(Preliminary) Lessons from the “Euro Crisis”

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Slowly the smoke is clearing over the “Euro battlefield”. The speculative “war of aggression” against the Eurozone, as the head of the German Financial Supervisory Agency (Bafin), Jochen Sanio, put it on May 5, seems to have topped out. The pundits are proclaiming that the battle was lost by Europe and the euro. Supposedly, the status of the euro as a world reserve currency has been irreparably damaged, while the US dollar has asserted its role as “the” world reserve currency and safe haven for angst-driven investors.

by Michael Liebig


What concerns the fate of the euro, I would argue, “the condemned live longer”. Second, when it comes to the geo-economic “winners” and “losers” of the “euro battle,” I would argue, “when two people are quarreling, a third rejoices”. I think there is only one winner – which can be circumscribed by the acronym BRIC.

Christine Lagarde, the French Finance and Economics Minister, has acknowledged this fact when she noted that the world financial and economic “epicenter is not longer situated somewhere in the Atlantic Ocean in between the United States and Europe.” The “global correlation of forces the roles are changing dramatically. The big emerging nations are substantially gaining in economic weight and they are demanding their political share as well.” (Frankfurter Allgemeine Zeitung, interview with Christine Lagarde, May 17, 2010)

The “Euro Crisis” & the 1997 “Asia Crisis”

A few days earlier, Lagarde’s German colleague, Rainer Brüderle, was in Singapore for the 12th Asia Pacific Conference of German Business. At the event, the Secretary General of ASEAN, Surin Pitsiwan, said: The crisis in Europe “means increased focus on our region, because it has become the well-oiled engine of the world”. Via the Chiang Mai-Initiative, ”Asia has created a protective umbrella of $600 billion. If necessary, we can protect ourselves,” said Surin, adding that opposite to Europe public debt levels in Asia are low and represent no risk. The Indonesian Minister for Foreign Trade, Mari Pangestu, told Brüderle: “We are ready to offer advice and ideas to Europe on how to overcome the crisis, because we have mastered such crises.” (quotes, FAZ, May 15, 2010)

In April/May 2010, the European Union has gone through a experience which is comparable to what the leading economies of Asia – the ASEAN countries, South Korea and to a lesser extent China – experienced during 1997. The “Asia crisis” was a massive speculative attack exploiting some very real problems in the region: high short-term capital imports, big current account deficits, and real estate bubbles. The speculative attack, driven by Anglo-American financial institutions, hedge funds and rating agencies, let to a frenzied sell off of Asian currencies, beginning with the Thai bath. The currencies of Thailand, South Korea, Philippines and Malaysia were devalued by 30-40%, and in the case of Indonesia the devaluation was 80%. Several Asian countries – Thailand, Indonesia and South Korea – faced state bankruptcy and had to be “bailed out” by the IMF, with harsh conditions attached to the vast “rescue packages”.

But the Asians have lessons learned. Financial regulation was tightened and investment re-directed into the real economy – after a rather short time, the Asian economies were back on their feet. Now, as the head of the German chemical giant BASF put it at the Singapore event: “The coming decades will be determined by Asia. More than half of global economic growth will come from Asia.” (loc.cit.)

How to Manufacture a Crisis

As in Asia in 13 years ago, the current problems in the Eurozone are real, notably its Southern belt: excessive capital imports, current account deficits, and public debt plus real estate bubbles and credit-financed consumption instead of productive, technology-vectored investment. But these problems were made a pretext for the speculative attack on the Euro. The main actors in the speculative attack were the same as in the “Asia crisis”: Anglo-American financial institutions, hedge funds and rating agencies.

Since the beginning of 2010, in a spate of downgrades within a couple months, Anglo-American rating agencies cut down Greece’s rating to “junk”. This had two effects, institutional investors cannot keep “junk” bonds in their portfolios and the refinancing costs of Greece’s public debt exploded: In early March, the interest demanded for (two-year) Greek state bonds was at 6.1% – on May 7 it was 23.2 %!

There were no economic or financial basis justifying such a literal explosion of Greek bond yields. No country – whatever its economic and financial condition may be – can afford to pay an interest rate of 23% for its state bonds. This obvious fact was used to spread rumors about an imminent state bankruptcy not only of Greece, but of Portugal, Spain and Ireland as well. Beginning May 4, the markets for Greek, Portuguese and Spanish state bonds became illiquid.

And, on top of this, a campaign on an imminent “breakup” of the Eurozone was geared up. Already, on February 8, the Wall Street Journal had reported about a meeting of hedge fund managers in New York preparing a speculative attack against the euro. Since, a growing number of Anglo-American financial “experts” and media have joined the chorus on the “breakup” of the euro system, among them George Soros, Nouriel Roubini and Paul Volcker, not to speak of Ambrose Evans-Pritchard and the like.

