Imagine that you knew Greece was still Greece and Italy was still Italy and that the prices quoted in the markets represented the bond-buying activities of banks pushing down yields rather than an estimate of the risk of the bond itself. Why would you buy such securities if the yield did not reflect the risk? You might realize that if you bought enough of them—if you became really big—and those assets lost value, you would become a danger to your national banking system and would have to be bailed out by your sovereign. If you were not bailed out, given your exposures, cross-border linkages to other banks, and high leverage, you would pose a systemic risk to the whole European financial sector. As such, the more risk that you took onto your books, especially in the form of periphery sovereign debt, the more likely it was that your risk would be covered by the ECB, your national government, or both. This would be a moral hazard trade on a continental scale. The euro may have been a political project that provided the economic incentive for this kind of trade to take place. But it was private-sector actors who quite deliberately and voluntarily jumped at the opportunity.
...the centrality of competitiveness as the key to growth is a recurrent EU motif. Two decades of EC directives on increasing competition in every area, from telecommunications to power generation to collateralizing wholesale funding markets for banks, all bear the same ordoliberal imprint. Similarly, the consistent focus on the periphery states’ loss of competitiveness and the need for deep wage and cost reductions therein, while the role of surplus countries in generating the crisis is utterly ignored, speaks to a deeply ordoliberal understanding of economic management. Savers, after all, cannot be sinners. Similarly, the most recent German innovation of a constitutional debt brake (Schuldenbremse) for all EU countries regardless of their business cycles or structural positions, coupled with a new rules-based fiscal treaty as the solution to the crisis, is simply an ever-tighter ordo by another name.If states have broken the rules, the only possible policy is a diet of strict austerity to bring them back into conformity with the rules, plus automatic sanctions for those who cannot stay within the rules. There are no fallacies of composition, only good and bad policies. And since states, from an ordoliberal viewpoint, cannot be relied upon to provide the necessary austerity because they are prone to capture, we must have rules and an independent monetary authority to ensure that states conform to the ordo imperative; hence, the ECB. Then, and only then, will growth return. In the case of Greece and Italy in 2011, if that meant deposing a few democratically elected governments, then so be it.The most remarkable thing about this ordoliberalization of Europe is how it replicates the same error often attributed to the Anglo-American economies: the insistence that all developing states follow their liberal instruction sheets to get rich, the so-called Washington Consensus approach to development that we shall discuss shortly. The basic objection made by late-developing states, such as the countries of East Asia, to the Washington Consensus/Anglo-American idea “liberalize and then growth follows” was twofold. First, this understanding mistakes the outcomes of growth, stable public finances, low inflation, cost competitiveness, and so on, for the causes of growth. Second, the liberal path to growth only makes sense if you are an early developer, since you have no competitors—pace the United Kingdom in the eighteenth century and the United States in the nineteenth century. Yet in the contemporary world, development is almost always state led.
What made this spending possible was that having adopted the euro, Greece and the other European periphery states (Portugal, Italy, Spain, and Ireland) were effectively endowed with Germany’s credit rating on the assumption that the ECB would back all outstanding debt issued by member states since it was all in the “same” new euro currency. As such, the historically high borrowing costs of these countries fell. Greece’s borrowing costs, for example, fell from 20 percent on a ten-year bond before the introduction of the euro to around 4 percent in 2005, and in the case of Greece in particular, more borrowing was the result.24 Since Greece was able to borrow more easily, money became more plentiful locally, financing both consumption and investment. However, this also raised Greece’s labor costs relative to its Euro Area neighbors; its competitiveness fell, widening its current account deficit—Greece was importing more than it was exporting with the extra cash.
The “German problem” after 1970 became how to keep up with the Germans in terms of efficiency and productivity. One way, as above, was to serially devalue, but that was beginning to hurt. The other way was to tie your currency to the deutsche mark and thereby make your price and inflation rate the same as the Germans, which it turned out would also hurt, but in a different way.The problem with keeping up with the Germans is that German industrial exports have the lowest price elasticities in the world. In plain English, Germany makes really great stuff that everyone wants and will pay more for in comparison to all the alternatives. So when you tie your currency to the deutsche mark, you are making a one-way bet that your industry can be as competitive as the Germans in terms of quality and price. That would be difficult enough if the deutsche mark hadn’t been undervalued for most of the postwar period and both German labor costs and inflation rates were lower than average, but unfortunately for everyone else, they were. That gave the German economy the advantage in producing less-than-great stuff too, thereby undercutting competitors in products lower down, as well as higher up the value-added chain. Add to this contemporary German wages, which have seen real declines over the 2000s, and you have an economy that is extremely hard to keep up with. On the other side of this one-way bet were the financial markets. They looked at less dynamic economies, such as the United Kingdom and Italy, that were tying themselves to the deutsche mark and saw a way to make money.The only way to maintain a currency peg is to either defend it with foreign exchange reserves or deflate your wages and prices to accommodate it. To defend a peg you need lots of foreign currency so that when your currency loses value (as it will if you are trying to keep up with the Germans), you can sell your foreign currency reserves and buy back your own currency to maintain the desired rate. But if the markets can figure out how much foreign currency you have in reserve, they can bet against you, force a devaluation of your currency, and pocket the difference between the peg and the new market value in a short sale.George Soros (and a lot of other hedge funds) famously did this to the European Exchange Rate Mechanism in 1992, blowing the United Kingdom and Italy out of the system. Soros could do this because he knew that there was no way the United Kingdom or Italy could be as competitive as Germany without serious price deflation to increase cost competitiveness, and that there would be only so much deflation and unemployment these countries could take before they either ran out of foreign exchange reserves or lost the next election. Indeed, the European Exchange Rate Mechanism was sometimes referred to as the European “Eternal Recession Mechanism,” such was its deflationary impact. In short, attempts to maintain an anti-inflationary currency peg fail because they are not credible on the following point: you cannot run a gold standard (where the only way to adjust is through internal deflation) in a democracy.