Wednesday, April 16, 2014
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Rescuing Europe from the Ground Up

MUNICH – The European Union has earned its place as an instrument for peace in Europe. Free trade has brought prosperity to its peoples, and the freedom to choose a place of residence guards against the resurgence of totalitarian regimes. The Acquis Communautaire protects all member states’ citizens under the rule of law. Anyone who doubts the existence of these benefits need only look to Kyiv’s “Euromaidan,” where hundreds of thousands of people have been gathered for weeks to demonstrate their support for closer ties with Europe, rather than an alliance with Vladimir Putin’s Russia.

The paradox is that the same enthusiasm and benefits do not apply when it comes to Europe’s common currency. On the contrary, the euro has plunged southern Europe and France into a deep economic crisis that is fraying the nerves of all involved. I have never seen so many swastikas and hateful slogans directed at Germany. The ex-head of the Eurogroup, Luxembourg’s longtime Prime Minister Jean-Claude Juncker, has said that 2013 makes him think of 1913, when no one could imagine what would happen a year later. That may be stretching things a bit, but a statement like this by such a distinguished politician is chilling.

Unfortunately, the crisis is far from over. While the insurance that the European Central Bank has offered, free of charge, to buyers of EU members’ government bonds has temporarily calmed financial markets, ordinary workers fretting about their jobs look to the future with trepidation. In Greece and Spain, half of all young people not studying are unemployed, as is a quarter of the adult workforce. Particularly worrying is the continuing rise in unemployment in France and Italy, where industrial production has been shrinking and price competitiveness continues to deteriorate.

The euro itself is responsible for this debacle. During the first several years after the EU’s Madrid Summit in 1995 officially launched the move toward a common currency, too much capital was steered into southern Europe, creating an inflationary credit bubble there. An inordinately lax regulatory environment proved lethal, encouraging northern European banks to pad their balance sheets with southern European government and bank bonds. When the bubble burst, it left in its wake woefully expensive economies that had lost their competitiveness.

Europe should now use the calm between the storm fronts to rethink the European currency union from the ground up. The effort to create a European equivalent of the dollar and impose a fiscal union on top of it, despite the absence of a common European state, is bound to fail. It will turn member countries into debtors and creditors to each other, stoking even more animosity.

The fundamental requirement for functioning monetary and fiscal unions in Europe is the establishment of a United States of Europe, with a real parliament that gives all citizens equal representation, together with a common legal system. Above all, the success of the European peace project requires a common army and a common foreign policy – that is, a genuine, long-lasting mutual-insurance union based on reciprocity in ensuring security and stability. Those who try to anticipate such a common state with a fiscal union will never achieve their goal.

Because France is not yet willing to accept a common European state, we need an intermediate stage to preserve and stabilize the eurozone. This requires sorting out the current mess and introducing a flexible membership system based on hard budget constraints. Four measures are needed to achieve this.

First, a debt conference is needed, with creditors of the southern European governments and banks forgiving part of the debt. The creditors relinquishing part of their claims must include public entities, first and foremost the ECB, that have now largely replaced private lenders.

Second, eurozone members whose path to regaining competitiveness through price and wage reductions is too long and grueling, and whose societies risk being rent asunder by the necessary imposition of austerity, must temporarily exit the monetary union. The pain of exiting should be cushioned with communal financial help, which would not be necessary for long, because a devaluation of the new currency would quickly restore competitiveness. In fact, a “breathing eurozone” that permits – and regulates – exit and re-accession should be clearly stipulated. Europe needs a system that is halfway between the dollar and a fixed-exchange-rate system like Bretton Woods.

Third, this breathing currency union must include hard budget constraints on its members’ national central banks. Specifically, a ceiling must be set on local money creation by establishing the obligation to settle balance-of-payments imbalances with gold or other comparably safe means of payment.

Finally, bankruptcy regulation for countries is essential in order to make it clear to investors from the outset that they are taking on risk. This is the only way to avoid the destabilizing credit flows that drove southern Europe to ruin.

If we are serious about deepening European integration, we must recognize that there is no credible alternative to reforming the euro from the ground up. Otherwise, Europe’s admirers and aspirants, like those in Ukraine, will eventually look elsewhere.

