Markets, Politics, and the Euro
One of the most memorable quotes of the financial crisis was delivered by German Chancellor Angela Merkel in May 2010, when she declared that "in a way, it is a struggle between politics and the markets. We must re-establish the primacy of politics over the markets." Though unusually stark, this formulation echoes a widespread perception in Europe. Disorderly market movements, such as the successive increases in Greece's borrowing costs, are overwhelmingly blamed by political leaders on speculators, abetted by their dubious sidekicks, the credit rating agencies.
This depiction is both natural and misleading. It echoes centuries of uneasy relations between political leaders and financiers in both Europe and the United States, which oscillate between excessive proximity and excessive antagonism – sometimes both simultaneously. From Friar Savonarola's anti-banker revolution in Florence in 1494 to Louis XIV's crushing of France's finance superintendent, Nicolas Fouquet, in 1661, to President Andrew Jackson's undermining of the Second Bank of the United States in 1833, this is a running theme of Western history.
At the same time, the anti-speculator rhetoric does not quite fit the facts of the euro crisis. Bond market investors are moved by fear more than greed. The problem now is that too few investors want to buy sovereign debt from the Eurozone periphery, and this "buyers' strike" is driven by economic and policy uncertainty, rather than by market manipulation at the hands of unethical private-sector participants. This is not to say that the financial community is immune from conflicts of interest or reckless risk-taking, but only that these are not at the core of the current crisis episode.
But the Chancellor's quip also mirrors specific tensions inherent in the institutions of today's European Union. EU integration not only creates a supranational decision-making machinery that is structurally hobbled by its democratic deficit. It also disempowers national leaders from levers of action on an increasing range of issues, including most financial market policies that are now mainly governed by EU legislation, and whose supervision will increasingly move to the recently-created European Supervisory Authorities. As political scientist Ivan Krastev has put it, Europe increasingly has policies without politics at the EU level, and politics without policies at the national level. This mismatch creates an unstable, accident-prone environment.
The effects are highly visible in the euro crisis. The current context puts at the center of EU decision-making a country, Germany, whose fiscal soundness bond investors have never been seriously in doubt in living memory. Germany also no longer has a world-leading international financial center on its territory, as its financial groups' wholesale market activities have largely migrated to London. And the German banking system is ridden with market distortions, idiosyncrasies and interdependencies with political structures at local level. As a consequence, most German policymakers lack financial crisis-management skills based on their own past experience. To the extent that they have a dialogue with the financial sector, their exchanges are predominantly with bankers rather than with bond investors; and these bankers have powerful specific interests of their own, which make their advice less than neutral.
In sum, German leaders' domestic policy framework and their fellow citizens' collective memories do not help them meet the current challenges of managing the euro crisis. Observers of European negotiations may argue that this is partly mitigated by France's input, to the extent that France's finance ministry appears to have maintained more financial acumen, as far as sovereign debt issues are concerned at least. Perhaps this is due to relatively recent recollections of being put under heavy market pressure as during the 1992-93 European currency crisis, as well as the experience that comes from chairing the Paris Club that coordinates rich countries' discussions of sovereign debt issues. But any such countervailing effect remains ostensibly insufficient to bridge the gap between the EU-wide issues that need resolution and the national political dynamics on which their resolution hinges. The recent weeks' confusing public communication by European leaders on Greek debt restructuring, reprofiling, rollover, and/or private-sector participation has caused more damaging market volatility than any mischievous rating downgrade could possibly trigger.
For policy decisions to be rational, one would expect that European leaders acting at the EU level should take into consideration every stakeholder group that influences outcomes. But under the present institutions, the incentives are for them to focus on their home country's constituencies to the exclusion of all others. As long as this is the case, it is natural for German leaders to view bond investors as akin to hostile foreign powers, rather than as a group that needs to be somehow embedded into the decision-making process. From this point of view, the euro crisis is as much institutional as it is financial or fiscal, and this makes its eventual resolution all the more difficult.
Nicolas Véron is a senior fellow at Bruegel in Brussels and a visiting fellow at the Peterson Institute for International Economics in Washington.