The recent critique by 172 German economists of the EU Summit plans to save the euro– an open letter in the Frankfurter Allgemeine newspaper – met with reactions so hateful that its content was only of secondary importance.
- The Financial Times accuses the 172 of “dilettantism”.
- The Economist, under the headline “170 German professors can’t be wrong”, ridicules both the authors (“Only a handful of the signatories are much known outside their faculties”; which is demonstrably false) and their message.
- Even the (non EU-area) Swiss media talk of “Stammtisch-Ökonomie” (kitchen-table economics) and call the leader of the 172, Hans-Werner Sinn, a “Rattenfänger” (Pied Piper).
Going Dutch or EUROpean?
What is the matter? The 172 perceive a European banking union as a scapegoat for joint liability by taxpayers for banks’ debt. They swim against a current that swelled in recent weeks and months. Even The Economist, typically reliably market-oriented, hammers the Germans: face it and pay! Chancellor Merkel is portrayed as a spoilsport or even euro-terminator, just for her reluctance to pool European debt. Not so, claimed the 172. The opposite is true; in agreeing the recent EU-summit resolution, Germany went too far.
Among the many rejoinders, an open letter by a group of highly reputable economists around the Frankfurt Center for Financial Studies stands out (see English translation on Vox, Burda et al 2012). The group, which includes Michael Burda, Dennis J Snower, Beatrice Weder di Mauro, Frank Heinemann, Jan Krahnen, Martin Hellwig and others, provide alternative views on the issue. They reach what they call “totally different conclusions” from the 172 and defend the EU-plan. In particular, they trust the centralization implied in a European banking union; the rescue mechanism ESM, though empowered to recapitalize banks directly, would be subject to appropriate conditions.
Who is right? Hope and reality
The two positions might be closer than one thinks. The ‘dueling open letters’ differ mainly in their interpretation of the resolutions of the EU summit and the implementation of the proposed measures. The judgement one makes depends upon whether one puts faith in:
- The desired outcome; or
- The likely reality.
The ideas behind the desired outcome are completely sound. There must be no pooling of bank debt. In fact, the analysis in the Frankfurt Center for Financial Studies letter is so sound that presumably many of the 172 economists – led by Hans-Werner Sinn – would also be willing to sign the Frankfurt letter.
However, the likely reality might be less sound. As with many of the past EU summit decisions, this looks like a money-today-against-a-promise-to-pay-back-tomorrow. And that is a promise which foreseeably will never be met.
Anatomy of a Crisis
A way through the crisis jungle starts by distinguishing the three main problems.
- First, there is the Eurozone crisis.
The countries of the Eurozone find themselves far apart with respect to their competitiveness. The euro as a currency will not perish, but some of the 17 states will be able to remain members only under enormous efforts and help from the outside - if at all.
- Second, there is the sovereign debt crisis.
Most industrial countries are indebted to a dangerous extent. The confidence of financial markets is dangling on a string. When it breaks, the interest burden explodes, and bankruptcy is imminent. Just a few days ago, Japan’s giant debt was barely mentioned in the media. Now, it just takes some political quarrels and Japanese bankruptcy will be just around the corner.
- Third, there is the bank debt crisis.
The European banks suffer from the burden left by the financial crisis, real estate bubbles, and high stocks of government bonds on their books. Via the mutual credit relationships, a rescue of Spanish banks benefits French and German banks as well. Many severely undercapitalized banks still pay huge amounts on dividends and executive payments. This does not come as a surprise. If new capital can be expected from the ECB, neither managers nor shareholders need to worry.
Big words instead of concepts
The EU leaders have been responding to these three crises without any discernible conceptual framework. What we have seen is ever-larger dollops of euros and ever-emptier buzzwords. In May 2010, in the face of the first strains, politicians declared war on "speculators". Later it was proclaimed that “If Greece falls, the euro falls”. Mixing the debt crisis with the euro crisis – “If the euro fails, Europe fails” - came in handy as it offered a pretext to slash the solemnly-adopted rules.
The increasing amounts of funds invested in rescue operations and emergency pots benefited neither the euro nor the indebted countries. They were not spent on the structural reforms in individual countries, which will be key in saving the euro. Rescue packages ended up at countries’ creditors; to wit, at banks. Only for the Greek debt restructuring did banks make a concession, when the ECB elbowed its way to the front of the queue. Banks played along since they would need the ECB later.
Rescued banks - shattered state institutions
With the bailout of Spain, the facade has now fallen. De facto, money will go directly from the printing press of the ECB to ailing commercial banks. Imagine such transactions five years ago. The financial press would have raised hell. A central bank finances troubled commercial banks! By abandoning the commercial banks’ (and their owners’) responsibility for losses and by abandoning its abstinence from handing out selective benefits, the ECB destroys two main pillars of the financial architecture.
Today, nobody seems to worry much – except those 172 economists from German-speaking countries through their, in light of the circumstances rather tame, letter. Admittedly, the letter simplifies much and some unfortunate formulations invite misunderstandings. But in its essence it is right on target. Saving the Eurozone from break-up and defaults might leave us with far-reaching bank bailouts at the price of a shattered European monetary system, shattered public finances, and a shattered confidence in European institutions.
But this time no one can say “The economists did not warn us.”
Editor’s note: This is an edited English version of an article (“Den Euro kann man nicht mit Geld retten”).
Michael Burda, Hans Peter Grüner, Frank Heinemann, Martin Hellwig, Mathias Hoffmann, Gerhard Illing, Hans‐Helmut Kotz, Tom Krebs, Jan Pieter Krahnen, Gernot Müller, Isabel Schnabel, Andreas Schabert, Moritz Schularick, Dennis J Snower, Uwe Sunde, Beatrice Weder di Mauro (2012). “Manifesto for a banking union by economists in Germany, Austria and Switzerland”, 9 July.