The Eurozone – the road to nowhere?

We recently entertained Laurens Vis, Managing Director of KAS Bank London, to address the Financial Services Club.  Here’s a manuscript of his speech which, to say the least, has some very key messages for the future of the Eurozone:

“The Eurozone – the road to nowhere?”

Introduction

‘The European Union or the Tragedy of the Common Market’.  This is what economists call the ails of the Eurozone. It is a dilemma arising when individuals or countries pursue their own self-interest and, in doing so, eventually deplete a shared limited resource even when it is abundantly clear that this in not in anyone’s long term interest for this to happen. May I also refer you to the depletion of the rain forest, the pollution of the air and the overfishing of the world’s oceans.

Allow me to also make reference to the Greek Classics who, after all, invented present civilization and its democratic principles, where Thucydides (460bc-395bc) stated:

“They devote a very small fraction to the consideration of any public object, most of it to the prosecution of their own objects. Meanwhile each fancies that no harm will come to his neglect, that is the business of somebody else to look after this or that for him; and so, by the same notion being entertained by all separately, the common cause imperceptibly decays”.

This is the Year of QE. For the purpose of my short introduction titled “The Eurozone -  the road to nowhere?”, this abbreviation is not to be confused with the initials of the majesty herself, but with the ominous behavior of the Super Bankers to save the economy from recession by means of what is known as ‘Quantitative Easing’. One of the many European lessons learned during the past ‘so-called’ financial crisis years, and subsequent EU woes, is that Quantitative Easing is a good thing.

Although the prime motive of Central Bankers in the EU and the US is first and foremost to preserve price stability, the US in particular has always kept a keen eye on the state of the national economy.  Few periods can be compared to the Great Depression which still weighs heavily on the collective memory of the US.  The New York stock market crash, the soaring suicide rates, the bread lines, the bank runs and the bank holidays, the bankruptcies, the currency speculation, the wave of protectionism to follow and eventually the atrocities of the Second World War, tell us of, even now, the devastating effects of the Great Depression and what can go horribly wrong with capitalist market systems.

The current Chairman of the FED, Mr Ben Shalom Bernanke, wrote an entire book about it: ‘Essays on the Great Depression’. What Mr Bernanke preaches in his book, he is doing today: flood the system with money to avoid a depression.

Since the start of the recession the FED has completed two such programs through which it bought more than 2 trillion Treasury Bonds and Mortgage Backed Securities, adding a mere 2.8 trillion USD portfolio to its balance sheet.

Meanwhile in Europe, the collective memory has been more occupied with hyperinflation and its effects in that same time period. Hyperinflation had a devastating effect in Germany, where in the space of a year, 1922-1923, the highest denomination went from 50.000 Deutsch Mark to 100.000.000.000.000 Deutsch Mark. John Maynard Keynes wrote that Governments are too short sighted to secure from loans, and/or taxes, the resources they required, and have made the fatal mistake to create money instead of balancing their books. As a result, business starts to mark up prices to cover the

expected decay in the currency’s value. In 1924 the Deutsch Mark exchange rate was 4.200.000.000.000 to 1 US Dollar.

In the midst of conflicting views on how to handle the situation, only Britain in those dark days sought, to no avail because of French Opposition, to allow Germany a moratorium to financially reconstruct the country first before the repayment of their Great War Debts later. 

In hindsight, hyperinflation is believed to have contributed to the Nazi takeover of Germany. Adolf Hitler himself made many references to the German Debt Burden and the inevitability of National Socialism (Nazi) because of it. Hyperinflation also raised doubt in the minds of the German population about the competence of Monetary Institutions in those days and created the breeding ground for resentment against Bankers, Brokers and (particularly) Foreign Investors who were blamed for the financial crisis by the politicians and the press alike.  And so we see that hyperinflation has been a traumatic experience for Germany and this helps to explain the aggressive stance by the Bundesbank and thereafter the ECB in regards to maintaining price stability and encouraging stiff wage controls.

By now, the severity of the European crisis has visited the ECB in full force, with European QE measures to date already exceeding 1 trillion Euros and the ECB rapidly catching up with their US counterparts.  Its’ balance sheet has jumped from 5% before the crisis, to 10% in 2009/10 and is now edging towards 19% of the current total GDP in the EU, which is in itself close to the balance sheet levels of the Bank of England (23%) and the FED (20%).  All this is not without hefty debates taking place in the key Eurozone countries. In particular Germany, where the argument reigns that liquidity provision helps banks to remain bad banks, unwilling or incapable of managing the normal flows of credit while turning the Eurozone from a monetary union into a transfer union, and where the Northern taxpayers are made liable for the Southern bank’s failures and risky profit making practices.

