So, after reading up on the Cyprus deal from the Financial Times, the Economist, and Quartz, I think I have a pretty good idea of what happened. Tyler Cowen isn't happy with the deal, and I can see why, but I don't think that means the deal won't stabilize things for a spell. My four quick takes: 

1) I've been pretty insistent that the most surprising thing about the aftermath to the 2008 financial crisis is how much global policy norms haven't changed. By and large the major economies are still rhetorically and substantively committed to trade liberalization, foreign direct investment, and a constrained role for the state in the private sector. The one exception? Capital controls. The earth has moved here, and the fact that this deal will require fair amounts of financial repression and cross-border controls is just the latest sign of this fact. 

From a normative perspective, I can't say I'm too broken up about this. It's not that I'm a huge fan of capital controls or anything. In the various policy trilemmas or unholy trinities that Dani Rodrik and others talk about, however, it strikes me that unfettered capital mobility is the policy preference with the least upside. And Cyprus does seem to be the fifth iteration of the lesson that countries that live by large unregulated offshore finance will die by large unregulated offshore finance. 

2) If the FT's Peter Siegel and Joshua Chaffin are correct, then the political backlash in Cyprus from this deal won't be that great: 

In Nicosia, political leaders generally greeted the deal as painful but necessary.

The city streets were quiet and peaceful, with most businesses closed for a public holiday.

Even before the agreement was clinched, most Cypriots had come to grips with the fact that the offshore financial business sector that has powered the economy since the Turkish invasion in 1974 would be but a shell of its recent self.

And as the Economist explains, the current Cypriot reaction is based on the fact that the new deal is a damn sight better for them than the previous deal:

On March 16th Cyprus’s president, Nicos Anastasiades, desperate to protect Cyprus’s status as an offshore banking model for Russians, had decided to save the two biggest banks and thus to spread the pain thinly. He would have applied a hefty tax to all depositors: 9.9% for those too big to be covered by the EU-mandated €100,000 deposit guarantee, and 6.75% for the smaller depositors.

But after a week of brinkmanship—including protests by Cypriots, the extended closure of banks to avoid the outrush of money, a failed attempt by Cyprus to throw itself at Russia’s feet, an ultimatum by the European Central Bank and an eleventh-hour threat by Cyprus to leave the euro zone—a different decision was made: to apply the pain much more intensely, but on a smaller number of large depositors.

Which leads me to....

3) So much for Russia as a counterweight to the European Union. Cyprus tried to realign itself closer to Moscow, but it didn't take. Furthermore, the new deal really puts the screws on the large deposits of Russian investors that have parked their money in Nicosia. As Felix Salmon explains: 

In the Europe vs Russia poker game, the Europeans have played the most aggressive move they can, essentially forcing Russian depositors to contribute maximally to the bailout against their will. If this is how the game ends, it’s an unambiguous loss for Russia, and a win for the EU.

The Financial Times makes a similar point: 

One Moscow businessman blamed the harsher haircut on the Kremlin, which he accused of failing to protect Russia’s interests, “thereby allowing the Germans to bully Cyprus and thousands of Russian depositors”.

“As soon as the EU saw that Russia was not going to protect its citizens, the confiscation of Russian money in Cyprus was pushed by the EU. All that was necessary for Russia to do was to provide €2.5bn secured by Cyprus’s nationalised assets,” he said.

With Xi Jinping's visit to Moscow, there's been a lot of chatter about "rise of BRICS" and "Russia turns East" and "SCARY!! SCARY!!" Bear in mind, reading all of this, that Moscow couldn't budge the ostensibly enervated EU from its position on the EU member with the closest ties to Russia. 

[Can't Russia just mess with the Europeans on energy?--ed. Um... no. Sure, they could try to do that, but the long-run implications of that move for Russian exports ain't good. To paraphrase an old Woody Allen joke, Russia might find its economic relationship with the European Union to be totally frustrating and irrational and crazy and absurd... but Russia needs the eggs.]   

4) What I said about Cyrprus last week still seems to hold for this week. So I guess this means Cyprus now falls under the "good enough" global governance category, with the caveat that this involves eurozone officials, so "good enough" here is defined down to mean "managed not to wreck the rest of the global financial system."

