Wednesday, 5 September 2012

Dr. Wihelm Hankel on why the euro system is unsustainable

You don't need to look at recent materials to get answers to the issues currently facing the Economic and Monetary Union of the EU (EMU). In an interview back in 2005, Dr Wilhelm Hankel (who tried to stop the replacement of the German Mark by the Euro), said the following,
For early critics of the euro such as myself, to find that others have woken up to the euro's drawbacks, gives one grounds both for satisfaction, and bewilderment. The drawbacks were plain enough from the starting-block: How could anyone have anticipated that a single currency might work, for a conglomerate of such diverse states and national economies?
In the euro zone, the competitive setting has been totally distorted: Relatively poor, backward economies can now compete—thanks to their very backwardness—with advanced economies. Backwardness, has become the competitive edge! With the euro, countries whose currency is weak and capital formation scant, enjoy a currency risk close to zero. The poorer national economies, which have low wages, low living standards, and where costly infrastructure is less developed, and which therefore have low taxes, are drawing away investments from more developed nations—thanks to their "cutting edge" in terms of tax levels, social costs, and wages.
What we find here in Germany, namely investors fleeing into the Europe's "rim states," is a manifestation of an utterly distorted competition, which violates the law of productivity. The more productive nations, those that have worked damn hard to build up costly infrastructure, high social standards, and high wages, are now being punished for their prosperity. They are losing out on jobs, capital, investment, and growth potential. In the first 40, glorious years of the Common Market, Europe could protect itself against this, to a significant degree, through currency-competition. In countries like Ireland, Portugal, Spain, Italy, and until recently, even France itself, the currency was devalued every two to three years, for reasons that are easy to grasp. A foreign investor, therefore, had to consider the eventuality that overnight, part of his capital might go up in smoke.
Germany, for its part, enjoyed a substantial advantage with its hard and stable currency; foreign investors could even cash in on currency revaluations. We had the lowest nominal and real interest rates in Europe. On losing the D-mark, Germany no longer had the magnetic drawing power of its highly productive economy.
There are those "selfless good guys," (Gutmenschen), here in Germany, who will say: "But isn't that just what's wanted. Burden sharing throughout Europe." In my book, this is a dangerous illusion. For countries, in the EMU, with feeble capital formation, the prospects may look bright in the short term, but it will not hold. Besides a boom there, you have inflation. At the moment, there are huge capital flows into national economies where the domestic rate of capital formation is weak and the savings rate is low. Or else, they are afforded cheap credits by the European Central Bank (ECB), because they are entitled to the same rates as countries with a high rate of capital formation. The outcome spells inflation.
On the question "Is the property boom in Ireland or Spain one expression of the inflationary dynamic?" he answers,
Indeed. There is a quite extraordinary inflationary trend through the euro zone's money markets. It becomes all the more evident, when one considers asset prices: real estate, stocks, and so forth.
At a glance, there you have it: A European Central Bank will necessarily be snowed under. What will the ECB do, when, in the "rim states," the priority is fighting inflation, while in the productive, core states, it is deflation and unemployment? To fight inflation, one would need higher interest rates in the "rim states," but that will only worsen the deflationary crisis in the core states, while feeding political unrest. Should the European Central Bank cave in to pressure from the productive states and cut the rates, it will be pitching oil onto the fires of inflation in the rim states.
What does [ECB chief] Mr. Trichet do then? Nothing at all! Just go with the flow. The lesser evil, eh? The problem is that the lesser evil means, that the process—inflation here, deflation and crisis there—by which the nations grow apart, will but intensify. In a nutshell, the euro's days are numbered.
Even Mr. Greenspan has understood this. Sometime in the 1990s, he went on the record saying that "the euro may come, but it will not be sustainable." He said this around the time that we four professors [Schachtschneider, Nölling, Starbatty, and Hankel] filed a complaint in the Federal Constitutional Court of Germany against the euro.
And on the question "What you identified as the European Monetary Union's main flaw, is the deflation/inflation tandem. Why then was the euro system rammed through with such brute force?" he explains,
A theory has been making the rounds, known as the "Factual Constraint Theory": "As we seem to be getting nowhere with the United States of Europe, then let's do it via the currency. Once we've got a common currency, the factual constraints of coordination and adjustment will be such, that political unity will emerge, as though automatically, from the monetary union." In our complaint to the Federal Constitutional Court, we asserted that this Factual Constraint Theory is unproven. It contradicts all historical experience. Never, in the history of the world, or the history of money, have such currency unions ever worked for long.
The European currency union cannot hold longer than five to seven years, because those who have incurred prejudice, the losers if you will, want out. . . .In a Europe where such diverse circumstances prevail, with a structural, cost of living, and per capita income differential of no less than 3:1 (which is the actual ratio, among the 12 EMU member states), diverging interests will crop up, and will lead to push-pull-and-tear, which is not quite the political purpose that allegedly inspired the move towards currency integration.‹ec
A European single currency could not work, unless, beforehand, there were a political agreement to level out divergences, through gigantic structural and financial compensation. And for this, there never has been, nor does there now exist a single clue—the currency union was worked out without the faintest notion of structural and financial compensation. The little that has been done in that respect, is a drop in the bucket, quite insignificant.
There you have it and most of the problems identified above have occured and is a problem for the EMU today. As this was written in 2005, the five to seven years he predicted has almost expired and the euro and EMU by all means have failed (just think about the bailout funds committed and the boom-bust cycles in Ireland, Greece and Spain). And the euro system is clearly unsustainable.


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