Based on Ch.5, “Euro
Crisis” of my book, Can Keynes Save
Capitalism?,
Kyoto: Showado, 2012 (in Japanese)
Lecture 6
The Euro Crisis
― May 2010
Toshiaki Hirai
1. Introduction
In January 1999
the EMU (European Monetary Union) implemented common currency, Euro (a complete
implementation in January 2002), which was soon highly evaluated as having a
potential of being international currency which could be a rival to dollar . The
Euro zone, which started with eleven nations, was to have nations which were
eager
Although
the Lehman shock attacked the US in September 2008, the EU did not afflict a
severe damage even in the summer of 2009, which further heightened the status
as a mega economic zone which could be a rival to the US.
The EU as well as the EMU had been proud
of this situation, and proceeded as if to become big by accepting many nations
as members could contribute to an enlargement of influence in the field of the
world economy (as well as politics).
It was, in fact, the Lehman Shock that
built a momentum of revealing the danger and fragility of the Euro system. As
is stated below, the danger and fragility which had emerged within the Euro
zone (or the EU) just because of Euro appeared in the form of the Greek fiscal crisis in the
fall of 2009, suffering a big wave of the Lehman Shock with a time lag.
Then the problem soon became more and more serious, reaching the Euro Crisis in May 2010.
Euro suddenly turned from a shining star into an embarrassment to be grasped in
the framework of the possibility of sustainability.
The present lecture deals with this Euro
Crisis. First, we would see the process leading up to it, and then what kinds
of measure were adopted. Finally we would see the problem which the Euro zone might
face hereafter.
2. Development
2.1 Fragility which Euro Brought About to
the EU
As an incident which came to reveal the Euro crisis, we mentioned the
Lehman Shock. However, it was a momentum, albeit serious. The fundamental problem could be
found in the Euro system per se .
Due to an adoption of Euro , there
emerged a situation of
minus real rate of interest ( = nominal rate of interest – rate of
inflation) in several member states (such as Spain, Portugal, Greece, Ireland) and
several member states in the EU (such as Latvia, Lithuania, Estonia, and
Hungray) in which firms could have an opportunity of making huge profit by
means of borrowing. Money thus financed was poured, among others, into the
immobile market, which rapidly brought about the bubbled economy.
The European economy in the 1990s was not in
a good performance but rather in stagnancy, as typically shown in the German
economy which suffered from the heavy burden due to unification.
At the end
of the 1990s, due to the birth of Euro , the monetary policy of the Euro zone
came to be implemented by the ECB (European Central Bank).
Initially
the ECB set the rate of interest at a low level. In the member nations
above-mentioned, which had experienced high rates of interest as well as high
rates of inflation, the real rate of interest became minus due to the adoption
of euro , as a result of
which there emerged the situation in which borrowing money should turn out to
be very advantageous.
Loan in terms of euro was made in the form of a
national debt in the case of a government, and in the form of debt or loan in
the case of firms and individuals. It was German and French megabanks (together
with the UK ones) which were keen to make this loan (See
Diagram 1).
That is, it was megabanks of the leading nations of the EU which made
huge loans to some member nations within the Euro zone and some member nations
within the EU which had enjoyed high economic growth, which was to contribute
to lead these nations toward the bubbled economy.
What was problematic, moreover, German, French and
British governments allowed their banks to go on making huge loans while these
governments allowed the governments of the PI[ I] GS (Portugal, Ireland, [Italy],
Greece and Spain) to go on implementing loose fiscal policy.
Not just
that. It was, in fact, among others Germany and France which came to breach the
“Stability and Growth Pact” agreed in the Maastricht Treaty (a rule of setting
the ratio of budget deficit over GDP less than 3 % and the ratio of national
debt over GDP less than 60 %). These nations seem to have reproached the bad performances by the
PI[ I] GS, while closing their eyes to their own past behaviours .
The birth of the Euro plan of 1992 had
induced the above-mentioned situation within the Euro zone as well as the EU
zone, which was to cause a devastating influence, with some time lag, due to
the shock wave of the Lehman Shock.
2.2 From the Greek Fiscal Crisis to the Euro
Crisis
The Greek fiscal crisis started around the fall of 2009 by the
disclosure by the new government that the former government had manipulated the figures
concerned at a very low level, violating the Stability and Growth Pact
(it was later revealed that at the suggestion of the Goldman-Sacks the Government had operated
foreign exchange swap in order to pretend to observe the Pact). Thereafter
there spread a suspicion
that Greek might not redeem the national debts when they would fall due.