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  1. CommentedUsamah Uthman

    The first abd by far the most important measure to get out this mess is massive debt forgivness. However, in order for that to activate slack economies, debt forgivness must extend to businesses and households. It is only then all economic agents can feel some confedence in the future. When that happens aggregate demand picks up and the economies' wheels starts to spin much faster. There is no point to speak of continued austerity measures under the current circumsances. Economies are sluggish not because they are spending too much, rather because they borrowed too much and spent too much in the past. But by-gones are by-gones; and continued austerity shall never enable these economies to pay their debts.

    1. CommentedTomas Kurian

      Again it is seen how people do not understand what debt really is.
      Debt is a direct consequence of hoarding of profits and personal savings.
      Debt forgivness calls for cancellation of personal savings ( a la Cyprus), as debt is just an another side of balance sheet, covering the "saved" money.

      While this is OK if you agree on say 10% reduction of your savings in order to forgive 10% of debts, you have to tell it to the people upfront.

      But debt is not what matters: it is the missing aggregate demand, which was supplemented by annual deficits, which are now gone.

      The permanent solution is of course move to fully digital financial system, which allows for recycling of such unmoving, hoarded capital.

  2. CommentedJoshua Ioji Konov

    The United States of Europe is just a dream: there will be too many Ghettos in an economy ruled by the large corporations, where the central government through all kinds of programs helps the concentration of wealth, in a world of Globalization and rising Productivity whereas the less developed European Countries are put into total disadvantage and an screw your neighbor attitude, of rising discrimination and xenophobia. To make the United States could be only possible if the system start valuing a common development, curbs on the wrongful distribution of wealth, let small businesses and small investors compete to their big brothers in a fair competition...., and many more

  3. CommentedH.Publius H.Publius

    This situation reminds me so much of the aftermath of World War I. Only substitute the southern periphery for war-savaged and indebted Germany and Germany of today for the victors, France and England. I've been reading The Economic Consequences of the Peace, and the same arguments that Keynes makes on behalf of Germany could be made on behalf of Spain and Greece today.

  4. Commentedstefano visalli

    I tend to agree that an integrated, democratic federal Europe is not likely anytime soon. In absence of that Mr. Sinn proposal may indeed be sensible. Obviously once out of the Euro is not very clear why any country should join it back - at the maximum the could be scope of a semi-fixed exchange rate system like the one existed in the 90's .

  5. CommentedPaul A. Myers

    I think the option to exit the eurozone should be expanded and institutionalized through a two-currency eurozone: a northern euro and a southern euro. The northern euro zone might feature a more cohesive fiscal union than a southern euro zone. Eventually countries could migrate to the euro zone that their national political outlook is most comfortable with. A two currency EU would also allow for two different competitive spheres. One would presume that a southern euro zone would adjust to imbalances over time through devaluation while the northern euro zone might pursue a more stringent fiscal policy.

  6. Commentedhari naidu

    I get IFO newsletter regularly in spite of not being able to share Sinn's views on EMU. However, in this piece he has provided thoughtful ideas which demand full discussion.

    * Fundamentally it's clear sovereign French Assembly will not approve United Europe with accompanying fiscal union.

    * Banking Union is not going to resolve current monetary impasse...but it could facilitate moving closer to what's meant by Single Market under EMU.

    *Paradoxically it's Merkel who is holding up ever closer union by her insistence on enforcing a fiscal union.

  7. CommentedFriedrich Böllhoff

    It is not only France who is not willing to accept a common European state. If referenda would be held, a number of countries would reject it. And there is no common ground for a common European foreign policy to speak of, by the way. Different views lead to different deeds, as everybody can watch. I don’t see how there could evolve one single approach to foreign policy problems of it.
    The introduction of the Euro was a step too far towards integration. I don’t believe that the proposed four measures will be agreed upon anytime soon. But the second proposal with temporary exits from the Eurozone is quite interesting. Didn’t we have the system between the dollar and a fixed-exchange-rate system until 1998, called Exchange Rate Mechanism? A return to this might be an option.
    Even if governments would agree on these measures, I doubt that they can back them up with enough credibility. They might be seen as some more in a list of bureaucratic steps and half measures of wishful thinking. People might not believe that this is the long-term solution which is capable of pulling the Eurozone out of its crisis. In the meantime, Italians and French watch their industries further decline.
    The reintroduction of national currencies followed by their depreciation at least in some Eurozone countries, maybe in all, is probably the best way to regain competitiveness. This would be bold enough to convince that things get moving again. The losses for granting credits to those who cannot repay them have to be borne anyway, sooner or later.
    That Germany and others would lose some of their competitiveness would be a consequence. Or would anyone guess that it is possible to keep Germany as competitive as it is while lifting up southern Europe out of its misery, thereby creating huge trade surpluses of the Eurozone towards the other parts of the world? I don’t believe that. But a growing southern Europe would benefit all EU countries after all.
    And I don’t think that war lurks around the corner, if there is no single currency anymore. The demographic decline helps enormously not to try this again, helped by memories of past experiences, established democracies and still relatively high standards of living.

