Europe drops the Euro’s market-based fundamentals
A drama in five acts

“The Euro will come, but it will not be sustainable“ (Alan Greenspan, 1999)

The condition of the European patient is again showing signs of improvement. Research institutes are easily revising their forecasts upwards for economic growth in Europe. The debt crisis no longer invokes the type of fear that it once did. Only Greece continues to be the odd one out. However, this is only half the story. Here, neither structural reforms nor consolidated budgets are the drivers of economic growth. Rather, significantly cheaper oil is improving the economic atmosphere. And with the trillion-euro asset purchase program the ECB is noticeably decreasing the value of the Euro and keeping interest rates at historically low levels. The debt crisis is being temporarily swept under the carpet. A glance at the labor markets, however, shows where in Europe the shoe really pinches. Mass (youth) unemployment is not decreasing. Only in Germany is the situation wholly different. The fate of the EMU rests on the labor market, and there the future is anything but rosy.

Prologue: Greece cooks its books

Everything could have been so nice. The architects of the Euro had a simple, but also risky plan. At its core was a central European monetary policy, with all other economic and social policies decentralized and organized at the national level. The fear of excessive indebtedness of the members induced them to establish safeguards to protect national fiscal policies from political recklessness. The fiscal admission criteria à la Maastricht, the Stability and Growth Pact, the no-bail-out clause and a general prohibition of monetary government financing was intended to prevent the worst fiscally. The Germans’ specific fear of inflation was to be addressed by formation of a politically independent ECB patterned after the Bundesbank. The social partners should bear the main burden of the adjustment to constantly recurring exogenous, asymmetric shocks through flexible wages and labor mobility.

That was the plan. And then along came Greece. From the very beginning Greek membership has been based on lies and deceit. Greece didn’t meet the criteria for inclusion in the EMU. The debt was twice as high and the deficit three to four times higher than was officially stated. Sugarcoated balance sheets fluttered before an illusory economic world. Everyone knew it. In spite of this, the euro was introduced in Greece on January 1, 2001. Irresponsible politicians overruled critical economists, as is so often the case. But it wasn’t just Greece acting against the rules of the EMU. Germany and France didn’t care one bit about the Stability and Growth Pact. In 2005 they summarily ignored the deficit criterion, and the fiscal flank was effectively exposed. Nor could the fiscal pact of December 9, 2011 restore lost credibility. It amounts to nothing, when sinners sit in judgment upon other sinners.

Act 1: Europe breaks contracts

The financial crisis has revealed additional design flaws in the EMU. The Euro provided mainly the Club Med countries with a hefty interest rate dividend. It was with the artificially low interest rates that the inefficiency really began. Favorable financing in the EMU created in these countries greater incentives to continue to live beyond one’s means. Fiscal rules were no barrier. Public and private debt levels rose. In the financial crisis shaky, system-relevant banks had to be rescued. This drove public debt even higher. Nor were wages and prices spared by the interest-driven, volatile economic boom. They rose faster in the periphery than anywhere else. This did international competitiveness no good. Current account deficits increased. By 2010 the twin deficit could no longer be financed privately. The debt bubble burst.

That was the litmus test for the EMU. The proposed mechanism of adjustment to exogenous shocks through internal devaluation functioned, after a fashion. Only Ireland was successful in the existential crisis, becoming more competitive again through lower wages. Spain and Portugal attempted it with middling success, and Greece failed miserably. This was also due to the fact that the euro-countries broke their contractual agreements. Fiscal rescue packages of huge dimensions were deployed by the Euro Group and the IMF. The no-bail-out clause was overridden without hesitation. Additionally, the countries had little incentive to adapt to the changing economic circumstances through the mechanism of relative prices – especially those of wages and non-wage labor costs. Multiple “moral hazards“ brought the dynamic heart of the EMU out of sync.

Act 2: ECB delays bankruptcies

In spite of the fiscal bailouts, policymakers were not successful in bringing the intense, self-reinforcing euro crisis under control. The danger of the EMU’s collapsing like a house of cards could not be denied. In this time of the existential euro crisis the ECB became a stabilizing force. With the massive scale buy up of risky government bonds and the Mario Draghi’s energetic “Whatever it takes“ strategy, it stopped the slump in prices in the bond markets. This provided the ailing governments with some fiscal breathing room. The uncontrolled collapse of banks was avoided and the impending financial meltdown in Europe was prevented. Through the TARGET2 balances the ECB deployed another gigantic monetary rescue package. Through these actions the ECB violated two contractually agreed upon rules of the EMU: it conducted prohibited monetary government financing and overrode the “no-bail-out clause“.

