The European Union And The Eurozone Within It Are Not Like The USA – Washington Would Have To Bail Out Michigan, No Matter What – Germany Does Not Have To Bail Out Greece If The Price Is Too High

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By Paolo von Schirach

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August 8, 2012

WASHINGTON – A few days ago I argued (see above link) that the eurozone simply cannot carry on with all its current members on board. Some of them, Greece, Portugal, Spain and Italy, (the “Club Med” countries), are just too weak economically and institutionally to get back in shape and regain the pace of better organized, more productive and more efficiently run Northern European societies such as Germany, Austria, the Netherlands or Finland.

Why should weak countries leave the euro?

A reader asks me why is it that the weak states have to exit the euro. After all, he points out, when municipalities, counties and states get into economic or financial trouble in the United States, they do not have to leave the Union. They do their best to fix their problems, with Washington’s help, if need be. Here is how he stated his comment:

Agree in general, but have a question: why is “restructuring the monetary union” necessary? In the common-currency-US, states, cities, municipalities, and counties all go bankrupt. They don’t then pull-out of the union, but restructure. The questions for Greece et al in this scenario is this: Is it better to be a member of the EU with the concomitant currency and leading-edge societal/competitive benefits, or is it better to fall backwards and run their traditional finances and depreciate their currencies unendingly….

What is Europe?

The reader’s comments and basic questions really require us to examine what “Europe” is and what the “eurozone” is. I think that it may be appropriate to use this opportunity to clarify some key issues and possibly some misunderstandings about what “Europe” really is –and especially what it is not. I hope to be able to clarify why Greece getting into serious trouble is not at all the same as Michigan, or Alabama falling behind.

First of all, one fundamental point that really shows the qualitative distinction between Europe and America: unlike the United States of America, “Europe” is not a state. It is not one country. We may think it is, as it calls itself officially “European Union”. But the use of the term “Union” is quite misleading. A “real” European Union is at best an aspiration, a dream to be realized may be one day.

Europe is not a country

Today, Europe is neither a country nor a federation. The European Union is the result of a set of complicated arrangements among sovereign states regulated by a variety of treaties that are in fact inter-governmental agreements. Unlike the states within the United States, the EU member states are fully sovereign states. There is no elected President or Prime Minister of Europe. There is no elected European government. There are no European armed forces. There is no European judiciary. Most fundamentally, there is no European Ministry of Finance. There is an executive, the European Commission, but it is an appointed body and it does not have policy making powers along the lines of a real executive. There is however a European Central Bank, ECB. the ECB is similar to the US Fed; but not quite the same as it operates in a completely different context of the 17 sovereign states that adopted the euro, as opposed to one single country.

No federal government

The European Parliament, while duly elected, does not have the legislative powers of the US Congress. Most powers still rest with the individual legislative bodies of each member state. While there is a European Union budget, it is very small and it covers mostly agricultural subsidies and a variety of regulatory and administrative tasks. There is no real Europe wide budget covering defense, international affairs, justice, education, welfare programs and so on. There are small bits and pieces of all that, but nothing that would resemble the US federal government prerogatives vis-a-vis those of the 50 states. While the 27 members of the European Union and the 17 states of the eurozone jointly manage a number of activities, each member state retains its separate sovereignty, its separate fiscal policies, its separate welfare programs and its own national economy.

The US is a country

In the US, within a system that respects states’ powers on a variety of issues, the federal government has a significant fiscal, tax and regulatory presence across the 50 states. All citizens and corporations pay federal taxes. In return, all Americans receive federal benefits: Social Security, Medicare and Medicaid. On top of that, the Federal Government provides block grants to the states and offers a variety of other programs, from education to infrastructure, that benefit states. When we had the financial crisis in 2008-2009, the federal government arranged for a gigantic bail out of banks nationwide. It rescued General Motors and Chrysler. Freddie Mac and Fannie Mae took over most of the mortgages and so on. On top of that, the Federal Reserve manages monetary policy.

