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Ambrose Evans-Pritchard: The euro has failed, threatens democracy, and should be abolished

Section: Daily Dispatches

By Ambrose Evans-Pritchard
The Telegraph, London
Wednesday, January 2, 2019

To be charitable, you could say the euro has proved itself merely by surviving until its 20th birthday this January. That is a low bar.

Monetary union has otherwise failed as an economic and political endeavour. The evidence of Europe's 'Lost Decade' is that it can be made to work only under a regime of technocrat Caesaropapism -- that is to say by stripping elected parliaments of their lifeblood control over taxation, spending, and the core economic policies of the nation-state.

"One day the house of cards will collapse," says Professor Otmar Issing, the founding chief economist of the European Central Bank and the chastened prophet of the euro project.

... Dispatch continues below ...


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The London School of Economics has assembled package of papers by illuminati from Europe and North America to mark this week’s anniversary, published by the journal Comparative Political Studies.

Mark Copelovitch, Jeffry Frieden, and Stefanie Walter do not pull their punches in the prologue. The calamitous European Monetary Union saga has led to the "most serious economic crisis in the history of the European Union." It has done "more lasting damage" to swaths of Europe than the Great Depression of the 1930s and has pitted eurozone states against each other in a bitter struggle for control over the levers of policy.

The political dynamics have become poisonous. Years of rolling crisis "entrenched and amplified the power and influence of creditor countries such as Germany," working through the European Central Bank and the European Council.

In other words, EU bodies became debt collectors for the creditor bloc, and enforcers of a German-imposed strategy of debt deflation and fiscal contraction. The burden of adjustment fell on the weaker states, leading to a contractionary bias for the whole system. The Nobel fraternity have watched this display of pre-modern and pre-Keynesian illiteracy with a mixture of horror and despair.

Yet nothing is actually changing. There has been no Truth and Reconciliation to probe the disaster that was allowed to unfold. Those in control of the EU machinery still think they were right. The ideology prevails.

The London School of Economics papers said EU leaders have responded at every stage with half measures in a "sequential cycle of piecemeal reform," just enough to stop the collapse of EMU without resolving the core deformities of an orphan currency with no fiscal union to back it up. "What is clear is that the status quo cannot persist indefinitely if the euro is to survive in the long term," it said.

I would argue that the spectacle of an EU in such a shambles from 2010 to 2015 led directly to Brexit. It profoundly shook the moral prestige of the EU and demolished claims of economic competence.

While EU leaders quibbled over decimal points and debt repayment in Brussels, youth jobless rates reached 57 percent in Greece, 56 percent in Spain, and much the same across Italy’s Mezzogiorno. These were levels once unthinkable in a modern developed democracy. They have left a wreckage of "labour hysteresis" that will lower economic speed limits for a generation to come.

Several hundred thousand economic refugees came to work in Britain from the EMU depression belt. A further wave from Eastern Europe came to the UK instead of going to the eurozone as they would have done in normal times. The double surge had maximum impact just before the referendum.

More subtly, the euro crisis revealed that the pathologies of monetary union cannot be managed by normal democratic means. The elected prime ministers of Greece and Italy were toppled in 2010 and 2011 and replaced by EU functionaries in soft coups organized by Brussels and the pro-EMU vested interests of each country.

The ECB switched off liquidity support for Greek commercial banks in 2015, knowingly (and illegally?) precipitating a banking collapse that was hard to reconcile with the ECB’s treaty duty to uphold financial stability. When push come to shove, the reflex was authoritarian. It spoke to the character of the EU. That I why I voted for Brexit.

The London School of Economics says the euro crisis was predictable and was in fact widely predicted. It mimicked countless episodes in Latin America, East Asia, and other emerging markets, where debtors borrowed heavily in dollars they could not print.

The pattern is for countries to succumb to credit booms while money is loose and the "carry trade" is in full bloom. They spiral into busts when confidence evaporates and the capital flows dry up. This is the classic "sudden stop" faced by states that do not borrow in their own currency.

Europe’s elites imagined that current account deficits did not matter in the magical euro union, even though the deficit states in southern Europe and Ireland had lost their sovereign policy instruments and no longer had a lender of last resort behind them. They were therefore no different from Argentina or Thailand.