Meanwhile the Euro zone leaders went on
discussing a series of meetings to deal with this problem but in vain. The main
reason of this stalemate was due to Germany as a central player. Among others,
there was a strong
opposition against the rescue of Greece among the German public, so that
the Merkel cabinet, which was ready for an important local election in May
2010, hesitated to go forward.
Diagram 1 Exposures
to Greece, Ireland, Portugal and Spain,
By nationality of banks, End-04 2009; in
billions of Us dollars
(Example:
The case of Spain; German (DE) banks possesses the Spanish National Debts (in
madder colour ), loans to Spanish banks (in grey colour ), and loans to the
Spanish private sector beside the Spanish non-bank private sector (in light
brown colour ) (Sources: BIS Statistics)
In time the
Lehman Shock, which took place in September 2008, was to affect the EU economy
as a body blow. Among others, it was the PIIGS, in which the bubbled economy had proceeded
around the real estate market, that were affected most. Leaving monetary and
exchange rate policies to the ECB, these nations were forced to rely on fiscal
policy in order to meet the impending economic depression, as a result of which they were
to have huge fiscal deficit .
While the
EU leaders were hesitant to decide concrete measures to deal with the Greek
problem, there occurred an
event in which the S&P –rating agency – downgraded, in April 2010, the rating for the
Greek national debt at a junk level, meaning that the Greek government was not able
to issue national debts in the market. Moreover, the same situation attacked
Portugal and Spain, which brought about the downgrade of their national debts.
These state
of affairs were to induce
speculative activities by hedge funds of selling euro and national debts
in euro (“naked short transaction”and“naked CDS
transaction”, to be explained below, are representatives ). At
this moment, the Greek crisis showed a sign of the PIIGS crisis. The problem was extended to the
Euro crisis at a stretch.
3. Measures Adopted
The Euro leaders, who was put in this serious situation, took, in
reversal, a speedy and positive action. Let us see it.
3.1 Bailout
to Greece
On May 1, 2010,
the Euro bloc and the IMF agreed to make a three-year loan worth 110 billion euro to Greece.
It was composed of the Euro block loan worth 80 billion euro and the IMF loan
worth 30 billion euro
The first instalment was soon carried out,
and on May 19 Greece was able to redeem the national debts payable by means of 8.5
billion euro.
3.2 The
Stabilization Fund Set Up
There were some
countries (PII[ G] S) among the Euro bloc which were faced with a fiscal problem
similar to Greece. So with the aim of not letting them fall into default, and
stabilizing the Euro system, the EU and the IMF reached an agreement to set up
the fund totalling 750 billion euro (hereafter, the “Stabilizing Fund”). The breakdown runs as
follows: 60 billion euro in the form of the debt guaranteed by the EU; 440
billion euro in the form of the fund guaranteed by the Euro member nations; 250
billion euro staked by the IMF.
The Stabilizing Fund was to be involved only
in the case such as bringing about a Euro crisis. In that case the Stabilizing
Fund would make a loan provided
that a recipient country observes a fiscal discipline. The Fund would
check how the observance is implemented, and, if not, would cancel the loan.
The Stabilizing Fund took the form of the SPV (Special Purpose Vehicle).
3.3 Behavior of the ECB
The ECB was set
up, following the financial tradition of Germany, so the main focus was exclusively put on controlling
inflation by means of policy interest. However, faced up with the
present Euro crisis, it was forced to be largely diverted from this convention.
The ECB made a decision to purchase national debts, that is, to carry out an
open market operation. It
is a policy to raise the price of national debts (to lower the rate of
interest) by buying up them which are likely to be bad. Although the ECB
states it as a temporary measure, there is a great possibility of
3. 4 Strict Observance of the Stability and Growth
Pact
The Euro system is not fiscally integrated, so that the Stability and
Growth Pact is set for maintaining stable growth for the Euro bloc as a whole.
To repeat, it requires a member state to keep the ratio of budgetary deficit
over GDP at less than 3 % and the ratio of national debt balance over GDP at less
than 60 %.
However, it has not been
applied so far, albeit it has punitive clauses.
