Europe on Autopilot: How Krugman predicted the euro-mess in… 1998

I came across a December 1998 article in Fortune magazine by the indomitable Liberal economist and Nobel prize winner in which he takes a critical look at the monetary union the Europeans were creating. It’s quite amazing how much has not changed in the concerns he raises, whether it’s on Germany vs. the rest, EU central bankers’ insensitivity to economic performance in favor of “hard money”, or the efforts of “subtle Europeans” to come up with dense, unclear and loop-holey texts so as to have something that can pass for “agreement”.

Most impressive of all is how Krugman describes the weaknesses of the emerging euro system as one that not only jammed together disparate economies but set its core institution, the European Central Bank, on an “autopilot” hostile to both growth and jobs. I can do no better than to quote him at length:

But come actual monetary union, this subtlety [hiding German preferences/predominance behind inscrutable bruxellois] will no longer work, because a truly unified currency must have someone – a European Central Bank – explicitly in charge. How could this institution be set up to give each country an equal voice, yet satisfy the German demand for assured monetary rectitude?

The answer was to put the new system on autopilot, pre-programming it to do what the Germans would have done if they were still in charge.

Krugman then notes the characteristics for maintaining “autopilot”, including the ECB’s independence, it’s “very narrow mandate: price stability, period – no responsibility at all for squishy things like employment or growth”, and appointing the monetary über-hawk, Dutch central banker and bouffant enthusiast Wim Duisenberg as the first ECB president.

He goes on to lament that despite falling inflation, double-digit unemployment and the rise of pro-stimulus centre-left governments across Europe (including France, Germany, Italy an the U.K.), there was no sign that the Bundesbank/the embryonic clique of eurobankers might favor a looser monetary policy:

Instead of an “asymmetric” economy, in which some countries want tight money while others want a boost … and all of the major governments agree that the central bankers should emulate (EMUlate?) that wild and crazy guy Alan Greesnpan, and loosen up. So there is, in the end, no conflict of interest. Indeed, EMU could get off to a rousing start by cutting interest rates and making everyone happy.

But EMU wasn’t designed to make everyone happy. It was designed to keep Germany happy – to provide the kind of stern anti-inflationary discipline that everyone knew Germany had always wanted and would always want in future. So what if the Germans have changed their mind [under social democrat Gerhard Schröder], and realized that they – along with all the other major governments – are more worried about deflation than inflation, that they would very much like the central bankers to print some more money? Sorry, too late: the system is already on autopilot, and no course changes are permitted.

To say yes, to give the politicians what they want even if what they want is entirely reasonable, feels like a betrayal. In fact, the more the politicians demand action, the more the central bankers dig in their heels.

The latter, incidentally, is probably why Nicolas Sarkozy, even as he has been pushing for a more interventionist ECB, has relegated his efforts to private lobbying rather than public exhortation, lest he offend the technocratic priesthood in Frankfurt.

Krugman’s account is a good explanation as to why the ECB, by its very structure, failed to manage the sovereign debt crisis of 2009-201?. The bank was unfazed by the damage a $1.40-€1 exchange rate was having on exports, had no mandate to guarantee low interest rates on government borrowing by buying up bonds (thus avoiding self-fulfilling debt-spiral in the periphery-minus-Greece), and indeed had no inclination to encourage business by lowering its main interest rate below 1%.

In short, the ECB’s “autopilot” meant it behaved in the exact opposite manner of other central banks, including the Fed, the Bank of England, and the Bank of Japan, which all engaged in rock-bottom interest rates and guarantees of low interest rates for government borrowing. So, now, Europe alone has a double-dip recession, rising unemployment and an exponentially worsening debt outlook. Oh, and according to the World Bank, the Old Continent is likely, in due course, to drag everyone else down with it.

In addition, both the European models of integration and of social protection have been tarnished as a result. The latter is particularly vexing as U.S. Republicans and other opponents of the welfare state can quite reasonably point to Europe as “proof” that it is synonymous with economic disaster – spending beyond one’s means, etc. – even as eurozone countries’ actual debts and deficits are no worse, and sometimes better, than other developed countries’.

Krugman concludes by saying “These Europeans, they are a subtle race. And this time they may have subtled themselves into a very tight corner.” Indeed, nowhere is this “tight corner” clearer than in looking at France and the U.K., comparable in terms of economy and budget. But because one is shackled to the euro and has ceded the responsibility for choosing the right economic policy to whims of Frankfurt, it is France alone which pays higher interest rates and has lost its triple A rating.

The “European subtlety” of hiding differences and (in)action behind verbose bruxellois has been at the heart of integration since the beginning. It may be fine for ever-so-slowly breaking down trade barriers, adopting product standards, and so on. But it is fatal when decisive and reactive leadership is necessary (which is indeed why “Europe” has failed whenever there was a crisis, notably in foreign policy, see Iraq, Yugoslavia…).

The non-discourse and remorseless, inscrutable and/or imaginary consensus of “subtlety” continues: We will have the Necessary fiscal compact even if the Luxembourgish foreign minister says it’s a “waste of time”, the ECB will not print money (lest the Germans protest) but will engage in stealth quantitative easing by making €489.2 billion (sic) in loans to banks, and all PMs and presidents (minus the Brits) are in total agreement on the direction Europe is going even as national politicians voice dissentare cowed and vow to renegotiate the new treaty.

The result is no one really – be it professional observers, markets or, least of all, public opinion – has any idea what’s going on. Perhaps the European ruling class, multinational as it is, must necessarily articulate its thoughts in the habitual diplomatic subterfuge and techno-bureaucratic platitudes.  I just hope they don’t doom a generation, mine, to perpetual unemployment and a ruined welfare state as a result. That wouldn’t be very subtle.

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