Why the Second Unification Isn't Going As Well
Thanks for the responses last night and this morning about the euro. As I noted in the comment feed, Chancellor Merkel got a boost this morning when her cabinet approved a plan to expand the size and scope of the EU's stabilization fund. She still will need full party support and will need to get the country's constitutional court to go along with the plan. Neither of these are assured.
The standard line, to which several Ricochetizens have already commented, is that the monetary union has to either split in two (as Walter Russell Mead opines this morning, and it's not very different for the Germans to create a super-Euro club rather than have the PIIGS leave the euro) or that somehow the fiscal and thereby the political unification of has to occur. Several of you already expressed dismay over the latter. What is striking is that so do the Germans too. In Michael Lewis' essay on Germany and the debt crisis in the latest Vanity Fair is this opinion of the Greeks by a German deputy finance minister.
“They have not sufficiently implemented the measures they have promised to implement,” he says simply. “And they have a massive problem still with revenue collection. Not with the tax law itself. It’s the collection which needs to be overhauled.”
Greeks are still refusing to pay their taxes, in other words. But it is only one of many Greek sins. “They are also having a problem with the structural reform. Their labor market is changing—but not as fast as it needs to,” he continues. “Due to the developments in the last 10 years, a similar job in Germany pays 55,000 euros. In Greece it is 70,000.” To get around pay restraints in the calendar year the Greek government simply paid employees a 13th and even 14th monthly salary—months that didn’t exist. “There needs to be a change of the relationship between people and the government,” he continues. “It is not a task that can be done in three months. You need time.” He couldn’t put it more bluntly: if the Greeks and the Germans are to coexist in a currency union, the Greeks need to change who they are.
This is a very astute economic observation. Currency unions are observed by economists through a prism of the literature on "optimal currency areas". Two countries (or two states or provinces) are an optimal currency area under some conditions that are noted in the link. When the eurozone was formed, there was heated debate over whether or not the countries that joined were an OCA. I was pretty firmly on the side that it was not. But its first decade had made it easier for many to say those on the no side of the debate were wrong. Until now.
Yet the best argument made by the "yes" side on unification was not that this country or that met conditions 1-5 or whatever, which is what the deputy finance minister was ticking off. It was that "the euro will drive Europe towards unification, which they want, just not all at once." And that had me remember the previous unification, when West and East Germany joined. West Germany allowed the Ostmark of the east to convert at very favorable rates to its Deutschmark; interest rates went up; there were significant transfers of resources to permit east German consumption to begin to rise towards the standards of its new compatriots. This was all a political decision; the speed of the transition took everyone by surprise, and it put Chancellor Kohl's government at real risk. That is, the first unification went fast because the Germans wanted it to, and damn the consequences. (See this interview from 2010 with Condoleeza Rice, e.g.)
The second unification is not going well because of political considerations. The Germans want the Greeks to be more like them, and the Greeks don't want that. As Frederic Bastiat observed, "Government is the great fiction through which everybody endeavors to live at the expense of everybody else." The east Germans got to live at the expense of the west Germans because the west Germans were willing to accept it -- even at the cost of an overvalued currency that eventually ruined the old Exchange Rate Mechanism of Europe's common market and started discussions towards the euro.
This fact cannot be lost on Angela Merkel, who grew up in East Germany and whose family traveled regularly between the two countries before unification. Perhaps it informs her in thinking about whether or not to let the Greeks live at the Germans' expense. Her electorate has made their wishes known. Whether she can buck that, her rank-and-file support, and the Constitutional Court remains to be seen.
The consequences of this choice, that neither the Greeks nor Germans want to be like the other, will be our topic tomorrow.
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Jul '10
Re: Why the Second Unification Isn't Going As Well
The Greeks are putting the lie to the idea that Europe is a homogeneous culture. They may share some commonalities, but they all have their own distinctive national/regional flavor. Americans should be more concerned about this than they are because you can easily substitute Greece with California and see the same problems developing in its relationship to other more fiscally responsible states.
