What Else? Brexit

Everyone is talking about Brexit. It reminds me of the conversation I overheard after the NBA Championship. One person remarked about how he was very sure that the Cavaliers would win despite being down in the beginning of the series. His curious friend asked why. He said it was the uniforms. He really loved the uniforms.

When an event gets elevated to infinite coverage in the media we all think we need to have strong opinions despite not knowing a thing about it. That’s how I feel about Brexit. EVERYONE is part of the national obsession to have an opinion about it. I cannot believe how much has been written or spoken about it since the results of the referendum were known. What are we to think?

As in the NBA example above, a beginning step would be to know answers to some basic questions. What is the NBA? What are the rules of basketball? Why do players constantly touch each other and then get irritated when the little men in the striped uniforms blow whistles?

There are a lot of similar questions we might ask pertaining to Brexit before we start having opinions about its impacts on us. What is the EU and why would any self-respecting country ever join it when national sovereignty is at stake? What is the UK? Is it in Kentucky?

Today’s post has two objectives. First and foremost I want to provide some background and write about the EU and the UK. The upshot is that while national sovereignty is at issue, the loss portrayed by the LEAVE group was highly exaggerated. The LEAVE group has as much to fear from its own government's ideological tendencies than it had from some centralizing devil called Europe.Second I want to make the point that compared to other crises suffered in the near-past, this one is almost totally psychological.

Let’s start with the second objective. Nothing has happened except to announce that a referendum declared that Brits want out of something called the European Union. While the UK government will probably go along with the popular will, it will take a while. So let’s be clear. For a while nothing has happened. Stocks of dotcom companies did not find reality. The load of bad subprime mortgages did not become impossible to bear. No government raised taxes or reduced pension spending.

Nothing bad happened in the way of the usual macro suspects. What happened is that a country decided to not be in the European Union. So the first point is that nothing happened to directly cause crashing stock and foreign exchange markets not to mention the price of a gallon of gasoline.  Okay -- the British government has become less functional. Is that a plus or a minus? Really! 

Aha you say – but markets did crash and babies cried. And that’s my point. It is mostly psychological. It is all expectations! What happened is that a bunch of soccer rowdies decided to quit the EU club sometime in the near future. And that set off a lot of concern. I am not making fun of the concerns. They have some basis. But keep in mind that Brexit will be gradual and it will be in the best interest of most parties involved to make it work smoothly and to try to minimize the many impacts that will arise as the divorce takes place. Recall that President Obama advising Brits to stay in the EU said some threatening things. But now that the decision has been made he is already promising to find ways to make the transition work.

I am not forecasting the future but what I am saying is that the alarm bells may be a little too shrill for the reality. Brexit is not the end of the world and Brexit will unfold with many impacts in many places and we will deal with them. Let the markets take a big breath.

Now for the background. A basketball is a round thing that you bounce on the floor and then shoot through a little hoop. 

Now for the United Kingdom. Straight from Wikipedia (https://en.wikipedia.org/wiki/United_Kingdom )

The United Kingdom is a constitutional monarchy with a parliamentary system of governance.^[12] …The UK consists of four countries: England, Scotland, Wales, and Northern Ireland.^[15] The latter three have devolved administrations,^[16] each with varying powers,^[17][18] based in their capitals, Edinburgh, Cardiff, and Belfast, respectively. The nearby Isle of Man, Bailiwick of Guernsey and Bailiwick of Jersey are not part of the United Kingdom, being Crown dependencies with the British Government responsible for defence and international representation.^[19]

Most relevant is that the UK (often called Britain or Great Britain) is a sovereign state in Europe and is mostly composed of England, Wales, Scotland, and Northern Ireland but not Ireland or Puerto Rico or Texas. The UK joined something called the European Economic Community (EEC) in January of 1973 and then in June 1975 another vote solidified its membership in Europe. As of last week Britain will be the first country to reverse a decision to join the EU. Apparently the English wanted Brexit but not so clearly in the other countries in the UK. So that brings up a possible change in the make-up of the UK itself.