Neither the “Greek crisis” nor the “Euro crisis” did “break out” – they were orchestrated. What happened is sometimes called building up an “asymmetric risk perception”: Two actors face similar problems, but one of them manages to be perceived as being in much better shape than the other – even though there’s no objective basis for such a perception. For the year 2010, public debt in the USA will be 10.1% of GDP, 11.8% in Britain 11.8%, and 6.6% for the 16 Eurozone countries. As former US Treasury Secretary O’Neill said, the US too could “follow on the path of Greece.” (bloomberg.com, May 19)

The Blowback

In the first week of May the campaign on the “Euro breakup” reached a crescendo. But then the orchestrated hype developed a life of its own. The interbank markets began to dry up. Banks – mistrusting each other – began hoarding money or transferring assets to central banks. And then – on May 6, 2010 – the New York stock exchange crashed. The automatized trading computers had registered the market abnormalities and activated sell-off orders on a grand scale. The latent panic became a real panic. What was intended to cripple the euro and Europe turned into a blowback for US financial markets.

President Obama frantically telephoned Chancellor Merkel and President Sarkozy. As usual when things get really critical, the Franco-German tandem did function – no matter what europhobe British media outlets are saying. On May 9, the creation of a 720 billion euro “protective umbrella” for the Eurozone was announced. 60 billion euro in credit pledges come from EU budget; a 220 billion credit facility from the IMF, and 440 billion in loan guarantees from 15 Eurozone countries (minus Greece). Of the total, roughly 200 billion come from France and Germany.

720 billion euro looks like an enormous sum. And it is an enormous sum, even if it‘ constitutes “only” a emergency credit line. Sofar, only 20 billion euro have been cashed out to Greece. When compared to the “ASEAN plus Three” monetary facility the Eurozone emergency fund no longer appears so enormous.

Also, on May 9, the European Central Bank decided to purchase states bonds of Eurozone member states if necessary. By May 17, the ECB had bought such state bonds worth 16 billion euro. That compares to an estimated $500 billion in treasury bills bought by the Federal Reserve and roughly 200 billion euro in guilts bought by the Bank of England.

As we noted in the May 9 Letter from the Rhine: During March and April 2010, while the speculative campaign against the Euro and the Eurozone was in full swing, the United States government quietly sold treasury bills worth $500 billion with yields of less than 3%. Sales of American public and commercial bonds to foreigners tripled in March, compared to February.

However, I think that is unlikely that – after the events of May 6, 2010 on the New York stock exchange – the US government will continue its “benign neglect” attitude towards American speculators targeting the Eurozone. The blowback potential of such speculation has become too obvious.

And there is another paradox: The euro exchange rate is currently at 1.23 to the US dollar – that’s a 23% devaluation compared to its peak in April 2008. Is such devaluation bad? No. It’s helping Eurozone exports a lot. And it helps the “PIIGS” in the Eurozone, because it’s dampens the downward pressure on wages and prices – the so-called “internal devaluation” – in the Eurozone’s southern rim.

Either Disciplining the Finance Sector or Committing Mayhem

Moreover, financial market regulation in the EU is getting serious. The latest speculative attack against the Eurozone has crossed a red line for European governments. On May 18, EU finance ministers decided to regulate hedge funds and private equity firms, operating in the EU. After loosing the May 9 state elections in North Rhine-Westphalia, the Christian Democratic-Liberal coalition government under Chancellor Merkel is seriously pushing for a financial transaction tax.

On May 18, the German Financial Supervisory Agency (Bafin) banned “naked short selling” of Eurozone state bonds, Credit Default Swaps (CDS) on Eurozone member countries, and stocks of the largest German financial institutions. The German push for a financial transaction tax and the banning of “naked short selling” came ahead of the May 19-20 “International Conference on Financial Market Regulation” in Berlin, sponsored by the German government in preparation for the Toronto G20 Summit on June 26-27.

And here we come back to the “winners” and “losers” of the “euro battle.” The loser is the “West” as a whole – Europe and USA. If the West fails to discipline its financial sector – re-transforming it into a mechanism servicing the real economy – the result will be the rapid, self-induced atrophy of real economic (and financial) strength and state capacity. And that means: The West’s geo-economic and geopolitical weight in the world will further shrink relative to that of the rising powers of Asia and Latin America.

I would think that the Continental European governments, not just those of the Eurozone, but in Central Eastern and Southern Europe and Scandinavia as well, have learned their lesson in the “Euro crisis”. These governments – whatever their (many and grave) defects and idiosyncrasies – do know that their peoples are fed up with paying bill for speculators. A key factor bolstering these governments up, is the deepening split between the private “financial industry” on the one side and real industry and technology-vectored Mittelstand firms on the other side – across Continental Europe. What will happen in the United States and the United Kingdom is another question.

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