A final song for Europe?

Holland and Holland together with their friend Lamont Dozier wrote a string of hits for Motown artists in the 1960s, including ten number ones for The Supremes. One of their last songs for Motown was for Martha and the Vandellas, titled “One Way Out”.

Now we have an altogether less melodic pairing of Hollande and Holland that could be penning a final song for the eurozone and possibly the EU project itself. The collapse of the Dutch government is a particularly bitter blow for the austerity autocrats.

Hitherto, the Netherlands has been at the forefront of the drive for austerity and discipline. Strange how it’s so much easier to call for austerity when it cost you little or nothing. When it causes real sacrifice at home, it becomes a different matter for politicians.

Arguably, the Dutch are even bigger culprits than Germany in the game of imbalances in the eurozone. Its trade surplus is even larger as a percentage of GDP than Germany’s. If a country with as strong a mercantilist bent as the Netherlands can’t hack fiscal consolidation, what incentive is there for the Club Med countries?

The Germans must be seriously thinking whether this whole euro project is worthwhile. Despite the soothing noises from the ECB, the Bundesbank looks horribly exposed to credit risk through the Target2 system. Delay has only caused an ever increasing exposure.

Meanwhile, back on planet France, it seems we have regressed to the 1960s. M. Hollande’s policies seem to be stuck in a pre-globalisation and pre-single market time warp. Lowering the retirement age, employing 60,000 new teachers and soaking the rich with a 75% tax rate ignore the realities of France’s financial situation, you have to wonder whether Hollande has been imbibing some 1960s psychotropic drugs. Perhaps underneath his crisp white shirt he has a tie dye t-shirt.

If M. Hollande wins, then all hell could break loose in the eurozone. All pretence of an austerity solution will disappear in the eyes of the market and it will be every man for himself. It is not fanciful to suggest that it will shake the European Union to the core.

The reassertion of national sovereignty is likely to lead to the rolling back of a number of important integrationist policies. Namely, the free movement of goods and capital. Capital controls may well be imposed in the financial turmoil of a eurozone disintegration. The single market would also be called into question.

Left wing political ideology tends to be inward looking and defensive. Trade protectionism is a common policy of both far left and far right political persuasions. When things get tough, the natural inclination is to hunker down and look after your own narrow interests.

Absolutely central to the eurozone’s survival is the willingness of Germany to act as a provider of capital to the stressed periphery through the Target2 system, including to France. If France goes socialist, will the Germans say enough is enough? Perhaps Germany will be singing “One Way Out” and rush for the exit.

It’s the imbalances, stupid

To understand the world, policy responses and consequences, you really need to look at the macroeconomic imbalances. I’ve banged on enough about the eurozone and the reluctance of policy makers to accept that imbalances in the eurozone require a set of policy responses from Germany that seem politically unfeasible (i.e. domestic demand expansion, higher inflation, accumulation of debt and a trade deficit). No matter how much wriggling and squirming there is, it is impossible to get away from these verities.

However, it’s not just the eurozone that faces difficult and painful choices. China is another region of extreme economic imbalances that require policy makers to make hard choices. Michael Pettis outlines the choices that need to be made and the reasons and consequences in this thoughtful blog post. In some ways, I have more confidence that China will make sensible choices.

At least leadership understands the issues. The political system has the capability to take tough decisions and to see them through, unlike the eurozone. Whether those options will be taken is open to doubt given the influence of various interest groups within the Chinese political system.