The swollen balance sheet of the ECB (more than 2,3 trillion Euros) is indeed the silent witness of the EU’s worries. Firstly because the European Treaty itself is crystal clear in prohibiting (please check article 101 and 103 of the Treaty) the Eurozone to become directly liable to the debts of the Member States, and secondly because net-lending to credit institutions thus far has only resulted in further deposits with the ECB. The ECB ‘anno’ 2012 is now a hostage to the fortunes of the Eurozone economy and its loans of, and I quote, ‘unknown discounted value’. Quantitative Easing is solely buying time for countries and banks to take timely action to be able to pay off their debts. But the question remains as to whether they will do so in practice, how will the EU make them do this and are the Eurostat statistics a trustworthy compass to steer on?    

The Conundrum

The legal basis for the establishment of the Euro is a series of international treaties covering the EU’s constitution. From the first Treaty of Rome, in 1957 establishing the European Economic Community (EEC), to the Maastricht treaty which was implemented in 1993 to establish the European Union, of which the Monetary Union was an integral part. What has happened in between with the Economic Community nobody knows, but of course, it might have been ‘lost in translation’. The EU boasts 23 official and working languages. Due to budgetary constraints official documents are translated in four working languages, but for the EU members of Parliament a full translation service is employed to facilitate the smooth flow of political deliberations in Brussels and Strasbourg.

The Treaty of Maastricht provided for the introduction of a single monetary policy based upon a single currency managed by a single and independent central bank. According to the Treaty, the primary objective of the single monetary policy and exchange rate policy should be to maintain price stability and, without prejudice to this objective, to support the general economic policies in the Community, in accordance with the principle of an open market economy with free competition. These activities of the Member States and the Community should entail compliance with the following guiding principles: stable prices, sound public finances and monetary conditions and a sustainable balance of payments (Article 119 TFEU, ex Article 4 TEC). 

As provided for in Article 118 of the EC Treaty, the composition of the basket of the EMU was "frozen" on 1 November 1993, the date of the entry into force of the Maastricht Treaty.  The European Council, meeting in Madrid on 15 and 16 December 1995, decided that, as of the start of stage three, the name given to the European currency should be the euro, a name that symbolises Europe and should be the same in all the official languages of the European Union, taking into account the existence of different alphabets, i.e. the Latin and the Greek.  In preparation for the move to the third stage, the Treaty required a high degree of convergence assessed by reference to specific criteria: a rate of inflation which is close to that of the three best performing Member States in terms of price stability and a government budgetary position without a deficit that is excessive, meaning a government deficit not exceeding 3% of GNP.

Following the procedure and the timetable set out in the EC Treaty, the Council meeting at the level of Heads of State or Government on 3 May 1998, decided that 11 Member States satisfied the necessary conditions for the adoption of the single currency on 1 January 1999: Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland. In July 2000, the Council agreed that Greece also fulfilled the convergence criteria and could therefore adopt the single currency. The Council had previously stated that Sweden did not at that stage fulfill the necessary conditions for the adoption of the single currency, because it did not participate in the mechanism of the European Monetary System. It did not examine whether the United Kingdom and Denmark fulfilled the conditions, because, in accordance with the relevant Treaty provisions, the United Kingdom notified the Council that it did not intend to move to the third stage of EMU on 1 January 1999 and Denmark notified the Council that it would not participate in the third stage of EMU. Member States benefiting from an "opt-out" and those which do not meet the criteria from the outset participate nevertheless in all the procedures (multilateral surveillance, excessive deficit...) designed to facilitate their future participation.

In the meantime the Euro itself has been a resounding success and, in case Turkey joins the EU, will be roaming the continent in all the EU wind directions as far as the borders of Iran and the Kurdistan region.  The currency has even been given legal tender in Montenegro while not being a member state.  The value of both the euro notes and coins in circulation now exceed comfortably that of the United States Dollar, and although the greenback is the global reserve currency, the Yuan-Euro exchange rate is nearly as important. There is already also a large Eurozone in Africa, the awakening horn of affluence, where postcolonial states are using a common currency pegged to the Euro and guaranteed… courtesy of the French Treasury.

Currently the 17 States of the Eurozone generate 16% of the global economic output, with Europe’s small to medium enterprises contributing more than 60% to that number. SME’s are also responsible, according to a recent study of the World Bank, for creating 85% of new jobs in Europe and it is here that the recession is clearly visible in the EU - the job creation machine has come to a halt. The scenario which Bernanke dreaded in his essays written in peacetime, is happening. The dysfunctional banks are no longer lending to the SME’s. Banks are obsessed with only one thing: debt. Their credit processes stutter and their (regulatory driven) bureaucracy has taken over from applying local expertise and local knowledge at Branch level.

