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The European Union may not survive the euro

By Marshall Auerback

This post first appeared on Truthdig

The euro is “celebrating” its 20th anniversary this month, but they aren’t popping corks across the continent. Except, perhaps, with the notable exception of delusional Eurocrats such as Jean-Claude Juncker, president of the European Commission, who argued: “The euro has become a symbol of unity, sovereignty and stability. It has delivered prosperity and protection to our citizens…”

Some prosperity!

Much of the continent is characterized by double-digit unemployment, rising inequality, political strife, and a virtual lost generation of youth, who have never experienced anything remotely approaching a robust, ebullient economy. Greed-based integration is giving the EU a bad name.

The worst thing about the Eurozone as a whole is the currency union itself. The euro reinforces structural inequalities between member states as well as between social groups within countries. It is also worth recalling that its creation was supposed to be an intermediate step toward the inevitable formation of a “United States of Europe” of a supranational fiscal authority—i.e., a federal union in which a central government for the whole of Europe becomes responsible for the economic stabilization and income redistribution for the whole of the EU, while the allocation of resources is left in the hands of the nation state governments. That is clearly a long ways away, given existing political tensions between the creditor nations of the Germanic north and the debtor southern periphery nations.

To quote Abraham Lincoln, “A house divided against itself cannot stand.” Nor can a currency union minus a real fiscal authority to go with it. Since the latter seems politically impossible against a backdrop of Brexit, yellow vest protests in France, and a governing coalition in Italy that openly toys with abandoning the euro, a more likely outcome is the breakup of the currency union. Or a model of integration that isn’t simultaneously an enrichment program for the investor class.

In an ideal world, the euro’s end would come via coordinated action: reintroducing national currencies and immediately requiring all tax and other public contractual obligations within the nation to be denominated in that currency so as to create immediate demand for those currencies. Much more likely, however, is that the dissolution will occur via disruptive crisis.

That the euro has survived for 20 years is not a sign that we are moving closer to the day of “an ever closer union”: the longstanding aspiration of the fathers of the modern-day European Union (originally started as the six-nation European Coal and Steel Community). Rather, it is a sign of democratic subversion, a technocracy run amok that has survived by depriving elected national parliaments of control over fiscal policy: taxation, spending, and the core economic policies of the nation state. The euro has been both the method and the cause of this democratic disenfranchisement, by design, not by accident.

How, you ask? Because by substituting national currencies with a supranational currency, the euro’s creation severed the link between state and money, and with it the flexibility to confront economic crises of the magnitude that have been experienced throughout the euro’s history (especially post-2008). It has therefore become an instrument of greed as it has facilitated a massive wealth transfer toward the top tier of European society, along with an evisceration of the social welfare state.

National parliaments remain therefore constrained because without a national currency, they lack the fiscal capacity to respond (and they also faced potential bankruptcy, much like an American state, which is a user, not an issuer of the dollar). Mario Draghi’s “whatever it takes” speech in July 2012 alleviated the solvency problem of the national bond markets of countries in the Eurozone (because the European Central Bank is the only entity that can create the euros needed to backstop the national bonds credibly). That, along with some alleviation of fiscal austerity, induced a modest cyclical recovery from 2015 to 2018.

But the recovery, such that it was, has proved ephemeral. The GDP growth of the European Union as a whole has flamed out and is now experiencing its lowest growth in four years. The trillions of euros mobilized during successive crises have largely been devoted toward covert bank bailouts, and recycling money to creditors, rather than assisting the vast army of unemployed. Greed. And while each successive crisis since the euro’s inception has hitherto been enough to avert the ultimate blow-up of the currency union, the poor economic baseline has remained constant.

In fact, economist Michael Burrage recently compared the economic performance of the 12 founder Eurozone members with 10 independent countries, which are comparable in terms of economic structure, labor institutions, and productivity. Surprise, surprise, the Eurozone countries rank at the bottom. It is worth reiterating that this is not a “European Union” problem, but a Eurozone problem because high unemployment caused by austerity policy is an enduring Eurozone (EZ) characteristic. Consider that countries such as Norway, Switzerland and even the UK, beset by Brexit woes, are outperforming the EZ countries, especially on the unemployment metric.

