Saving The Euro

Do you want to save the Euro? Well one idea for how to do it has been proposed by University of Missouri-St Louis history professor John Gillingham: reissuing the 12 national currencies that were replaced with just one, while at the same time retaining the euro as a parallel currency that finds its market value in competition to reissued national currencies (podcast here).

This would seem to have the advantage that you can still move round the eurozone and pay for your holidays in one currency while at the same time allowing national governments to run their own – appropriate, tailor made – economic policies. It would also seem, however, to have the rather substantial disadvantage is that it significantly resembles all those proposals for scrip money which were current in Argentina just before the final crash. It would also – depending on the details – seem to fall foul of what is known in the trade as Gresham’s Law: ie bad money will always and inevitably drive out good.

I propose in my book an idea that has considerable circulation within the City and which was at one point on the Treasury agenda in Britain. That is changing the euro, not destroying it, but changing its operating mechanism from being the sole currency in a single economic area to a parallel currency that finds its market value in competition to reissued national currencies. It does two things: first of all I believe that it is technically credible and sensible because it allows the currencies to adjust against one another on a daily basis. It eliminates the life of the major shock that the euro could still face once it becomes apparent that a currency that was designed for a political goal, that is to be a step towards a closer economic and political union has been organised for a country that will never exist.

Now what is interesting about this proposal isn’t the details, but the way it refelcts the fact that such ideas (that the euro isn’t working) are now becoming common currency among thinking economists. As Mathew Lynn points out

You can pick holes in the plan. Whether you really need to resurrect the Belgian franc from the history books is debatable. Spain and Portugal might want to get by with one currency, for example, as might Belgium, the Netherlands and Luxembourg.

Whether this particular proposal is the right one may not matter much in the end. What is important is that people recognize that the euro hasn’t worked as planned, and start talking about how to fix it.

There are only three ways forward. One is to struggle on with a permanently sluggish economy. Another is to wait for a financial crisis, or a bad-tempered exit (probably by Italy). The third is to preserve what is good about the euro, while repairing the parts that don’t work.

Wolfgang Munchau, who certainly isn’t associated with this proposal in any way shape or form, also has a piece in the FT today, and he does correctly identify the twin poles which make the balanced conduct of eurozone monetary policy virtually impossible: Germany’s growth crisis and the Spanish housing bubble:

The European Central Bank no longer keeps us guessing about the timing of its interest rate decisions. Jean-Claude Trichet, its president, last week gave a strong hint that the ECB’s governing board will raise the short-term interest rate on Thursday. The ECB has also encouraged markets to expect at least one further rate rise later this year.

But what then? In deciding the future course of monetary policy, European central bankers are confronted with two interesting questions: what to make of the German economic recovery, and whether to prick the housing bubble that has built up in some parts of the eurozone. As far as I can tell there is no broad consensus within the ECB’s governing council on either issue yet.

Listening to John Gillingham it isn’t clear to me that his agenda is exactly the same one the Open Europe group have. Gillingham’s view seems to be summarised in this exract:

The EU does some things well. For example by acting as a trade negotiator for all member states. Secondly by enforcing competition laws within the community which is essential to prevent a lapse into protectionism. To be able to enforce common rules and standards, not micro manage, and we saw a very destructive failure in this case with Botstein’s attempts to develop a financial services action plan.

Is there a common denominator of European nationhood? No it doesn’t exist yet. The idea that you can stand people on a mountain and say “Mozart belongs to all of us”- what it really means is that Mozart belongs to Brussels. God forbid!

This cultural identity of Europe is no place to begin. For example trying to define the European Social model. Is that the Italian social model or the Danish Social Model or something in between? It is very difficult to define this.

What will make the EU work is demonstrating over a long period of time say, ten years, the superiority of an open to a closed system. It will take that kind of thing to bring about change.

This does seem to be a valid point of view. Certainly we cannot abolish our national identities by pure fiat, their dismantling needs to be a process, and a comparatively long one. The big divide is between those who see the need to proceed with the demoltion works, and those who don’t. But even assuming that at some stage there was a consensus that they have to go we have to start somewhere, so why not now?. The real hot potatoe, and it gives us a connundrum that Gilllingham is obviously trying to address is ‘what to do with the euro in the meantime’?