As already pointed out, there has been a tendency for the Pact to be
breached. Moreover, in the present economic crisis it was impossible for the
Pact to be observed, and in fact, there was no country to do so. (See Table 1).
Table 1 The S&G
Pact Breached (％)
Ratio of budgetary deficit over GDP (less than
3%)
|
Ireland 14.3
|
Greece 13.6
|
Spain 11.2
|
|
Portugal 9.4
|
France 7.5
|
|
[Germany less than 3%] (UK 11.5)
Ratio of
National Debt balance over GDP (at
the end of 2009) (less
|
Italy 115.8
|
Greece 115.1
|
France 77.6
|
|
Portugal 76.8
|
Germany 73.2
|
|
(UK 68.1)
(Source) EUROSTAT
( except [ ] )。
And
yet, the UK leaders are critically aware that unless the Pact is
3.5
Activities of the German
Government
The behaviour which the German government took after so much hesitation
was not confined to the above-mentioned ones. It strongly stated that the EU
also needed to set some provisions which are incorporated in the Dodd-Frank Act
in the US (which was enacted this July). Let us see this.
3.5.1 Stern Posture against Speculators
Firstly, the German government clarifies a stance against speculators.
Germany took action alone, prohibiting the“naked CDS transaction”and the “naked short
transaction”.
The naked short transaction should be a
gamble rather than a speculation. It aims at making the prices of the national
debts of some weak member countries of the Euro bloc plunge by selling out them
by means of “short”. What
Merkel did was a policy to defend the Euro system by prohibiting this kind of
gamble by hedge funds.
Let us turn to
the naked CDS transaction. An Usual CDS (Credit Default Swap) is a kind of
insurance to guarantee the principal in return (swap) when a debt (credit) would
fall into default.
In
the case of a naked CDS, however, it is a transaction in which there does not
exist a debt – therefore, naked, so that it is not an insurance but a pure
speculation.
Suppose that company X issues a
corporate bond A, and an insurance company makes the following announcement.
“In
case of a default of corporate bond A, this company would guarantee the
principle provided that premiums are paid.”
If a person Y
applies to this, this is a naked CDS. Y does not hold a corporate bond A, so
that it means that Y is involved in a bet by
3.5.2 “New Stability Culture”
Secondly, Prime
minister Merkel and Finance minister Sheublё put forward the following as a plan for
defending Euro.
(i) Intensification
of overseeing budget plans of member states.
(ii)
Introduction of stern penalty against member states which breach a fiscal
discipline – such as suspension of a voting right in the European Council
Meeting, establishment of a ruling of bankruptcy procedure of a member state.
Prior to this
plan, the EU finance
ministerial conference reached an agreement as follows: Intensified
regulation of hedge funds; announcement of information on trading strategy;
introduction of financial transaction tax (a sort of Tobin tax). The conference also decided to overhaul rating agencies,
including foundation of rating agencies within the EU.
The above-mentioned measures directly
derive from the following awareness of crisis as stated by Merkel.
If Euro falls,
Europe would fall. Euro is in a state of crisis. If we could not avoid this
crisis, the consequence which Europe would afflict would be inconsiderable as
well as those beyond Europe.
4. Uncertainty Ahead
― Tunnel
without Exit
Faced with the
Euro crisis, the leaders of the EMU adopted various measures in succession, as
we saw above. Among them, institutional framework from now on are included.
And yet it cannot be said that the problem
has been solved. The Euro
bloc ahead is rather put in a very uncertain situation. Let us see it.
What
has been so far agreed in the Euro bloc are a relief for Greece, the foundation
of the “Stabilization Fund” and a strict observance of the Stability and Growth
Pact. In the case of Germany, moreover, prohibitive measures against
speculative activities (thereafter, through the common communiqué by Merkel and
Sarkoji, this became an agenda which the Euro as a whole should tackle).
However, they are, in nature, preventive measures for
rectifying the financial system. No measures are yet to be put forward for rectifying the real economy
of the EU. Although only the defence of the Euro system are seriously
taken , and discussed, the Euro problem cannot be fundamentally solved unless the plight of the real economy
would be solved.
The number of the member of the Euro bloc is
sixteen, many of which are suffering from depression (see Table 2).
