Thinking the Unthinkable
This week, like the last one, was dominated by euro babel. Speaking in their various tongues, all at once, Europeans were talking nonsense. Especially Jose-Ignacio Torreblanca. The senior fellow at the European Council of Foreign Relations begins: “in an ideal world,” he says it is “fair and rational” for people to get what they’ve got coming… referring to the people who lent money to Irish banks. He even quotes the old Latin maxim: fiat iustitia, pereat mundus (follow the rules, even if the world should perish).
He should have stopped there. Instead, he misses the point he has just made. This time it’s different, he says. Why? Because “there is a good chance that in real life the eurozone could be killed…”
When the financial crisis hit in ’08, Europe might have let the chips fall where they may. But for nearly a century, elected officials have thought they could keep the chips from falling at all. Instead of merely consuming and redistributing the fruits of the economy; they pretended, by enlightened management, to increase them. Few people noticed the audacity of it. But in a downturn, government no longer lets wealth perish. It counteracts corrections with “stimulus.” And it doesn’t merely provide a stable currency, it manages a “flexible” currency system to help guarantee full employment and prevent debt crises.
By the 21st century, diddling the economy has become second nature…but much less effective. In the US, the fiscal and monetary stimulus of the early ’30s – equal to about 8% of GDP – had a powerful effect. One year later the US economy was growing at an 11% rate. Nearly four score years later, a combined stimulus effort of about 30% of GDP produced a response of barely 2% GDP growth. As for last week’s 85 billion euro Irish bailout, the market rally was over by tea time the following day.
The trouble with trying to get the outcome you want is that you end up getting the outcome you deserve anyway. Ireland guaranteed bank assets nearly 6 times greater than the nation’s GDP. Now, with unemployment at 20% and GDP down nearly 15% over the last two years, investors wonder how Ireland can possibly be good for the money. And they are beginning to wonder about Spain, Portugal, Italy and even France. Between them, French and German banks hold nearly a trillion euros worth of peripheral European nations’ debt. How long will it be before they go down too? The Irish bailout may cost about 100 million euros. Spain is ten times as big. These were “unthinkable” thoughts, said former Italian Prime Minister, Romano Prodi.
The periphery states benefited from the low interest rates of the Eurozone. With lending rates at 3%, instead of the 10% rate it had before it took up the euro, Irish property boomed. Irish banks were able to lend their way to insolvency. When the bust came, potential losses became real losses. But insolvent institutions do not become more solvent by borrowing more money. By the time the fix for Ireland is fully implemented, the Irish government will be deeper in debt – with a quarter of its GDP needed for debt service. At that level, they will be sunk. And you can forget about “growing” out of this debt problem. This year, for the first time ever, more Europeans will retire than join the workforce. Retirees are not producers of tax revenues. They are consumers of it. Besides, how will the Irish economy grow at all, with the government cutting back by 10% of GDP over the next 4 years, probably followed by another 10% cut when this one proves insufficient?
But that’s what happens. One manipulation leads to another improvisation. You pretend it’s a matter of principle, but you’ve already thrown out the “iustitia.” You’re just trying to get what you want, making it up as you go along.
The euro is a managed paper currency, like the dollar. Still, it is not managed enough for many Europeans. The Irish might revolt, leave the euro, and bring back the punt. In the old days of drachma and pesetas, Europe’s sunny countries could scam their lenders with shady currencies. There is even a proposal to introduce a new currency, known either as the “medi” or the “sudo” – designed to help Europe’s periphery states to manage their way out of their financial obligations. A weaker currency would lower the real value of debts, employment contracts, pensions and just about everything else.
“There will be no haircut on senior debt,” said Olli Rehn, the EU’s commissioner for economic and monetary affairs, still trying to keep the chips in the air. And why not? Because the consequences are unthinkable? No, he’s thought about them. He just doesn’t like them. But who cares? You can’t really manage an economy. You have to let it happen. Here we offer some constructive criticism: Stop worrying. What will happen if lenders suffer the losses they deserve? We don’t know. But we’d like to find out.