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Friday, May 25, 2018

Euro Crisis (Again)

Spreads are widening again the euro periphery. It is clear that things could go horribly wrong in the euro area, and so one needs to take this tail risk seriously. That said, I would not hold my breath waiting for a euro implosion. Things will only get scary when there once again is a synchronised downturn; I do not know whether current events are enough to trigger such an event.

UPDATE (2018-05-28): The European governing elites managed to undershoot my already low expectations for their political competence. Thwarting a democratically elected government on the theory that its proposed finance minister might have a secret plan to leave the euro is insane. Who is this guy -- Dr. Evil? Rather than using multi-national institutions to grind the shaky coalition into the dust, they managed to force a straight up and down vote on euro membership -- which is the only way to get a country out of the euro (as I wrote below...).

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The "hard money" interpretation  of the euro (favoured in Germany) is unsustainable, which is a fairly standard critique. In practice, the euro shifted from a rules-based system to a system that says whatever the European Central Bank wants to do is acceptable. As a result, it has considerable capacity to keep the show on the road.

As the Greeks found out the hard way, the European establishment has the capacity to smash its boot on the face of small countries indefinitely. This is not true for the larger countries, as a default risks taking out the entire creaking banking system. As a result, negotiations are a game of chicken, and the European establishment attempts to muddle through. Will this time be any different?

It is a conventional observation to note that the European countries have put themselves into the same position as Canadian provinces. However, very few people want to explore the analogy. Leaving the euro is remarkably similar to a province exiting Canada -- a prospect that has been dangled in front of Quebec voters since the 1970s.

The mechanics of Quebec separation are not very well understood -- particularly in Quebec. It was always viewed as a process where Quebec negotiated the terms, then separates. The obvious problem is that Quebec's counter-parties had no mandate to negotiate terms. They could just reject Quebec's position, and we are back at square one. Quebec needs to either declare independence and then negotiate, or (more likely) have a strong mandate to declare independence if negotiations fail. (The problem with past referenda was that the questions were deliberately weasel-worded, and so no such mandate existed if they passed.)

Until a European party that is specifically taking a run at euro membership rises, all that will happen is that they will make protest noises, then cut a deal with the euro authorities. I could be wrong, but I am not seeing any signs that the current crop of "populists" in Europe have the will to confront directly the prospect of euro exit. (That said, the strategy of weeding out weak political movements poses risks in the longer term on natural selection grounds.) This makes some form of face-saving compromise inevitable.

Things are more difficult in the case of a synchronised downturn. Once again, we would see rapidly rising unemployment, banking system stress, and cross-country imbalances would explode higher. In that environment, the magnitude of interventions required to save the euro might be enough force the savings surplus countries to pull the plug.

(c) Brian Romanchuk 2018

4 comments:

  1. Nice piece, except in leaving the Euro your country would not be dismembered, whereas most of Northern Quebec, both the 1898 and 1912 land transfers would be likely be recinded. So whereas leaving the Euro does entail a reduction in one's factors of production (rather the reverse), leaving QC would involve a reduction in the real resources available to the QC population.

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    1. should read: leaving the Euro does NOT entail a reduction in one's...

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    2. Yes, but the opinion about those land transfers around here are different (“what land transfers?”). (Not sure whether they’ve changed, but primary school textbooks (used to) include Labrador in Quebec. (Never mind that First Nations treaties were with the UK sovereign, not “Quebec...”) So yeah, there’s a lot of room for pretty ugly disagreements about borders. The border issue is what makes the “declare independence, then negotiate” strategy very risky.

      On paper, leaving the euro looks easier legally, but not if it puts EU membership at risk. As our friends in the UK have discovered, getting out of the EU is a mess. The UK had negotiated the ability to be in the EU without using the euro, I heard rumblings that this would not apply to exiting periphery members back when the euro crisis was running hot.

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  2. As the Greeks found out the hard way, the European establishment has the capacity to smash its boot on the face of small countries indefinitely.

    That's not what happened. The Greeks found out the hard way that they have the capacity to smash their own boots in their own faces indefinitely, by refusing a negotiated Grexit, the best reasonably possible outcome, which they achieved. Smashing their own faces is what they are doing now, under the leadership of one of the stupidest humans in the world, Alex Tsipras.

    Leave the EU or only the EZ, who cares? Of course staying in the EU might be a wee bit better. But the "benefits" of staying in the EU or of negotiating instead of just leaving tomorrow are trivial compared to the harm that staying in the EZ does every day.

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