The Financial Guns of August

That’s the title of my latest piece in Foreign Policy, about the seemingly inevitable collapse of the eurozone

The Financial Guns of August
Is it too late to stop Europe’s impending economic disaster?

Among the great and tragic questions of modern history, one of the most important is: How did the assassination of an Austrian prince turn into the conflagration of World War I, a disaster that in turn produced Nazism and Soviet communism, and which swept away most of the states that went to war in 1914? The answer, in part, is both simple and shocking. Following the rise of railways and the growth of mass armies, European countries had developed systems of military mobilization that, once set in motion, could not be reversed. As a result, they stumbled into war before they even realized they had passed the point of no return..

The conditions for an even greater disaster existed during the Cold War, when the doctrine of mutually assured destruction (with the appropriate acronym MAD) meant that any confrontation between the superpowers ran the risk of wiping out the entire human race. The United States and the Soviet Union built up systems that in effect were automatic doomsday switches, guaranteeing that a nuclear exchange, once started, could not be halted.

We escaped that disaster and now tend to imagine that the system worked as a force for stability. Arguably, though, this was a matter of good luck rather than good sense. With different people in charge, or a slightly different course of events, the Cuban missile crisis could easily have ended in all-out nuclear war, as could the Hungarian crisis of 1956 and the Yom Kippur War of 1973.

The problem is that systems built on deterrence and automatic responses work well much of the time, but when they fail, can lead rapidly to catastrophe. In a crisis, everyone tends to assume that it is up to someone else to avert disaster.

Europe’s current economic crisis seems to be headed in the same direction. All of the main parties are set on autopilot, and each seems to expect someone else to fix the problem.

The Greek political system is clearly incapable of implementing further austerity, and yet there is essentially zero support in Greece for an orderly exit from the eurozone, even if such a thing were possible. The only way an exit can occur is if the so-called troika consisting of the European Commission, the International Monetary Fund, and the European Central Bank (ECB) enforces it by provoking a banking crisis in Greece. Such an action would be the economic equivalent of a mobilization order.

Meanwhile, the central European institutions are making noises about preparations for a Greek exit, as if such an outcome will be the automatic result of any Greek refusal to continue the failed policies of austerity. Such saber rattling allows them to avoid thinking about any effective alternative to further growth-killing budget cuts.

The obvious alternative, a shift to fiscal expansion, faces two major obstacles, one of which has been the subject of much comment, while the other has been largely ignored. The clear obstacle is the unwillingness of German voters to pay more taxes that, in their view, will be used for the benefit of profligate Southern Europeans. The reality, that the primary beneficiaries of the bailouts have been German and French banks, is almost never mentioned.

The much bigger problem is that because European governments cannot print their own money, any fiscal expansion must be financed by debt, and any increase in public debt is likely to produce a new crisis. The proposal for a shift to Eurobonds, backed collectively by European governments, would spread the pain but not resolve the problem.

In Europe, as in the United States, the problem underlying the crisis was an excessive buildup of debt, partly public, but mostly private. The rub is that whereas the United States was able to resolve the most critical problems through quantitative easing (large-scale purchases of public debt by the U.S. Federal Reserve), this option has been closed off in Europe because the ECB refuses to buy government bonds and remains fixated on controlling inflation.

In retrospect, the ECB’s creation looks like a repetition of the systems of military mobilization built up before 1914, or of the doomsday switches built into the MAD system. The ECB’s design reflected the policy preoccupations of the 1990s, most notably the belief that low inflation would ensure macroeconomic instability, and fears that a common currency would encourage national profligacy. These preoccupations produced an institution carefully insulated from any kind of democratic control and explicitly precluded from any action that could sustain fiscal stimulus. As long as the ECB remains on its current course, disaster is inevitable.

But even in 1914, there were a few weeks between the assassination of Archduke Franz Ferdinand in June and the general mobilization at the end of July, during which determined action could have prevented war. The time is similarly short today, and there are few signs of hope. But there is still time for European leaders to act to save themselves.

20 thoughts on “The Financial Guns of August

  1. ‘The ECB’s design reflected the policy preoccupations of the 1990s, most notably the belief that low inflation would ensure macroeconomic “instability”, and fears that a common currency would encourage national profligacy.’

    Is this really what you meant?

  2. ok so let me distil all of this down to one sound-byte sized assertion

    “if the ECB does not undertake huge quantitative easing there will be World War III”

    or how about

    “If the Germans don’t give away all their wealth to Greece and Spain etc there will be WWIII”


    “If we don’t give away free money the world will automatically erupt in global war”


    “if you don’t pay for me to live i’ll destroy your world”


    “pay the poor or everybody dies”


    “give me your wallet or the (rich) kid gets it in the head”



  3. Along the plus ca change, plus c’est la meme chose theme, French President Hollande has announced a lowering of the retirement age.

