Musings On The Euro Crisis

For the past couple of years, I’ve been lucky enough to travel regularly back-and-forth to Spain (and I lived there in 2009). It’s been fascinating to watch the state of the country change each time I return.

A good analogy is watching a young family member, like a cousin, grow. You see them irregularly, and each time you see them they appear to have totally changed. On the other hand, if the family member is a brother or a sister, you see them every day and therefore the change is never as obvious – it’s continual, and you don’t notice the change as much.

Each time I return to Spain, it’s as though the place has changed in a major way since I left. The change is much more noticeable precisely because I haven’t been there every single day. Every time, there are a few more people living on the streets in central Madrid. There are less people in the shops. There are more people protesting. And there generally seems to be a less happy feeling in the city.

Reading the media, it seems as though a crisis in Spain has only just occurred in the past few weeks. And that’s true, yes, with the bailout of Bankia and the bond risk premium spiking. But those are the immediate causes. In reality, Spain has been looking in a bad spot on the verge of crisis for a while now.

When you look through history, people blame crises on a specific event – an immediate cause. An example that springs to mind is the assassination of Archduke Franz Ferdinand, which people often describe as the cause of the first world war. That wasn’t the cause of the war. A better description of it is the spark that ignited the war. And that description implies that there were larger causes that were just waiting for something to light them to become a war. Indeed, this description is very apt in this scenario, where those longer-term causes are often called the “Balkan Powder Keg”, where the volatile situation in Balkans, as well as the alliance system, made war inevitable.

Just in case you’re not convinced with that unrelated example, another example is the 2008 financial crisis. I usually hear people say that the collapse of Lehman caused it. I’d say that the state of the subprime mortgage market (perhaps the subprime system itself) made the crisis inevitable, and Lehman’s collapse was the “spark” that caused it.

It’s the same thing in Europe right now, from my perspective (and this is just an objective perspective – by no means any authority on the subject). For over a year now, things in Europe have been getting progressively worse, with unemployment rates rising, austerity being the goal, and growth very low or nonexistent. The way I see it, my intermittent trips to Madrid have demonstrated this worsening of situation by making the change more obvious.

Now with stories of workers withdrawing their life savings at lunch and converting them to Pounds and Swiss Francs, combined with Spain’s bond risk premium frighteningly high, it looks as though that spark may be about to be lit. I would guess however that a Greek exit of the Euro, or a major bank collapse in Spain, is most likely to be the spark in this case.

From reading European politicians’ statements in Europe a couple of weeks ago, you’d never have guessed that a disintegration of the Eurozone was a possibility. The statements were all strongly-worded, implying that they wouldn’t let a disintegration happen under their watch. This week, even Mario Draghi (head of the ECB) was saying that it was on the verge of disintegration.

A thought piece by a guy called Ivan Krastev provides a compelling look at the similarities between the Soviet collapse and the perhaps impending Euro collapse.

“The Soviet collapse teaches us that just because the economic costs of disintegration would be very high, this is not a reason for it not to happen. To believe that the EU cannot disintegrate simply because it would be too costly offers only weak reassurance that the Union will continue to be stable. Paradoxically, the belief that the Union cannot disintegrate, backed by the economists and shared by Europe’s political class, is one of the risks of disintegration. The last years of the Soviet Union are a classical manifestation of this dynamic.”

Read his full piece here, and notice how he mentions the change in tone in the Soviet Union from “it will never collapse” to “collapse is now much more likely”.

I’m trying to make two points here. Firstly, current events are the result of many underlying causes. Secondly, the answer to the crisis may not be found in dealing with the causes of the crisis.

It seems as though many of the underlying tensions in the Eurozone that are causing problems are between Germany and other countries. Other countries are not arguing amongst themselves, but rather every other country in the Eurozone is trying to deal with Germany. This comes from the fact that Germany’s economy is doing very well, and other economies aren’t. Logically, if they weren’t monetarily unified, other countries would simply encourage devaluation in order to regain competitiveness. But this can’t happen because Germany won’t let it. The other option is to transfer wealth from productive Eurozone countries (Germany) to non-productive countries (everyone else at the moment). But Germany isn’t happy to do that either.

Look at the United States. It works because a proper mechanism is in place to transfer wealth from productive states to less-productive ones. In Europe no such mechanism exists. Perhaps that’s the underlying cause.

What does that leave? It leads to the fact that perhaps Germany should be considering their own exit of the Eurozone. Every other country could then encourage Euro devaluation and become more competitive, and Germany can be free of its bonds to the other Eurozone nations. A few people I know have been saying this for a while now.

Whether that is the solution or not, I think continually bailing out banks is a bad idea – it simply keeps the “spark” at bay. But eventually – as with Lehman – a “spark” will manage to get past and light the fuse. Europe should be focussing on deflating the long-term causes, which in my opinion come from the German refusal to transfer wealth to less productive nations or to let the Euro lose value. A bailout may keep crisis at arm’s length for a few months, as the 2008 Bear Stearns bailout did – but we know where that story ended with Lehman.