Am I missing anything? 

A little more than a year ago I blogged that global policymakers had reached a "focal point" moment on the merits of austerity as a macroeconomic policy during a global recession. Namely, central bank authorities had concluded that the policy doesn't really work well at all. If true, this was a big deal. One could argue that from the May 2010 Toronto G-20 summit to the end of 2011 was a period where the austerity policies were widely touted and occasionally implemented. If this was the wrong policy, and there was a shift, that's kind of a big deal.

So where are we now on this? 

On the public commentary side, I'd say we're approaching near-consensus on the failures of austerity for large economies. The passing of time has allowed for a comparative look at the data, and the results are not pretty for austertity enthusiasts. Martin Wolf sums up the indictment rather neatly, riffing off of a paper by Paul De Grauve and Yuemei Li: 

[T]he chief determinant of the reduction in spreads over German Bunds since the second quarter of 2012, when OMT [the ECB pledge to open up its monetary taps] was announced, was the initial spread. In brief, "the decline in the spreads was strongest in the countries where the fear factor had been the strongest."

What role did the fundamentals play? After all, nobody doubts that some countries, notably Greece, had and have a dreadful fiscal position. One such fundamental is the change in the ratio of debt to gross domestic product. The paper makes three important observations. First, the ratio of debt to GDP increased in all countries even after the ECB announcement. Second, the change in this ratio turned out to be a poor predictor of declines in spreads. Finally, the spreads determined the austerity borne by countries.

On the policy output side, there's been a demonstrable but partial shift. In the past year, the European Central Bank, Federal Reserve, and Bank of Japan have rejected austerity policies in favor of greater levels of quantitative easing. Furthermore, contrary to the outright hostility developing countries directed at quantitative easing in the fall of 2010, the reaction to the past half-year of quantitative easing has been far more muted. When the latest G-20 communique said: 

Monetary policy should be directed toward domestic price stability and continuing to support economic recovery according to the respective mandates. We commit to monitor and minimize the negative spillovers on other countries of policies implemented for domestic purposes.

That was code for "hey, G-7 central banks, you gotta do what you gotta do. We get that."  Which is demonstrably different from yelling "currency wars", a meme that seems not to have caught fire this time around. 

Top central bank authorities have also been willing to speak truth to power -- in this case, GOP members of Congress. John Cassidy recounts Ben Bernanke's testimony from yesterday: 

Departing from his statutory duty of reporting to the Senate Banking Committee on the Fed’s monetary policy, Bernanke devoted much of his testimony to fiscal policy, warning his congressional class that letting the sequester go ahead would endanger the economic recovery and do little or nothing to reduce the country’s debt burden.

"Given the still-moderate underlying pace of economic growth, this additional near-term burden on the recovery is significant," Bernanke told his students, who included a number of right-wing Republican diehards, such as Senator Bob Corker, of Tennessee, and Patrick Toomey, of Pennsylvania. "Moreover, besides having adverse effects on jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run."

Translated from Fed-speak, that meant that congressional Republicans have got things upside down. Bernanke has warned before about the dangers of excessive short-term spending cuts. But this was his most blunt assertion yet that Mitch McConnell, John Boehner, et al. should change course. "To address both the near- and longer-term issues, the Congress and the Administration should consider replacing the sharp, frontloaded spending cuts required by the sequestration with policies that reduce the federal deficit more gradually in the near term but more substantially in the longer run," Bernanke said. "Such an approach could lessen the near-term fiscal headwinds facing the recovery while more effectively addressing the longer-term imbalances in the federal budget."

So does this mean some additional policy shifts? Alas, probably not. The consensus against austerity seems pretty strong on the monetary policy side of the equation. On the fiscal policy dimension, however, austerity remains the de facto policy for a lot of economies. This includes the United States, which is conventionally depicted as not having embraced austerity. The New York Times' Binyamin Appelbaum outlines the current fiscal austerity in his story today: 

The federal government, the nation’s largest consumer and investor, is cutting back at a pace exceeded in the last half-century only by the military demobilizations after the Vietnam War and the cold war.

