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European Debt Crisis

A Way Forward, Not Out

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European policy continues to drift with events. Momentum builds for a “pro-growth amendment” to the fiscal pact, but there are no convincing plans for pulling the moribund economies of the periphery out of the doldrums. Germany continues to toe the hard-line of austerity while paying lip service to growth, and refusing to recognize that they are as responsible as the debtor nations for the current crisis.

Little – in fact nothing – has come out of the most recent spate of  top leadership meetings, the G8 and NATO summits in Camp David and Chicago, respectively. This was a horribly wasted opportunity. NATO naturally focused on the short-term plans to exit Afghanistan, while ignoring the threat to the alliance and to democracy from a European break-up. The G8 summit was similarly disappointing, with leaders merely agreeing that more growth policies were needed, something which has been known to everyone but them for months[1]. What’s worse, European leaders returned to Brussels for an informal Executive’s meeting which Angela Merkel has already promised would produce nothing except for an agenda for the next “official” meeting in June.

The EU does not have until June. Already rumors are circulating about capital controls in Greece (later disproved)[2][3]. Deposits are flowing out of Spain and Italy as well, despite government efforts to play it down. Europeans don’t seem to realize how quickly an economic system can enter a death spiral – like Argentina 2002 or Lehman Brothers 2008 – and continue their lackadaisical, unhurried approach to crisis management. It doesn’t help that Luxembourg PM Jean-Claude Junckers has subtly called for states to develop contingency plans for a Greek exit.[4]

The Great Unraveling

We are witnessing (and some of us are immersed in) a great unraveling of civic institutions in Europe. This is the greatest threat to democracy on the continent since the rise of Fascism and Communism in the wake of the First World War.

Hungary is already governed by the openly ultranationalist party of Victor Orban. Greece is not governed at all, and a military coup to restore order cannot be ruled out should the June elections prove abortive or violence escalate.

Even old, mellow states are dealing with the resurgence of extreme politics. The Dutch government collapsed when the far right coalition partners refused to sign the budget. Finland is governed by the True Finn Party, which cannot be described as liberal progressive. The French Republic, our oldest ally, saw Marine Le Pen’s xenophobic rightist party win a frightening 18% of the vote[5].

Failed Policies, Failed States

The failure of “Core Europe’s” austerity policies is evident. Indeed, economists like Paul Krugman and Nouriel Rubini have been saying so for the past two years, and been loudly reviled for doing so.

The question now is not if the policy failures can be corrected, but if Europe is salvageable at all, and if so, how much of it can be rescued.

The answer is and must be “yes”. The consequences to Europeans, and the world, of failure is a long night of untold misery. Twice last century Europe descended into barbarism. Let no one doubt it can happen again.

Heading Off Armageddon

Saving Europe will require much more than “more of the same” policies from mediocre politicians, so we’re off to a bad start. Too few people currently think of themselves as “Europeans” rather than “Germans”, “French”, or “Italians”. Thus the diagnosis and remedies are too narrow in scope and too limited in action to be successful. The time of half measures is passed: even Eurobonds by themselves may no longer be enough to rescue the situation. I believe that there are only two permanent solutions to the crisis: a federal union, or the dissolution of the currency bloc.

Politicians have not yet arrived at this conclusion; indeed they are nowhere near it. That is where an outsider’s role is critical: to provide the initiative and support for EU leaders to rise above their merely national considerations and really start to work on European solutions to the European problem. To date, world leaders have been conspicuously absent in this regard, especially President Obama. His gentle chiding of austerity and a call for growth policies during the G8 summit could hardly be called inspirational.

This is strange considering that Mr. Obama’s reelection may very well depend on whether Europeans take determined steps or simply continue to muddle along. The US and Japan[6] are carrying the full weight of global economic recovery at the moment, as emerging markets slide and Europe enters full-scale recession. A prolonged European downturn will have serious consequences for the US economy, as 18% of our total 2011 trade was with the EU[7]. Mr. Obama’s prospects depend very directly on maintaining steady, even if historically low, growth in GDP and jobs, neither of which is likely should Europe implode.