The Open Europe collective, on the oether hand, seem more than happy to accept what we have, a Europe of Peoples. They seem to rule out the longer term project ‘tout court’. I myself question this whole ‘inviolability of peoples’ assumption, its adequacy and its validity in a globalised and rapidly changing world. Open Europe are however basically right in drawing the conclusion that a Europe based on nation state nationalism is incompatable with the euro. But once we arrive at this recognition there would seem to be two main alternatives which open up: abolish the nationalism, or abolish the euro. The choice gentle readers is yours. (Incidentally this recent thread and this one are highly relevant to interpreting what I am trying to say in this post. In particular since Gllingham is arguing explicitly for a weakening of the Commission, and I am arguing for its re-inforcement).

41 thoughts on “Saving The Euro

  1. Edward, if you mean for the euro, I’d prefer to keep it as it is – with flaws – than to reintroduce national currencies.

  2. “abolish the nationalism, or abolish the euro”

    Abolishing the nationalism, in my uninformed opinion, would be nearly impossible. There simply is too much insecurity right now and people need to feel they belong to a place they can identify with. Of course, I am speaking from the vox populi point of view. That place, right now, is not Europe as a whole.

    To abolish the euro would amount to admitting the defeat of the European project (first the constitution, now the euro). I believe for many people the euro is the only tangible element of European unification, something 12 member states at least have in common. The euro may not be popular because it is thought to have made life more expensive, but for holiday makers and small internet trade it is a real boon.

    I believe abolishing the euro would lead to more popular (as in vox populi) nationalism and it would reinforce the position of virulent euroscepticism.

    Now, I do know that the vox populi only accounts for so much when it comes to decision making, but it is a factor to consider if you want to sell the EU.

    What we need is one ‘huge’ and tangible/observable success that will prove the EU’s worth. Again, from the vox populi point of view. *insert economic happy happy joy joy Hollywood scenario*

    Another article/link that may be of interest and more relevant to Edward’s post: http://www.findarticles.com/p/articles/mi_qa3724/is_200507/ai_n14902842

    One quote:What all this may imply for the future of Europe’s single currency, or indeed of Europe, is for others to debate. We at Negroni Finance will remain open to expressions of interest. It is not for us to impose political solutions, but we are free to respond to market forces. From that point of view, we might argue that the decision, carried out six years ago, to abolish Europe’s biggest market – the market in currencies – was premature. It introduced a new rigidity into the member countries’ economies when they were quite inflexible enough already. Their subsequent performance tells its own story, and if that story has a moral, it ought to be familiar: ministers may propose but markets dispose.The sentence in bold is very revealing, methinks, in that it suggests that politicians have a relatively small role to play in all this.

  3. Guy, re. ‘perceived inflation’: there’s been a lot of talk about this, but our stats office tells us it really is only ‘perceived’ and not real. So does the ECB, if I understand them correctly.

    Or are they cooking the books?

    Personally, I’m pleased with the euro. It does make a difference not wasting money for exchange costs; I’m pleased I can trade in the same currency as our major partners; and I’m pleased I can compare prices across the market.

    So others may differ, but I’m not won over by Gillingham’s argument. To me it would mean a big step back.

  4. For “reissuing the 12 national currencies”, perhaps read “reissuing the lira”? I would be astonished if the Germans, say, opted to quit: the obvious motive for doing so would be to devalue, and they ain’t much for competitive devaluation.

  5. Before going in to the points raised, I’d like to make a couple of comments on Gillingham’s actual arguments on the podcast, which I think is worth listening to. As I say, I don’t agree with how he sees the Commission at all, and in a way you may be right Hirvi, that this is a typical Anglo Saxon mindset about the Commission, and one I don’t share. OTOH he is attempting to present a coherent argument, and as such this helps open up rational debate, and this is what I think we need at this stage.

    If you listen to the Open Sources set (and for me their very voices were a big giveaway, they were – almost to a man, there were no women – English nationalists. In this sense they were not very representative of British views in general. And they were like the ‘usual suspects’, they weren’t especially interested in addressing what is going to be a very grave crisis, they were simply interested, like their equivalents on the other side of the fence, in scoring points. I think they are actually completely oblivious themselves to the scale of all this.

    If the geyser blows in Italy or Spain, then the shock waves in London, New York or Tokyo will be extremey important. I don’t think they have grasped the significance of financial globalisation (but then, little englanders wouldn’t, would they) or the importance in this system of the eurobond market, which would, of course, be thrown into chaos.

    Now where I think Gillingham makes important points is on Russia and on the future of Italy after the elections.

