Anniversary of W.I.T.

Three years ago this month, ECB President Draghi issued his now-famous pledge to do "whatever it takes" to save the euro.    Indeed, it has done its part.  The ECB has a negative deposit rate, something that even with a protracted fight against deflation, the Bank of Japan never tried.  The Federal Reserve is said to have considered it but obviously chose not to do it. 

 
The Outright Monetary Transactions (OMT) was recently endorsed by the European Court of Justice as a legitimate exercise of the ECB's authority, over the objections (and testimony) by the Bundesbank (though supported by the German government).  The ECB has launched an asset purchase program, which includes asset backed securities, covered bonds, and sovereign bonds.

The euro area is enjoying a cyclical recovery.  The decline in oil prices, interest rates, and the euro provided the stimulus with a lag.  While the 50% bounce in the price of Brent from the January lows has arrested deflation, it, along with the firmer euro and backing up bond yields, warns that the cyclical recovery may have seen its best days in the first half.  Draghi has noted that eurozone countries have been slow to implement structural reforms, leaving the cyclical recovery vulnerable. 

Despite the somewhat better economic conditions and Draghi's pledge, EMU is having an existential crisis.  Encouraged by some European politicians, investors are not convinced that monetary union is irreversible.  Some argue that Greece lied to enter EMU in the first place.  That has little to do with current circumstances.  Moreover, at the time, Germany and France needed liberal interpretations to meet the Maastricht requirements.  

Indeed, the door that was wide enough for the core was wide enough for the peripheral countries to join too.  Greece, we would argue, did not bamboozle the seasoned bureaucrats in Brussels, Frankfurt or Paris in 2001 when it joined monetary union. 

Others, including European officials, argue that monetary union is predicated on rules and mutual obligations. Yet many, if not most rules regarding monetary union, fiscal transfers and the Stability and Growth Pact are more recognized in violation than in adherence.

  
Through the Greek crisis, we repeatedly have drawn on Keynes' insight from the Economic Consequences of Peace.  The way that many officials and investors have characterized Greece is reminiscent of how Keynes' characterized France's Clemenceou's view of Germany.  Keynes writes that Clemenceou was a "foremost believer in the view of German psychology that the German understands, and can understand nothing but intimidation, that he is without generosity or remorse in negotiating, that there is no advantage he will take of you and no extent to which he will not demean himself for profit, that he is without honor, pride, or mercy."

Keynes finishes his summary of Clemenceou's views with the observation that it is not clear if the French Premier would characterize other countries in the same way.  If he did, this is the realist recognition that sentimentality has no place in foreign policy. 

Despite the various differences between the US and China, officials in both countries seem incredulous that European officials are willing let Greece go.  Despite some claims to the contrary, even if a majority of Greek voters reject the creditors' demands, how a no vote turns into a Greek exit is not clear.   It is true that the ECB could cut rather than simply freeze Emergency Liquidity Assistance (ELA).  This could trigger a significant banking crisis, but the key is how Greek policy makers respond.  

Nobel-prize winning economist Stiglitz has argued that a yes vote in the Greek referendum to accept the creditors' demands is a vote for a depression.  We agree with the IMF's own economic research that demonstrate that austerity during an economic contraction exacerbates the downturn.  However, a vote to reject the creditors demand, as the Greek government wishes, will not avoid a sharper economic downturn.  In fact, the Greek economy was expanding a year ago.  Has the living condition of Greek people improved over the past five months?  Is there less corruption?  Tax evasion?  Rent-seeking behavior?

Others argue that what is at stake is a clash of democracies:  Greek voters are pit against German voters for example.  But this is an exaggeration as well.  Syriza was elected with about 36% of the vote.  One of the criticisms of the European project is that it has been largely an elite project.  The so-called democratic deficit within Europe is not resolved by a hurried referendum on issues that are not clear.  Greece's Tsipras wants the Greek people to vote against an offer than is no longer on the table, and for which he agrees with most. 

It has been three years since the ECB President promised to do whatever it takes to save the euro.  The reason that EMU is having this existential challenge is that European officials refuse to make the same promise.    The immediate risk of contagion is limited, but if European officials cannot find a way to make monetary union inviolable, then every crisis will become an existential crisis.  Contrary to worries that the Europe is failing, this crisis is likely to reinvigorate efforts to improve and tighten integration.


    

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