    In Antony Belvoir’s account of WW2 the French decision makers were invariably out to lunch or with their mistresses and sometimes both.

  4. At risk of labouring the metaphor, I suppose the debt equivelant of a START treaty is simply too much to hope for? Or is that what we have already seen with the Greek ”haircut” (which like the reductions after START still leaves plenty of scope for MAD)?

  5. Maybe it is our modern Keynesians who are MAD and BAD.

    According to European Central Bank – the money ‘lolly-shop’ is now open. This is stimulus gone mad.

    According to New York Times:

    The central bank also promised to continue to provide European Union commercial banks with effectively unlimited low-interest loans, at least through the end of 2012. That move came as Mr. Draghi noted the increased level of stress in Europe and signs of flagging growth.

    Original text is at:
    NYTimes – Stocks Jump After Central Bank Officials’ Remarks

    By CHRISTINE HAUSER – Published: June 6, 2012

    Stocks on Wall Street and in Europe surged on Wednesday after remarks from a Federal Reserve official stirred stimulus hopes and after the European Central Bank kept the door open to making a future cut to its benchmark interest rate.

    The Dow and the broader indexes recorded their best daily performances this year. The Dow closed up 2.4 percent, or about 287 points, bringing its year-to-date gain back into positive territory. The Standard & Poor’s 500-stock index gained 2.3 percent for the day, and the Nasdaq composite rose 2.4 percent.

    Earlier, European stocks closed sharply higher, with the Euro Stoxx 50 and indexes in Germany, France, Spain and Britain up more than 2 percent.

    Mario Draghi, the European Central Bank president, said that some of the 23 members of the central bank’s governing council had argued for an interest rate cut in advance of Wednesday’s decision to stand pat on rates, and he left open the option of a cut later on. “We will stand ready to act,” he said.

    The central bank also promised to continue to provide European Union commercial banks with effectively unlimited low-interest loans, at least through the end of 2012. That move came as Mr. Draghi noted the increased level of stress in Europe and signs of flagging growth.

    Howard Archer, IHS Global Insight’s chief British and European economist, said there were “clear indications that an interest rate cut is now in the cards” because Mr. Draghi had stated that a “few” governing council members favored a cut in discussions leading up to Wednesday’s inaction.

    “We expect the E.C.B. to deliver an interest rate cut to 0.75 percent in July,” Mr. Archer wrote in a research commentary.

    Rick Bensignor, the chief markets strategist for Merlin, said Mr. Draghi’s remarks that he stands ready to act if things get worse also could have helped stocks.

    Other analysts noted that a rate cut on Wednesday would have had a limited impact because short-term rates are already close to zero.

    Stocks also may have been buoyed after Dennis Lockhart, president of the Atlanta Federal Reserve, signaled that stimulus was still an option.

    In a speech in Florida on Wednesday, Mr. Lockhart said that if needed to help growth in the United States, “further monetary actions to support the recovery will certainly need to be considered.”

    Bond prices fell, pushing the United States 10-year Treasury yield up 8 basis points to 1.652 percent. Energy and financial stocks rose the most among the S.&P. 500’s sectors, with gains of about 3 percent and 2.6 percent, respectively. Crude oil futures rose in New York trading, by almost 1 percent. In currency markets, the euro rebounded from just below $1.2450 to back above $1.2510.

    A currency analyst, Christopher Vecchio of DailyFX, said Mr. Draghi’s remarks that the E.C.B. was watching economic conditions closely also contributed to stoking the “risk-on” rally.
    “Over all, it’s difficult to say that President Draghi was optimistic,” Mr. Vecchio wrote. “He noted that ‘euro-area growth remains weak’ and that the ‘economic outlook is subject to downside risks.’”

    The central bank president also mentioned market tensions and unemployment weighing on the euro zone.

    “While these may be the prevailing facts, hope seems to be what’s driving trading activity,” Mr. Vecchio wrote.

    Jack Ewing contributed reporting from Frankfurt.

  6. History note.

    The fact that two events happen in sequence need not indicate causation. The idea that the assassination of Archduke Franz Ferdinand “caused” or “led to” WW1 has no credibility amongst those who have some idea of the complexities of history. Did it act as a catalyst or accelerator? Possibly, but I have my doubts about that too.

    Political Economy note.

    A vital principle is that a sovereign democratic government should not give up the right to issue its own currency. Neither should it sign compacts with other nations which hamstring its own parliament in the key areas of economic and social policy. If it does these things it is weakening its power to run fiscal and monetary policy in particular and handing parts of these powers to foreign powers or international financial interests. It is a betrayal of the very nature of national democracy and a betrayal of the people.

    Basically the EU was a neoliberal con job like much else that yhas happened from circa 1990 to the present. And like all neoliberal con jobs it is a disastrous mess destroying lives and livelihoods in the working class.