What’s more, the American President is the natural initiator of such a dialogue. Not only is the United States the architect of the liberal democratic system now threatened by European disintegration; it is history’s oldest and most successful democracy. Mr. Obama can draw upon the strikingly similar parallel in our own history of the crisis between the Articles of Confederation and the Constitutional Convention.

Welcome to Philadelphia, Mrs. Merkel

After winning the Revolutionary War, the newly independent states were saddled with high debts, excluded from financial markets, and unable to compete with the more developed states in the world (sound familiar?). The central government had been deliberately designed to be weak, without taxation authority and requiring unanimous consent by the states for any measure it wished to enact (sound even more familiar?)

It took Americans 3 years (September 1783 to September 1786) to realize that the continuing national crisis could not be resolved under the Articles of Confederation. Delegates of five states met at Annapolis and agreed that only a major revision of the Articles could save the newly formed nation.

Europeans are now well into their third year of crisis. Instead of coming together, however, the old specter of nationalism threatens to tear them apart.

Mr. Obama should now be working to convince Europe’s leaders to convene their own constitutional convention. So bold and visionary a step would, at the minimum, buoy markets and buy time for delegates to sit and decide whether they truly want a European Union or whether they are too wedded to their national states and identities. There is no reason for all seventeen nations to remain – a United States of Europe can begin with fewer integrants, if they are the right ones.

The delegations would be well advised to work quickly and to avoid the legalistic incomprehensibility of the previous, disastrous, attempt at a European Constitution. To secure legitimacy, the new Constitution should be subjected to national referendums; to ensure practical functionality, it could enter into operation as soon as more than half the current members had ratified it.

The constitution would need to deal with the immediate issue of the crisis – lack of credibility in institutions, lack of faith in the individual states. This would be handled by the taxation authority in a new EU treasury, the federalization of some amount of the individual member’s debt with a guarantee of the remainder. The ECB’s mandate should also be amended to act as a true central bank, and an explicit lender of last resort.

Of course, it would be necessary to create a “divorce” process for those EU member states that did not wish to join the new European federation. Fortunately, a strong Federal Europe could much more easily manage the financial and political issues involved in such a divorce. Like the US government arising out of the Constitutional Convention, it could mutualize the debt of the separate states; in this case, the trillion plus in euro-denominated debt which could not easily be converted into new national currencies. I would not expect many defections at all, however.

It would be most appropriate if the United States of America should midwife the birth of a United States of Europe. The US has always been the greatest supporter of the European project, as a bulwark of democracy on the Old Continent, and it would be appropriate for us to cement that democracy through this historic process.

None of this is new. What’s different now are the stakes. The failure of the previous EU Constitution was highly embarrassing, but not fatal. Failure now – especially a failure to act decisively – could spell catastrophe.

 


Sources and Notes:

[1] CNN Wire Staff, “G8 focusing on Greece; NATO, on Afghanistan,” CNN, 20 May 2012
[2] “La fuga de depósitos dispara los rumores de un límite a la retirada de efectivo en Grecia,” El Economista, 17 Mayo 2012
[3] Carney, John, “Capital Controls Loom in Greece,” CNBC, 14 May 2012
[4] Johnston, Ian, “´So Much for ‘the Spanish dream’: Euro crisis turns suburbs into ghost towns,” MSNBC, 24 May 2012
[5] Leduc, Sarah, “Le Pen shocks France as far right hits historic heights,” France24, 23 April 2012
[6] “OECD cuts euro-zone forecasts, backs Eurobonds,” MarketWatch, 22 May 2012. The OECD forecasts GDP growth for the US of 2.4% in 2012 and 2.6% in 2013, and for Japan of 2% and 1.5% in the same period.
[7] 2012 Foreign Trade Statistics, Bureau of the Census, U.S. Department of Commerce

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