As the French National Front barrels into the first round of local elections this weekend, the international media is sure to latch onto its anti-European (or Euroskeptical) rhetoric as a sign of the times. Indeed, given the raft of Euroskeptical parties like the UK Independence Party (UKIP), the Alternative for Germany, the True Finns, the Sweden Democrats, the Dutch Party of Freedom (PVV), and the Italian Northern League, it is easy to jump to the conclusion that Europeans have lost confidence in ‘Europe’ as a political project. One look at the travails that European leaders have faced responding to the macroeconomic crisis and it is not hard to see why that is the case.
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The Dollar, the Euro, and the Currencies in Between
Two of the most important macroeconomic stories today are dollar strength and euro weakness. The dollar strength story is important because it threatens to sap momentum from the U.S. economic recovery and to give pause to monetary policy makers on the federal open markets committee of the U.S. Federal Reserve as they consider when to start raising interest rates. The euro weakness story is important for the opposite reason, because it promises to breathe life into the euro area economies even as it lowers the pressure on the Governing Council of the European Central Bank. My point in this note is not to deny the significance of these reflected narratives, although I do think they warrant qualification; rather I want to focus attention on the currencies (and economies) caught in between.
The Threat to Exclude Russia from SWIFT
The second Minsk accords have succeeded in fostering a cease-fire and yet the Russian government continues to support the armed separatist movement in eastern Ukraine, small acts of violence continue to take place, and the peace is fragile. The challenge for western policymakers is to come up with some greater incentive for Russia to embrace a lasting peace settlement. The threat of large-scale western military assistance for the Ukrainian government is unlikely to be sufficient. Russia has the advantage of proximity and a greater stake in victory than the west. If anything, overt western military involvement could cement support behind Putin in Russia and lead to further escalation in Ukraine.
The alternative sources of western leverage over Russia are only slightly more attractive and the prospects that any new sanctions will find agreement in a European Council that includes Cyprus, Greece, Hungary, France, and Italy are slim. Nevertheless, there is one financial sanction that seems to be gaining traction in conversations on both sides of the Atlantic. That sanction is to exclude Russian banks from the financial messaging service known as SWIFT — the Society for Worldwide Interbank Financial Telecommunication. British Prime Minister David Cameron raised this prospect last August suggesting that excluding Russian banks from SWIFT would offer considerable leverage over the Russian government. He returned to the idea late this February.
Brexit and Grexit — Process and Event
Two of the great risks facing the European Union (EU) economy are the exit of Greece from the euro area and the exit – or distancing – of the United Kingdom from the European Union. It is easy to think of these threats as similar, even if only because they have similarly catchy names to use in popular debate. But Kings College London Professor Anand Menon reminded me in a recent conference call that they are actually very different. His point was that any British exit from the European Union – or ‘Brexit’ – would be a long, difficult, and conflictive process. My argument here is that any Greek exit from the euro – or ‘Grexit’ – would centre on a short, punctuated event.
Now Is Not the Time
Today was another ‘crunch day’ in the negotiations between Greece and its creditors in the euro area. The Greeks have made their proposal. Now the Economics and Finance Ministers have to make a decision about whether to extend the Greek bailout That decision may require that the Greek government offer even more. The Greek government is reluctant because it fears betraying the electorate that just voted it into office. The German government is reluctant to concede more either because it has its own voters to worry about. It also has to worry about its allies – like Finland, Slovakia, Portugal, Ireland, and Spain – who have supported a hard line on Greece, also for domestic political reasons. Hence we are at a democratic impasse. The two sides are close to an agreement, but close is still ‘no cigar’.
Credibility as a Powerful Idea
As an academic, I am interested in the power of ideas. If ideas didn’t matter, I would probably look for another job. Fortunately, the power of ideas is all around us. This is not a reference to the terrible events in Copenhagen, although I suppose it could be. That was a conference about ideas attacked by people who have a deep fear of the power of ideas to threaten them. Slavoj Žižek made that argument about the Charlie Hebdo attacks earlier this year; his reasoning applies equally well in this more recent tragedy.
The power of ideas I find most interesting at the moment centers on the notion of credibility. The reason this is interesting is credibility can seem so solid at one moment only to collapse in another. I worry this could happen to the euro as a single currency if some accident were to happen and Greece were to leave the euro. This essay is a long way of making a simple point. Anyone who thinks that Greece can leave the euro without having dramatic consequences is underestimating the power of ideas.
Central Banking as Politics
Central bank independence used to mean that central bankers would take economic decisions without regard to the political consequences; now it appears to mean that central bankers take political decisions without regards to the economic consequences. This is a very bad development for macroeconomic policymaking because it is likely to give political momentum to those who oppose the prevailing policy framework. The result will be a crisis of legitimacy for the central banking community and an increase in volatility and uncertainty in the world economy writ large.
Hard Bargaining
Italian Prime Minister Matteo Renzi won a big victory this weekend. He threw support behind Sergio Mattarella as candidate to replace Giorgio Napolitano as President of the Italian Republic and Mattarella managed to win almost two-thirds of the votes of the Italian electoral college in the fourth round of balloting. This means that Renzi was able not only to hold together his fractious Democratic Party but also to split Silvio Berlusconi’s Forza Italia on the Center Right and to show the growing irrelevance of Beppe Grillo’s Five Star Movement in national politics. Mattarella becomes President and Renzi is much strengthened as a consequence.
This result was not a foregone conclusion. Things could have ended differently. The Democratic Party could have split, Renzi’s center-right coalition partners could have refused to support Mattarella for President, Berlusconi’s Forza Italia could have held together in the electoral college and then turned on Renzi’s institutional reform agenda, or Grillo’s Five Star Movement could have tried to create chaos in the whole proceedings by introducing a Democratic Party grandee like Romano Prodi or Pier Luigi Bersani. Renzi had to negotiate skillfully to avoid most of these obstacles; he had to be lucky to avoid the rest. Hence the take-away for most Italians is that Renzi has a good mix of cunning and bravery — the Italian word is ‘furbizia’ — to carry the day.
Quantitative Easing: Toward a New Liquidity Glut?
The European Central Bank’s new quantitative easing program may end up pushing liquidity into the wrong economy: the United States. This may be beneficial for the euro area in the short run as the money that flows out of Europe pushes down the value of the euro relative to the dollar and as the capital inflows into the United States fuel U.S. demand for European exports. To give you a sense of how strong this effect is likely to be, I am pasting a recent history of the euro-dollar exchange rate that dates back to the start of the Greek sovereign debt crisis in January 2010. This data is provided by the Dutch national bank.
Greek Elections and Moral Hazard
Viewed from the United States – or, maybe better, from an American perspective – the Greek elections highlight the problem of moral hazard in Europe. This is not a normal problem you would expect to arise from a democratic contest. ‘Moral hazard’ describes a condition where one party takes on excessive risks because they believe, whether rightly or wrongly, that any negative consequences can be shrugged off onto someone else. The classic example is a borrower (or a banker) who takes on too much debt and then walks away when it proves unsustainable. When we talk about elections, it is hard to see how this situation might arise. Voters can vote irresponsibly, but they are likely to bear the consequences of their own foolishness.
Erik Jones 