    The first case is interesting, since I think that. yes, he does have a cold war mindset. But leaving that on one side, the Russian problem is a big one, Russia is not a democracy, isn’t likely to become one any time soon, and extremely large quantities of money and power are in the hands of a very few people, a few people who we can rest assured, don’t have our best interests at heart. On top of all of this, Russia is facing demographic melt-down and this will be highly problematic for all of us.

    On Eastern Europe, btw, he is completely in the wrong ballpark. These will not remain paragons of the free market economy. They are still quite poor, and the demographics dictate that they won’t be getting very rich anytime soon. They will need active support, financial and otherwise, from the richer states in shouldering the burden. I always knew this was going to be the case, and indeed not leaving them to shoulder all this on their own was one of the reasons I was enthusiastic that they join us. I simply think there are limits to what you can do, and I doubt we will be able to render much assistance to Russia: she will have to venture into the unknown alone.

    Now Italy. Here I absolutely agree with Gillingham. Whichever government wins this situation won’t be resolved. If Berlusconi wins, then the Italian government will push and push until the thing bursts.

    If Prodi wins they will try and comply with the requirements of the Commission, but doing so will probably mean negative growth and deflation, this will not be at all popular, and at some point or another the government could well fall fall, and this will be when Italy will come hurtling out of the euro. I am reminded of the well meaning, but foolish, De La Rua in Argentina.

    My only real question is which will happen first, Spain’s housing bubble breaking, or Italy being forced out. Whichever happens first the other will be produced as a domino effect.

    Ok, they were supposed to be a few brief points :).

  6. “Abolishing the nationalism, in my uninformed opinion, would be nearly impossible.”

    “To abolish the euro would amount to admitting the defeat of the European project (first the constitution, now the euro).”

    Well, I present two alternatives, and neither of them seem to be exactly doable. The thing is nationalism is not only not being abolished, it is growing. So we are left with the euro. This we don’t need to abolish, one of these fine days it will explode round our heads. All we have to do is do nothing and wait.

    This kind of quietism doesn’t appeal to me somehow.

    “What we need is one ‘huge’ and tangible/observable success that will prove the EU’s worth.”

    Well that was plausible just after the referendum votes, but nearly a year has gone by and things are worse by the day. I’m afraid I’m not convinced that this will happen.

    So I suppose I am now resigned to seeing what is going to happen happen, and start now thinking about a strategy to try and rescue victory from the jaws of defeat after the walls of Jerusalem come crashing down. That is why I am looking at the coalition of the willing idea. How to go about putting the pieces back together again. You may not like the world as it is, but it won’t go away just because you don’t like it.

    “Personally, I’m pleased with the euro.”

    Hirvi, I understand what you are trying to say, but I fear we are now past that stage.

  7. “I would be astonished if the Germans, say, opted to quit:”

    Of course, Alex. So would I. But when a snowball starts to roll, who knows where it will stop. The issue will be capital flight from Italy. A large quantity of this will move from Italy to Germany, and in a verys short space of time. So who honours the euros if the Bank of Italy refuses to?

    Try this link:

    http://www.law.harvard.edu/programs/pifs/pdfs/scott_euro.pdf

    This is going to be far more complicated than most people are imagining, even in their wildest dreams.

  8. I would be astonished if the Germans, say, opted to quit: the obvious motive for doing so would be to devalue, and they ain’t much for competitive devaluation.

    If Italy goes, the average desirable interest rate goes up and the benefit of a laregr trading area goes down.

  9. Edward, good points, but I don’t share your pessimism to the same degree.

    For example, the Spanish housing ‘bubble’ may pop, but that means house prices go down to where they ought to be, and not disaster for everyone. Sure, some will suffer, but at the end they at least get affordable homes – so there is a silver lining.

    (Not trying to downplay this, but it doesn’t have to be the catastrophe it may appear at first sight).

    And Italy? You seem to suggest they might default at some point, but I don’t think they will. You remember when they were struggling to qualify for euro-membership? – then they invented a special euro-tax to ‘solve’ the problem, and it worked at the time. Why couldn’t they do the same again, or try something different? Italians can be very creative people.

    (Btw, your Harvard link is 8 years old. I’m not saying this invalidates it, but it is nevertheless a highly theoretical text from days before the euro was introduced).

    Also good points about Russia, but it’s a reality we have to live with, and it won’t go away. We made an insurance policy, in the form of a new atomic power station, but it only makes us less dependent, not independent.

    For the rest we will adapt – that’s flexible, isn’t it?

  10. “the Open Sources”

    I’d never heard of them, so after reading the speech, I clicked on the links for “Board” and “Supporters”.