May '10
Re: Why the Second Unification Isn't Going As Well
Frankly, I see less likelihood that Americans will bail out California vs. Germany bailing out Greece. We've been warning the Californians for longer...
Edited on Aug 31, 2011 at 12:42pmJul '10
Re: Why the Second Unification Isn't Going As Well
In my hometown, there is a Hastings chain bookstore. They're pretty expensive for suburban-rural Indiana. Years ago, I asked a manager about the prices. He said that they were set by the home office in San Antonio.
The cost-of-living in the Indianapolis area is noticeably different than my hometown, about an hour east. San Antonio's COL, from what I've been told, is even higher.
When the European Commission announced, years ago, that they would standardize prices throughout the EU, they doomed the common currency. The same good would have the same price in Paris, Athens, or Berlin. It doesn't take an economist to realize how the COL in Greece would soar. The government tried to compensate, perhaps because the European Commission is not accountable to anyone.
So, two instances where the market was not allowed to act. In the former case, people turned to big box stores and Amazon for their books and Hastings has barely gotten by. The market acted. It seems like in Greece, there would be an opportunity for small business, but...that gets complicated. What a mess.
May '11
Re: Why the Second Unification Isn't Going As Well
What has happened to the trillions of dollars given to the banks (both U.S and others) through Fed bailouts? How much of that money has gone to shore up the Euro? How will it effect us if they don't pay it back?
Oct '10
Re: Why the Second Unification Isn't Going As Well
Wasn't it obvious to anybody with a sense of monetary history that the Euro was doomed from the moment its creation was mandated by the Maastricht treaty? When, in all of human history, has a common currency endured without a political union and central fiscal policy? One need only look at the Latin Monetary Union (which included Switzerland!) to see the folly of such a policy. Then, as perhaps now, it was Greece who was spit out first.
Of course the Euro will collapse. The only question is which fiat currency will win the race to the bottom as confidence in all of them evaporates.
Sep '10
Re: Why the Second Unification Isn't Going As Well
The Euro was an attempt to reverse this: to make political union inevitable after the Europeans adopted a common currency. Margaret Thatcher knew this, and knew that giving up the Pound for the Euro would mean erosion of Britain's sovereignty. Thank God she resisted.
Sep '10
Re: Why the Second Unification Isn't Going As Well
When the monetary system is put in the hands of government and not the market aren’t schemes such as the Euro inevitable? Give the Fed a few more decades and once they have completely debased the dollar they will be working for a world currency.
Feb '11
Re: Why the Second Unification Isn't Going As Well
(Part 1 of 2)
King, thank you for this fascinating post.
Since I’m not an economist, I let Milton Friedman do all my thinking for me. Here’s what I understand about his positions on this, and I’m more than happy to be corrected if I mess this up.
Friedman was against returning to the gold standard, that is, he was for staying with fiat currency. The reason is that a gold standard makes it very expensive to increase the money supply – you have to actually mine more gold. But he did think that the Fed had too much discretion in controlling the money supply and controlling interest rates. His proposal (I believe in Capitalism and Freedom) was to have the Fed increase the money supply by some publicized pre-determined constant number, say 3% per year, and leave it at that, regardless of price fluctuations. A computer should be able to do it. The Fed should just consist of a couple of people making sure the computer is working correctly.
Edited on Aug 31, 2011 at 6:15pmFeb '11
Re: Why the Second Unification Isn't Going As Well
(Part 2 or 2)
So it seems that the Euro isn’t really the problem. The Euro is just preventing the PIGS from inflating away their debt, but as we saw in the 70s that’s no fix either. The problem is that if Greece defaults, the credit shock waves will propagate worldwide. Is that any worse than letting Greece pay its debt back with some devalued AthensDollar? If Germany comes to its senses and refuses to bail Greece out, then a bunch of banks fail, and Greece can’t borrow anymore and has to clean up its act. Why is that the Euro’s problem?