Moving along, what is the EU? The EU was a club of 28 sovereign nations. In the future it will have 27 members. The beginnings of European integration came after WWII when Belgium, the Netherlands, and Luxembourg joined France, and Germany, and Italy in something called the European Coal and Steel Community. The basic idea was that maybe if they cooperated on economics they would quit starting world wars. It worked pretty well and a very quick history is that they moved on from coal and steel to the idea of a single largely unimpeded market across Europe.

Until last week more and more countries embraced the idea of a free market in Europe. And they joined the EU. Sure Germany was the economic heavy weight. But like most free trade areas, the rest joined because of the expected benefits arising from fewer trade barriers and the removal of tariffs. Not all was tea and crumpets – with the single market came incursions into national sovereignty. Then came the euro currency that was adopted by 19 of the 28 countries (and not by Britain). Some thought a single currency made sense in a single marketplace. Others see it as too much togetherness. Now some want a single fiscal policy. So far no cigar on that one.

So you see the story, right? A free single market makes a lot of sense. That is the glue of the EU. Giving up too much power to Europe is not always popular in any given country or countries. But keep this one fact in mind. The institutional design of the EU is to protect national sovereignty. As in any club you join you win some decisions and you lose others. So long as the benefits of club membership are great enough then you stay in the club.

Quit snoring. I am almost finished. Like the US, the EU has executive, legislative, and judicial branches. All the institutions are run by representatives of the sovereign states. For example, the Council of Ministers is literally a group that consists of the government ministers of each EU country. The EU Parliament members are voted for in each country by the citizens of that country. The point is that EU legislation and rules are legislated and approved in each country before they can become EU law. 

Most rules must have unanimous support from all 28 states. In the very relevant situation of immigration, a country has the right to opt out of any or all EU agreements. This link lists all the area of EU governance that require all 28 states to have unanimous support 
https://en.wikipedia.org/wiki/Voting_in_the_Council_of_the_European_Union#Unanimity

Whew. Where is my bottle of scotch? Er I mean JD. 

Greasing the European Union

When you grease your car it reduces friction and makes it run better. Many machines need grease. The question these days seems to be whether or not the EU needs grease. And by that we mean Greece!

I don’t usually like to implicate others in my madness but I should thank my colleague Michele Fratianni for years of discussion about the EU.

We start with the idea that the EU is like a machine. It can work well or it can work poorly. To understand what contributes to EU performance one needs to know more about it. Wikipedia says the EU is “a politico-economic union of 28 member states that are located primarily in Europe.” That little group of words is correct but it is also subject to a wide degree of interpretation. One of the key points is that the EU is a union with most of the political clout residing in the individual countries. While a central EU institution (like the EU Parliament) might decide to impose a law or regulation on its members – that law or regulation would have to go through 28 national governments separately to become EU law. If the USA were such a union, Obamacare would have had to pass in the 50 legislatures and be signed by 50 Governors. If one country failed to pass it then it would not have become USA law.

So the first point is that the EU is not a highly centralized form of government. It has central bodies but the main clout remains in the 28 countries that comprise the member states. For more information about the EU see http://europa.eu/about-eu/institutions-bodies/index_en.htm

Much of what has transpired under the rubric of the EU has been a movement toward a single market space for its members. The underlying belief is that freer trade among the 28 countries would make them all better global competitors. Notice that 28 countries believe this – or they never would have joined the EU and they never would have passed hundreds of rules and regulations in their national governments. These hundreds of new rules and regulations essentially make it easier and less costly for a business to operate in Europe. They eliminated numerous barriers to trade among the 28 countries.

While the EU has been growing since the end of World War II, one of those barriers was not fully removed until 1999. If you are going to make the EU a single market then it hardly makes sense to have marks and liras and lats. Wow – what a mess trying to do business with all those piles of currencies!

