The Politics of the Eurozone Crisis: Premier Global Strategist Edward Luttwak Sat Down with TIE Founder and Editor David Smick. the Question: Given the Grimy, Intractable Underside of Greek, Spanish, and Italian Politics, Are Structural Reforms and Fiscal Consolidation Even Possible?
Smick, David, The International Economy
Smick: We are at a critical moment in the eurozone debt crisis. The EU sum-roll's reforms are already being watered down. The European Central Bank has an ambiguous policy which some suggest is a backdoor means of quantitative easing, if not creating some equivalent to eurobonds. Yet the Bundesbank is resisting. The future seems murky. At the end of the day, the eurozone's enormous pile of sovereign debt is between 5 trillion [euro] and '7 trillion [euro]. What's the endgame in all of this?
Luttwak: It depends on one essential unknown: whether the ruling elites of the countries most brutally affected continue to be prisoners of a gotterdammerung mentality, whereby they refuse even to evaluate the costs and benefits of staying in the euro.
Smick: Please elaborate.
Luttwak: The effects of the current austerity policies are not merely extremely recessionary with no recovery expected for years--in some countries the effects include mass emigration and a collapse in fertility. If and when any of the respective governments decides to leave the euro, accepting sharp currency depreciation and the resulting need to negotiate debt relief for the sake of rapid growth and increased employment, the European debt problem could become manageable. The sheer volume of the debt could then decline to sustainable levels. The claim that the debt is already manageable is simply false. Even in the case of Greece, that pretense was long maintained by the European Central Bank and the French and German governments, as if arithmetic did not exist. The pretense of sustainability continues still in the case of the colossal Italian debt.
For the new European Fiscal Union that the German government has almost single-handedly created--approved by the seventeen euro countries at the European Council meeting of December 9, 2011--the debt problem is not qualitative, and cannot be resolved by more "credibility." It is a question of impossible numbers. Members are obligated to reduce their sovereign debt by 5 percent per year. The fiscal drag caused by adding that 5 percent to current interest payments would further damage economies already in recession, and totally sink the economies of Italy, Spain, and Portugal. By contrast, if they left the euro and negotiated debt relief, the remaining European Fiscal Union members would only face the bounded problem of recapitalizing banks to the extent necessary to offset the losses caused by delayed maturities, if not outright cuts. It would be in everyone's interest to minimize disruptions and the resulting damage to intra-EU trade. In any case, a multi-directional, political, social, economic, and financial problem would be drastically simplified, a matter of the German government putting some money into Deutsche Bank, the French government doing the same for Societe Generale and Paribas, and so forth.
On the other hand, the ruling elites of these countries may decide to stay in the euro regardless of the consequences, accepting more mass emigration in the case of Portugal, the catastrophic collapse of the birthrate in the case of Spain, and disastrous youth unemployment in the case of Italy. If they continue down that path--remaining with the euro that makes them structurally uncompetitive--then of course the European debt problem will continue to be unmanageable. I do recognize that the pro-euro elite is not irrational: no growth and unemployment are simply less important for them that to be accepted as full, that is, "Nordic," Europeans.
Smick: Let's use Italy as an example. In this new German-run effort at reform and consolidation, isn't reforming the Italian situation just too politically complicated? The real power is on the regional and local level. Italy is a country rich in government assets, but wouldn't privatizing those assets be difficult because so many are controlled at the regional and local levels? The same is true for cutting government sector spending, including for public pensions. …