The elites also failed to grasp that fixed exchange rate systems (without full fiscal union) switch currency risk into default risk. The rating agencies also missed this elephant in the room and so did the International Monetary Fund, as it confessed later in its devastating mea culpa. Ideological capture drained everybody of their senses.

The illusion that monetary union was risk-free led to epic bubbles, made worse by a one-size-fits-all interest rate set for German needs when Germany was in trouble.

When the storm hit, the Berlin-Frankfurt-Brussels riposte was to misrepresent what was in essence as a cross-border banking and capital flow crisis as if it were caused by fiscal profligacy in the south. This became the "morality tale" version of EMU. It lives on in the policy structure.

It was and is fundamentally bogus -- except for Greece under New Democracy -- but it served the interests of Northern creditors. Prof. Issing says the rescue of Greece in 2010 was in fact a bailout for French and German banks. The IMF has admitted that the country was in effect sacrificed to save the euro and the European banking system at a delicate moment.

Yes, the south was naive. Nations feasted on the windfall of lower interest rates. They let unit labour costs ratchet up, even as Germany was ratcheting them down through the Hartz VI wage squeeze in what was objectively -- if not intentionally -- a beggar-thy-neighbour policy. They forgot that they cannot devalue their way back to exchange-rate equilibrium.

The EU’s cardinal error was to then try to force the high-debt states to claw back 20 or 30 percent lost labour competitiveness against Germany through "internal devaluations," a euphemism for slashing demand. This was self-defeating even on its own crude terms. It shrank the economic base and drove up debt ratios faster through the denominator effect.

The London School of Economics says the result of so much damage is that the eurozone’s troubles today "appear disturbingly similar" to those of Japan, trapped in deflationary stagnation for 20 years with broken banks. Except that euroland is not Japan. It is not a cohesive society with a monetary and fiscal machinery working in harmony. "Europe’s debt problems look even more serious and threatening," the LSE said.

Debt-to-GDP ratios in a string of vulnerable countries are far closer to the danger line now they were at the onset of the global financial crisis a decade ago -- up from 68 to 125 percent in Portugal, 36 to 98 percent in Spain, 99 to 131 percent in Italy, 65 to 99 percent in France, 54 to 96 percent in Cyprus, and 103 to 176 percent in Greece (despite haircuts).

A weaker euro, interest rates of minus 0.4 percent, quantitative easing (six years too late), and a belated end to fiscal austerity did induce a modest cyclical recovery from 2015 to 2017 but it is not self-sustaining and is already petering out.

The eurozone risks crashing into the next global downturn with no defences. Rates cannot drop any lower. There is no proper banking union with pan-EMU deposit insurance. The dangers of a sovereign-bank "doom loop" remain. They are on full display again in Italy.

Emmanuel Macron’s grand plan to rebuild EMU on safer foundations has come to nothing. There is no fiscal entity worth the name. Counter-cyclical budget stimulus to fight shocks is prohibited by the machinery of the Stability Pact and Fiscal Compact. The ECB is still unable to act as a full lender of last resort.

Berlin has written a "debt brake" into the German constitution, a way of telling the world that it will not take any serious steps to reduce a current account surplus of 8 percent of GDP -- a much greater threat to EMU survival than anything happening in Greece.

The LSE team takes a long view, comparing the eurozone’s travails to struggles between Alexander Hamilton and Thomas Jefferson over the handling of state debts in the United States. The battle saw disputes over the first and second national banks and lasted until the completion of U.S. monetary union in the 1870s -- and took a civil war to resolve. "Crafting a functioning economic and monetary union is a long, hard road," the LSE said.

The presumption is that the Europe’s leaders must in the end agree to some form of fiscal union, but this runs into the fundamental barrier of democracy. Such a system would eviscerate the tax and spending prerogatives of elected parliaments, forgetting the lessons of the English Civil War and indeed the American Revolution.

It can retain democratic legitimacy only if the EU goes the whole way to a supranational federal union akin to the United States, and for this there is not the slightest popular support in any major country.

The ineluctable conclusion is that a monetary union of budgetary sovereign states cannot be made to work, and should not be made to work. The euro is a constitutional anomaly. It must therefore be broken up. All else is self-deception.

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