The euro was thought to be an important part of reducing trade barriers. And so far – 19 of the 28 countries have joined in a European Monetary System with its own Central Bank that emits euros in much the same way as the US Fed emits dollars. And therefore, the ECB has become a very strong centralizing policy institution. While its rules were adopted by representatives of the EU nations – monetary changes do not have to go through each of the governments. Thus the ECB is truly a supra-national body.

I don’t want to get hung on that last point. My main point here is that the EU is here to help! It is a voluntary organization solidified by formal treaties meant to improve economic outcomes for every country from tiny Latvia to super power Germany.

If I can now direct my remarks to the 19 countries in the EMU – one specific thing to note is that these countries willingly gave up their own currencies. That means also that they gave up a policy tool. These countries can no longer adjust the values of their own currencies. They can try to influence the ECB to change the value of the euro – but there are no longer any dracmas to depreciate. When countries encounter into slow growth, they will sometimes depreciate their currency as a means to make their goods look more competitive in the global marketplace. These 19 countries, including Greece, no longer have that tool available.

Thus there are many tears being shed for Greece these days. But let’s face it—this is a bit silly. Depreciating ones currency might be something to use for small day to day adjustments but it doesn’t make reality go away. Competitiveness is basic. A kid wins the state track meet in the 100 meter dash because she worked harder and smarter for years. Maybe a competitor had another teaspoon of sugar the day of the meet, but it is fundamentals that determine the winners year in and year out. The exchange rate is like the sugar. It is not the solution.

Worse yet, currency depreciation is self-defeating. A continuous depreciation may help the trade balance and growth for a while, but the depreciation of the currency means that imports are priced higher and cost more. To the extent that depreciating countries import materials and capital goods, they because less productive. Worse is when speculators see a declining currency value in a country without any solutions – and they flood the markets with even more of the sad currency. This makes the depreciation even worse and causes panic

Greece is in trouble because it tricked the EU. It pretended to want to be a good member. Everyone knew that Greece and several other countries were not as solid as others when they joined. But the implicit bargain was that they would give up the dracma and try to be more competitive – more like the other countries. Well they didn’t. They acted more like Zorba the Greek than Ms Merkel.

I looked at some numbers. I compared European countries competitiveness before and after 1999 when the European Monetary Union began. If European countries losing their own currencies attempted to sharpen their competitiveness after 1999, then we should have seen improvements in their trade balances. And we do see some improvements between 1999 and 2007 (before the world financial crisis muddied the water). Trade improvements came for Germany, Austria, and the Netherlands.

Unfortunately, despite small initial improvements these next countries had vast deterioration in their balances of trade with the world – Greece, Ireland, Italy, and Spain. For example, the balance in current of account for Spain before 1999 was a deficit of less than 1% of GDP. By 2007 this deficit was about 10% of GDP. The story is the same for the other countries mentioned. In the case of Greece, the current account deficit was almost 14% of GDP in 2007.

Don’t cry for Greece. Greece accepted a gamble – a gamble that could have paid off handsomely. But they conned the game. They now need to decide what they want. They can have their dracma back and hope its depreciation solves their competitiveness problems. Or they can get down to the serious business of governing a country within the EU. Either way I think the EU will be fine.

Manifesto to Macroeconomic Nonsense

Alan Blinder and then Paul Krugman (with Richard Layard) wrote articles that showed up in the last week of June – one in the WSJ (The Long and short of Fiscal Policy) and one in the FT (Time to Speak Up: Manifesto for Economic Sense). They basically say the same thing. Krugman and Layard go a little farther since they are recruiting like-minded economists to show support for their manifesto. Please do not humor these guys.

