Now and again, sifting through those puffed up self aggrandizing and overly complicated articles (aka messages of doom/rants) written by ‘celebrated’ economists, you find a few golden nuggets that are both enjoyable to read and useful. Robert E Wright (Bloomberg) recently penned such a shining example – ‘Why the Early US Didn’t Go the Way of the Euro: Echoes.’
Obviously its quite timely, although equally obviously, its subject matter is anything but obvious (if you follow me). In the original PIIGSty publication on the euro, I made a few comparisons between the US and the European ‘federation’ experience – mainly that, the Americans nailed down their political unity quite early, allowing a standardised economic federation to follow quite early in the genesis of their union wherein most subsequent US states (ignoring the Civil War, of course) have done so with their feet firmly planted on this solid foundation. In effect, political union predated full, accepted economic federalism. For Europe, it’s far more complicated although not all that different (at least at one point in history)– except for the fact that the EU is trying to achieve a similar outcome by working in reverse.
Wright adds historical substance to this argument. Below are his findings:
Similarities between the 18th Century US and today’s EU
- Citizens saw themselves as state citizens first and ‘federal’ citizens second
- Flow of human capital was open but movements limited due to cultural (ethnic and linguistic) differences
- Flow of financial capital across state lines limited (local and state banks)
What did the US do?
- Economic statesmanship was provided by Treasury Secretary Alexander Hamilton (late 1790s). He established the gold/silver standard dollar, federal tax system and the US Federal Reserve (Central Bank).
- ‘Assumption of state debt’ was proposed which allowed the US federal government to issue debt (bonds) as a federal whole which superseded state bonds, providing a mechanism for the feds to control the whole bond system and also, alleviate state debt (which indebted nations could not resist). This effectively mean that the federal Treasury would pay all state debts, financed by a 4% interest US gov bond. This action bound bondholders, no longer to the states but to the federal US as whole.
- The action also bound states to the federal government. In exchange, states lost their control over money (couldn’t set interest rates, exchange rates) and their control over their fiscal policy was diluted.
- The US government refused to ‘pay’ state debts (i.e. bailout states), enshrined in Constitution after Civil War (Post-1865) in 14th Amendment
Adding meat to this argument is another recent article (there have been many in recent months) by C. Randall Henning and Martin Kessler.
Henning and Kessler build on Wrights assertion about the state debt issue. Although Henning and Kessler use the more liberal term ‘bailout’ describing the federal assumption of state debt, the point remains that this was a supranational power grab which sounded the dealt knell for state control over their own fiscal policy. This is, of course, runs counter to the idea of ‘fiscal sovereignty’ (state control of fiscal policy), the demands for which are becoming fashionable (violently, in some cases) in Europe today.
Back to history, the US feds stance on this issue changed with the economic winds. Originally, in the days of Hamilton, the ‘bailout’ stance (1790s) continued past the 1812 War. The warm embrace of the federal government continued only until federal authority was firmly entrenched and accepted which it was by the 1840s and a hardline ‘no bailout’ period began. States defaulted, and the federal government had pretty much proved its resolve. The states, raised like children with their finances managed by a trustworthy and careful parent, now had to understand how to make their own decisions. Thus, ‘balanced budget’ rules entered into state constitutions.
The question now, is how EU rules as expressed in the fiscal compact intend on squeezing essentially a century of economic ‘evolution’ in the US into a few decades without the necessary acceptance by member states. Effectively, the EU hopes to do the same, quicker and with it being about as popular as a German bank manager at a Greek bank.
So why is it so much more difficult for the EU to achieve its aims?
- The US and the EU are different. Its easier to build a fledgling economic structure around a relatively politically unified confederation of states (eventually federation) which have unified concerns i.e. security from invasion etc. Europe lacks that impetus to act because each member state has felt the economic crisis in varying measures. The PIIGS in the periphery have been hit harder than others.
- There a timeline here which needs to be remembered. The banking crisis exposed a sovereign debt crisis which provoked an economic crisis (questions over the euro) which has exposed a political crisis in the eurozone. As in Ireland, a solution to alleviate the problems in the banking system, inevitably saddles banking losses on the public’s shoulders. Focusing on how to keep states finances in order, when peripheral states are heavily burdened by banking decisions made (in some cases) by northern European banking groups, is creating a two tier crisis for which the political ‘elites’ i.e. in those big northern chums (France and Germany) must somehow solve.
- The US (smartly) leveraged the warm embrace of the federal government (‘assuming state debts’) in exchange for significant powers to tax and eventually, spends on social programmes (New Deal etc). This has balanced against state governments and provided ‘automatic stablisers’ where required. Europe needs this ASWELL as control over debt levels.
[For detailed research by Henning and Kessler, see the PDF here]
Simply put, if Europe wants to follow the US example, it has a few things to do:
- Develop the fiscal capacity of the ECB via assumption of state debt, issuance of federal debt (Eurobonds?) and tax power. For more info on Eurobonds see here and here.
- Member states need a balance budget provision (not the watered down Fiscal Compact or ‘debt breaks’). This is necessary to dampen the effects of the cyclical forces in the economy.
- European political union.
Hence you can see the mountain the EU has to climb. Even assuming EU leaders can achieve A and B, point C appears next to impossible as euro-scepticism and antipathy toward Europe hit fever pitch. Unless of course, things get worse economically and European leaders are forced to act. Considering for the US in the 18th century the catalyst was the overwhelming threat to the continuance of American freedom and liberty, you can imagine that the modern day European equivalent is going to have to be a very big as yet unseen event. Keep an eye on Greece.
piigsty 