Lazy, profligate, scheming Greeks versus honest, thrifty, industrious Germans. Southern vice versus northern virtue.
For much of the news media—not only in continental Europe’s “virtuous” north, but also in the United States—the euro sovereign debt crisis could be summarized in the form of this morality play opposing national or regional stereotypes. If in Germany itself it was the deliberately over-the-top tabloid Bild that famously took the lead in lecturing the Greeks on Greek vice and German virtue, in the United States, New York Times columnist Thomas Friedman adopted essentially the same tone and underlying “analysis.” “Can Greeks Become Germans?” Friedman asked in a column written last year, suggesting that this was the only way the crisis could be resolved. Even the acronym commonly employed for southern Europe’s fiscal “sinners” reflects moral opprobrium and contempt: the “PIGS” (sometimes written “PIIGS,” so as to include also the northern European special case, Ireland, along with Portugal, Italy, Greece, and Spain).
But what if the financial strains on the PIGS that threaten the eurozone are a product of the eurozone itself? What if the problems of the euro, in other words, are of the euro’s own making?
Despite its demagogic appeal, the “fiscal saints” versus “fiscal sinners” schema has never had much explanatory purchase. Germany—reputedly a “saint”—was among the first eurozone countries to breach the fiscal rules of the so-called Stability and Growth Pact, running up a budget deficit of more than three percent of GDP in 2002 and for each of the following three years. (According to current Eurostat statistics, Germany in fact had already violated the three percent deficit limit in 2001, although the breach was not noted at the time.) Germany was joined in its sinful ways by France: a country well known to be of dubious virtue in fiscal regards, but, nonetheless, the country with whom Germany has willingly got into bed, so to speak, in order to launch and sustain the project of monetary union. France exceeded the three percent deficit limit for three straight years from 2002 to 2004. Neither country suffered any sanction for its transgressions.
While it is true that Greece has persistently run budget deficits exceeding the three percent limit since joining the eurozone, the behavior of one of the other PIGS, Spain, has been positively “saintly.” In the three years prior to the onset of the financial crisis, from 2005 to 2007, Spain had budgetary surpluses. Portugal and Italy, the two other “PIGS,” have sinned, but in dimensions comparable with their supposedly more virtuous northern partners.
The second of the famous “Maastricht criteria”—public debt as a percentage of GDP—is no more effective at separating “saints” from “sinners.” According to the latest available statistics, even today—in the aftermath of the financial crisis and in the very midst of the debt crisis—Spain’s public debt is only around sixty-five percent of GDP. This compares to more than eighty percent for both Germany and France. For a full decade, from 2000 to 2009, Spain did not once exceed the sixty percent limit laid out in the Stability and Growth Pact. During the same period, Germany was only below the limit once; France has exceeded the limit every year since 2003. Although its debt has ballooned since the financial crisis, for most of the last decade, Portugal, like its Iberian neighbor Spain, clearly outperformed both France and Germany in controlling its debt, staying under the sixty percent limit for five years running.
Italy is a particularly interesting case in this connection. At one hundred and twenty percent of GDP, the country’s public debt is legendary. According to the standard narrative about the debt crisis, Silvio Berlusconi had to be removed as prime minister last November in order to placate the financial markets, as if Berlusconi had been personally responsible for the deterioration of the country’s finances. But Italy’s public debt was already at or above one hundred and twenty percent in the mid-1990s. (Berlusconi was briefly prime minister from May 1994 to January 1995, but he only came into office for an extended period beginning in June 2001.) Before the financial crisis, the debt had been brought down to as low as one hundred and three percent, only ballooning up again in its aftermath. Moreover, even under the remarkably difficult circumstances of the last year, the Berlusconi government had in fact succeeded in reining in public spending. The Italian budgetary deficit for the third quarter of 2011 was 2.7 percent—below the prescribed limit.
If not “national character”—or character defects—what then is at the root of the eurozone debt crisis? A look at some related statistics suggests an answer: the euro. Consider the following chart (Figure 1) showing the evolution of the current accounts of each of the “PIGS” from the 1999 launch of the euro through 2010. The current account represents a country’s balance of payments on goods and services, plus investment income and so-called unilateral transfers (i.e., employee remittances and foreign aid). Each of the countries’ national currencies were first linked to a virtual, non-circulating euro at “irrevocable” rates of exchange and then, beginning on January 1, 2002, replaced by actual euros in circulation. Portugal, Italy, and Spain were part of the original launch of the “virtual” eurozone in January 1999. Greece joined two years later.