The ECB supports the all-or-nothing game of the new Greek government. Meanwhile Greece has long been bankrupt. It depends upon the financial aids programs drip of the “troika“. However, they only want to pay the last installment when the agreed upon “money in exchange for reforms“ deal is finally implemented. As the government in Athens struggles against it, it is slowly running out of money. At this point the ECB has forbidden it from buying Greek bonds. They are excluded from the trillion-euro asset purchase program. Tsipras’ government is managing to stay above water through the issuance of short term T-bills. These are purchased by Greek banks and financed by the ECB through ELA credits (emergency credits). It is a paradox: The ECB provides the funds with which Tsipras’ government is repaying the IMF and Euro Group credits. It is acting as an accessory to delay of bankruptcy petition filing and in doing so ends up even more deeply tangled up in the political quagmire.

Act 3: Syriza runs amok

The 1992 single market project was a Copernican revolution of economic integration in the EU. Up until then integration of politics had always been attempted from the top down and was dominated by the concept of a planned economy. The way was paved by market regulations. Since the days of Jacques Delors as President of the European Commission one relies upon market integration in Europe. The plans of the economic subjects are to be coordinated through the price mechanism. This market economy concept also forms the basis of the EMU. The members ought to adjust to exogenous, asymmetrical shocks through internal devaluation and revaluation and mobile production factors. However, this only works if goods and factor markets are well integrated. Only then are prices in the markets sufficiently flexible and the production factors sufficiently mobile. The regulatory model of the E(M)U is a market economy one.

The new left-right government in Greece openly questions this fundamental regulatory consensus. Not only for the numerous neo-Marxists and the extreme right-wingers is the market economy system the root of all evil. Their goal is (significantly) less market and (still) more (social) government. This is also apparent in the core of the EMU: the flexibility of labor markets. Each and every one of most recent reform proposals from Athens is moving in the wrong direction: higher minimum wages, more centrally coordinated wage and collective bargaining, more stringent employment protection, more government employment, reintroduction of the 13 month pension, suspension of the “zero deficit“ clause in the pension insurance fund. These are all elements of the social and labor markets political agenda of Tsipras’ government and will not lead to more flexible labor markets, rather to precisely the opposite. This is a slow poison for the EMU.

Epilogue: Europe neglects its regulatory policy

Despite what Giannis Varoufakis would like to believe, Greece is not the economic center of the world. Accordingly its exit would not cause the collapse of the EMU. However, the fatal regulatory policy development in Athens is the writing on the European wall. The anti-market sentiment in Greece is just the tip of a huge iceberg in Europe, one which has the potential to sink the E(M)U. What we are currently seeing with Syriza in Greece has been spreading like political wildfire in Europe for a while now.  Podemos in Spain, the Lega Nord in Italy, and the Front National in France are all political parties to whom the market economy system is an abomination. They are currently doing everything they can to destroy the still prevalent fundamental regulatory consensus in Europe. They desire that the government should once more be in charge, while the market leads only a shadowy existence. Europe is to neglect its regulatory policy. This would be the end of economic integration in Europe as we know it.

And there would be consequences for the EMU. The members of the Euro Zone will become less and less willing to bear the burden of adjustment to asymmetrical shocks through flexible wages and labor mobility. Rather, they will attempt to shift the burden of economic changes onto others. Imbalances will be financed with the money of others. The EMU will degenerate into a transfer union, one which will only be stable if the donors are willing to support the takers permanently if need be. That is rather unlikely. All inter-regional transfers produce disincentives, which does not do economic growth any good. Europe will be threatened with economic stagnation. And the donor countries will resist permanent redistribution which only benefits the recipient countries. The former will attempt to free themselves from the financial burden. A process of adverse selection will begin. The donor countries will leave the EMU.


The future of the E(M)U is already behind it if the market economy system decays any further. There is much evidence to support this. Throughout Europe there are strong political forces which don’t give a damn about market economy principles. Syriza and Podemos make up the vanguard of the extreme left, while the National Front and the Northern League are the two players on the extreme right. Unprincipled parties of varying political color often act in the space between. Private property rights, individual freedom of contract, and freer market access count for little in these anti-market circles. Government as an active entrepreneur, paternalistically active politicians and heavily regulated markets prevail. State redistribution dominates market-based competition. In the end the EMU becomes a transfer union. The burdens of economic change will not be borne individually, but rather collectively with the money of others. It is the end of the hazardous monetary experiment of the Euro. The EMU will change its size.


Hinweis: Das ist die englische Version des Blog-Beitrages “Die EWU verwahrlost ordnungspolitisch. Ein Drama in fünf Akten” Herr Michael Labate hat den Beitrag übersetzt. Herzlichen Dank!

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