Since both articles amount to the same thing let me try to summarize their arguments. Policymakers who disagree with Krugman and Blinder are “inflicting massive suffering.” This suffering comes from too much austerity. National demand needs to be stimulated, preferably by hiring more police, firemen, and teachers supplemented by more spending on national infrastructure. The government needs to make up for the lack of spending on the private side. Larger government deficits can be sustained by most countries but would damage long-term economic growth if not reversed at the right time sometime in the future. There are no supply constraints – the problem today is simply not enough spending.

I think this is a bunch of hooey (silly or worthless talk) and hardly deserves a response but it is either this or working in the yard in 105 degrees.

First question I ask is: What austerity?  I wrote a post on that a few weeks back (May 22 Austerity is hot) and showed there is not really much austerity going on except in Greece. Mostly we have seen historically strong government stimulus.

Second, they lament austerity in the US. But the numbers show nothing but government deficits and rising debt as far as the eye can see. Surely these two economists know the difference between stocks and flows. EVERY year a government has a deficit means an economic stimulus. While it is true that a smaller deficit yields a smaller stimulus, it remains that $1 trillion or so of deficits is having a walloping impact on aggregate demand. Saying there is austerity in the US now is like telling someone to eat a quart of ice cream to lose weight.

Third, in virtually no US budget that I have seen is there anything amounting to spending cuts. We all know that spending was increased dramatically at the onset of the recession.  Taking spending back to normal levels would not be a cut in my book. But even that is not happening. Spending continues to grow from these bloated levels.

Fourth – so while I agree that private spending is holding back, I seriously doubt that more government spending is the answer to our problems. We have plenty of government spending thank-you.

Fifth – these guys say that people who disagree with them are old fogies who fail to embrace the new and relevant economics. But what are they embracing? Keynesian economics is not exactly the Justin Bieber of economics.

Sixth, what they are embracing is a remedy that simply does not fit the patient. “Nurse, give the patient more heart medicine. But Doctor, the patient hurt his big toe. I don’t care, give him heart medicine.”

These mouth-breathers say that governments did not cause the recession. They are correct though decades of growing national debt definitely didn’t help us prepare or deal with a financial crisis. What caused the recession some 5+ years ago was housing and finance. Do these guys not see that lacking remedies for these problems, the economy is NOT going to improve?  Do they not see how much trouble Europe is having because of sovereign debt increases? Do they not see that promising a return to fiscal balance at some unspecified time in the future is like your daughter’s 16 year old boyfriend telling her that he will disengage just before the big moment arrives?

Seventh, these guys dismiss supply constraints as they obsess about demand. Yes demand is weak. But demand is weak because banks won’t lend and because firms won’t borrow or hire. Banks won’t lend and firms won’t hire because they don’t see government solving the housing and financial problems. In fact, many think them think the government is making the financial problems worse as they throw a Spiderman net of regulation over business activity from healthcare to investment.

Krugman and Layard (and Blinder) want you to sign a manifesto (a ticket on the Titanic). I suggest you send them free passes to the Betty Ford Clinic. They need a time-out to get off this Keynesian high. 

More “Gooulish” Nonsense about European Fiscal Integration

Austan Goolsby wrote in the WSJ on May 30, “A Fiscal Union won’t fix the Euro Crisis.” I first thought that since he is a professor at the University of Chicago that we might be kindred spirits. But that is not the case. While we agree about the ineptness of a proposed European fiscal union we seem to come at this agreement from very different angles. I dislike the fiscal union because it would create too much pressure towards populist expansionary policies across Europe. He dislikes it because he thinks it won’t do enough to supply a coordinated European government stimulus.  

Here’s his reasoning. First, his data shows that a fiscal union among the 50 US states means that US states routinely subsidize each other.  For example, Minnesotans routinely bail out Mississipians through the magic of a federal government. Goolsby worries that a European fiscal treaty would allow any country to easily veto that kind of inter-state redistribution. Thus in a European fiscal union Goolsby worries the austerity hounds would win. I am concerned about the opposite.