The underlying assumption of a common currency—namely, that it would lead to a convergence of the member countries’ production, employment, and trade structures—has been proven false. Other than the currency itself, the only commonality in the EZ has been poor economic growth in virtually the entire region. A “one size fits all” currency union doesn’t work. There is a multiplicity of challenges—private debt, unemployment, automation, education, worker productivity—that can only be resolved via more socially inclusive (i.e., generous) national/supranational development strategies. But that is within the purview of fiscal policy, which in turn is constrained by the existence of each country effectively “borrowing” in a “foreign currency,” which is de facto what the euro is, given the institutional separation between the state and the currency itself. So going back to national currencies seems a necessary first step.

Why not simply attempt to devalue the euro?

For one thing, relying on external boosts to growth via currency devaluation depends on the willingness of other trading partners to adopt growth strategies that will accommodate the resultant increased imports (highly problematic in today’s increasingly protectionist environment). Furthermore, during previous periods of relative euro weakness, the biggest beneficiary by far in the Eurozone has been Germany, as evidenced by the fact that the country has a current account surplus now a shade under 8 percent of GDP, which largely comprises the bulk of the European Union’s external trade surpluses with the rest of the world. The rest of the bloc, particularly the Mediterranean members, are still registering subpar growth and substantially higher levels of unemployment. So in the first instance, a euro devaluation helps Germany, not the European Union as a whole.

Furthermore, the common currency means a common monetary policy, which has amplified the strains of the Eurozone, rather than mitigating them. In the period leading up to the 2008 global crisis, inflation rates in the Mediterranean countries were higher, which meant that real interest rates were lower. Hence, cheap credit fueled asset bubbles in countries such as Greece, Spain, and Portugal, which in turn provided the illusion that they were “converging” with the northern European economies. By contrast, post-2008 European Central Bank (ECB) interest rates remained too high for too long for those now debt-laden periphery countries, and they therefore have suffered greater fall-out from the financial crisis than Germany.

The economist Servaas Storm has quantified the impact:

What Is GDP in China?

By Michael Pettis

This post first appeared on China Financial Markets at the Carnegie Endowment for International Peace and has been cross-posted with the permission of the author.

The Chinese economy is not growing at 6.5 percent. It is probably growing by less than half of that. Not everyone agrees that the rate is that low, of course, but there is nonetheless a running debate about what is really happening in the Chinese economy and whether or not the country’s reported GDP growth is accurate.

The reason for the widespread skepticism is the disconnect between the official data and perceptions on the ground. According to the National Bureau of Statistics, China’s economic growth in every quarter last year exceeded 6.5 percent. While that is much lower than the heady growth rates China has experienced for most of the past forty years, it is still, by most measures, a very brisk rate of growth.

And yet, when you speak to Chinese businesses, economists, or analysts, it is hard to find any economic sector enjoying decent growth. Almost everyone is complaining bitterly about terribly difficult conditions, rising bankruptcies, a collapsing stock market, and dashed expectations. In my eighteen years in China, I have never seen this level of financial worry and unhappiness.

These concerns have even breached academia. One of my students told me yesterday that there was a huge increase last semester on the university website in the number of students selling their belongings because they are hard up for cash. They are selling their phones, computers, clothing, and lots of other possessions. He said the amount of selling is noticeably higher than last year, enough so that everyone is talking about it. And he indicated that this is apparently happening at other schools too. It seems that the poor and middle-class kids are squeezed for cash because they are getting much less money from home than they have in the past.

This isn’t what you’d expect to hear from an economy growing at more than 6.5 percent. So what does it mean exactly to say that China’s GDP is growing at that pace? It turns out that there are three completely different sets of problems that affect how China’s GDP growth statistics should be interpreted. Analysts must keep these three problems straight and make sure that they don’t confuse matters by conflating these separate issues.

What Does GDP Measure?