And the turn toward austerity is set to accelerate on Friday if the mandatory federal spending cuts known as sequestration start to take effect as scheduled. Those cuts would join an earlier round of deficit reduction measures passed in 2011 and the wind-down of wars in Iraq and Afghanistan that already have reduced the federal government’s contribution to the nation’s gross domestic product by almost 7 percent in the last two years.

The cuts may be felt more deeply because state and local governments — which expanded rapidly during earlier rounds of federal reductions in the 1970s and the 1990s, offsetting much of the impact — have also been cutting back.

Federal, state and local governments now employ 500,000 fewer workers than they did on the eve of the recession in 2007, the longest and deepest decline in total government employment since the aftermath of World War II.

Total government spending continues to increase, but those broader figures include benefit programs like Social Security. Government purchases and investments expand the nation’s economy, just as private sector transactions do, while benefit programs move money from one group of people to another without directly expanding economic activity.

The reason for this split does not require rocket science. Monetary policy is a tool of politrically insulated central bankers. Fiscal policy is a tool for elected politicians. The public might dislike specific budget cuts, but damn if they don't love austerity in theory. 

So, in retrospect, I think early 2012 was a focal point -- but only for central bankers and commentators. As Cassidy notes, there remain elected politicians who are super-keen on austerity: 

Corker, a former builder who is a long-time critic of Bernanke’s expansionary policies, called him "the biggest dove since World War Two." Toomey, a former head of the conservative lobbying group Club for Growth, questioned whether the sequester would have any real impact on the economy. Bernanke shrugged off the criticisms, calmly and methodically laying out the realities of the situation.

Developing...

Walter Russell Mead shares my enthusiasm for the prospect of a transatlantic trade deal, though I fear he goes a bit overboard in his post: 

The mobilization towards an agreement reflects the changing landscape of global trade. If a deal emerges, it will allow the U.S. and EU more leeway to set the rules of the road for the industries that matter most to them....

This potential trade deal is also a further sign of the collapse of the movement toward global free trade. The new round of WTO negotiations is effectively dead, and a major deal between two of the world’s largest economies would be a further signal that bilateral negotiations are once again becoming the norm.

Finally, this deal shows us that the BRICs are not quite as influential as many think. A U.S.-EU trade deal is essentially a way to ignore countries like Brazil and India while crafting rules that will govern some of the high-tech industries and information-based services that play a growing role in US-EU trade.

Mead is correct to point out the advantages of the US and EU trying to craft an FTA template, particularly for the sectors they care about a lot.  Still, a few quibbles and disagreements. 

First, a transatlantic deal doesn't signal a "collapse of the movement toward global free trade" -- it signals a different pathway towards that goal.  The collapse of Doha suggests that the traditional multilateral round negotiaions are dead, but it's worth remembering that the global economy got very close to zero barriers in the late 19th century and there was nary a multilateral institution to be found.  True, the trade agreements of the 19th century had most-favored nations clauses and their 21st century counterparts do not.  Nevertheless, the political economy of trade diversion still generates competitive incentives for a growth in FTAs, thereby leading to a similar end outcome -- a world blanketed in free-trade agreements. 

Second, contra Mead, I'd suggest that a transatlantic trade deal is not a sign of US-EU strength, but rather its weakness.  There have been rumblings and trial balloons to do something like this for the past fifteen yewars, but it never really got off the ground.  The reason it never got off the ground was simple -- both Americans and Europeans were worried that any trade deal this massive would scupper the WTO system.  It would seem like a developed country effort to completely rewrite the rules of the global trading game.  Since everyone had a lot of skin in the WTO game, it didn't seem like it would be worth it. 

Two things have changed.  First, the traditional method of multilateral trade liberalization has died.  Second, while both the US and EU are major trading states, they're not quite as pivotal as they used to be.  Ironically, it's their declining (though still appreciable) importance in global trade that makes a US-EU agreement feasible now.  The BRIC economies are now sufficiently large that a transatlantic trade deal doesn't seem like an existential threat. 

Developing....

As China gears up for its 18th Party Congress and the trial of Bo Xilai's wife Gu Kailai on charges of murdering a British business partner, there have been accompanying press stories (even from the Chinese press) about the opaque nature of the Chinese regime. For example, consider this Edward Wong and Jonathan Ansfield New York Times front-pager about the relationship between China's civilian leadership and the People's Liberation Army: 

During a holiday banquet for China's military leadership early this year, a powerful general lashed out in a drunken rage against what he believed was a backhanded move to keep him from being promoted to the military’s top ruling body.