Second, Goolsby blames the woes of Ireland, Greece, Spain and others on the monetary union. He notes that since the monetary union began German’s real wages have grown slower than productivity while the opposite happened in the peripheral countries. Thus, the monetary union – according to Dr. G (how many times can I type Goolsby?) – has made the peripheral countries less competitive. This might not be so bad but the monetary union prevents these countries from overcoming this competitive disadvantage through currency devaluation. Dr. G laments that without an exchange rate the only avenue left for these countries is “moving, inflating, struggling, or subsidizing”. Thus he wants the stronger European countries to either subsidize the weaker ones or he wants them to inflate.

Wow. Can we check the facts please? The US federal experiment succeeds because some states subsidize the rest? That is Dr. G’s main explanation for decades of US growth? The only choice for Europe to improve the lot of Italians and Greeks is inflation/subsidy from Germans and Finns? The implication is that the countries that have benefited from monetary union should be the ones doing the subsidizing and inflating. This is the secret ingredient necessary for EU growth?

From Dr. G’s analysis one should find in the years after 1998 when the monetary union began, the peripheral countries were weakened while Germany and some of the others were strengthened. I found a table of real GDP growth figures for OECD countries (  http://www.oecd.org/document/3/0,3746,en_2649_34109_2483901_1_1_1_1,00.html ) with data for the years from 1987 through 2007). There is little support for Dr. G in a pre- post- comparison of real GDP annual growth around the year 1998:

·         Finland’s growth rate was higher after monetary union (2.2% per year versus 1.7%)       

·         France’s growth rate was about the same in both time periods at about 2.2% per year

·         Germany’s average growth rate fell from 2.6% per year to about 1.6% per year after monetary union

·         Ireland’s growth rate fell very marginally after monetary union from 6.1% to 5.8% per year

·         Italy’s average annual real GDP growth also fell marginally from 1.9% to 1.6%.

·         The Netherlands’ growth was helped by monetary union – from 2.5% to 3.1%

·         Portugal’s growth rate almost halved from 3.4% per year to 1.8%.

·         Spain improved considerably after monetary union – from 2.7% before to 4.6% per year afterward.

Germany and Spain’s performances are just the opposite of G’s conclusion since Germany seems to be weakened while Spain was improved by monetary union. Using data on standardized unemployment rates across these same countries shows that except for Portugal, Eurozone countries were greatly improved by the monetary union. For example, Spain’s unemployment rates averaged well above 15% in the years before 1998. Afterward Spain’s unemployment rates averaged about 10% and fell to 8.3% in 2007. It is true that trade patterns after 1998 changed international competitiveness within the Eurozone – but these changes are not mirrored in overall economic indicators like output and employment.

The most outlandish ghoulish assumption, however, is that somehow economic growth and prosperity has much to do with national stimulus and subsidization. I know of no growth theory that supports such an unwarranted conclusion. Growth is all about marshalling inputs and using them in increasingly productive and innovative and competitive ways.  In today’s cynical and skeptical environment stimulus and subsidy are even less useful. There is a widespread concern about more stimulus since governments are deeply in debt and so little has been accomplished in the way of competitive restructuring of financial, product, and labor markets.

Back to the main point about increased fiscal integration of Europe. Dr. G is right – a tighter fiscal cooperation among the 17 Eurozone countries would not be a good idea for Europe. But the reason for the failure is not that it would bring too little stimulus and subsidy. It is precisely the opposite.  Such a democratic project among the nations of Europe would soon produce a majority for the same kind of populist policy trash that now dominates the US. I wouldn’t wish that on anyone! A fiscal union is not warranted by monetary union nor is it in the best interests of any of these countries. 

Financial Tornados Part 2: Satellites falling from the sky

In my last blog I suggested that it is important to distinguish between events that will likely repeat and those that won’t. Policy cannot be backward looking or we waste the people’s money. No matter how devastating it might be to have part of an orbiting satellite fall on your head, it makes absolutely no sense to spend huge sums of money to prevent something that almost never happens. Yet, more and more evidence is piling up that policymakers continue to suggest remedies that make little sense when a repeat of the past financial crisis is so unlikely. That does not mean that there are not affordable and reasonable things that can be done. Building better satellites or programming them to fall in the ocean seems more reasonable than building a roof over the globe.

