes. Holding a monopoly of them has little value, if no one wants your bonds.

The solution to this is a common euro bonds with collectively responsibility of sovereign debts. But, in order to be ‘saved’ by this, each member must not only surrender its sovereignty but also yield to a budgetary slavery that whips financial indiscipline.

So we are struck in a political crisis. Austerity everywhere cannot last. Once one of the major Euro-zone economies, Spain or Italy, goes pass the point of no return (in its bond rates) everything falls. A bailout for one will trigger a chain reaction.

See the original post in Cheshire Cat’s Blog Redesigning the Foot

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One comment

  1. I have another version to this history. The Maastricht treaty, which was where the euro was decided was a total failure and the euro survived it by accident.
    What happened? The Dutch government, at that mooment chairing the EU, had a very ambitious plan to indeed form a USEurope. The plan consisted of all kind of big reforms. From democratic to economic. But in essence it was a complete treaty to fuse Europe into one. It was the brainchild of Ruud Lubbers and his foreign minister Van den Broek. They were at the end of their long careers in Dutch politics and wanted to finish with a Grand Travaille. Like the French presidents do. The USE would be it.
    Warnings before the summit were not headed. And at the summit the big countries shoot the whole plan down. It was a huge loss of face and a big fight and in it the euro survived as one of the compromises.
    Yes, it might have survived to create a backdoor for a future creation of a USE. But my point is, Cheshire Cat implies, and a lot will agree, that there was a Big Plan behind it. As in fact it was more or less an polical accident that the euro survived and all its conditions and guarantees did not.
    OK, one can argue that this failure was part of the Big Plan too. But I am of the school that thinks that instead of Big Plans, stupidity, incompetence and accidence create big parts of our future.

    Another point: in other countries there are anti-islamic neo-nazies in the government too. Or in the case of The Netherlands, they are supporting actively a minority government. No pressure of banks to do that. Just voters creating that situation. And suggesting that this would be in the slightest connected to reluctance of people to pay taxes is not only insulting but degrades the credibility of the rest of the post.

    Another point: I agree that this crisis is deeply one of political failure. To name just on example: accounting rules reside under political influence. Politicians like to see that banks lend a lot of money to businesses and citizens, because that leads to economic growth and brings in votes. This lead to an orgy of lending and credits. CDS are no devine financial tool. It rules are sanctioned by democratic elected governments. It really does not matter if the spread is X or Y. You see Italy now pay more than 7% for their new bonds. And still the world doesn’t stop. It’s all just political will to manage or not to manage this crisis.

    And those who are elected to control these governments have failed big time too. Democratic accountability never was there. In fact it is now bigger than ever before. At least a lot of parliaments have now claimed the right to veto the deals their government make at the summits. 10-15 years ago that was simply not happening.
    There is more democracy and more transparency than ever. Movements can be created in a second and be very effective through the new media. And still we are in the crisis we are in. Why? Because a big part of the Europeans lived this orgy of credit. Yes also here in Greece. They inflated their wealth with the help of the banks and the politicians. That this couldn’t go on was clear. But those who warned were treated like Kassandra. Or they were declared mad not to participate. Oh yes, and those Kasandras and crazy people are now the ones who are summoned here in Greece to foot the bill again.
    And that has nothing to do with Eurobonds, ECB, or whatever grand scheme. It is a local political choice to cater again for those few millions of this society who prospered in this flawed system for a decade or so at the expense of those who did not participate in this madness. And soon this group will not stand for it any longer and will make that clear. And I pray it will be without violence.