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Tuesday, 29 July 2014

The EU deserves a Nobel Prize for Literature

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Rather than peace, or even, at a stretch, economics, perhaps the European Union should get a Nobel Prize in literature, as it is a work of imagination, creation, and, at least for a time, the suspension of disbelief. This is not necessarily a criticism.

James Saft, Reuters Columnist

The Nobel Committee awarded the EU this year’s peace prize, citing what it said was the evolution from being “a continent of war to a continent of peace.”

That can’t be gainsaid, but what is also remarkable is the way in which, as we witnessed the knitting together of the euro area, rational people, investors who prided themselves on only acting in their own cold self-interest, failed to appreciate the underlying structural absurdities.

We bought it, we believed the story; and for the best explanation for how and why we must turn to Samuel Taylor Coleridge, who in 1817 described how an author can coax the reader into the “willing suspension of disbelief for a moment” by imbuing romantic characters and unlikely events with what he called “a semblance of truth.”

Big people were going to do big, important and good things and there was more money to be made going along for the ride than nitpicking.

How else do we account for all of those pension fund managers and investors who bet on narrowing interest rate differentials between Greece, Spain, Italy and Germany, despite easy to obtain and real indications that the players had both the ways and means to play one another for fools. And moreover, that the EU itself had no adequate protection against this. “Ode to Joy” was definitely playing in the background when they made those allocations.

How do you credit the unworkable halfway house of a common currency without common taxation and fiscal policy? How do you have a common central bank which is expressly forbidden from playing any central bank’s ultimate trump card: financing its government? How do you support a system in which banks rely on governments, governments on the central bank but the central bank, which is unelected, can neither fully support nor sanction its clients?

To do this participants had to, in essence, close their eyes and buy into a pleasant fiction, one which may have had peace as a byproduct but which was in no way grounded in economics, even if you define economics broadly as a very social science.

Big people were going to do big, important and good things and there was more money to be made going along for the ride than nitpicking.

Hard road

This tells us a lot about the psychology of financial markets, which can build confidence on confidence with little foundation. It tells us a lot less about the future of the euro area.

The EU, and with it the euro, is a fundamentally romantic notion and enterprise, and as such it is extremely difficult to judge what will happen from, as it were, outside the marriage.

Just consider, as we head towards this week’s EU summit, all of the huge uncertainty over what will be reformed, by whom, and even which countries will participate.

Greece, rapidly running out of money, will probably be unable to agree by the summit yet another package of measures with its sponsors at the EU, ECB and IMF. Germany and France are preparing to do battle yet again over austerity. Movement may happen towards a needed central framework of bank supervision, overseen by the ECB, but the workability of that is seriously undermined by the fact that ultimately banks are guaranteed by governments and ultimately, failing fiscal unity, governments can still pursue divergent policies.

This is only underscored by the somewhat embarrassing modesty of the proposal for a federal euro zone budget, which would only be used as a cushion and which is already opposed by Finland.

All of this is to say that the euro project faces huge and complex difficulties getting from where it is to some place where its continued existence in current form is not in serious question. None of this is to say that won’t happen: as a romantic, and worthy, exercise it is less subject to the normal distribution of probabilities.

What is worrying though is Coleridge’s use of the phrase “for a moment” to modify “willing suspension of disbelief.” When I covered the European bond market in the run-up to and after the advent of the euro the structural problems which are now so plain were the obsession of a minority. The rest went along with the narrative. Now that the illusion is punctured it will be much harder to get the majority to play along.

That may not be a full explanation of why the EU deserved the peace prize, but it is definitely why it got it.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)

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