In the US, when individual municipalities or states get into financial trouble they continue to benefit from belonging to a federal entity that provides a floor to all, including the implicit guarantee that, if things turn really ugly, Washington will intervene. Besides, there is no provision in the US Constitution to expel any city, county or state for bad behavior. The United States is one country.

A common currency without a country

Whereas Europe is not a country. And this the problem –and fundamental weakness– that was conveniently forgotten when some members of the European Union –a Union, remember that is not a Federal State– decided to go ahead and adopt the euro as the common currency that would help strengthen trade and economic ties among them.

Quite correctly it was understood at the time that the common currency could come to life and later on succeed only if all the countries that adopted it would voluntarily abide by ”rules of good behavior” they would willingly sign on to.

Mandatory rules

Most critically, all signatories agreed that, as a precondition for accessing the monetary union, all members would agree to limit their annual budget deficits to an amount that would never exceed 3% of GDP, while their total national debt would never surpass 60% of GDP.

The ability of all eurozone members to stick to these rules also implicitly postulated that their economies would function all at the same speed, in a fairly harmonious way.

For some strange reason, at the time, (early 1990s), it was believed that such tight mandatory rules, based as they were on ultra optimistic assumptions of existing and continuing good behavior on the part of all and equally good economic performance shared by all, would be easy to follow. Knowing what we know today (all fiscal rules broken by huge margins, systemic economic weaknesses deeply embedded in many countries), this optimism appears really stupid –or at least incredibly naive.

The advantages of the eurozone

The economic advantages of a common currency would be significant. France, Germany, Finland and Italy would be able to trade with on another using the same currency, thus cutting costs and making all payments and transactions a lot easier and faster. The advantages of all eurozone members adhering to sound principles of fiscal discipline would also be significant. A strong and stable currency used by strong economies would mean low interest rates for all euro users, something beneficial for both the private sector and treasuries that could borrow at a low interest rate.

All in all, the common currency seemed to be a good deal across the board. The eurozone countries would emerge as a stronger trading bloc, all transaction costs among the euro users would be lowered, while the euro would be able to rival the dollar as a dependable international means of payment.

Good behavior stopped

All very well, except for the fact that the fundamental preconditions of good behavior and equal economic performance have vanished. In simple terms, the deep debt crisis now affecting the weaker members is the necessary outcome of chronic under performance coupled with over spending. The dilemma for Germany and the other rich states is whether they want to bet on the ability of Greece and the others to get back on their feet by financing their recovery, or admit that they will never make it and thus cut them loose.

Imagine a similar crisis in the US, but without federal remedies

Transposed to a US context, picture this: Colorado, New Mexico, North Carolina and Florida are all on the verge of bankruptcy, and all at the same time because of structurally poor economic performance, fiscal mismanagement and a lot of corruption. The federal government (in this imaginary scenario) has no institutional means to intervene. Each state has its separate government, its budget, its banking regulator, it own pension system and so on.

Washington would have to invent, and only with the concurrence of the states in trouble, new means to bail them out. The only institution that could do something is the Federal Reserve. Except that, by statute, the Fed cannot legally buy the bonds issued by the states. Nor can the states in trouble issue bonds that would be guaranteed by the federal government. A real mess, wouldn’t you say?

Well, this is where the eurozone is today.

Can the weak states recover?

Remember: Greece is not part of the (non existent) United States of Europe. And Berlin is not Washington. It cannot make policy or issue orders. Given these constraints, if you are optimistic and bet that the troubled Mediterranean countries with huge amounts of help from their richer northern neighbors will eventually get back on their feet, then all is well.

But if Germany and the others think that the “Club Med” countries cannot make it, then, as painful as the cure may be, they will cut them loose. It is unthinkable that Germany will keep bailing out Greece for ever in the same way as it would be unthinkable that the US would keep bailing out Mexico, even though we all belong to NAFTA.

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