  8. CommentedZsolt Hermann

    I would like to congratulate the writer, as this article is very important, we could say a breakthrough.
    Indeed we have to build from the ground up and not the other way around as we tried so far.
    Understandably so far recommending a complete integration in Europe or anywhere else in the world was thought to be a political suicide, but today, when from the "elites" to the "simple people of the street" everybody understands that we evolved into a globally interconnected and interdependent human network, such notions as supra-national integration, United States of Europe, are logical and self-understanding.
    Of course there will still be a lot of resistance, extremist parties, organization will try to hijack it, scaring people and using the confusion, surprise for their own benefit.
    It is very important that such a fundamental social change has to happen through positive motivation, without coercion, threatening, trickery as most of our revolutions, changes happened before.
    For this reason the leaders understanding the necessity of this change, have to use all the tools they have in their hands to start a proper, global, integral education program, and societal value change in order to help the people understand the necessity and obvious benefits of full integration.
    A fully integrated Europe, mutually complementing each other, can achieve a previously impossible, unprecedented quality of life for all those involved, above the miserable crisis our fragmented, self-calculating, greedy ruthless competition brought us into.
    Thank you Mr. Sinn.

  9. CommentedTomas Kurian

    Mr Sinn, and what would Germany be doing in case South would indeed reach "competitivness" through once off measures ?

    The whole economic miracle of Germany is made of excessive exports - neocolonial exploitation of the rest of Europe, made possible by Euro, preventing DM to appreciate.

    Without these export surplusses, Germany would quickly have to abandon its balanced budget delusions.

    And this is at the root of today Europe problems:
    There are economic models of 20 century: - deficit financing / monetary policy which are not negatively affecting its neighbours and ensure stable development.

    Model of 21 century, enabled through fully digital financial system described in my work:

    Germany has choosen 19.century economic model - neocolonialism.

    And unless Germany moves at least to 20 century economic model, there is no future for Europe.

  10. CommentedMr Econotarian

    No "lax regulatory environment" caused banks to invest in Southern European government bonds, BASEL regulations required banks to hold highly rated securities, with government bonds being considered the "safest".

    Southern Europe doesn't need inflation to solve its problems. Paying people less real money under the existing labor and business regulations will not solve anything (getting rid of high minimum and sectorial wage regulations would be better for the economy than inflation, for one). The excessive labor and business regulations need to be abolished. Look at Germany's Hartz reforms, but go farther. When businesses feel safe about taking a risk to hire an unknown young person (because they can fire them if things don't work out), it won't matter if they are being paid in Euros, Dollars, or Bitcoins.

  11. CommentedGunnar Eriksson

    We need to consider that the common denominator for recent crisis has been undercapitalized and dysfunctional financial institutions. Island blamed the "Outside Euro "cause, Greece and Ireland the inside Euro cause. The US blamed whatever Fox News told them to believe.
    EU need to write off a very substantial part of the debt, recapitalize the banks with the aim of reaching 30 % equity (instead of the 3% Basel III suggest). A substantial equity is the only way to foster responsible boards and management.
    A creative wealth tax on EU level to be levied to ensure productive investments. Rent seeking idle money to be targeted and investment in research for prioritized areas to be tax free.

  12. CommentedMarco Cattaneo

    There is a way to re-engineer the european monetary system to allow problem countries to print money, support demand. realign competitivity with Germany's and stay solvent: all of that WITHOUT breaking up the euro. It's a matter of modifying it to restore flexibility by introducing parallel monetary instruments on a country-by-country basis. Here you a have a template suitable for Italy; France, Spain etc. can adapt it to their own specific conditions.

  13. CommentedStéphane Genilloud

    It's not so often that I agree with Mr Sinn, but this article certainly deserves widespread publicity.
    This is the only way forward for Europe. All the other options are bound to stagnate or go backwards.