    I’m glad you think they aren’t representative.

  11. “…a highly theoretical text from DAYS before the euro was introduced”

    Apologies – I meant YEARS.

  12. Yeah right, run two currencies in parallel. Just to make everything even more complicated and increase transaction costs?

    Apart from that I’m getting a bit bored with all this “The Euro is a failure” stuff. If the Euro is a failure based on the usual arguments (not flexible enough because different areas/countries need different rates etc pp), then the Dollar or the Pound are exactly the same failure. Or are you still telling me that the economic conditions in every single state in the US are the same? Or that booming South East England is in the same situation as the struggling north?

    Or the oh so slow European growth: Yes, it’s slower, but a lot of the numbers are debatable. Let alone the question if GDP is really an effective measure.

    Also, looking at the OpenEurope Board, strangely enough a lot of the people are also on the Business for Sterling list, part of the No Euro campaign. Coincidence? I doubt it.

  13. The Scott paper describes “a significant chance that the euro will break up” as “greater than one in ten”, which I take to mean a roughly 90 percent chance that the causes he looks at will not cause a breakup. If this were a business decision, I’d go with the 90 percent every day of the week and twice on Sunday. If it were a life-or-death choice, I’d take out a little insurance and still go with the 90 percent.

    I wonder, Edward, if either here or in another post, you could walk through what you think happens after Spain and/or Italy leaves the euro zone. I still don’t think either likely, but I think the exercise would be worth doing because it is exactly there that things get interesting.

    The international financial system has taken a lot of stress at one time or another (make your own list from, say, the mid-80s Latin America crises forward), and if the argument is that this would be the straw that breaks the camel’s back, it’s important to be specific about why. The EU survives with a number of significant economies outside the euro zone. If an I/ES departure were to change that, it’s important to argue why and how. Domestically, too, unwinding the euro is where the decisions get very difficult. But decisions of some sort do get made — witness Argentina’s recent history — and things go forward. Those are all reasons I think it would be good to have at least a Gedankenexperiment of what happens if and when I/ES try to make their way out of the common currency.

  14. was at one point on the Treasury agenda in Britain …

    … says Gillingham. If that is intended to add credibility, a bit of context dispels it. It was a John Major initiative, which I believe they christened the “hard Ecu”, and needs to be understood as part of the slow-motion car crash of Tory disintegration over Europe.

    The attempts at monetarism of the early Thatcher period had given way to an unacknowledged shadowing of the Deutschmark. A furious debate was underway regarding whether to formalise this by joining the Exchange Rate Mechanism. Major’s predecessor as finance minister had resigned, largely because of this. So poisonous was the row that – in large part as a result – Mrs Thatcher was forced to resign less than six months later. The “hard Ecu” was hatched by Major as a means to ensure the ERM would not evolve into a single currency, and so make it more palatable. It failed. Britain joined the ERM. The single currency was agreed at Maastricht (Major suggested it be called the “florin”). Britain then left the ERM, at speed, upside down.

    The hard Ecu joins a list of great Major initiatives that included “safe areas” in Bosnia, the “Beef War” over BSE, and the setting up of a special hotline for people to call if they were upset by the number of plastic cones on the motorway.

  15. “For example, the Spanish housing ‘bubble’ may pop, but that means house prices go down to where they ought to be, and not disaster for everyone.”

    Ok. Let’s dig a little deeper. The issue here is that this is a complex problem, and there are many inteconnected pieces.

    The first point is this:

    “house prices go down to where they ought to be”

    But where is this? No-one (not even Edward 🙂 ) really knows. Bank of Spain governor Caruana says that they are 30% overvalued, but this is just an educated guess. He doesn’t really know.

    But lets assume (since we have to assume something) that he is right. Does this mean that prices will fall 30%. Well not necessarily. I may be wrong, and we may not have a bubble (although I would give this, say, a 75% probability, given that things really got going when the internet bubble crashed, and the money went over from the stock market into housing, this is pretty classic, he says, mentioning Japan for the first time).

    If we have a bubble, then things *will* overshoot, so we may be talking about an intial panic drop of say 40%.

    But this isn’t the important point. What then happens to prices is what matters. They may well *not* recover. This would be the killer app.

    You need to look at this link from the Economist:

    http://www.economist.com/surveys/displaystory.cfm?story_id=1794873

    and this one:

    http://www.economist.com/finance/displayStory.cfm?story_id=4079027

    and note what has been hapening to prices in Germany and Japan over the last decade.