I want to continue this line of reasoning with some comments about various solutions that keep popping up in the business news. For example, in the Financial Times of October 25^th, William Dudley, president of the NY Fed called for a “comprehensive approach that should start with an urgent effort to remove the obstacles that make it difficult for all borrowers to refinance at today’s low mortgage rates.” In my previous blogs I have been a strong advocate of finding ways to solve the housing finance crisis. And refinancing is clearly important in that regard. But Dudley’s message misses the point. What got us into this mess is exactly what Dudley is suggesting. It is like telling an alcoholic that he needs to drink more to cure his addiction. The “obstacles” he refers to include the very things that are necessary to make sure that loans are repaid by the people who borrow the money. Dudley should be more direct. He really wants the government to subsidize the loan process. If that’s what he really wants, then he should recommend that bankers continue to use good banking principles while he asks for direct government support to those who cannot afford to pay back the loans. The latter would be temporary and more befitting of the problem. Suggesting that banks use poor policy is more permanent and guarantees a replay of the financial crisis.

In the same issue of the FT is an article by Barry Eichengreen and Raghuram Rajan recommending that central banks expand their responsibilities to include a dual mandate for monetary policy.  Instead of central banks focusing on employment and inflation alone, they recommend central banks also aim their policies at financial stability. While it is true that financial regulators were and are part of the problem of the financial crisis, it is not clear that the lack of a dual mandate for central banks caused the current crisis. Every country has a regulatory system with one or more institutions that oversea financial stability. In some cases they have too many overlapping institutions. But the industry is covered. I do not know what it is that suggests that central banks have an advantage in producing good financial policy. Most experts believe that central banks have a difficult enough time with just one mandate – finding a satisfactory balance between inflation and unemployment. E&R want to saddle these struggling central bankers with tradeoffs between unemployment, inflation, and financial stability? Wow. Crazy.  It’s like asking a one-armed juggler to add a few more flaming rings to his act.

Then there are the recommendations for increased European integration. George Soros has a plan to save the eurozone. It was not enough to have a stability pact that required that eurozone nations be mindful of the sizes of their deficits and debt. This pact had penalty fines attached and seemed like a great solution to protect the value and reputation of the euro. That worked until Germany had a little problem with the requirements and fines and the Germans simply said nein. That ended that. So now we are to believe that since there is a sovereign debt crisis, Europeans will enact a new treaty that creates a common European Treasury, a newly empowered European Central bank with direct controls over credit lines and portfolios of all banks, and more.  Did the lack of explicit policy integration stop countries from exerting their own preferences for fiscal policy? The answer is no. There was a treaty and when it infringed their own sovereignty, they found ways to avoid it. When Frenchmen and Finns feel threatened by European events they will always find ways to preserve France and Finland, regardless of agreements and treaties. Perhaps in 50 years Finns and Frenchmen will believe their interests are best served by a United States of Europe. For now, however, the recommendations of Soros and others amount to treating a one-time bout of the flu with an Iron Lung Machine.

The problem with Soros’ and other proposals for more European integration of fiscal and monetary policy is that these are solutions to problems that do not exist. The EU is not the United States of America. The EU is mostly a single market with a single currency designed to make its members more productive and competitive. It was designed to be a loose federation of sovereign states. This worked well until 2008. Then a “satellite fell on their heads”. This satellite is likely not to return yet serious economists and political leaders want to "build a roof" over all of Europe.  The sovereign crisis of Europe is serious. But the solutions should fit the causes of the problem. It makes no sense to enact permanent edifices for rare events. It would be much better to find short-term remedies designed to overcome the worst problems and then get on with the task of being a loose federation of sovereign states with a single market and money. 

