Pat Nolan's Euro-Crisis Primer: Part One of Three

Economic dispatches out of Europe often include the invocation of gravity: unity “teeters,” banks “hang,” ratings “drop,” and currencies “float,” for now at least. Relative to its prior trajectory, the continent is not faring well.

Histories of the crisis are constantly popping up, often appearing as 1,200-word articles in elite semi-specialized geopolitical or economic news weeklies. It’s worse when they’re dangling blog posts. The histories usually attempt to posit one of many theories of causation, it makes the authors feel as if, “hey, I’m contributing to the solution by putting to stone a warning for future generations.” The authors often feel obliged to tack on a section on what they would do to fix things.

I’ll follow suit: the European Debt Crisis was caused by a combination of poor foresight and even worse oversight.

[This post, on poor foresight or the structural causes of the European crisis, will be the first of three. The second will cover poor oversight, and the third will offer that ever-tacky “fix.”]

I. Poor Foresight

It is best to conceive of the European Union as a project or experiment. Its history goes back to World War 2’s aftermath when political and economic integration were seen as safeguards against future continental infighting and collapse.

Between 1945 and 1993, the concept of what would come to be called the European Union went from just that, a concept, to a full-blown confederation. The intervening decades saw industry-specific unions lead to a customs union. More countries signed on, and groundwork was laid for a “single market” economy.

In 1991, a consensus was made on the formal conditions of the European Union. Implemented in 1993, the Maastricht Treaty (the EU’s history is one of treaties), formally chartered the European Union and set it on course to issue a single currency, the Euro.

The single-currency union, geographically dubbed the “eurozone,” was not the grand consensus it was heralded to be. There were two problems with the consensus, problems of bad foresight: there was the poor selection of member states, and the great blunder of establishing a monetary union without a fiscal counterpart

Selecting member states, the first problem, was flawed for two reasons. On the one hand, countries were admitted that would damage the union’s integrity. On the other, member states instrumental to that integrity were not adequately incentivized to join.

Greece was admitted when it should not have been for two reasons. First, popular opinion forced an overly romantic conception of the West—one that demanded the birthplace of democracy to be part and parcel to the “West,” whatever that means. Second, the central bankers in Greece, realizing they didn’t meet the required demands of economic indicators (set out in the convergence criteria), hired American financial gurus to cook the books. Goldman Sachs and AIG got a tidy sum for their derivative-shuffling magic.

The United Kingdom, the continent’s financial and banking nexus, was “euroskeptical” of the currency zone, and instead opted-out of the part of the Maastricht treaty governing countries’ obligation to adopt the currency. While it should be noted that the UK did not meet the convergence criteria, an exception could have been granted due to the size of its financial industry. Given the UK’s investment in the rest of Europe, and therefore its exposure, its omission would prove disastrous when bailouts became necessary.

The bottom line with member state in/exclusion: there needed to be a better balance of stable and unstable nations. Had there been two wealthy, large, and stable nations (Germany and the UK), today’s debate might not be “should they pay?,” but instead, “who should pay?.”

If, for argument’s sake, the right combination of member states had been united, then the monetary-sans-fiscal problem could still result in the current catastrophe. Monetary policy was not enough to solve the crisis. Creating a monetary union without a corresponding fiscal union was the second failure of European foresight.

In 1997, as a German safeguard to rising inflation among other countries, the Stability and Growth Pact was passed by all 27 member states of the European Union. It was an agreement to allow the European Commission, the EU’s executive branch, to enforce the Maatrsicht’s fiscal convergence criteria. It was an attempt at a fiscal policy framework. The pact was too strong.

Upon realizing the political reality that further integration allowed poorer countries to mooch off richer countries, the Council of the European Union (part of the legislative branch), in 2005 elected to loosen the criteria in order to prevent having to force the mooching countries out of the Union. The loosening was too weak.

In 2011, after the crisis had struck, a countervailing political reality arose: the European Union would no longer support the mooching Greeks. The European Council—a group of all EU heads of state, not to be confused with the Council of the European Union—once again opted to reserve the option to reject Greek membership. This reservation was too strong.

You can see the pattern that has emerged with regard to eurozone fiscal affairs: different EU government branches could not decide on fiscal policies, so the relatively non-government group of heads of states stepped in.

When you hear of the politicization of the EU and the need for technocracy, this is the story being told. Without a fiscal union, the monetary union was in disarray.

In the next post, I’ll examine the drama that began to unfold as the crisis spread. By asking the question “what could have been done differently?,” I will attempt to explain how these failures of foresight may have been dampened or even corrected by proper oversight. Spoiler alert: they weren’t.


--By Pat Nolan