    Why do I think Spain will be like this? Essentially one word descibes the situation: demography. Spain has (without the immigration, which is itself tied to the housing boom, more loops within loops) the most rapidly ageing society on the planet.

    So my guess is that prices will fall dramatically, and not recover. The psychological shock will be enormous. People are just not prepared for this. You have to think about ‘animal spirits’ here.

    So we could see a phenomenon called Irving Fisher type debt deflation. This would be pretty serious.

    Try this piece from Paul Krugman on 09/11.

    http://www.pkarchive.org/economy/FearEconomy.html

    Basically a huge chunk of Spain’s private retirement savings have gone into housing, and at the same time all the young peple are in debt up to (and over) their heads, with 40 year mortgages now becoming the norm. If prices don’t resurrect then these mortagages are going to become unsustainable.

    For all these reasons I think the Spanish housing bubble when it finally crashes will be very big beer.

  16. “The Scott paper describes “a significant chance that the euro will break up” as “greater than one in ten”

    I want to emphasise that I am only really recommending the Scott paper for the technical details it provides. He is a legal expert in banking institutions, not an economist, so I would read him for the structural not the economic side.

    He is very revealing though for his explanation of what happens at the Deutsche Bank if Italy has to leave due to capital flight.

    Today’s FT has this relevant article:

    http://news.ft.com/cms/s/f4ccc4fe-a7d8-11da-85bc-0000779e2340.html

    Tucked away at the bottom is this little gem.

    Since the beginning of this decade, M3, the broad measure of money supply, has been expanding at an annual rate faster than the 4.5 per cent reference rate that the central bank regards as consistent with medium-term price stability. In January, M3 growth rose to 7.6 per cent, from 7.3 per cent in December.

    However, the signals sent by money supply data are less clear than the lending figures. Julian Callow, economist at Barclays Capital, said that growth in deposits held by households had been modest, and that much of the acceleration in M3 was the result of the rapid expansion in the number of €500 notes in circulation.

    Put in plain English, someone somewhere is moving money. Where? Why? We don’t know. And changes in the interest rate are going to be driven by this apparently.

    “I wonder, Edward, if either here or in another post, you could walk through what you think happens after Spain and/or Italy leaves the euro zone. I still don’t think either likely..”

    I’m afraid I regard one or other of these as being now absolutely inevitable. But looking into how the Eu and the eurozone will look after it happens is impossible now. This will only become clearer during the transition. How the various players react will be one of the configuring dimensions. I think this is a process, it just moved on with the arrival of ‘neo-protectionism’, and the Italian elections will be the next hurdle.

    Lets take this one day at a time.

  17. “If that is intended to add credibility, a bit of context dispels it. It was a John Major initiative, which I believe they christened the “hard Ecu”,”

    Thanks for this Bert. I think it is a bit of contextualisation which helps us understand. This talk that ‘some bankers favoured…’ struck me a bit of slipping something in under the blanket. As I say, what they are talking about is re-introducing currencies as a form of scrip money. The proposal is worth noting though, since I think we may se an attempt at some version or other of scrip money in Italy at some stage, even if this is only in the form of govt backed IOUs to pay teachers, hospital workers etc when the governemnt is forced to cut back.

  18. the rapid expansion in the number of €500 notes in circulation.

    I seem to remember this was a possibility a few people mentioned back at the euro-beginning – that the global criminal fraternity would light on the euro as their new favourite currency *because* a €500 note is worth considerably more than the biggest $ note – hence large sums of cash are easier to handle in €s.

  19. “You need to look at this link from the Economist”

    Edward, thanks.

    However, I see the problem as more limited in scope.

    Why? Because individual Spaniards will only suffer if they can’t afford to service their debt. Since most of them live in their own homes, how many of them would be so irresponsible as to buy a house they can’t afford?

    (I admit, my thoughts are culture-bound, and I can’t imagine speculating, then extracting equity like the Americans seem to – for me, a home is to live in, and most people can only afford one).

    Anyway, so far as I can see the losers would mainly be speculators (including many foreigners), institutional investors, and unfortunately the construction industry.

    Ok, that’s bad news, but is it really enough to send Spain out of the euro?

  20. “I seem to remember this was a possibility a few people mentioned back at the euro-beginning – that the global criminal fraternity would light on the euro as their new favourite currency *because* a €500 note is worth considerably more than the biggest $ note – hence large sums of cash are easier to handle in €s”

    Alex, a €500 note is only the same value of an old DM 1.000 note, and there were plenty of those around. So the €uro offers criminals no more opportunities than the DM did (except that there are more €uros on the market than there were DM).