The European jobless are on a steady climb, from 7% of the EU workforce in 2008, to 10% in 2010 and more than 11 % to date. For the youngsters in Europe the labor market is particularly grim with 22% of under-25 year olds unemployed. Those numbers are higher in Spain and Greece with 50% youth unemployment.  The Eurozone has also witnessed substantial pay rises between 2000 and 2012, averaging 18% overall, but with Greece as a clear winner with an average pay rise of 32,5 %. That Germany is far behind with 5.4 % must by now no longer come as a surprise to us. Nor that the popular vote is turning against any further Greek bail outs. They had it coming….  or ‘sie hatten es kommen’ as they say in German!

In the meantime, compared to the US, Europeans work five weeks less than Americans in an average year. And although Germany and the Benelux countries have closed the productivity gap with the States, the resulting wealth is spent on a better balance between the working and the private life. It is as if Americans have collectively decided to work harder to be materially better off…. 5 weeks harder to be precise, whilst much of Europe closes up shop in August and heads for the coast. Long before this yearly ritual, agreements are stricken all over Europe to lift projects and initiatives ‘over the summer’ as there will be no colleagues around to make any meaningful headway - recession or no recession. Sell in May and go away, but remember to be back in September. We witness foreign tourists wandering aimlessly through the empty capitals of Europe to be confronted with the last remaining members of Europe’s service industry, the waiters, saying, ‘I will be right with you’ whilst walking away in the opposite direction…

So the conundrum for the EU is that the currency, successful as it might be, cannot buy a Union, albeit monetary, of which the participants do not really believe it to be irrevocable. The opt-out or break-up of the Union is indeed a lively and openly debated topic in the democracies around Europe who believe they have still have the luxury to do this and who not only cherish their sovereignty in doing so, but also reserve their right to play their trump card to elect a party that favours by political majority the withdrawal from the Union.

A Federal European Bank for Europe

Since 2008, Europe has not shut down many of its’ banks contrary to The States where hundreds of Bank closures have taken place. The results of the latest stress test in the US have published 19 banking institutions on a name basis with the minimum tier 1 ratio of Q1, 2012 and the common outlook for Q4, 2013. 15 institutions received the green light, also against the stringent Dodd-Frank Act levels, while 5 of them need to work on their capital structure or proposed capital actions. 

In the EU, no fewer than 91 Banks participated in nation-specific stress tests, however this did not result in an EU (Eurostat) publication and gave rise to continuous uncertainty and speculation about the true extent of bad loans. And so the nervousness amongst depositors continues, near-overall credit downgrades are released and Europe has to quantative ease once again to play for time.

It is time to impose the proven concept of the subsidiary or full branch organization customary in the cross border Banking Sector into the Central Banking landscape of Europe, but so far I have not found much proof in the monetary public domain, in spite of continuous G8, G20 and Political EU Summits which points in clearly into direction.   

And so the Eurozone gave it their best shot to smile themselves away from the financial Brink.

Humour and Culture

Last year, the following joke was presented by a Belgian Member of the European Parliament as the official ‘European joke’ in an attempt to improve the relationship between the Nations and to inject some cross-border humour and culture at a tense moment for the EU. The joke read as follows:

Europe in Paradise is when you are invited to an official lunch. You are welcomed by an Englishman. The food is prepared by a Frenchman, an Italian puts you in the mood for the occasion and everything is organized by the Germans.

Europe in Hell is when you are invited to an official lunch. You are welcomed by a Frenchman. The food is prepared by an Englishman, a German puts you in the mood but, don’t worry, everything is organized by the Italians.

The European Council met in order to make a decision. Should the joke be the Official European Joke or not?

The British representative announced, with a very serious face and without moving his jaw, that the joke was absolutely hilarious.

The French one protested because France was depicted in a bad way in the joke. He explained that a joke cannot be funny if it is against France.

Poland also protested because they were not depicted in the joke.

Luxembourg asked who would hold the copyright on the joke. The Swedish representative didn't say a word, but looked at everyone with a twisted smile.

Denmark asked where the explicit sexual reference was. If it is a joke, there should be one, shouldn't there?

Holland didn't get the joke, while Portugal didn't understand what a "joke" was. Was it a new concept?

Spain explained that the joke is funny only if you know that the lunch was at 1 o’clock/ 13h, which is normally breakfast time. Greece complained that they were not aware of that lunch, that they missed an occasion to have some free food, that they were always forgotten. Romania then asked what a "lunch" was.

