The day after the Syriza victory

January 26, 2015

Syriza Logo

I was delighted by the Syriza victory as it offers a chance for new thinking in Europe but we must be realistic about what is really required to fix Europe. Here are some thoughts on what is wrong and what is required to fix it.

Clearly writing off some of Greek’s debt mountain would be a good place to start but that won’t really address the structural problems of the Eurozone. I am not optimistic about the prospects of the Eurozone.

Here are what I see as being the major problems in the Eurozone.

a) The current currency union is inherently unstable because it is not matched by a simultaneous fiscal, and therefore political, union. I don’t think that most people in the EU in fact want a full political union and that even if such a full union came about it would have shallow democratic roots. In reality the years of crises have actually driven the nations of the EU apart rather than together and greatly undermined any sense of pan-European solidarity so I don’t think a political union is likely. But without one the deep problems of the Eurozone will continue.

It is worth remembering that the single currency project was, for the European political elites that drove it forward, always primarily a political project which it was hoped would be a halfway house on the road to full union and, and this is very important, it was recognised from the start that the current currency union was inherently unstable but it was expected that this instability would drive political union. In fact the reverse has happened and the currency union has tended to fragment the EU and undermine solidarity.

In order to understand why a political/fiscal union is necessary imagine a place called the Sterling Zone. A zone made up of independent countries with names like Yorkshire, Wales, Devon & Cornwall and London that have decided to use a single currency – the pound sterling. These countries have opened their borders and created a single market, and have built some limited political structures to coordinate their activities but each of these countries in the Sterling Zone have their own government structures. Each of these independent countries has its own central bank, tax system and parliamentary government institutions. All government expenditure in, say, Yorkshire, must be funded by taxes in Yorkshire or by Yorkshire borrowing the money in the open markets. The government of London, by far the biggest and richest country in the Sterling Zone, sees no reason to send money to Yorkshire to pay for the Yorkshire government (for it’s social security system, or health system or education) and instead just urges the government and people of Yorkshire to tighten their belts, work harder and be more like the prudent and hardworking folk of London. The Yorkshire government got into financial difficulty recently and with great reluctance London lent it some money but insists that all that money has to be paid back and in the meantime interest on the loans must be paid. Meanwhile unemployment in Yorkshire has reached 25% and malnutrition is now a common problem. The people and Government of London think that this is unfortunate but they have no duty to pay for other countries who cannot work hard and pay their way like London can.

The Sterling Zone is of course absurd and could not work. But that’s exactly how the Eurozone is currently structured. In the UK money from tax receipts in London flows all over the UK in a more or less invisible process and that is not really a political problem because almost everyone in the UK thinks we are all one country and are one people. That sort of mostly unproblematic solidarity and sense of shared community is what the Eurozone needs right now.

b) Within this inherently unstable currency union Germany took the unilateral decision to strongly orientate its economy to generate exports, a trading surplus (of massive proportions) and to eliminate its government deficit. Most of Germany’s trade (around 75%) is within the EU so Germany’s surplus became other EU country’s deficits. Germany will not let go of it’s economic model so other countries must reduce their deficits independently and weak German demand will not help them grow their economies. As the deficit countries cannot reduce their exchange rates (because they are inside a currency union) the only alternative is to drive down living standards, raise unemployment, reduce labour costs and reduce imports. This is what has happened and the trading deficits have been reduced but at great social costs.

The years between currency union in 1999 and the crises in 2007, the years when Germany was relentless building its huge surplus, saw counterbalancing movements of cheap capital into the peripheral countries of the EU and this fuelled asset bubbles (such as the property bubbles in Ireland and Spain) and excessive government borrowing in Greece (much of it linked to the 2004 Olympic Games). Surpluses always generate counterbalancing flows of capital. It was Germany that supplied the cheap and plentiful money for the speculative property bubbles and Greek excesses.

c) The global financial crises which started in 2007-8 has had a major and damaging impact on the currency union. The crises has had three major impacts.

Firstly a number of EU member states had to bail out their banking sectors at huge expense in order to prevent a general banking collapse. This was mostly funded and managed at a national rather than Union level and as a result several countries (notably Ireland and Spain) have been left saddled with very large government debt.

Secondly the global crises has weakened the global economy and reduced global demand just when the weaker EU countries need strong overseas demand to generate growth and reduce their deficits. I believe that global demand and growth will continue to weaken and remain weak for several years to come.

Finally the financial crises has left the European banking sector in a weak and vulnerable condition. Most banks now have weak balance sheets, carry dubious debt assets and are not in strong position to finance growth and investment.

So to summarise:

Writing off some debt would be a good thing but is only a short term solution.

Longer term the Germans need to be convinced to inflate their economy, drive up their labour costs by increasing wages and not only reduce their current account surplus but actually run a trade deficit so that German demand can drive growth across Europe. Good luck with that.

Once the currency union is more stable and confidence in the EU has recovered fiscal and political union is imperative in order to create a lasting stable currency union founded on a deep political union. Good luck with that.

Next post: