Praying for Euro

In Criticism, Financial, Politics, Strictly Monetary: A Series on June 6, 2012 at 8:58 PM

Panic over the potential break-up of the Euro is at its highest point. People are withdrawing wads of Euro cash from Spanish and Greek banks, hiding it under the mattress and bracing for the fallout. In the Strictly Monetary Series (Part V), I told the story of how an American bank averted crisis during the panic of the Great Depression. It’s a textbook example of how banks can survive the shock of everyone demanding their money at once (bank-run) if they can secure additional cash to appease the frantic public. You don’t beat panic with prayer; you beat it with action.

This is what makes the European crisis so incredible. When you create a monetary system this large, the cause of panic gets complicated. In a normal bank-run, you need enough physical cash to appease the public’s demand for money. Europe has a central money-printing machine, known as the European Central Bank (ECB). Usually, once people can see that their money is in fact there and the bank won’t close its doors, they just return the money to the bank. But the problem in Europe goes beyond whether or not local banks are capable of paying deposits. If countries like Greece leave the Euro, people want Euros to protect their power to purchase things. They have no desire for Drachmas.

The focus of the crisis has shifted to Spain recently. In particular, the strength of their banking institutions is being questioned. But Greece remains in the lead for the worst-case scenario. The population of Greece recently elected many new faces from both the extreme left and radical right. What these politicians have in common was a promise to get Greece out of the austerity measures imposed on them by the European Union. With such contrasting political interests, the Prime Minister was unable to form a government. Greece will recast ballots again mid-June. Essentially, this re-election is a referendum on the most important question facing Greece today: Do the benefits of the Euro justify losing the ability to control how government money is spent?

Let’s not forget that most of the European Union is dependent on Germany at this point. Nations without crippling debt problems are scarce in Europe. Even worse, it has been reported that Germany is starting to experience inflation while the rest of the Euro zone tries to kick-start their respective economies. This complicates the situation further. Will Germany continue to print more money for the benefit of the Europe – even if it means Germans will be hurt through rising prices?

Even more amazing: There’s no consensus about whether the Euro is doomed or not. If we look at a snapshot of where it is now, it’s completely unsustainable. But there’s an unlimited amount of support and reform that can happen to save it. Europe benefits from staying united. A single voice would allow the smooth execution of monetary and fiscal policy. A united Europe has more options.

No politician wants to entertain a possible break-up of the Euro. Experts say that Greece existing outside of the Euro zone has the economy of Albania, or Macedonia. That would be a substantial drop in living standards. But nations want the benefits of cooperation without giving up their independence in policy making.

Even if politicians come to the right conclusions, diplomacy takes time. A union of so many sovereign nations will never be swift in its actions, something that is essential to avert financial panic. The irony is that while politicians deliberate and posture about the best path to save the Euro, panic may set in at any moment exposing this political indecisiveness, causing the Euro’s demise.

So everyone is on the same page, but on their own terms. Economists are screaming for more government spending as the Europe recession worsens and markets panic. At the same time, politicians are using market panic to leverage responsible behaviour from irresponsible nations. Until nations such as Greece demonstrate they are willing to sacrifice, why should it receive more bailout money? Bad monetary policy is good politics, and vice versa.

Marshall McLuhan used to say that we drive forward by looking at the rear view mirror. Governments look at what happened in the past and try to figure out which way they’re headed. Their policies are reactions that always lag. They’re trying to hit a moving target. Every nation has this problem, but the sheer scale of the problem in Europe makes it much more difficult to manage. Controlling a system of money for so many countries is something that has never been tried before.

But even if you could harness these complexities, politicians are exacerbating this crude economic process. Politicians put out fires; they don’t prevent them. Even a united effort toward saving the Euro will take years of crisis, uncertainty and panic. Time will tell if the Euro was unsustainable. But no politician wants to be around to experience life without the Euro. Some fires are easier to put out than others.

Europe’s system of money must contend with a political potpourri. Regardless of the outcome, it appears we have reached the limits of how integrated a financial system can be. It’s clear now that each nation must relinquish sovereign control for the benefits of integration. The more you gain from global trade, the less control you have over the trade system itself. The system becomes an irrational beast that you must accept. You must have faith that in the long run you will be better off as a nation. That’s the theory, anyway. In the meantime, everyone prays.

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