In light of the arrest of IMF head and Potential French Presidential candidate Dominique Strauss-Kahn in New York City on sexual assault charges, some people claim this as another nail in the coffin of the European Monetary Union. This may or may not be true. But what is certain is that the underpinnings of the Euro’s unraveling are much deeper and more profound than this one scandal. The present crisis is the natural consequence of unsustainable national and unrealistic EU policies that must be reversed in order to save Europe from itself.

More than a half a century ago, the predecessor of the European Union was founded on the idea that if nations banded together to create some common and free policies for trade, they would not only be more prosperous but better able to coexist in a region historically plagued by jingoistic antagonism. As decades went on the same concepts of free markets and free people brought people together and promoted prosperity, all the while maintaining national sovereignty.

But all that seems to be changing. The progress that has been made through the recipe of free movements of goods and people mixed with national sovereignty, may be a thing of the past. Today, Europeans are adding new ingredients and the outcome is less than desirable. A common currency–not one of the community’s original goals–is creating a crisis in Europe. Political and fiscal sovereignty is being sacrificed for greater centralization and huge transfers of taxpayer’s dollars. All the while the EU seems to be more concerned with expanding its size and power, than with putting out the fires within the union. The fact is that in order for Europe to be stable and prosperous, and for the EU to be effective, Europe needs to return to its original (intergovernmental) goals, rather than continuing overreaching (super-national) ones.

The Euro is disintegrating (photo courtesy of currencyhut.com)

The most important recent development in the EU, and single most troubling as well, is the bailout of three of its member states, Greece, Ireland, and Portugal. The nearly $400 billion of bailouts are truly radical steps toward greater political and fiscal centralization–no matter what anyone says to the contrary. There is no one who can seriously argue with certainty that these will be the last sovereign bailouts either. Now Spain and Italy wait in the wings, by which time many wonder if the monetary union will disintegrate.

In the case of Greece we were told that we must act in a swift and unprecedented manner to prevent the disease from spreading. Prudent nations obliged and Greece got a bailout in May of 2010. And while the interest rate it pays on its 10-year bond fell almost immediately from about 12.5% to 7%, it has grown all the way to 17% today.

Just months after Greece’s bailout-to-end-all-bailouts, Ireland suddenly approached sovereign default. Even after vehemently denying they would ever need it, the Irish accepted the second sovereign bailout in November. And while it brought the country’s 10 year bond yields down slightly from 9% to 8% in the short term, it has climbed to almost 11% today.

And since Portugal’s bailout at the beginning of May, the yield on its 10 year government bond has returned to 9.7%, about the same as what it was before it was rescued.

You cannot put a band-aid over a gaping wound, nor can you bail your way out of this crisis. The bailouts have not–and will not–do anything to stop the contagion–which was the pretense for taking these emergency measures. The countries whose economies are weakest and governments most profligate, will collapse on their own merit. You cannot wish away the costs of their irresponsibility, nor can you change the fact that fiscal realities–not short-term market sentiments–are what will bring these nations to the edge of default.

Simply put, there is no silver bullet, no magic cure that can save Europe from the national mistakes of profligate nations. Either they and their creditors bear the costs of their mistakes or the rest of Europe will have to. For a union whose primary goal was to augment the competitiveness of a continental economy that was loosing ground both to the east and the west, its bailouts are a rather curious development. Not allowing countries to take responsibility for their own binges only inculcates the status quo and preserves the affluence of the institutions who are responsible for their nation’s bankruptcy on whole. Its not just the moral hazard that is worrisome, its the fact that these policies preserve the economic arrangements that got us into this mess.

Consider Greece. Its 110 billion euro bailout, together with some austerity, has done nothing to convince the debt markets of solvency. Yet that 110 billion euros is still going to flow to its government to finance lavish compensation and pensions for its bloated public sector. Its no secret why Greece is the most fiscally unstable country in Europe: its pension obligations plus government debt is at least 486% of GDP, its government spending is almost half the economy, and the retirement age for public sector union members working “arduous” jobs is 55. Nevertheless, taxpayers around Europe, through no fault of their own, have to bail out Greece’s opulent public sector unions.