Welcome to the United States of Europe

 Recent events in Europe have several experts predicting the demise of the European Union and/or the disintegration of the European Monetary Union. Whether the discussion is about Ireland, Greece, Portugal, Italy, or DSK’s dickey, the oft-heard conclusion is that something is about to end. My hunch is just the opposite – humdrum stuff was making the EU/EMU pretty boring for a while but now we see the seeds of an even tighter Europe Union and new steps toward the United States Of Europe. Challenge and fear seem to be stronger motivators of integration at times when hopes and dream fail to spur change.

Let me frame my argument with a review of EU history and please excuse me for leaving out all the details. Please wake me up when this over. If you prefer a more formal (i.e. correct) summary of EU history you might try http://europa.eu/about-eu/eu-history/index_en.htm

·         There were two world wars that for the sake of convenience and generally accepted accounting principles George Bush named them WWI and WWII. These wars found Europeans as enemies and led to recognition by many European countries after WWII that life would be a lot more pleasant if they would find a way to stop killing each other. Estimates for deaths incurred during these two world wars begin at about 50 million. Germany, France, and the Benelux countries decided that if they cooperated in the production of iron and steel that would be a nice beginning. The idea was that economic integration might breed common interests and someday lead to zillions of tourists traveling in VW buses eating French fries gobbed with mayo while dropping gazillions of dollars and yens in GeFrBeNeLux. It soon seemed easier to start calling it the EU.

·         In 1973 Denmark, Ireland, and the UK joined the EU and thereafter other countries wanted to join. The US tried to join but EU leaders explained to Nixon that the US was not actually in Europe and while they appreciated being protected by the US military, they didn’t really like us enough to make an exception to that all-European thing.

·         Other European countries kept joining thinking that membership included Green Stamps. As of today there are 27 countries in the EU. There are another five countries asking for admission. 

·         In 1993 the single market concept was approved into law and that included a ton of legislation that helped form a single market for goods, services, persons, money, and Jerry Lewis.  As these countries expanded their trade with each other it made a lot of sense to remove as many obstacles as they could. A single market means that many national impediments to trade were removed and the economy of many nations functioned as if it was one.

·         In 2002 many of these EU countries decided it would be better to ditch their currencies and replace them with seashells. After some experimentation with this new idea it was felt that seashells were not the best idea so the euro currency was invented and has to date been adopted by 17 of the countries. As the markets were becoming more integrated the costs of having to deal in so many different currencies became pretty obvious. It was a big step for those 17 countries but they did it to make Europe work better.   Without home currencies the control over the new euro would be done jointly by a new institution called the European Central Bank. While the central banks of these countries participate in all ECB decisions, no single country holds a veto over ECB power.  Sovereign policy over money, interest rates, exchange rates and more was given over to an extra-national body.

·         Ever since the adoption of the euro it was pointed out by many experts that it makes little sense to have monetary union without a fiscal union. But then, you could also argue that it makes no sense to have monetary and fiscal union without complete national unity.   The EU has integrated one step at a time and the logic of slow and steady seems more prevalent than these kinds of arguments. I will return to this point below.

·         Along the way the institutional make-up of the EU took form and the EU is composed of a real transnational government with an EU Parliament, a Council of Ministers, A Commission, Court of Justice, Court of Auditors, and a Court Jester (Jerry Lewis). While this set of institutions reminds us of the USA and of American’s national institutions, our EU friends are quick to remind us that this is not a strong federal government and its budget reflects a loose federation with limited powers. These 27 countries have given up national sovereignty in some areas (as defined by EU Treaties) but unlike Alabama and Indiana, these 27 countries remain independent and sovereign nations.

This last point gets us a little closer to my main point. It seems to me that this is a mostly irreversible train that is heading towards USville. I get that these are 27 sovereign nations but I also get that over the years they have given up more and more independence and little of their posturing or behavior now would suggest that 55 years of experience makes them so sure that this was all a big mistake. 

