The Financial Guns of August
Is it too late to stop Europe's impending economic disaster?
Among the great and tragic questions of modern history, one of the most important is: How did the assassination of an Austrian prince turn into the conflagration of World War I, a disaster that in turn produced Nazism and Soviet communism, and which swept away most of the states that went to war in 1914? The answer, in part, is both simple and shocking. Following the rise of railways and the growth of mass armies, European countries had developed systems of military mobilization that, once set in motion, could not be reversed. As a result, they stumbled into war before they even realized they had passed the point of no return.
The conditions for an even greater disaster existed during the Cold War, when the doctrine of mutually assured destruction (with the appropriate acronym MAD) meant that any confrontation between the superpowers ran the risk of wiping out the entire human race. The United States and the Soviet Union built up systems that in effect were automatic doomsday switches, guaranteeing that a nuclear exchange, once started, could not be halted.
We escaped that disaster and now tend to imagine that the system worked as a force for stability. Arguably, though, this was a matter of good luck rather than good sense. With different people in charge, or a slightly different course of events, the Cuban missile crisis could easily have ended in all-out nuclear war, as could the Hungarian crisis of 1956 and the Yom Kippur War of 1973.
The problem is that systems built on deterrence and automatic responses work well much of the time, but when they fail, can lead rapidly to catastrophe. In a crisis, everyone tends to assume that it is up to someone else to avert disaster.
Europe’s current economic crisis seems to be headed in the same direction. All of the main parties are set on autopilot, and each seems to expect someone else to fix the problem.
The Greek political system is clearly incapable of implementing further austerity, and yet there is essentially zero support in Greece for an orderly exit from the eurozone, even if such a thing were possible. The only way an exit can occur is if the so-called troika consisting of the European Commission, the International Monetary Fund, and the European Central Bank (ECB) enforces it by provoking a banking crisis in Greece. Such an action would be the economic equivalent of a mobilization order.
Meanwhile, the central European institutions are making noises about preparations for a Greek exit, as if such an outcome will be the automatic result of any Greek refusal to continue the failed policies of austerity. Such saber rattling allows them to avoid thinking about any effective alternative to further growth-killing budget cuts.
The obvious alternative, a shift to fiscal expansion, faces two major obstacles, one of which has been the subject of much comment, while the other has been largely ignored. The clear obstacle is the unwillingness of German voters to pay more taxes that, in their view, will be used for the benefit of profligate Southern Europeans. The reality, that the primary beneficiaries of the bailouts have been German and French banks, is almost never mentioned.
The much bigger problem is that because European governments cannot print their own money, any fiscal expansion must be financed by debt, and any increase in public debt is likely to produce a new crisis. The proposal for a shift to Eurobonds, backed collectively by European governments, would spread the pain but not resolve the problem.
In Europe, as in the United States, the problem underlying the crisis was an excessive buildup of debt, partly public, but mostly private. The rub is that whereas the United States was able to resolve the most critical problems through quantitative easing (large-scale purchases of public debt by the U.S. Federal Reserve), this option has been closed off in Europe because the ECB refuses to buy government bonds and remains fixated on controlling inflation.
In retrospect, the ECB’s creation looks like a repetition of the systems of military mobilization built up before 1914, or of the doomsday switches built into the MAD system. The ECB’s design reflected the policy preoccupations of the 1990s, most notably the belief that low inflation would ensure macroeconomic instability, and fears that a common currency would encourage national profligacy. These preoccupations produced an institution carefully insulated from any kind of democratic control and explicitly precluded from any action that could sustain fiscal stimulus. As long as the ECB remains on its current course, disaster is inevitable.
But even in 1914, there were a few weeks between the assassination of Archduke Franz Ferdinand in June and the general mobilization at the end of July, during which determined action could have prevented war. The time is similarly short today, and there are few signs of hope. But there is still time for European leaders to act to save themselves.