Kornblum at Korbel: Crisis and Peril in the Eurozone!

A lot of students at Korbel are looking to find their way into the Foreign Service, and it’s not hard to see why. For one, Wikileaks has taught us that to a great extent, Foreign Service Officers, who live abroad serving in US Embassies all over the world, promoting US interests, spend a lot of time basically gossiping and socialising…

They go to parties, they meet, they chat, they “do lunch” and “have coffee”, and gather juicy tidbits of information about characters and events that they then type up in flowery language and shoot off to their bosses back in DC (I am thinking now in particular of some Wikileaks cables from the US Embassy in my home The Bahamas which I saw, concerning the impact of a certain now-deceased busty blonde, Anna Nicole Smith, wherein the higher-ups were told: “Not since Category 4 Hurricane Betsy made landfall in 1965 has one woman done as much damage in Nassau!”. O Rly US Embassy? Slow day at the Office?). Aside from that, they also get to be involved in the world of international affairs on a global level, live all around the world and immerse themselves in different cultures. Not a bad living, if you can make it.

Anna Nicole Smith: Havoc Was Wrought

So for this reason and many others it was a real treat for Korbel Students when former US Ambassador to Germany, John Kornblum, flew over to Colorado from his home in Berlin to participate in a talk on the importance and future of Europe. Mr Kornblum first spoke by himself at a presentation I was unable to attend on Thursday, and then alongside Korbel Professors Rachel Epstein and Martin Rhodes at a roundtable on the Eurozone Crisis on Friday (which just so happened to be moderated by our Dean, Christopher Hill, the former US Ambassador to Iraq). Prof. Epstein and Prof. Rhodes are now heading up Korbel’s Center for the Study of Europe and the World, which aims to deepen the engagement of Korbel with this now particularly tumultuous region of the globe.

Ambassador Kornblum served the US for 4 years as Ambassador to Germany between 1997 to 2001, with this being the mere tip of the iceberg for him professionally, capping a 35 year career in the foreign service which saw him deeply involved in hugely historic events. In fact, he orchestrated President Reagan’s “tear down this wall” speech at the Brandenburg Gate in Berlin in 1987. (So perhaps a little bit more substantial than the work of the foreign service officers I used to come in contact with in The Bahamas when I worked there….;)

Ambassador Kornblum: A Jolly Fellow

Which was why it was so interesting to hear his take on the Eurozone Crisis that continues to play out across the Pond.

Hindsight is ofcourse, 20-20, but to hear Europe experts talk about the apparent folly of the creation of the European Monetary Union really is incredible. The project was too much a “political and emotional” one, we were told, guided by a now-clearly misplaced feeling amongst European policymakers that the region, united, could become almost like a “utopia” – “socially and economically engineered” for the betterment of its people, according to Rhodes.

All of this, however, disregarded certain critical economic factors – the conditions did not exist for an “optimal currency area” (that is economist lingo for what are deemed to be the conditions necessary to make a joint currency feasible in reality amongst many different countries – a joint currency like the EURO, that is). No, instead the policymakers had some strange idea that they could come to this position through the backdoor – that by creating a European Monetary Union (EMU), they could create the optimal currency area necessary for it to work. “We’ll get to that part later”, you can just imagine them saying to each other whilst chomping on croissants and patting each other on the back.

Type "Croissant Utopia" into Google and this is what you find...

“Very rash decisions were made and quite a few chickens have come home to roost,” Prof. Rhodes told those gathered at the CSEW event. “They believed the continent and its institutions were ready for a massive leap forward that would bring more public goods for all.”

The major problem with all of this was the Europe was then, and is today, made up of a group of very different countries, which were operating at different economic speeds. Germany has been very competitive economically for many years – “the Mercedes Benz” of European economies, said Rhodes – whilst countries like Greece, Spain, Portugal, Italy and so forth had larger debt burdens, were less efficient economically and generally less productive. Think Greeks and their hugely generous public pension schemes, retiring at age 32 (ok, not quite) and drinking ouzo on the beach, while Germans scorn credit cards, accept less-than-productivity-level wages and arrive at 8.15am for 9am appointments.

“These peripheral (e.g. Greek, Spanish etc) economies went through a crash course in internal discipline before the euro came into being, accepting wage bargaining pacts, reduced deficits and debts. But the crash course came to an end when the EMU started,” explained Rhodes. Nonetheless, all countries accepted a “stability and growth pact” in order to reap the benefits of being “tethered” to the highly productive German economy via the EMU, whilst Germany accepted the EMU as a price for enlargement of Europe, which it believed would benefit its economy.

But this “pact” turned out to mean very little.

One of the impacts of the European Monetary Union, which I heard a very interesting story about on NPR the other day, was a “one size fits all” interest rate which was then applied across the Eurozone. Greek people who were used to tight credit conditions and high interest rates found overnight that they could borrow at relatively low rates – and borrow they did. Buying second homes, expanding businesses, getting new cars. All sorts. But this came without the economic conditions within their own country to support this type of behavior. In technical terms, their “business cycle became de-coupled” from that in Germany. They failed to contain massive ballooning public debts, or restrain wage rises, while in places like Ireland there were private market failures that saw huge asset bubbles develop – and a “massive wedge in competiveness” between “core” and “peripheral” European countries developed. Not good.