  21. ..although perhaps more liquid.

    Mind you, that does put a new light on the considerable quantities of DM that never returned at the changeover.

  22. Alex, a lot of the old DM will have been kept by households. The Bundesbank will always exchange old notes.

    Were many DM 1.000 notes not collected?

    Off topic somewhat: I was in Germany in summer 2001, and received two counterfeit DM 100 notes in one week!

  23. Why? Because individual Spaniards will only suffer if they can’t afford to service their debt. Since most of them live in their own homes, how many of them would be so irresponsible as to buy a house they can’t afford?

    If you have to move, you have to sell at a large loss. And if you are a construction worker, you will also suffer. And if jobs become scarcer, chances that you have to move grow. And here we go.

  24. Oliver, I don’t know how long this continues, but in Spain rents are below par against house prices. So if one had to move, why would one sell and not rent out at home and rent in elsewhere? They might not have to take the loss.

    Does this mean the country sinks?

    I’m not so pessimistic. I remember reading goggle-eyed at stats that showed growth, but unemployment of 20% or so – at the time I figured that was official unemployment, but this didn’t tell the whole story. Was I wrong?

  25. Here’s an honest counterfactual for y’all to comment upon.

    Spain could, if the central bank wanted to, stop the housing bubble. After all, the Spanish central bank controls banking regulation. There have been some noises in this direction, but by-and-large nothing has been done.

    Nothing has been done because, as other posters have mentioned, there are good reasons not to go around popping asset price bubbles. Assuming, of course, that Spain has a housing bubble, what with the huge net immigration rate and all.

    In that case, why do we assume that an independent Spanish monetary policy would be much tighter? Inflation is certainly within historical norms for that country.

    It seems to me that the real problem with the euro, inasmuch as there is one, is that monetary policy is too tight for Germany.

    Of course, I very well could be wrong.

  26. If you drive people abroad to get their loans, you will reduce domestic business and make the worst case worse. That debt has to be serviced in foreign currency. You can’t inflate and devaluation gets harder.

    So if one had to move, why would one sell and not rent out at home and rent in elsewhere?

    Who would pay current rents? Especially if immigration is cut by unemployment.

  27. “Since most of them live in their own homes,”

    I think as you rightly say your perceptions are a little culture specific. The majority of the people of my age I know here in Barcelona own two or three. I met a girl of 30 this morning – no children – but she has four houses, that her boyfriend has rebuilt.

    And we aren’t talking about especially rich people here, normal middle class Spaniards and Catalans. People collect houses like they collect ‘cromos’ (football cards). Who needs all thes houses? Good question. Ex-immigration the population is projected to fall steadily.

    On immigration, this is relevant:

    http://fistfulofeuros.net/archives/002335.php

    Also Spain’s inflation is not what one could consider normal, it has been over the ECB rate of interest for several years now, meaning that the money has simply fowed out of bank savings into housing debt (privaet savings are now, like in the US, very low indeed).

  28. “Spain could, if the central bank wanted to, stop the housing bubble. After all, the Spanish central bank controls banking regulation. There have been some noises in this direction, but by-and-large nothing has been done.”

    Oh, I absolutely agree, but that would be a move back to bank and credit regulation, and the whole mentality has been in the opposite direction. You might also have to control cross border capital flows, as banks elsewhere in the eurozone might want to ‘soak up the slack’.

    Obviously all this would be another form of dint in the euro, which is posited on the idea that the respective economies are converging and that this kind of thing isn’t necessary.

    “Nothing has been done because, as other posters have mentioned, there are good reasons not to go around popping asset price bubbles.”

    Of course, this is an issue. The trick is not to let the bubbles develop in the first place.

    “Assuming, of course, that Spain has a housing bubble, what with the huge net immigration rate and all.”

    On immigration see the ‘hot labour’ post linked above:

    http://fistfulofeuros.net/archives/002335.php

    The Spanish construction industry has become a huge turbine, sucking in capital *and* labour. The danger is that when it bursts you get both capital and labour flight.

    “It seems to me that the real problem with the euro, inasmuch as there is one, is that monetary policy is too tight for Germany.”

    Obviously I agree with this, but it is, shall we say, ‘another country’.

  29. How serious are the problems in Spain, Italy and Germany? Are they more serious than those of the rustbelt in the US or of the North/South and oil/manufacturing economy divides in the UK that get blamed for the death of manufacturing?