The general, Zhang Qinsheng, vented his fury in front of President Hu Jintao, according to four people with knowledge of the event. At the banquet, he even shoved a commanding general making toasts; Mr. Hu walked out in disgust.

The general’s tirade was one of a series of events this year that have fueled concerns among Communist Party leaders over the level of control they exercise over military officials, who are growing more outspoken and desire greater influence over policy and politics.

With China’s once-a-decade leadership transition only months away, the party is pushing back with a highly visible campaign against disloyalty and corruption, even requiring all officers to report financial assets.

“Party authorities have come to realize that the military is encroaching on political affairs,” said one political scientist with high-level party ties. “Although the party controls the gun, the expression of viewpoints from within the military on political issues has aroused a high level of alarm.” He, like others who agreed to discuss internal party affairs, spoke on the condition of anonymity because of fear of reprisals.

Now if you read the whole article, it's really not clear at all just how much of a problem this is.  We learn that Hu Jintao's relationship with the PLA is weak, even though he has engineered promotions of his favored generals (including, apparently, Zhang). We learn Ju's likely successor Xi Jinping allegedly has better ties to the military, but that Hu might keep control of the Central Military Commission for the next few years anyway. Oddly, we also learn that some PLA hardliners want to see China adopt a more liberal political model -- like Singapore. 

In other words, we know a bit more about the machinations than we do in, say, North Korea.  But we don't know much. 

Western readers are now likely clucking to themselves and thinking, "Man, am I glad that we don't have to live in a regime with that much political uncertainty and caprice." To those readers: Let's take a tour of Europe and the United States now, shall we? 

In Europe, there was a long WSJ front-pager about Italian prime minister Mario Monti and his efforts to push back against Angela Merkel's austerity policies.  The impresssion that was given in the beginning of the article is that Mnti was successful... and then we get to this: 

Mr. Monti didn't want Rome and Madrid to suffer the stigma of applying formally for aid or signing a list of policy demands written in Brussels, fearing this would undermine his public standing at home, as well that of his ally, Spain's premier Mariano Rajoy....

The evening before the [June EU Summit meeting], Mr. Monti hatched a plan to hijack the summit. Unless Ms. Merkel accepted his proposal on bond-market intervention by Europe's bailout fund, Mr. Monti would veto the growth pact -- stymieing Ms. Merkel in her parliament.

Italy had previously lobbied for the growth pact, so Mr. Monti's threatened veto -- announced just before Europe's leaders were due to sit down for dinner -- was a bombshell....

Mr. Monti's blockade lasted until 4 a.m., when leaders finally agreed to a text hashed out by their aides. It promised that Europe's bailout funds would be used "in a flexible and efficient matter" to stabilize the bond markets of vulnerable euro members.

It didn't go as far as Mr. Monti had originally wanted: Italy and Spain would still have to apply for any aid and sign a policy memorandum. But by planting the need to stabilize bond markets in the declaration, Italy had convinced Germany to recognize Italian reform efforts and pushed its approach for tackling the crisis into the spotlight.

An ebullient Mr. Monti spoke to reporters, claiming satisfaction for Italy and for Europe. A tired Ms. Merkel slunk off to her hotel.

German media and lawmakers were convinced their chancellor had buckled under Mr. Monti's pressure, granting Italy and Spain unconditional access to Germany's treasury. Her protestations later that morning that the fine print preserved the existing procedure for aid went largely unheard.

So did Monti get what he wanted? Beyond political optics, I don't think so, but the article makes it unclear. Actually, to be fair, the summit declaration itself makes it unclear as well, as the Financial Times' Peter Spiegel explains: 

Last week’s signal from Spain’s prime minister that he may be prepared to request assistance from the eurozone’s €440bn rescue fund to drive down his country’s borrowing costs has shifted the debate back to where it was more than a month ago: What strings will be attached to such aid?

Eurozone leaders had hoped to put the question to bed during an all-night summit in late June, where Mario Monti, Italy’s prime minister, thought he had won agreement that new aid from the bailout fund to buy a struggling country’s bonds would come with few additional conditions.