The chart shows that all of the “PIGS” suffered a severe and progressively worsening deterioration of their balance of payments following the adoption of the euro. The deterioration is especially pronounced after the 2002 introduction of the euro as a real circulating currency, and it remains virtually constant until 2008 and the onset of the global financial crisis. After the financial crisis, as credit dries up and domestic demand contracts accordingly, the trend is predictably interrupted and in some cases reversed.
Now, consider the evolution of Germany’s current account from the introduction of the euro until today (Figure 2). It may come as a surprise to non-specialists that prior to the introduction of the euro, Germany ran a persistent current account deficit for most of the 1990s. The German pattern is the inverse of that displayed by the “PIGS.” From 2002—and the introduction of the euro as circulating currency—until 2008 and the onset of the financial crisis, Germany enjoyed a steady and, overall, massive improvement in its current account balance. It was during this period that Germany famously became the world’s leading exporter—or “export world champion” (Exportweltmeister), as the German media enthusiastically proclaimed it.
But to a remarkably large extent—which has, nonetheless, barely been registered in public perceptions—Germany’s “champion” status was a result of its ringing up easy wins against weak intra-European competition on the regional circuit. According to official statistics, in 2009 Germany’s exchange relations with the (at the time) fifteen other members of the eurozone accounted for fully half of its overall current account surplus.
The final chart below (Figure 3) illustrates the evolution of Germany’s bilateral current account balances vis-à-vis the “PIGS” from the introduction of the euro to the present. In each case, Germany’s current account went from deficit or a small surplus before the introduction of the euro to increasingly large surpluses after. As in the aggregate charts, the trend is interrupted around the time of the financial crisis.
In the absence of the exchange-rate buffer, it was virtually a foregone conclusion that the “PIGS” would lose competitiveness vis-à-vis Germany—or rather that their real competitive disadvantages would be exposed in the form of a growing current accounts deficit. If basic economic theory and a touch of realism did not already make this clear, then the experience of the so-called Exchange Rate Mechanism provided a grim foreboding of what was to come.
The Exchange Rate Mechanism (ERM) was the system of “fixed-but-adjustable” exchange rates that served as precursor to European Monetary Union. As a rule, the values of the currencies in the system were permitted to fluctuate against one another only within restrictive bands of plus or minus two and a quarter percent. As a special dispensation, some currencies were accorded a larger band of six percent. In theory, the ERM was supposed to provide a “glide path” to monetary union. In practice, the experience was anything but smooth. If a pattern of progressive current accounts deterioration in southern Europe did not already appear under the ERM, then this was only thanks to periodic negotiated devaluations of which the Portuguese escudo, the Italian lira, and the Spanish peseta all partook. (The Greek drachma never formed part of the ERM.)
As recounted in painstaking—and often darkly amusing—detail in Bernard Connolly’s history of the ERM, The Rotten Heart of Europe, European governments’ efforts to pin down exchange rates by fiat created a field day for currency speculators. Speculators could anticipate the need for a downward adjustment of a currency and the inability of national monetary authorities to endure the high interest rates required to defend their assigned exchange-rate peg. Moreover, as Connolly explains, the German mark served as the de facto anchor of the system and it was an “unwritten rule” that while other currencies might be devalued against the mark, they could never be revalued against it. As consequence, even if their bets on a devaluation proved wrong, speculators knew they could not be too badly burned by a targeted currency appreciating.
Another currency that came under repeated pressure in the ERM was none other than the French franc. But unlike the plebeian currencies further to the south, the franc benefitted from what has been called a “sweetheart deal” between France and Germany. The deal assured that the German central bank, the Bundesbank, would intervene in support of the franc even when the ERM rules did not require it to do so. (As discussed by Connolly, the ERM rules only required countries to intervene whose currencies found themselves in “opposition,” i.e., at the two extremes of the assigned exchange-rate band. Thus, for instance, if the Dutch guilder was at the top if its permissible two and a quarter percent band against the Irish pound, but the German mark was not, only the Dutch and the Irish authorities were obligated to intervene. German authorities did not have to do anything. The “sweetheart deal” meant that Germany would—and in fact did—intervene in support of the French franc even when the mark was not at the top of its bilateral band with the franc.)
Eventually, after numerous devaluations, the outright departure of one currency (the British pound), and the ostensibly only “temporary” withdrawal of another (the Italian lira), the entire system finally blew up in August 1993, following renewed speculative assaults on the franc. The “sweetheart deal” was off. German monetary authorities were no longer prepared to compromise German price stability in the interest of defending the parity of the franc. Instead, the “normal” bands were expanded from the two and one quarter percent that had hitherto obtained to a generously roomy fifteen percent. The shell of the ERM was thus preserved—but it was obviously hollow.
