The global financial crisis has now hit Europe square in the face and, all of a sudden, this nascent continental superpower appears to have a chin far weaker than most thought.
The European Union was designed to create a strong trading zone of countries able to maximize each member’s industries, for mutual gains, in a global marketplace. Key to gaining cross-border industrial benefits was to fashion a financial harmonization that would eventually be crafted into a single market.
Fundamental to achieving this end was the formation of the Euro as the single currency, removing foreign exchange risks and making it easier for companies to grow across borders and produce a more flexible migration of workers. (The Euro was introduced across the European Union with the UK and Switzerland the biggest abstainers, mainly due to domestic concerns over independence.)
The EU’s political objective is now established as well—although it is very much work in progress. A complete harmonization of the European plan would impact businesses, cultures, and the way of life of everyone within the EU. If successful, the EU would be very well placed to compete on a global scale with other growing regions and probably would attract significantly more international business. However, the current financial crisis is putting an enormous strain on each member state.
The collective established within the European Union appears to be faltering under the strain of an unprecedented global financial crisis. We have seen the Irish go their own way to protect the customers of Irish banks, with similar situations occurring in Greece and Denmark. Heavyweight German economic regulators considered similar measures, but changed tack at the last minute, probably because of pressure from the UK and France. When the chips are down, it’s natural for countries to protect their residents, but this flies in the face of unity.
The European Central Bank (ECB) has proved powerless in this crisis. Each central bank in each state is taking its own unilateral action, leaving the ECB almost redundant. However, the worldwide reduction of interest rates agreed and acted upon recently shows how a coordinated focus can bring immediate benefits. Further actions of this type will eventually bring stability and allow the markets to settle at a new (albeit lower) level.
It’s worth making the point that there is a big difference between market volatility and the fundamental stability of global economies. Markets move by speculation and risk, while economies are slower to react and move more in line with inflationary forces and fiscal policies imposed by governments. For this reason, the billions of dollars that governments are pouring into supporting banks have little to do with the overall strength of markets, as the prices of shares in the banking sector may rise or fall with little linkage to the performance of other sectors as investors switch from one to the other. Governments must be cautious about pouring money into the markets as such actions can seem like casino bosses underwriting the losses of their biggest players. The players will simply continue to play harder betting more.
Each EU state should have deferred to the ECB for a central direction which, in turn, would have protected both states and the union. But in reality, each EU state and its central bank went its own way.
Even in the political arena, some EU states are wavering and looking to go their own way, like Ireland, where a national referendum recently rejected a revised Pan-European constitution. The Irish government also unilaterally offered their guarantee to customers of Irish banks—which suspiciously looks like both a security measure and a ploy to attract more customers into their banks from other EU states. I suspect the Germans were aiming to follow this move, until a hastily arranged clarification presentation by the German chancellor, early this week, suggested she’d been misunderstood by the media and the markets.
All this indicates how easily fragmentation can occur amid the fragile nature of the EU. Though the European dream is often trumpeted in Brussels, in reality, it lacks support on the ground. So far the European Union has been a success in some areas, but in many others has fallen short. For example, there is no harmonization of fiscal policies or of the many domestic barriers designed to protect member states’ businesses.
The economic crisis is attacking the weak areas of the European Union, which now finds itself engulfed in a global meltdown of the financial system. Markets and economies are under threat and individual governments are seemingly powerless, trusting as much to luck or relying on forces beyond their control. This is a time when the European dream will be tested to the full. But can countries look beyond self protection to the bigger global picture?
For the first time in the history of the financial markets, the solution to the problem lies outside of individual markets or governments. To stem the tide, there needs to be conformity of domestic actions that dovetail with international steps to find solutions, transcending normal adversarial politics and nationalistic tendencies.
Tax payers need to be informed and educated about the crisis. There will be a need to steel ourselves as we enter a new financial dark age. Forget foreign holidays and the second and third car; concentrate on building savings. Still, people must see decisive and informed leadership, or we’ll risk social unrest on a scale not seen since the 1930s. Community leaders, politicians, and the best economic brains need to come together and work through the problem.
No single solution will put confidence back into the financial system or rebuild the industry to prevent any repetition. The problems are not only with the market but also with the global economy. The volatility of oil prices, the growth of China and India, and political unrest in many parts of the world are all contributing factors– creating uncertainty and fear in institutions and individuals. Indeed, in the EU, there is a general uncertainty about how to forge trading agreements with China and India. In the absence of consensus, each European state is looking to build its own trade agreements rather than operating as a single market. This surely shows that the EU is a union in name only. When push comes to shove each state reverts to protectionism. But the global financial crisis is a perfect opportunity to examine the real unity of purpose that exists within Europe.
The EU should begin with new fiscal security measures, including national programs backing the banks of individual countries, using tax funds to guarantee loans to ease the interbank credit issues at the heart of the crisis. Once banks begin to deal with other banks with confidence, the credit freeze will thaw and the crisis should have a chance of being turned around. But protective measures by individual countries will not be enough, and, in the long term, unilateral measures will do untold damage. This is the time for a coming together and the eventual creation of a truly global financial system that recognizes the interdependence of markets and economies.
The first priority must be to prove that the European Union works in practice. The financial crisis is the first time the European Parliament in Brussels has had a chance to demonstrate leadership and give direction to each state, but more importantly to the population at large. It has not made a great start in this respect.
The speed at which this crisis has spread across the globe is directly due to the exposure local and national governments, and investing institutions, have to banks of all sizes. Many local councils in Britain, for example, had their money in Icelandic banks. Iceland is now verging on bankruptcy. What if there are no longer sufficient funds to afford such basic social services as collecting the rubbish and maintaining roads? Imagine the prospect of pot-holed, litter-strewn streets across Britain as the last vestiges of UK taxpayers’ funds evaporate in Iceland’s banks. As this nightmare unfolds, other bizarre global interlinkages will reveal themselves. This is where the EU can act: getting involved with matters of this kind and resolving cross-border disputes.
Likewise, there must be a resolve by governments around the world to set up new regulatory safeguards to protect the finance system. Tighter controls of risk capital would produce better housekeeping by banks, including requirements that they retain funds in safe accounts to protect their counterparties and clients. Banks should be required to stick to less complex financial products unless boards of directors can assure regulators that they have detailed knowledge of the products and systems in place to measure risk.
Beyond this, a review of compensation agreements should ensure banks and other financial services firms pay executives only based on realized profits—not paper appreciation. This alone will bring about some semblance of control and a return to banking sobriety. Such tough measures must also include a return to more ethical attitudes toward business, which would carry more weight if banks enforced sanctions on any lapses. Transparency of these actions would force people to adhere or risk ruin to their careers.
The EU has an opportunity to lead and should begin this process by introducing policies and legislation to rebuild the global finance system. As the new hub of international finance, successful implementation in Europe will overflow into other markets around the world.
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Gary Wright is founder and chief executive officer of B.I.S.S. Research, which supplies technology and service analysis to the global financial industry.