Lithuania and Latvia complained that their translations were inverted, which is unacceptable even if it happens all the time. Slovenia told them that its own translation was completely forgotten and that they do not make a fuss. Slovakia announced that, unless the joke was about a little duck and a plumber, there was a mistake in their translation. The British representative said that the duck and plumber story seemed very funny too.

Hungary had not finished reading the 120 pages of its own translation yet.

Then, the Belgian representative asked if the Belgian who proposed the joke was a Dutch speaking or a French speaking Belgian. Because, in one case, he would of course support a compatriot but, in the other case, he would have to refuse it, regardless of the quality of the joke.

To close the meeting, the German representative announced that it was nice to have the debate here in Brussels but that, now, they all had to make the train to Strasbourg in order to take a decision. He asked that someone to wake up the Italian, so as not to miss the train, so they can come back to Brussels and announce the decision to the press before the end of the day.

"What decision?" asked the Irish representative.

And they all agreed it was time for some coffee. 

But the joke has not gone down well. Maybe Europe is getting to old for this. Europe’s baby boomers are getting tired of the Money Crisis, they want to retire and what do they get instead?

The Baby Boom & Bust

The trend, ladies and gentleman, seems to be unstoppable. In 1950, 22% of the World population came from Europe or lived there. In 2000 the world’s population increased to 6 Billion (from 2.5 billion in the Fifties: the baby boom!) but Europe shrunk to 12% of that figure, and in 2050 this will be a mere 8%, while by then there will be 9.1 billion people living on Planet Earth - the biggest increase being Africa (from 9% to 25%).

In other words, Europe is demonstrating a low fertility rate, while already a disparity becomes visible in favour of the immigrants of Europe (10% of the EU population was born outside its borders in 2010), giving further rise to social and religious tensions against the backdrop of an emerging Pension Crisis due to a growing life expectancy. Good news for the individual, not so good for the collective (nature) of Europe’s pension arrangements.

The Four Pillars of the EU Crisis

Before I reach my conclusion, I summarize the four main drivers of the extended European crisis which is now weighing on the Global recovery:

1. An ageing population challenged to work longer and accept further uncertainty over its pension arrangements.
2. A multi-cultural society, having to deal with ethnic, religious and cultural difference
3. A transition, or better lack thereof, of decentralized/National decision making to centralized/EU decision making
4. A sovereign debt crisis still at large.

In Conclusion

The question, in conclusion, is not so much for the Euro to be or not to be, the question is for the EU to persevere or not. In my introduction I spoke about the tragedy of the common good. The criticism, what started as the theory of the ecologist Garrett Hardin, written in 1968, is not so much on the theory itself, but more so that is has fallen into the wrong hands of the Western Economic ideology that our future is better taken care of by professional scholars and technocrats, who impose their own economic and environmental rationality on other social systems, than with local policy experts who do not look further than their electorate nose is long.

It is quite remarkable that the CEO of KAS BANK in his latest, may I (as an unbiased colleague) say, outstanding contribution the National EU debate in The Netherlands, called for a return of the civilized ‘poleis’ (the Greek word for Statesman) to save Europe and its democratic and political principles. Which would, monetary speaking, include the introduction of a common loan book of Eurobonds to finance the countries of Europe to an agreed maximum, set against the centrally agreed budget deficit. Excess financing is therefore allowed, but strictly self-supporting and quite probably costly as well. However, structural mismanagement of the EU’s Central Finances will result in a shift of decentralized powers to central EU Bodies. At that point, there is nothing democratic about keeping the common good of Europe at bay for the benefit of its future generations.

May I conclude, ladies and gentleman, with the story of Edmund Wellenstein, a Dutchman and international diplomat.  Now in his nineties, he is one of the pioneers of Europe; he was there right from the start, working alongside the great Jean Monnet, Schuman and Adenauer. As a young man, he joined the Dutch resistance and survived the NAZI concentration camp. After the war he went to Bonn and saw the creation of the European Coal and Iron Community - the frontrunner of the current European Union - as a reaction to the crisis of the Thirties and the Second World War. His drive has always been integration instead of protection. And although the EU has been able to establish open borders and a single currency, it so far has been unable to rise above the single-mindedness of the individual countries of Europe, be it Germany, be it Spain, be it Portugal or be it Italy… the semi-finalists of the European Tournament no less!

But there is hope! Only last week the Edmund Wellenstein street was unveiled by the Mayor himself, who spoke of dream houses for happy families. The street is to be found in the City of Ratingen… which is in Germany…which is not Holland. Or is it? I mean, EU speaking.