Indeed, Herman Van Rompuy, who chaired the summit as president of the European Council, publicly declared there would “not be any more countries” subject to full monitoring if they sought bond-buying assistance from the fund, the European Financial Stability Facility.

The only conditions, Mr Van Rompuy said, would be living up to existing commitments under EU budget rules.

Even before the summit wrapped up, however, that conclusion came into dispute. Indeed, the summit’s final communiqué appears to contradict itself.

At one point, it asserts bond buying programmes would be executed “in a flexible and efficient manner” -- code words for light conditions sought by Mr Monti and his Spanish counterpart, Mariano Rajoy. But in another section it says such aid would only be granted under “existing guidelines” -- code words for the more onerous conditions that existed before the summit (emphasis added).

So I'm gonna say that the EU is not winning a lot of points in the transparency department right now. 

Well, there's always the United States, right?  Right? Oh, wait, what's this New York Times front-pager from Monday saying? 

A rising number of manufacturers are canceling new investments and putting off new hires because they fear paralysis in Washington will force hundreds of billions in tax increases and budget cuts in January, undermining economic growth in the coming months.

Executives at companies making everything from electrical components and power systems to automotive parts say the fiscal stalemate is prompting them to pull back now, rather than wait for a possible resolution to the deadlock on Capitol Hill....

All told, the political gridlock in the United States, along with the continuing debt crisis in Europe, will shave about half a percentage point off growth in the second half of the year, estimates Vincent Reinhart, chief United States economist at Morgan Stanley.

More than 40 percent of companies surveyed by Morgan Stanley in July cited the fiscal cliff as a major reason for their spending restraint, Mr. Reinhart said. He expects that portion to rise when the poll is repeated this month.

“Economists generally overstate the effects of uncertainty on spending, but in this case it does seem to be significant,” he added. “It’s at the macro- and microeconomic levels.”....

In Washington, powerful business lobbies like the National Association of Manufacturers, the Business Roundtable, and more specialized groups like the National Electrical Manufacturers Association have grown more vocal about their frustration with the inaction of Congress, and the possible dangers ahead.

“It’s totally irresponsible and absolutely insane,” said Evan R. Gaddis, the president of the electrical manufacturers’ group. “The two parties are really dug in. Companies see the writing on the wall and business decisions are now being made on this.”

Sure, China is an opaque mess when it comes to governance. Sure, praising China's governance in an uncritical fashion should trigger critical blowback. Let's face it, however -- 2012 is not a year for democracies to be crowing about how their governing model is more transparent. 

Yesterday, in commenting on the eurozone crisis, Barack Obama said the two words all political scientists hate to see: 

"Europe is wealthy enough that there's no reason why they can't solve this problem," Obama told reporters at the White House.

"If they muster the political will, they have the capacity to settle markets down, make sure that they are acting responsibly and that governments like Italy are able to finance their debt." (emphasis added)

By and large, political scientists hate the concept of political will.  As I've said numerous times on the blog, "political will" is usually tantamount to saying, "if only politicians would completely ignore short-term political incentives and do the right thing!"  Or, to put a finer point on it, "if only politicians stopped acting like politicians!"  Because we as a profession tend to focus on structural forces and immutable preferences, "leadership" as a variable often (though not always) falls by the wayside. 

Looking at the latest EU summit/eurozone machinations, however, I'm beginning to wonder if we need to think about "first image" explanations for what just happened.  As the Wall Street Journal, Felix Salmon, Financial Times, Paul Krugman,  and Economist are all reporting, it was pretty friggin' disastrous.  Salmon provides the most complete autopsy -- here's a snippet: 

[A]nother half-baked solution is exactly what we got. Which means, I fear, that it is now, officially, too late to save the Eur ozone: the collapse of the entire edifice is now not a matter of if but rather of when.

For one thing, fracture is being built into today’s deal: rather than find something acceptable to all 27 members of the European Union, the deal being done is getting negotiated only between the 17 members of the Euro zone. Where does that leave EU members like Britain which don’t use the euro? Out in the cold, with no leverage. If the UK doesn’t want to help save the euro — and, by all accounts, it doesn’t — then that in and of itself makes the task much more difficult.

