I haven’t really said much about the catastrophic debt crisis unfolding in Europe, other than to say that it would be really bad for America to play beggar-thy-neighbor when the whole continent is at real risk of pitching over into the drink, and to wonder why, if the Germans decide they don’t want to bail out Italy, the northern Italians should decide they want to do so (in other words: why is the Eurozone more likely to break up than the Italian state).
But what’s unfolding is enormously important, not only to the world’s short-term economic outlook (if Europe collapses into a depression, they’ll surely drag the rest of the world with them at least part-way down), but to pretty much every aspect of America’s foreign policy going forward.
First: background. The European Union, is, was, and always will be a primarily political project. The gains to be had from businesses no longer having to hedge a variety of small currencies were always small and are now really negligible. For both France and Germany, the central partners in the enterprise, it meant not only a kind of formal commitment to the notion that there would never again be a war between the two largest continental powers, it also meant playing a larger role in world affairs, and a massively larger role in continental affairs, than either country could on its own, in France’s case because it just wasn’t all that big anymore, in Germany’s because it was, well, Germany. These goals could only be achieved by a progressive deepening of the Union, from being a trade and customs union, through regulatory harmonization and a common currency, to a common foreign and defense policy and some degree of fiscal union. So long as Europe remained purely a collection of states, unable to act as a union, the fundamental political objectives of the European project were not achieved. And these objectives were the reason for the project in the first place.
For many other countries in Europe – and particularly for Britain, for whom it spelled the end of the traditional British foreign policy objective of avoiding any single power dominating the continent (and objective that, by the time the US-Soviet rivalry matured, to say nothing of once it had ended, was thoroughly obsolete, but still) – the prospect of ever-deeper-union presented a Hobson’s choice: join, and give up a measure of independence for some share of decisionmaking; or don’t join, and retain formal independence but be dependent, practically, on the decisions made by the rising power in Brussels. Different European states have chosen differently – which is both what one would expect and entirely appropriate.
For certain countries – Italy being the most important – with longstanding, shall we say, governance issues, the European project presented an additional opportunity: the opportunity to do an end-run around their own government. Back in the days of the Lira, Rome resorted to regular devaluations to compensate for its chronic over-indebtedness. This, in turn, meant that Italian debt always carried a higher interest rate than German debt – reflecting market expectations that the Lira would generally decline versus the Deutschmark. Joining the Euro, for Italy, meant paying lower – more like German – interest rates on their debt in the future. In exchange, Italy would simply have to gets its fiscal house in something resembling better order – less like Italy, more like Germany. Which it promised to do.
And which, to some extent, Italy did – at least in terms of the budget. But that hasn’t mattered in the current crisis. The current crisis started off being about a country – Greece – that borrowed fraudulently, actively lying about its budgetary situation. But it’s not about that anymore. Spain was in excellent budgetary shape before the crisis. Italy wasn’t in great shape by any means, but it was in better shape than was the historic norm – and the trend line was going the right way. The current crisis is due to the fact that no country in Europe has a central bank; none have the option of using unorthodox monetary policy to avoid slipping into another recession; and countries across Europe have been thrown into budgetary crises by the recession that followed the financial crisis. Radical austerity across the continent would trigger a new recession, which would worsen the budgetary situation. Within the existing framework of decisionmaking, there’s no way for Italy to solve its budgetary problems – which is why Italian bonds now trade at a much higher yield than German bonds, precisely what joining the Euro was supposed to prevent. And as market fears of a possible Italian default or a breakup of the Euro have gotten more serious, the crisis has spread to France, the Netherlands, and even Germany – because none of these countries will avoid catastrophe if the Euro collapses.
What’s going on now is, I believe, an extremely high-stakes game of chicken. The acute crisis could be resolved immediately if the ECB would simply agree to buy Italian bonds in sufficient quantities to drive Italian interest rates down to a sustainable level. A firm commitment of that sort, backed up by market intervention, should have the desired effect. In the absence of any change in the structure of decision-making in Europe, however, this would amount to writing Italy a blank check. Because for the commitment to be credible, it needs to be unconditional – the ECB can’t say, “we’ll buy bonds if Italy keeps its debt ratio below so-and-so” because then the market can wonder, “well, what if the recession gets worse, and tax receipts drop; or what if Italy’s politicians simply rescind some of the austerity measures passed, pocketing the ECB’s commitment and going back to business as usual – what then?” And once the market wonders that, credit spreads widen out again – and the ECB has to either take stronger action, and you begin a race to the bottom as other countries scramble to be less-responsible than Italy; or the ECB surrenders and we’re back where we are now, only worse.
For a credible intervention not to amount to a blank check, the market would need to be satisfied that there was a mechanism in place to ensure that Italy could not cash the blank check. In other words, Italy would have to surrender a pretty significant degree of control over its own budget. Whatever form such an arrangement might take – whether it was run through the ECB or through some more accountable branch of the European bureaucracy – it amounts to fiscal union.
This isn’t, of course, how anybody wanted to get here. But it is, in fact, where the people who championed the creation of the Euro wanted to go. Monetary union could only work in combination with fiscal union. The architects of Europe were never able to sell “Europe” as a concept to the various peoples of Europe – they have generally proceeded on the assumption that democratic accountability was an obstacle to be avoided rather than a goal to be achieved. It looks to me like that continues to be their preferred mode of operation, and that what the leaders of Europe are looking for is to be forced into fiscal union rather than assenting to it, and for that union to be accomplished through the least-accountable governmental bodies possible.
But that, I believe, is what this game of chicken is about: the terms of deeper union. What Italy – and, subsequently, the other nations of the Euro-zone – will have to give up in order to qualify for support by the ECB in a crisis.
At least I hope that’s the case. Because if it isn’t, and there isn’t a “yes” to be gotten to, then we can kiss the world economy goodbye.
As a post-script, let me say this. The United States has, from the beginning, approached Europe from the perspective that we prefer it to get broader rather than deeper. We don’t want a European army, or a common European foreign policy; we are not particularly interested in fiscal union or even in the common currency; but we definitely want Britain and Turkey and heck, Ukraine to be part of the European Union – we want the Union to be as diffuse as possible. This diffusion has made it progressively harder for the EU to actually do anything as a corporate body – which, I think, was a feature, not a bug, from the American perspective.
But I have always felt that this perspective was wrong – in terms of American and global interests, not just the interests of Europe. Nobody’s interests are served when the world’s largest economy is effectively ungoverned. And if America’s interests were profoundly threatened by the emergence of a functional Europe on the diplomatic stage, then we really have to question how we conceive of our interests – is it not enough that there is no power on Earth capable of standing up to us; must there be no power capable of standing beside us either? American interests would have been better served by advising the architects of Europe to pay attention to the democratic deficit, and to grow the EU only at such a pace as was consistent with the development of functional European institutions. Peripheral countries would always be free to join the customs union, to voluntarily harmonize various regulatory matters, to peg their currencies to the Euro, etc. – without submitting to being governed from Brussels. I don’t, frankly, understand why America has any interest in whether London or Ankara or Kiev do submit to such governance – nor, for that matter, Paris or Berlin, but if Paris and Berlin were dead-set on creating Europe then it is in our interest for Europe to function. Which required, and now requires more than ever, deeper union.