In fact the temperature of the debate over Greek debt underscores how serious they are about saving both the EU and the EMU. Yes these are difficult and heated disagreements. The French and the Germans have very different ideas about how to solve the crisis and are almost as vehement about their positions as they are about soccer. The ECB also has its own ideas about the correct solution.

And they should feel strongly about all this. Why? Because the Greek crisis isn’t so much about Greece as it is about a new round or a new layer of EU control and loss of national sovereignty. It was one thing to allow the EU to have control over laws governing the flow of goods, services, people, and money. It was another thing to create a European Central Bank that replaced the independent decisions of 17 countries over money and meant that 17 countries gave up direct controls over their own exchange rates. It was another leap to change the voting and other rules for making EU decision so that 27 countries would have more equal voting rights.

But despite all that brotherhood and giving up of sovereignty – they still had their own 27 fiscal policies. These countries could set their own taxes and government spending.  Sure, the Maastricht Treaty codified guidelines that said how large a country’s deficits and debts might be. But that was not a real dilution of national control. These Maastricht limits have been avoided on numerous occasions. Inasmuch, Finland had no responsibility towards a German debt and vice versa. And while it was true that an economic calamity in one country could spill over and harm the citizens of other EU countries, there was not a lot of discussion of how that might be handled.  

Well, the Irish-Greek-Portugal-Spain-Italy situation has changed all that. There is a real chance that fiscal problems in one country can severely damage economic prosperity of the rest. They always knew there was such a potential but until it was screaming in their faces every day, the motivation to do something about it held a low probability. While much of the energy is being devoted in the last weeks to EU or world solutions to the Greek debt problem – this situation is better considered as a new chapter in loss of sovereignty of EU nations. It isn’t only about Greece. It is all about a future EU. It is all about how the EU or the ECB should behave in what has become a new and different economic/financial situation. All of a sudden Finland and Germany have a lot to say about another country’s debt and deficits – and how they resolve them. The Finns would not have been so bold a few years ago. Expanding the EU’s policy jurisdiction was not so important a few years ago. But the fiscal hammer came down. It has everyone’s attention.

If one country’s debt cannot be repaid this acknowledgement impacts the euro’s value. If one country has deficits or debts or real prospects of future deficits and debts – the same is true. If Ireland can’t pay, then the economies of all countries in the eurozone will be impacted. Spillovers are not limited to the exchange rates since the financial systems are highly interdependent. If risk suggests higher interest rates in Greece, then interest rates will rise in other EU countries.  Never before have EU countries looked so closely at each other’s deficits and debts.

One solution is to eliminate or remove the bad guys from the EU club. How exactly do you define a bad guy? Even if you could I don’t see expulsion as a reality. History says it won’t. There are countries that never joined the EU – but there are none that have left. The benefits of the Union are simply too strong and the reasons for leaving too weak. A single market and a single currency create enormous benefits and no country once in will want to be out. Being out gives a country more control over its own currency value but let’s be honest – a plummeting currency value is nothing to be wishing for. These countries are in trouble not because of weak currencies but because of bad policy. The better policy will come more easily from within the Club than from without.  Political leaders of one country never want to admit they failed and need help from the other countries. But the situation today requires that they do this.

The European Financial Stability Facility and a European Treasury are proposals that envision a lot more integration and less national sovereignty when it comes to EU fiscal policy. Euro bonds envision a true regional monetary policy. It is hard to predict what will come of this sovereign debt crisis but one can bet that this current challenge will be met like all the past ones – with lots of heat and light followed by a treaty or agreement in which more countries give up more sovereignty for the purpose of overcoming another challenge to a successful economic experiment that has now lasted more than half a century.  The EU is still a long way from being as integrated as the 50 states that comprise the USA – but they promise to move closer to not farther from that model as time moves ahead.