This is really what led us to where we are today in the Eurozone, with Greece technically bankrupt and unable to pay its debts, and other countries like Spain and Italy not looking too hot either, and other European countries like Germany and France trying desperately to keep the whole thing together lest the unimaginable happens – Eurozone crash!

Meanwhile, back in Greece...

Former Ambassador Kornblum said he believes the US is not paying enough attention to this situation. China is the talk of the day, but the Eurozone has even greater implications, he suggested. “This is much more fundamental to the US’ future,” he said, citing the fact that Germany is now the world’s third largest economy and trade with Europe accounts for 60 -70% of the US total.

As a former diplomat and current resident of Berlin with undoubtedly continued connections to the high level world of international diplomacy, the former Ambassador’s comments were particularly intriguing. He talked of how Europe and Germany itself is now going through “many levels of crisis”. The situation is as much to do with internal German politics and identity issues as it is with external economic concerns.

“The European leadership is caught between, on the one hand, these jazzy new financial markets and their own voters. You do have some leadership there, in Merkel, but she is really deeply frightened by her own voters. The problem is that the Euro was sold to them as a peace project. There would be no more war, there would be eternal Franco-German friendship. No one ever talked about an imbalance of payments. It was sold as an emotional, political project.”

“Merkel is doing all she can, but she’s caught between an electorate who were never told when they were adopting the Euro that they were adopting Europe and that if they did not the whole world would collapse.”

So what is the answer? “They do what they know how to do best: Have meetings and issue communiques” whilst probably believing that in reality their future is better suited to lie with the US, Singapores and Japans of the world, whose economies are more “up to speed” with Germany’s than those of the economic “klutzes” of Europe – Greece, Italy, Spain etc.

Merk-Hell.(Oh fine, just shoot me now... )

“Merkel is without now totally without a peer, a rival, in Germany now. She now has the entire responsibility of figuring out what Germany is going to be. But she doesn’t really know anything about financial markets. She is doing the things she knows – discipline and stability – which is wrong in my view. They should be talking about what’s good for the prosperity of all countries,” said Kornblum.

In fact, what may be most problematic is that the “next steps” Germany, France and the core European countries are looking at to address this crisis may very well be “unconstitutional in many European countries, and probably in Germany too,” said the former US official. (Think recent headlines about Greece descrying the “insulting” suggestion from Germany that it be able to place a “commissioner” in Greece to monitor how it spends public money within its own economy).

At the end of the day, however, Kornblum charged that the Euro will likely survive and Germany’s position will probably increase. But it will not be without pain. “They know they’re going to have to bail out many people but making it as painful as possible”, in a probably-futile attempt to appease their electorate, he said.

The same aggrandizement may not turn out to be the case for the Central and Eastern European economies, according to Prof. Rachel Epstein. As an expert in post-communist European societies, Prof. Epstein has some stark observations about the implications of the Eurozone economic crisis for these recently democratized countries.

The crux of the matter is that as they made their transition from communism to capitalism in the post-Cold War era, they were compelled in one way or another to sell large chunks of their financial systems to Western European banks – something Western European countries or the US would be loath to do themselves, given the implications for sovereignty over such a key sector of the economy.

“The European debt crisis imperils not only the Euro, but also the ongoing democratic project in Central and Eastern Europe,” said Prof. Epstein. “Only three of these countries use the Euro but they are terribly exposed, due to the relationship between economic hardship and democratic chaos.”

Not only do these same Western banks which now own much of these Central and Eastern European countries’ financial systems hold large amounts of “dodgy debt” issued by the like of the governments of Greece, but they are now being asked to write off huge losses to help save Europe, whilst simultaneously being hit by demands from governments in their home countries to shore up their capital bases (read: keep more cash at hand at home in case of losses) and to lend at home (rather than in these subsidiary areas).

“This all speaks to potentially very negative consequences for Central and Eastern Europe,” said Prof. Epstein. If these western banks begin to pull back on services and credit to customers in these countries, or even back out altogether, this kind of financial/economic doublewhammy could mean a major backstep for their democracies, which sit on relatively shallow institutional foundations given their newness in the post-communist era.

As one example of this type of threat, Prof. Epstein pointed to the rise of the right-wing “authoritarian and power aggrandizing” Fidesz party in Hungary, which, since 2010, has “Germans and Europe very worried.” The party has taken worrisome steps such as limiting the independence of the judiciary and imposing new levies on banks which could compound their incentives to withdraw.

Chairman of the right-wing Fidesz party after they sweep the parliamentary elections: Can you not raise your arm like that please?

On the other hand, Latvia is a country in this part of Europe which went through a terrible economic situation following the collapse of Lehman Brothers in 2008, losing 10 per cent of its population to other countries due to the downturn in social/economic opportunities, but yet retained its democratic character.

Whatever the case may turn out to be, Ambassador Kornblum’s warning that the US must pay more attention to Europe is no platitude.

(By the way, if this interests you, you should DEFINITELY listen to the episode of This American Life hosted by NPR’s Planet Money Team on “Continental Break-up” in the Eurozone that aired a couple of weeks back – great story telling about a complex subject: http://www.thisamericanlife.org/radio-archives/episode/455/continental-breakup).