Fiat currency doesn’t seem to be the problem. Bailouts are the problem.
Someone help me out here. Am I missing something?
Edited on Aug 31, 2011 at 6:16pmRe: Why the Second Unification Isn't Going As Well
Some replies:
John Walker: It was "obvious" to me, except for that intervening decade while we waited to be proven right. I went from Macedonia (excuse me, FYROM) to northern Greece (a/k/a Macedonia) and found Thessoloniki remarkably full of investments in public sector improvements. They really didn't go on the big borrowing spree until the Olympics period beginning in 2007, but they were clearly enjoying an inflow of capital. They were living at the expense of others.
Pilli: Lent by Fed, not really taxpayers. The real story there isn't the lending, it's the Fed's efforts to hide the story from Bloomberg News and others.
liberal jim: indeed, meet Robert Mundell. Father of the literature on optimal currency areas, now arguing the world is one.
Doctor Bean: What are the PIIGS' choices? They can default explicitly, they can repudiate via inflation via a new devalued currency, or they can seek long terms during which they collect taxes above their spending and ship the rest to German and French banks (and protect American interests who wrote credit default swaps.) Or hope the Germans and French can pay their debts for them. Where else to turn?
May '10
Re: Why the Second Unification Isn't Going As Well
King, I think this thread is by far the most important topic in the world today. Merkel will ram through the bailout if she can, but all it will accomplish is to kick the can down the road and make the problem bigger.
In the two best examples of a debt unwinding depression I know, Japan and the 1930s USA, the similarities with today are striking. In both cases the market worked its way down to a loss of 86% - 90%, with dead cat bounces along the way. Two decades after the bubbles burst in Japan, they are still at zero growth - and when inflation starts, as it eventually must, the misery index could go off the charts.
I started studying this seriously around 9 months ago to prepare for retirement. The thing most difficult to get my mind around was, as you point out, the obfuscation and outright lying by governments to hide just how bad the situation is - aided by the media.
There are a lot of retired folks, forced by the Fed (and other central banks) into higher risk investments to stay ahead of "their inflation" (as opposed to CPI) that are going to be wiped out.
May '10
Re: Why the Second Unification Isn't Going As Well
http://www.bis.org/publ/othp16.pdf
There is a new study out by BIS that puts numbers around the impact of debt to economic growth. While no one but an economist will wade through all the numbers, a quick read of the front end and a look at some of the charts will illustrate the size and scope of the global problem we are facing. All the major economies are interrelated and they are all showing huge increases in debt. This highlights why a significant sovereign debt crisis in Europe will have an equally significant impact on the rest of the developed world.....including us.
In fact, I suspect the situation is much worse than the paper suggests. It does not include for example the estimated $65 - $100 trillion unfunded liabilities the USA has incurred.
Re: Why the Second Unification Isn't Going As Well
Steve MacDonald: http://www.bis.org/publ/othp16.pdf
There is a new study out by BIS that puts numbers around the impact of debt to economic growth.
Steve, yes, that's the paper Ceccheti gave at Jackson Hole (Bernanke in attendance) last week. Very clear-eyed.
May '10
Re: Why the Second Unification Isn't Going As Well
So on the one hand, the huge mountain of debt accumulated by the developed world is going to severely restrict economic growth - favoring the developing world who have lower labor rates and stronger balance sheets.
On the other hand, the Fed and many other developed country central banks (E.G. ECB, BOJ) must fight increasing interest rates or their immediate debt payments will become unpayable.......assuming bond markets allow them to, which seems increasingly doubtful. This at a minimum hinders the balance sheet correction required to regain position, as it continues to promote malinvestment and creates other bubbles.
Where is the way out without a) a prolonged period (decades?) of economic stagnation & high unemployment as balance sheets gradually unwind - assuming political will to do so, or b) a huge crash?
I am no economist, just a simple turn around business guy - but I don't see a way forward that lends itself to a better future for my kids than I have enjoyed.