By David Keene
As we all woke up yesterday to the adrenaline rush of the big EU bailout, and the subsequent U.S. stock market rally, it brought home how in spite of the sometimes niche and insular nature of our industry, we’re still all swimming in a sea of global market forces and market changes. This year, I’d like to think that the very real economic recovery in our niche industries is solely the result of our wisdom and the power of our revolutionary technologies, from placed based advertising to security messaging. But the fact is, the recovery is steaming ahead with a great deal of momentum from quarters larger than the domain of our beloved technology providers.
Nobody needs more platitudes about the global economy. What we really need are reminders that the laws and lessons of economics have not changed.
I’ve been saying for years, throughout the slide of the value of the U.S. dollar, and the U.S. bashing that came on the heels of the supposedly U.S.-generated “financial crisis”, that the other shoe would eventually drop… and it wouldn’t be a U.S. shoe, it would be the shoe of our two-legged race partner, Europe. Last week, it felt like that EU shoe was about to have a blowout, as the EU was failing to reign in the debt crisis in Greece. But Sunday in Europe, the EU leaders got together and basically said “let’s not do a U.S. style bailout. Let’s go for the gusto, and tell the markets that we’ll do whatever it takes to defend the Euro.” Bold action they did take, pledging about a trillion dollars toward a slush fund to bail out the Greece’s and Spain’s of the EU. The markets loved that news yesterday. But is it enough? For now. But no amount of dollars or Euros changes the laws of economics.
When the Euro was fully adopted by most of the EU countries, in 2002, the idea was simple: by creating a U.S. style common currency (the Euro), market efficiencies are reached. Trade is facilitated. (And a side benefit to the EU, it was thought, might even be that the Euro could whittle away at the dollar’s place as the global reserve currency of preference.) But of course, anyone who took Economics 101 in college could predict that the system would not work, if as in the past, individual European countries continued to have vastly different budget surpluses/deficits, balance of trade surpluses/deficits, different welfare regimes, etc. In past decades, all the different European countries of course did have vastly different monetary and fiscal policies. Countries like Greece, Italy, and Spain routinely got into hot water with overspending, over-borrowing, budget deficits, etc. But the remedy was easy: if Italy or Greece, for example, overspent and over-borrowed, they simply allowed (or encouraged) their currency to devalue. Under the old, pre-Euro, system, Greece, when faced with big budget deficits and big foreign debt, simply devalued their currency. This had the immediate effect of: 1) increasing their exports as their goods got cheaper to buy overnight, leading to a mitigated current account deficit; 2) decreasing the real value of their debt by devaluing it vs. the lender country currency overnight; 3) allowing their citizens to continue to get paid in the same local currency amounts (or even more) as before the crisis– economists call this the “money illusion” and it works: citizens, if they get even slightly more in pure number terms on their paychecks, think they are better off, even if inflation means their money buys way less than before. Give then a few more Drachma, or Lira, and they’re happy, even in a very inflationary period; cut their Euro paycheck by even a tiny amount and they’ll take to the streets).
But the EU/Euro architects, in their infinite wisdom, foresaw this dilemma (that a universal EU currency would take away the “devaluation” remedy above) and said: OK, to make the Euro work, every Euro-adopting country must agree not to overspend, over-borrow, or otherwise act like they have been doing for centuries. [Add canned laughter here]. And the EU did formulate guidelines for maximum budget deficits, etc. So how did the EU countries that perennially got into trouble before the establishment of the Euro deal with this? They cheated. They borrowed Euros like drunken sailors, and taking a page from U.S. banks, loaned to anyone with a pulse. And they funded expansions of their own government infrastructures at a breakneck pace, running up budget deficits and straining the logic of a common EU currency.
The creation of the trillion dollar slush fund last weekend will allow them to cheat a little longer. But I don’t want to be cynical. It’s possible that Spain, Greece, Italy, Ireland, and the other EU countries in trouble could restructure their economies, and really make the EU, and the Euro, stronger.
And don’t forget, the power of Germany–that had the sign-off on the package this week– is massive. Germany–the country that was behind the most aggressive lobbying to push the Euro through in the 1990’s– is after all the country that in 1990 engineered what can only be described as a leveraged buyout of an entire country, when they assimilated East Germany after the fall of the Berlin Wall. When Germany converted the East German Mark at one to one with the West German Mark, that was the single boldest, most ambitious financial rescue package in modern world history. Don’t underestimate their ability to do it again. The 1992 Maastricht Treaty obliges most EU Member States to adopt the euro upon meeting certain monetary and budgetary requirements; however, many EU states have not done so– most notably the UK. Germany has all the more reason to ride to the rescue of Greece and Spain– they have to prove that their aggressive Euro vision was well-planned and well-thought out. And if their plan works, it could be the final part of a international package (with the U.S. and China carrying the flag as well) that locks in a five year growth trajectory for the global economy that makes us forget all about Lehman Brothers and the rocky roads and seas at the close of the first decade of the new century.
By David Keene