Greece and the Future of Europe

In this edition of MarketView, Marc Chandler takes a look at the impact of the Greek crisis and Germany’s role in the future of the European Project.

German Finance Minister Schaeuble claims that he raised the possibility of a Greek exit to push for an alternative, and he did so with backing of the Merkel government.    He used the threat of violating the “irreversible clause” of the EMU Treaty as a cudgel to beat Greek Prime Minister Tsipras into submission.

It appeared to work.  Tsipras has not only agreed to all the terms he previously called “blackmail”, but he agreed to essentially implement all the earlier agreements since the crisis began and more.

There is a powerful argument that believes that Germany crossed an important line.  As Wolfgang Manchau wrote in the Financial Times, “They have destroyed the eurozone as we know it and demolished the idea of a monetary union as a step towards a democratic political union…They demoted the eurozone into a toxic fixed exchange-rate system, with a shared single currency, run in the interests of Germany, held together by the threat of absolute destitution for those who challenge the prevailing order.”

The conclusion of this argument that its vindictiveness toward Greece, Germany has asphyxiated the future of the European Project. It becomes a German sphere of interest, dictated by its narrow self-interest.  Rather than leading to greater integration over time, by threatening a Greek exit from the irrevocable monetary union, it has rendered EMU into a rigid form of the ERM.  It turns the union into an economic utilitarian exercise.

Manchau and others argue that on these more narrow terms, a common currency does not work for many of its members.  He specifically cites Italy and Finland, but others could make the case for many other members as well.

There are two currents here.  First, many of the perma-euro skeptics find in the Greek drama confirmation of what they have been arguing for nearly a quarter of a century.  Monetary union without fiscal union does not work, and there is no appetite for fiscal union.  The second current stems from the bias that exaggerates the significance of the latest data point as if it were the last.

Many of the economic challenges that European countries face today were not born with the euro but pre-date it.  Under the ERM, there were frequent crises that were resolved by changing the pegs against the German mark.  This adjustment path has been blocked, but without structural reforms, the adjustment occurs via debt accumulation.  In addition, in violation of EU rules about the magnitude of external imbalance that require an adjustment, Germany’s insistence on pursuing a large current account surplus requires by definition others to accumulate debt.  This is independent monetary union.

It seems true, judging from various press reports that the recent European meetings have been particularly acrimonious.   However, this is not really new.  The history of summits is replete with harsh words and all-night meetings.   Some argue that the demands put on the Greek government are unreasonable and are designed to produce regime change.  They claim this introduces a democratic deficit.  Yet the arguments were expressed when Greek Prime Minister Papandreou was pushed out after proposing a referendum (which Tsipras opposed) in late 2011.  It has been suggested too that European officials forced Berlusconi out of Italy, which has had three prime ministers since and none directly elected.

To reach the conclusion that the critics want, they chose to end their story now.   We argue that monetary union is still evolving and that the Greek crisis does not end that process.  Instead, recognizing the strains that have been caused, European officials will seek to heal the apparent fissures.   We think it is politically naive to expect Europe’s elite to simply give up on the European Project.  There might have been a Plan B for Greece, but there is not one for Europe.

The European Project dates back to efforts after WWII to avoid another ruinous war in Europe.  The way to do it is form a community and integrate the economies like never before.  While the timing of monetary union, and the form it took, was a result of specific historic conditions (e.g. the fall of the Berlin Wall), it was consistent with, and extended Europe’s evolutionary path.

Manchau and others argue the acrimony, and Germany’s pursuit of narrow nationalist self-interest, mark the end of the road.  More likely, it is not.   While it is unlikely to happen immediately, we expect there to be a strong effort, led by Germany and France, to push for greater integration.  Monetary union is not complete.  The banking union is incomplete.   The recent Five Presidents’ Report offers an interesting blueprint and expression of the recognized need at the highest levels to continue to deepen and broaden integration.

It is incumbent on the critics to explain the future of a non-integrated Europe.  Is it a resumption of tribal warfare?  Is real per capita income going be higher or lower for most Europeans if they return to national currencies?  What is the future of a handful of relatively small countries, with aging populations, in a world dominated by the likes of the United States, China, and India?   Integration, of course, has problems and challenges, but so does the opposite.  Ultimately, we find much wisdom in Benjamin Franklin’s framing of the issue to the thirteen original colonies on the eastern seaboard of North America:  “Hang together or hang separately.”