    Italy clearly has real problems but is it plausible that they would be relieved by exiting the euro? The exit would surely be painful and without other barriers the controllers of the new lira might find less room to manouvre and less influence than is presumed. Surely the right thing for Italy is to sort out its property market and grasp its destiny as the Florida of Europe.

    The €500 note is surely a step towards US style levels of seignorage benefits and it seems that the ECB has already failed to make a knee jerk response to the M3 figure.

  30. “How serious are the problems in Spain, Italy and Germany? Are they more serious than those of the rustbelt in the US”

    Frankly I don’t think this is a useful comparison. The rust belt is, well, rusting. But it is only one part, a declining part, of a more or less vibrant US economy. Italy and Germany are in some sort of decline, period. Spain is booming, but too much so, this is a different problem, at least at the moment it is.

  31. “I met a girl of 30 this morning – no children – but she has four houses, that her boyfriend has rebuilt”

    Edward, I realise you probably didn’t ask, but did she get those on borrowed money? If so, it’s a good job rates are low (for now). Wandering around German property sites, it seems many mortgages in Spain are variable rate. (And approx. 1,5 million dwellings in Spain are empty, 20% in some places).

    But you may have asked is she was worried about the bubble. If so, what did she say?

  32. “Edward, I realise you probably didn’t ask, but did she get those on borrowed money? ”

    Well this is getting very anecdotal, but sometimes anecdotes are revealing.

    Ms x is 30 ish, a biology graduate, works for a big pharmaceutical company, hates it, would love to live in the country and do something ‘different’ (really the houses, she thinks, are her ticket ‘out’ at some stage). She has no children, and spends significant time looking after her elderly father who lives alone.

    She could be, in this sense, Ms España, since this profile (apart from all the houses) is very typical. Normally people of her age have one property, but with the mortgage being the biggest one they can possibly get. The relation of all this with Spain’s continuing ‘lowest-low’ fertility would be the subject of another post.

    “but did she get those on borrowed money?”

    The answer would be yes, but one at a time, increasing the mortgage with each new acquisition. Let me explain. In this case her boyfriend (I think he works in IT) is fairly useful ‘on the tools’, and the two of them enjoy nothing more than buying a semi ruin in some charming spot in the country, and restoring it bit by bit.

    In a way, all of this is relatively harmless, and they enjoy themselves, so fine you would think. The only problem I see in a case like this is if they ever want to sell. I mean, who needs all these houses? As I keep pointing out Spain’s population is in long term decline. The immigration, as I am indicating is highly volatile and unstable, I see all these faces in the Barcelona metro every day, nothing is more obvious to me.

    Most of the immigrants are working in ‘fragile’ situations, and the first serious downturn will give many of them big difficulties making ends meet. Some will undoubtedly stay long term, but only some.

    Now back to Ms ‘x’. She has been borrowing money, and has some kind of flexible debt plan distributed over the properties and she draws down the money as she needs to spend it. So one day, if she has to pay a realistic rate of interest (by realitistic I mean what the Spanish economy can itself support) she will feel it.

    I could cite the case of one of my best friends. He has three homes. The first is a fairly modest flat in Barcelona. What you need to realise is that as property values have risen steadily the capital values of the mortgages (again also thanks to Spain’s oversize inflation rate) has continually reduced in real terms. So when the debt on the main home was under control he bought a small ruin in the country (late 80s) and, since he also is quite ‘handy’ and enjoys it, he did all of this on a low cost basis. Again, nothing bad here. They use their country home and enjoy it.

    But then in the late 90s he fell into the trap. He bought a third one. Again, the house itself wasn’t expensive, since it was in a small village, near the Costa Brava, but this one he didn’t really need. He bought it as an investment. His idea was to modernise the thing, rent it out to tourists, and one day to sell to pay for his retirement. The works have cost more than he imagined (this is a typical feature of the ‘boom’, anything to do with construction has now become much more expensive), and he is now leveraged as high as he can go.

    This is not an uncommon case. Every one who thinks about the problem seriously knows that Spanish state pensions have an uncertain future. This is one of the ‘pragmatic’ reasons why so much immigration is accepted so esily. He is in his early fiftees, he and his wife hate their jobs, and they would love nothing more than to take early retirement, but now I think this is going to be difficult.

    Really I have stopped talking with him about all this long ago, it only used to depress him. He is quite heartened by the seeming ‘recovery’ in Japan. I think if Japan’s recovery turns out one more time not to be sustainable this will have an important impact on a lot of people here in Europe.