The first set of problems relates to the meaning of GDP itself. This challenge affects not just China but the rest of the world as well. This is especially true for advanced economies with substantial technology and service sectors that employ technology whose value may be substantially understated by an inability to count it accurately.

GDP is typically assumed to measure the creation of real economic value. If a country’s GDP rises by 5 percent over the course of a year, for example, this is interpreted to mean that the amount of wealth the country produced in the last year is 5 percent greater than in the previous year. In other words, it would be assumed that the country’s ability to service debt would have increased by 5 percent, which means roughly the same thing.

But there is no way to truly measure a country’s creation of real economic value, as GDP is just a proxy for whatever it is thought to measure. Economists have agreed which measurements go into calculating GDP, and the resulting sum is referred to as a country’s aggregate GDP, or the value of everything produced locally in that economy.

Of course, not all value-creating activities are counted when GDP is measured. For instance, if you teach your friend Spanish for free, you add to the wealth of the economy, but you do not add to GDP. By contrast, if he does pay you, the country’s GDP does increase by the amount of money you are paid, even though you are adding exactly the same value to the economy itself whether he pays you or not. In addition, not all measured activity actually creates value: building a bridge to nowhere, for example, creates exactly the same increase in GDP as building a much-needed bridge.

No proxy of economic value is perfect, of course, but there are real questions about whether GDP is imperfect to the point of being useless as a proxy. Does GDP really do a good job of capturing all the value creation in an economy? While this is a serious problem everywhere, it may be even more of a problem in China because of the huge amount of investment in nonproductive activities that is counted in China’s GDP data even though this investment does not add to the country’s wealth or its debt-servicing capacity.

How Accurate Are China’s GDP Statistics?

The second set of problems has to do with how carefully and faithfully Chinese statisticians at the National Bureau of Statistics are calculating the agreed-upon elements that go into measuring GDP. Do they tend to collect the data in the way that introduces mistakes that are systematically biased (upward, to show higher than actual GDP, I would assume)? Or are they actually lying to please their political bosses?

I am pretty sure that China’s economic data collection is distorted in ways that smooth out volatility, but otherwise I assume, at least until very recently, that the National Bureau of Statistics has followed generally accepted rules for calculating GDP more or less correctly. I don’t have a high level of confidence in my assumption though: as I pointed out earlier, it is hard to find any sector of the Chinese economy that is behaving the way you’d expect a country growing at more than 6.5 percent to behave. Furthermore, especially in recent years, it has been hard to reconcile other economic proxies with the GDP numbers. (See, for example, this article by Johns Hopkins University economists Bob Barbera and Yinghao Hu, which itself refers to a satellite imaging study.)

What is more, people whose work I greatly respect, like Anne Stevenson-Yang of J Capital, seem very much to doubt the data and argue that China’s actual growth rate is much lower than the posted numbers, largely because the data is falsified at some level of the collection process. But whatever the case may be, if there is indeed a substantial discrepancy between what the statisticians actually measure and what they are claiming to measure, it is very hard to make predictions about how long the overstatement will continue and how much of an adjustment it will eventually undergo.

Is GDP Measured as an Output or an Input?

The third set of problems with GDP occurs in a very limited number of cases globally (today, China is the main example). But the implications are much greater. This has to do with whether GDP is even being used as a proxy for economic activity. In China, reported GDP does not tell observers about the economy’s performance; rather, it tells people how rapidly Beijing thinks it can impose the necessary adjustments on the Chinese economy. This is because GDP means something different in China than it does in most other major economies.

In any economic system, GDP is supposed to be a measure of output, and in most countries that is exactly what it measures, however messily. The economy does what it does, in other words, and at the end of a given time period, statisticians measure the things economists agree to include in the relevant calculations, and they express the change over time as the scale of GDP growth for that period.

This is not what happens in China, where GDP is actually an input determined annually as the country’s GDP growth target. The growth target of a given time period is decided well ahead of time, and to achieve it, various entities, including local governments, engage in the requisite amount of activity, usually funded by debt. As long as China has debt capacity, and as long as it can postpone the writing down of nonproductive assets, Beijing can achieve any growth target it desires. 

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