As compared to the Exchange Rate Mechanism, full-fledged monetary union spoiled the game of the currency speculators. There could be no more betting on downward adjustments in exchange rates, because there was nothing more to adjust. But the flip side is that the relief that those adjustments provided domestic economies burdened with overvalued currencies was no longer to be had. The same sort of relief would have been available as a matter of course in a system of floating exchange rates. Under a common currency regime, relatively underperforming economies would simply have to suffer.
Now, it is said that Germans do not want to have to pay for Greece’s debt woes. But then why has there been such great resistance to allowing Greece to default, exit the eurozone, and re-establish its national currency? Once re-introduced, the drachma could find an exchange-rate level vis-à-vis the euro—and all other currencies—that is compatible with domestic economic conditions. This would allow Greece to reduce its current account deficit and begin the process of recovery. As for Germany, it would no longer have to bear any part of Greece’s debt burden.
When, last fall, then Greek Prime Minister George Papandreou raised the prospect of just such a way out of the crisis, the entire European establishment reacted not with relief, but rather uncommon fury. On October 31, 2011, Papandreou announced his intention to hold a referendum on the latest EU bailout agreement. The terms of the deal included a slate of new austerity measures and government sell-offs. In light of massive popular opposition to the agreement, the likely outcome of a referendum was obvious: namely, a “no” vote, followed by default, and Greece’s exit from the eurozone.
Two days later, at the G20 meeting in Cannes, German Chancellor Angela Merkel and French President Nicolas Sarkozy are reported to have called Papandreou on the carpet, warning him that Greece would no longer receive eight billion euros in already committed aid unless the referendum idea was quashed and the deal accepted. The European Commission explained that Greece could indeed leave the eurozone—but that it would have, then, to leave the EU as well. Even the German tabloid Bild got in on the act, huffily insisting that if Greeks were going to hold a referendum on leaving the eurozone, then Germans should hold one on throwing them out. For once, the populist instincts of the Bild editors appear to have failed them. In an online poll hosted by the German weekly Stern, seventy percent of respondents approved of Papandreou’s plan.
But popular will—whether Greek or German—be damned. Faced with a united front of France, Germany, and the European institutions, Papandreou caved in. Just four days after calling for the referendum, he dutifully abandoned the idea.
The episode raises obvious questions about the state of democracy in Europe—so too, of course, does the subsequent imposition of unelected, ostensibly “technocratic” governments headed by former EU officials in both Greece and Italy. But the referendum affair also raises questions about the very nature of European Monetary Union. Why this unwillingness to let Greece go, when from an economic perspective it would be to the benefit of all parties concerned? The only possible reason is that European Monetary Union must fundamentally not be about economics.
This is indeed the thesis of Bernard Connolly’s book, first published in 1995. Connolly argued that the push toward monetary union was essentially driven by political considerations, which were persistently allowed to trump the economic illogic of the project. Whatever their differences—and they are legion—the French and German promoters of monetary union shared, as Connolly put it, a common “conception of the interaction between politics and economics.” “In that conception,” he wrote, “economics—and monetary economics in particular—is the instrument of political hegemony . . . currencies are an expression of state or caste power, and the wider the currency’s domain, the greater the power of those who control it.”
The point of monetary union was not the economic well-being of the European “periphery,” which would almost surely be condemned to relative impoverishment and dependency by the project’s realization. The point was power: creating an “economic space” large enough to permit Europe to challenge the United States for global supremacy. The European sovereign debt crisis—as much by the European elites’ response to it as by its mere occurrence—has proven Connolly right.
In recent months, there has been some talk of European leaders finally biting the bullet and preparing for an “orderly” Greek default, to be followed by Greece’s exit from the eurozone. It is said, hopefully, that the Greek economy only represents two percent of total eurozone GDP. But the problem is that, should Greece leave the eurozone and prosper, it would provide a positive model for the other southern European eurozone countries that have found themselves in the same situation for essentially the same reasons. It would also provide a model for newer Eastern European EU member states that have not yet adopted the euro, but are, in theory, obligated at some point to do so. It is not clear that the euro’s promoters can afford to let this happen. A Greece prospering outside the eurozone could be their worst nightmare.
John Rosenthal writes on European politics and transatlantic relations for such publications as the Weekly Standard, Policy Review, and National Review Online.