But that’s just the beginning of the failures we’re seeing from European leaders right now. It seems that German chancellor Angela Merkel is insisting on a fully-fledged treaty change — something there simply isn’t time for, and which the electorates of nearly all European countries would dismiss out of hand. Europe, whatever its other faults, is still a democracy, and it’s clear that any deal is going to be hugely unpopular among most of Europe’s population. There’s simply no chance that a new treaty will get the unanimous ratification it needs, and in the mean time the EU’s crisis-management tools are just not up to dealing with the magnitude of the current crisis.

The fundamental problem is that there isn’t enough money to go around. The current bailout fund, the European Financial Stability Facility, is barely big enough to cope with Greece; it doesn’t have a chance of being able to bail out a big economy like Italy or Spain. So it needs to beef up: it needs to be able to borrow money from the one entity which is actually capable of printing money, the European Central Bank.

But the ECB’s president, Mario Draghi, has made it clear that’s not going to happen. Draghi is nominally Italian but in reality one of the stateless European technocratic elite: a former vice chairman and managing director of Goldman Sachs, he’s perfectly comfortable delivering Italy the bad news that he’s not going to lend her the money she needs. He’s very reluctant to lend it directly, he won’t lend it to the EFSF, and he won’t lend it to the IMF. Draghi has his instructions, and he’s sticking to them — even if doing so means the end of the euro zone as we know it.

So, what explains this mess -- the inexorable structural problems of the European Union, or the lack of political leadership?  At this point, I'm genuinely uncertain.  For example, the facile explanation for British Prime Minister David Cameron's rejection of an EU treaty is catering to his domestic interests -- namely the British financial sector.  Then, however, we get to this bit from the Economist: 

After much studied vagueness on his part about Britain's objectives, Mr Cameron's demand came down to a protocol that would ensure Britain would be given a veto on financial-services regulation (see PDF copy here. The British government has become convinced that the European Commission, usually a bastion of liberalism in Europe, has been issuing regulations hostile to the City of London under the influence of its French single-market commissioner, Michel Barnier. And yet strangely, given the accusation that Brussels was taking aim at the heart of the British economy, almost all of the new rules issued so far have been passed with British approval (albeit after much bitter backroom fighting). Tactically, too, it seemed odd to make a stand in defence of the financiers that politicians, both in Britain and across the rest of European, prefer to denounce....

Britain may assume it will benefit from extra business for the City, should the euro zone ever pass a financial-transaction tax. But what if the new club starts imposing financial regulations among the 17 euro-zone members, or the 23 members of the euro-plus pact? That could begin to force euro-denominated transactions into the euro zone, say Paris or Frankfurt. Britain would, surely, have had more influence had the countries of the euro zone remained under an EU-wide system.

As for Merkel, well, my take on her leadership style has been documented already.  She's dealing with an opposition that is castigating her for not taking swifter and more drastic action to resolve the eurocrisis.  In response, she's pushing for changes that will take months, if ever, to accomplish -- and, if they are accomplished, have no guarantee of actually solving the problem.  It doesn't seem like the eurozone has that time. 

As for Draghi, well, one could attribute his range of half-hearted measures to his excessively cautious leadership -- after all the ECB is an ostensibly independent institution, so presumably Dragh has the greatest amount of autonomy.  It's not that simple, however -- Draghi wouldn't have been selected as the new ECB head unless he demonstrated the kind of policy traits that made him acceptable to Germany in the first place.  Oddly enough, although Draghi currently has the most freedom of action, the structures that ensured he would become the new ECB head ensured he would be the least likely person to exploit that freedom. 

So, stepping back, there appears to be a role for the quality of political leadership as an explanatory factor for the current eurozone crisis.  Properly defining that role, however, is beyond the capacity of this blog post. 

What do you think? 

Hey, remember when about ten days ago I blogged that things were getting so bad in Europe that it was legitimate to bring up the 1930's?  What's happened since that seemingly hyperbolic warning? 

As Felix Salmon blogged earlier this week, the European banking system is headed towards a full-blown liquidity crisis.  Yields on Spanish and Italian debt are hovering around the 7% mark, which was the tipping point that forced Greece, Ireland and Portugal to seek assistance from the European Financial Stability Facility and the IMF.  Multiple European countries, including France, have had difficulty completing bond auctions this week.   