Also consider Ireland. Its 90 billion euro bailout, mixed with some fiscal sacrifice, have too done little to ease the concerns of creditors. But the reason that Ireland’s government was on the road to bankruptcy was none other than the priorities it set during the recession. When its unrivaled real estate bubble burst and leveraged financial sector crashed, the government spent tens of billions bailing out banks (incurring an estimated net loss of 50 billion euros), instead of letting them fail and creditors take write downs. If the Irish government did not spend beyond its means bailing out failed banks, it would likely have no sovereign debt crisis. The unintended consequence of the bailout of Ireland is that, rather than rescuing the Irish people, Europe is bailing out Ireland’s banks.

When faced with a deep recession and fiscal constraints, a nation’s currency naturally devalues in order to ease those strains. Of course, that is not possible for one nation to do under a common currency. But still, the EMU has no alternative for dealing with such a scenario. Under the Euro there is no regime for restructuring sovereign debt, and no orderly process for transitioning a country off the Euro when it becomes evident that it cannot sustain the currency. And because there is no way to deal with the issue, it provides a pretext for hasty political consolidation of Europe.

A prominent columnist for the Financial Times, Wolfgang Münchau, has echoed what others have been saying for a long time, “history has told us that monetary unions that refuse to become political unions are destined to fail.” In other words this currency crisis can bring major political consequences that could change the face of Europe. In order to preserve monetary union at any cost, there will have to be more consolidated political power. When political union is the only answer, it is troubling to imagine what the future will look like. A democratic union of 27 different countries, consisting of over 500 million people, speaking 23 different languages, all with different national identities, histories, and value systems. Antithetical to a democratic union like America, there are minimal commonalities among Europeans. But, still, they would have to agree on many more, far more complex issues than ever imagined.

The votes in the EU government would not be so narrow as tariff limits for certain goods or minor agricultural expenditures. Instead they would be voting about budgets with large regional transfers of wealth or about increasing the EU VAT to 6% or 10% or higher.

And how do you think these issues would be resolved? Issues as big as these certainly don’t get settled by unanimity, or super majorities, or double majorities. Certainly not over a continent with 500 million people, speaking 23 languages, hailing from 27 nations. No, eventually even thinner majorities–thinner than those under the Lisbon Treaty–would be required to pass these types of legislation. And as the laws become more complex, it becomes impossible to decide all the regulation democratically. More and more, in the fashion of the complex regulatory states of Europe, the EU would rely on unelected bureaucrats to decide policy and arbitrarily execute the complex apparatus of Europe’s commanding heights. Decision made about the lives of Europeans would continue to drift further and further away from the individuals themselves.

As long as Europe maintains its levels of debt, maintains its policy of sovereign bailouts, and insists on a broad monetary union at any cost, it will continue to undermine it own original goals. A monetary union can work, but only for nations that are compatible with it. The only alternatives to an orderly monetary union are disintegration or bailouts. Currently the alternative the EU is choosing is bailouts, and its a far cry from the original intent and goals of the European Community.

The more that centralized European politics is the tool for resolving the reoccurring crises of Europe–which centralized policies themselves created–the more removed Europe becomes from the free markets, free people, and self-determination. Europe has a very fragile history of continental bickering and strife. Certainly, things are as good as they are today because of organizations like NATO and the EU, who have historically found areas where Europeans can almost unanimously agree–free movement of goods, of people, and common security. But if today’s trends are taken to their logical conclusion, much of the spoils of Europe will be at stake at the super-national level. This means much more discord between the people of Europe than today. And it also means less national sovereignty and individual determination than exists today.

It is not too late however. Europe still has its destiny in its hands. The future promise of Europe does not lie in overarching and wide-sweeping change, but in a return to its founding ideas that has brought stable progress since WWII. Improvements will need to be made, to be sure, including a roll back of much of today’s policies. There must be an orderly exit strategy for countries that cannot sustain the Euro. The requirement that all EU members join the Euro should be stricken. All sovereign bailouts must be stopped, and the European Financial Stability Fund should be divested. There should be greater free flow of services and more freedom and continuity in labor markets. The list goes on.

While there are many appropriate reforms to be made, these would be a good start. Most importantly, however, success is contingent upon adherence to the ideas that birthed the post-WWII European Community. Free markets, free people, and national sovereignty. Europe is home to a lot of special places, and unique identities. No one can change what Europe is in its essence, nor should they try. So long as these truths are remembered, a more prosperous, stable and free Europe can be achieved.

References:
-National and continental statistics from EuroStat
-Bond yields from Bloomberg
-Specifics on recent sovereign debt and bailout developments from the Financial Times
-Quote from Wolfgang Münchau from the Financial Times

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