  7. The right has developed a worrying tendency to try and entrench their policies beyond the reach of democratic challenge.

    A classic is Merkel’s proposal for an EU ‘economic government’. It sounds like a group of officials accountable to heir electorate in some way. What you get is the stability pact which entrenches the Merkel fiscal policy as a treaty enforceable against its signatory governments. The people who elect those governments are not mentioned, perhaps because that would be to admit the electorate is being locked out of the process.

    The same thing is happening in the US with ever-widening Republican claims that X is unconstitutional because the Philadelphia convention did not address issues like climate change or marriage equality.

  8. POP @1, “pay the poor or everybody dies” is a nice change from the “pay the banks or everyboy dies” that has characterised both US and European responses to financial crisis so far.

    And yes, the Germans need to be told outright that (in Clint Eastwood’s words in Unforgiven) “‘deserves’ aint got nothin to do with it”. They pay the poor southerners or everybody will die, including them. If you want a currency union without a fiscal union then it is ALWAYS, sooner or later, going to have to be a transfer union.

  9. Ikonoclast – you are quibbling about the meaning of the word “caused”.

    Of course the assassination caused WW1 – it initiated the sequence of events that led to war. Of course that sequence of events would have been very different if there weren’t an enormous number of other things that determined them, ranging from the rise of nationalism, through John’s (actually AJP Taylor’s) “War of the Timetables”, down to the self-acknowledged incompetence of the incumbent Austrian Foreign Minister. We live in an overdetermined world.

    But the events would have played out quite differently if the Archduke hadn’t been assassinated (and in turn he wouldn’t have been assassinated if, say, his driver had been familiar wih Sarajevo’s backstreets). Just because there were a myriad of other causes doesn’t mean it is wrong to say that the assassination caused the war. Read yer Aristotle.

  10. But would Jones have run over Robinson if Robinson hadn’t been a cigarette smoker? 🙂

  11. [According to European Central Bank – the money ‘lolly-shop’ is now open. This is stimulus gone mad.]
    Why do people keep calling the loaning of large amounts of money to insolvent countries and/or banks a “stimulus”? It is nothing of the sort. The respective countries and banks use the money to desperately pay back their debts, not stimulate the economy. Since the debts are often to lenders in the country loaning the payment, it is just an indirect way of German taxpayers paying out German financiers from bad investment decisions. i.e. public funds used to pay off private investment errors. Sounds more like a recipe for moral hazard than stimulus.

  12. @Socrates

    Indeed. Most of the money offered to the southern countries knocked on the door, said a quick hello and then did a fast exit in the direction of private banks in poor suffering Germany. The Eurozone is already an extraordinarily efficient transfer union, it is merely that the transfers all flow north instead of south.

  13. monetary union have been common in Europe since the nineteenth century. the euro is the latest to come under terminal pressure. shows that economists do not study economic history enough.

    The Latin Monetary Union (LMU) joined Belgium, Italy, and Switzerland with France in 1867. the arrangement held together until the generalized breakdown of global monetary relations during World War I.

    The Scandinavian Monetary Union (SMU), formed in 1873 by Sweden and Denmark and joined two years later by Norway. This was disrupted by the suspension of convertibility and floating of individual currencies at the start of World War I. finally abandoned in the global financial crisis of 1931.

    following the start of the Zollverein (the German customs union) in 1834, members established a German Monetary Union. A full merger of all the currencies did not finally arrive until after consolidation of modern Germany in 1871.

    The Austro-German Monetary Union was dissolved in less than a decade following Austria’s defeat in the 1866 Austro-Prussian War.

    The only truly successful monetary union came in 1922 with the birth of the Belgium-Luxembourg Economic Union (BLEU), which remained in force until 1999.

    Europe in the twentieth century has also seen the disintegration of several monetary unions, usually as a by-product of political dissolutions.

    After the Austro-Hungarian Empire was dismembered by the Treaty of Versailles, almost immediately in an abrupt and quite chaotic manner, new five currencies were introduced.

    There also have been many British and French currency unions with and between colonies.

    Rather than saying the euro cannot fall, the discussion should be dissolutions of currency unions are common, especially when Greece is a member.

    What happened? How was the dissolution done? at what cost?


  14. In the end it is just paper. Clearly economist have missed the most important point. To be a successful economy you have to use plastic money.

  15. What I wonder is the gains from entering currency unions such as Euroland have never been big numbers.

    The losses of exiting a currency union other than in tranquil time are thought to be huge if you believe the media reports

    Makes no sense? Either the initial deal was very bad because of the big downside if things do not go well or the fated downside of exiting from currency unions is much exaggerated.

  16. JQ – not sure if I asked you this already but what do you think of Greece having a 30% payroll tax? And what do you think the role of tax reform is in creating the environment for recovery?

  17. I actually thought Monday’s 4 Corners report on the Euro problems was quite good.

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