Among others, it is PIIGS which are
suffering from serious fiscal and economic problems. In the case of Portugal
and Greece, there are few strong industries. Although there was a period in
which many factories were built there by German and French companies, looking
for cheap labor, they have
now shifted to new member countries with lower wages,
Germany, the largest economy in the EU,
is itself a problem. It is still an export-biased economy, and has a strong tendency
to save, which shuts the way for other euro members to export there, resulting
in worse economic condition (The member countries cannot improve the situation
through adjustment of exchange rates).
Table 2
Rate of Unemployment（ %. April 2010）
|
Euro zone as a
whole 10.1
|
Germany 7.1
|
Italy 8.9
|
|
France 10.1
|
Portugal 10.8
|
Ireland 13.2
|
|
Spain 19.7
|
EU as a whole 9.7
|
|
(Source)
EUROSTAT
Closing eyes to the economic
fundamentals within the Euro system, it is of no use dictating “Implement
ultra-austerity finance, otherwise no bailout”. The countries in depression
might call its bluff at any moment.
Having handed over monetary policy and exchange rate policy to the ECB, the Euro members are now severely restricted in fiscal policy – the only method to meet the depression.
Having handed over monetary policy and exchange rate policy to the ECB, the Euro members are now severely restricted in fiscal policy – the only method to meet the depression.
The members have no means at disposal to
meet the depression, and yet they are told, “Observe the austerity rule,
otherwise no bailout”.
How
long could the peoples of the member countries concerned endure these humiliations? (It is not confined to the member
countries.
Very recently a
loan negotiation between the Hungarian government and the EU-IMF reached a
deadlock due to a confrontation over fiscal discipline. This is a nervous
problem which is capable of spreading easily to other non-Euro countries with
similar problems in the EU.)
Fiscal deterioration is not a problem
which cannot be attributed only to “profligacy”. An issue of national debt can contribute to
enlargement of domestic demand. But for it, a decrease in domestic demand would
have been more harmful.
Though there is a tendency for the EU
leaders to insist on rebuilding fiscal deterioration for the recovery of the
economy as if it would be a rock-ribbed law, it could not be solved by an endeavour
of ultra-fiscal austerity. It would be a problem which could not be solved
unless a recovery of economic activities would be attained.
At present, among the member states
(including the UK, a non-member state), an argument for ultra-fiscal austerity is prevalent.
So the stricter deflation would afflict the EU economy. A household would be
improved, if it would stick to austerity, but a nation would not. A strict
bee-society in Mandeville’s parable would become more and more miserable.
The economy might have the following
fundamental problem. In the capitalistic system which has entered the stage of
maturity, there is a tendency not to be able to induce sufficient domestic
demand. Because of it, a state cannot help relying on an expenditure by a government.
And yet, the economy is yet to have attained at a stage in which the market
economy could make an autonomous recovery.
While neglecting that the advanced
economies are subject to this vicious circle, even if fiscal deficit only are
set as target , a problem could not be solved (it should be added, moreover, that
there is a strange
asymmetry between monetary policy and fiscal policy. Monetary policy is
implemented without any surveillance from the outside while fiscal policy is
discussed in the parliament which is publicly overseen.
5. Conclusion
What would
happen to the Euro zone hereafter? As we saw in this lecture, the problem with
the EU is serious as if the EU entered a long tunnel. In the member countries
without any prospect for attaining economic recovery, it is only a strict fiscal discipline which is now
called out.
Faced with the Euro crisis, the community spirit of going
forward, esteeming the cultural and ethnic multiplicity of member
nations, which has been conventional after WW2, is likely to wane, and the EU is filled with hostile atmosphere.
“Europe cannot be a single unity. For Europe
which has cultural and ethnic multiplicity, unification cannot be attained.”
These sorts of argument are in full strength on the internet.
Could the Euro make a survival or a split?
There swirls a hot controversy over it.
References
Feldstein, M., “A Predictable Crisis: Europe’s
Single Currency Was Bound to Break Down”, Weekly
Standard, Vol.15, No.37, June 14, 2010.
Tarpley, W.B., “Euro Momentarily Stabilized: German Ban on Naked
Credit Default Swaps Is Working” , His
Website, May 21, 2010.
“No
More Naked - Germany and France Call for an EU Ban on Financial Speculation”, Spiegel Online, June 9, 2010.
“The Future of Europe: Starting into the Abyss”,
Economist, July 8, 2010.
“Ratings Agencies Threaten Hungary with
Downgrade”, Reuters, July 23, 2010.
