No Conclusion on the EU

Ten leading European economists have recently written an open letter to European leaders urging a coordinated rescue plan for the world financial crisis, specifically as it implicates European banks. (As ten economists drafted the letter, over 300 more have since signed it as of this writing, see this article).

The letter made the argument that the “piecemeal” actions being taken in Europe will never amount to a solution for the crisis. “The current approach of rescuing one institution after another with national funds will lead to Balkanization of the European banking sector.” The letter went on to say that the US has already learned that bailing out a few giants did virtually nothing to stop the bleeding. Due to the credit-default swap industry, or banks insuring each other’s bad debt, the banks are all tied together as if with rope while trying to stay afloat in deep waters. When one or two go under, they will take others with them.

Those economists are not alone in their assessment. According to a recent Bloomberg article about Europe’s challenges, European Commission President Jose Barroso called on Europe to remove the “mismatch between a continental-scale market and national systems of supervision,” (see this article). The European Union, while comprising 27 different nations with 27 national governments, acts as one financial market with one currency (one currency for 15 member states, anyway). Banks across national borders are deeply intertwined with each other and their relationships affect smaller countries where neither bank is located. So a “systemic crisis demands a systemic response.” Coming up with an aid package that successfully navigates all the multinational bureaucratic red tape involved will prove extremely difficult if not impossible.

Adding to what seems like a perfect storm in Europe is the extreme diversity within the continent. Besides having 27 different governments, 27 different heads of state, and 27 different constituencies to independently please, there are extreme cultural issues to overcome. There are 23 official languages within the EU. Whether generalizing Europe in terms of East vs. West, North vs. South, or Christian vs. Muslim, there is really nothing in common among all states besides soccer. Imagine the possibilities for disagreement over a solution between the Greeks and the Swedes, or the Spanish and the Polish. One doesn’t even have to cross the continent to find such contrasts. England and France, neighbors, are well-known rivals who loathe each other, and my Swiss roommate often has less than kind words to say about the Austrians. Besides the fact that Switzerland has been involved in fewer wars, how many people can detail the cultural differences between those two? I can’t. As the Bloomberg article notes in its lead sentence, “It took the European Union almost three decades to agree on what could legitimately be called chocolate.”

While America is the most diverse country in the world, she has centuries’ experience of dealing with its ethnic, geographic, and economic diversity. America also has the benefit of only one federal government in control. So the US is at an advantage over the EU in executing its comprehensive public bailout of the financial services industry. The House of Representatives voted against the first bailout plan and showed how difficult drafting such a plan will be even in the States. I just can’t grasp how pain-staking of a process it will be for Europe.

In my International Banking class of my graduate program, the professor explained how the European Union was relatively young historically, and that there was no real conclusion on how it will turn out. It has yet to pass the test of time to call it a success. This directly contradicts what almost came to be considered common sense in the media – the US dollar was in the toilet and it would never come out. Some day the Euro would be the reserve currency of choice. I also heard this incessantly from my European friends.

While never arguing with my friends native to the other side of the big pond, I always viewed the fall of the dollar as a normalization of what was long overdue. I thought that the dollar was probably overvalued for the generations that Europe was economically splintered (what I wouldn’t give to be an American in the 80s vacationing in Europe!). Europe finally united and quickly grew its buying power. Imagine how much waste was saved by creating a common financial groundwork and establishing an ease of crossing borders. Imagine the waste, before the economic unity, of all the financial professionals dedicating their time, labor and resources to currency arbitrage alone. The EU became a much more productive, cohesive continent despite its inherent diversity and government fiefdoms.

The EU normalized economic standards and collectively grew faster than ever. The Euro increased in value to somewhere around $1.50. However, most of the economic reforms were planned in 1993 and executed in 1999. Being so young, the EU has yet to pass a significant test such as the global financial crisis we are in today. This is a historic time, especially for the EU. How quickly it can produce a continent-wide solution, and how effective that solution is, will help determine its historical success. As the Bloomberg article explains, the unanimity requirement for changes makes decision-making terribly slow. In trying to solve this problem, it has tried to change rules in favor of a stronger governing body twice. The French and Dutch rejected a constitution in 2004 and the Irish rejected the 2007 Lisbon Treaty (which the Polish were expected to do if the Irish hadn’t). As the crisis deepens and pressure mounts, the financial bloc may hastily push through a plan that satisfies everybody but is ineffective or not ideal.

As the US dollar was artificially over-valued while Europe was an economic mosaic similar to America in the 18th century under the Articles of Confederation, the Euro may prove to be overvalued after it overshadowed the dollar, never having proved itself in the absence of the EU’s ever seeing a crisis. The dollar has already started to gain on the Euro (currently $1.34 / 1 Euro). Only time will tell what will happen. Being one who earns US dollars, I am cheering for a 1:1 ratio someday. But if the EU can successfully come together and take swift, effective action, it will bind the countries even more. This may set the stage for, and I will be dead long before this happens, the conversion from 27 nations in alliance to 27 states in one country: The United States of Europe. In 150 – 200 years, who knows? It could happen.