    Now here’s another example (I could go on and on). A girl in her late 20s. She is a colleague of Ms x and is expecting her first child. She and her partner have decided that they are undercapitalised, and want to sell their Barcelona home to go and live in a much more expensive property outside the city. The thing is, she has paid a deposit on the new home, but has to wait a year before it is built and she can sell her existing one. She thinks there is no risk here, since she imagines that the value of her existing property will simply rise and rise. If, however, the boom were to end before she sells, she would be caught in the most vicious of vicious traps.

    One last case. Someone I know who knows something of economics. He is Basque, and has money. He sometimes writes economic comment for the newspaper El Pais. He had three flats in Barcelona, but when he realised that nothing is forever, and that at some stage all this might blow, he sold them all (about a year ago) and went off and bought some property in Peru. He is more or less looking to the future with confidence.

    “it seems many mortgages in Spain are variable rate.”

    Oh yes, nearly all of them are.

    I’m sorry if I have gone on at length, but maybe these examples can give you a bit better insight in to what is really happening here. The key point is that many people are now ‘uneasy’ about the situation, but few can contemplate the possibility that prices could come down and stay down. In Spain, after all, prices only go up and up, don’t they?

  33. Is this more serious than the UK London property boom of the 80s or 90s or the US coastal property bubble at the moment? Would action to suppress it hurt Extramadura? Would that action be taken?

    Is it really the severity of the booms and busts that is calling the euro into question or the range of perceived potential solutions. So withdrawal from the euro is seen as a solution where currency secession for Michigan is not while unemployed Germans are not be geared up to go build things on the Costa Brava and Italians are not yet ready to reform their property markets.

  34. Edward, thanks for that. Knowing people who are in the situation must make a difference.

    “…few can contemplate the possibility that prices could come down and stay down. In Spain, after all, prices only go up and up, don’t they?”

    That’s exactly what I’ve read (about what people don’t contemplate). Unlike yours, my information is only second hand, but the word seems to be that Spanish people have “great faith” in property, they won’t sell for less than the price they want, and really believe they’ll get it – sooner or later. Hmmm… does this work?

    Others commented that “prices are moving sideways”, which I think means they aren’t moving at all.

    How would you comment on this?

  35. What Edward describes is a variant of developments that can be observed in some parts of the U.S.
    Except that Edward can´t accept that similar situations are similar. For him, “Italy and Germany are in some sort of decline, period.” The rustbelt, however, is obviously going to recover. How and why? He doesn´t tell. It just has to be that way because it´s a premise rather than a conclusion. And the sight of Spaniards behaving like Californians appears to instil fears that I just don´t understand. If there is a systemic danger, then it pertains equally to the two transatlantic economic blocs (yes, it´s very much possible to describe the U.S. as being economically as diverse as Europe without deviating into fantasy).
    For Europe, the ensuing crises would translate into the growth of new institutional structures -a process likely to be as difficult as Roosevelt´s New Deal. For the U.S., the answer is not for me to give – one answer I´d like to draw attention to is Nobelist Fogel´s prediction of a new era of puritanist reformism (That is the kind of vision that rings a bell with most educated Europeans´ view of the U.S., I guess. I´m just not too sure that it still reflects current reality.)

  36. In the US there is a hope houses will eventually be filled, as the population is rising. If houses are filled there is a transfer of wealth. If they decay you’ve thrown away a lot of the national savings.

  37. On second thought, for reasons of demography, don’t we want housing prices to crash and remain down?

  38. Nice to see how Oliver´s two-part comment demonstrates what´s wrong with Edward´s thinking. There aren´t enough second thoughts incorporated into Edward´s pronouncements. The fact that the global economy is highly interdependent doesn´t mean that business cyles have become automagically synchronous. Edward doesn´t have a sense of the economic time zones that characterize the global economic landscape. Which is odd, since he seems to admire Schumpeter – and one of Schumpeter´s real merits is that he recognized the genius of Nikolai Kondratieff. Let´s hope that Edward can retrain his imagination to take the long view – rather than indulging in breathless prognostications of a permanent extension of the Kondratieff winter in some parts of the world, while on the other hand proclaiming that the Kondratieff summer in other parts of the world will never end.
    (Obviously there are other seasons as well. I do not intend to imply that cycle analysis is easy. The quest for simplicity is what leads Edward astray. I´m not about to claim that other theoretical perspectives provide simpler explanations, make for “more interesting reading” or score higher in the ubiquitous intellectual beauty contests. They do fit the facts more closely, though.)

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