So it would seem that the European Central Bank needs to do something.  The New York Times, Wall Street Journal, and Financial Times all have lead stories today pointing out the enormous pressures that are being put on the European Central Bank this week.  We'll excerpt the non-gated NYT story to set things up: 

Only the fiercely conservative stewards of the European Central Bank have the firepower to intervene aggressively in the markets with essentially unlimited resources. But the bank itself, and its most important member state, Germany, have steadfastly resisted letting it take up the mantle of lender of last resort....

At issue is whether the bank has the will — or the legal foundation — to become a European version of the Federal Reserve in the United States, with a license to print money in whatever quantity it considers necessary to ensure the smooth functioning of markets and, if needed, to essentially bail out countries that are members of the euro zone.

Traditionally, and according to its charter, the European bank has viewed its role in much narrower terms, as a guardian of the value of the euro with a mission to prevent inflation. But as market unease has spread over the past two years, critics say the bank’s obsession with what they say is a phantom threat of inflation has stifled growth and helped bring the euro zone to the edge of a financial precipice.

With events threatening to spin out of control, the burden now rests on Mario Draghi, an inflation fighter in the president’s job at the bank barely two weeks who surprised many economists by immediately cutting interest rates a quarter point.

This morning, however, in his first speech as the head of the ECB, Draghi pivoted and redirected the pressure back at the politicial stewards of the EU:

National economic policies are equally responsible for restoring and maintaining financial stability. Solid public finances and structural reforms – which lay the basis for competitiveness, sustainable growth and job creation – are two of the essential elements.

But in the euro area there is a third essential element for financial stability and that must be rooted in a much more robust economic governance of the union going forward. In the first place now, it implies the urgent implementation of the European Council and Summit decisions. We are more than one and a half years after the summit that launched the EFSF as part of a financial support package amounting to 750 billion euros or one trillion dollars; we are four months after the summit that decided to make the full EFSF guarantee volume available; and we are four weeks after the summit that agreed on leveraging of the resources by a factor of up to four or five and that declared the EFSF would be fully operational and that all its tools will be used in an effective way to ensure financial stability in the euro area. Where is the implementation of these long-standing decisions?

The truly scary thing is that, given the state of the Italian and Spanish bond markets, even the full EFSF won't be enough to calm markets down. 

And so the pressure gets redirected back to Germany, as the most powerful actor in the ECB and EU.  As Matthias Matthijs and Mark Blyth explain in Foreign Affairs, however, Germany has not been reading its Charles Kindleberger:

In order to guarantee the strength of any international economic system, Kindleberger explained, a stabilizer -- only one stabilizer -- needs to provide five public goods: a market for distress goods (goods that cannot find a buyer), countercyclical long-term lending, stable exchange rates, macroeconomic policy coordination, and real lending of last resort during financial crises. The United States did not supply these things in the 1930s. Germany fails the test on all five items today.

First, rather than providing peripheral countries with a market for their distress goods, the Germans have been enthusiastically selling their manufactured goods to the periphery. According to Eurostat, Germany's trade surplus with the rest of the EU grew from 46.4 billion euro in 2000 to 126.5 billion in 2007. The evolution of Germany's bilateral trade surpluses with the Mediterranean countries is especially revealing. Between 2000 and 2007, Greece's annual trade deficit with Germany grew from 3 billion euro to 5.5 billion, Italy's doubled, from 9.6 billion to 19.6 billion, Spain's almost tripled, from 11 billion to 27.2 billion, and Portugal's quadrupled, from 1 billion to 4.2 billion. Between 2001 and 2009, moreover, Germany saw its final total consumption fall from 78.5 percent of GDP to 74.5 percent. Its gross savings rate increased from less than 19 percent of GDP to almost 26 percent over the same period.

Second, instead of countercyclical lending, German lending to the eurozone has been pro-cyclical. Indirectly (through buying bonds) and directly (by spreading its exchange rate through the euro), the country has basically given the periphery the money to buy its goods. During the economic boom of 2003-2008, Germany extended credit on a massive scale to the eurozone's Mediterranean countries. Frankfurt did quite well for itself. "European Financial Linkages," a recent IMF working paper, reveals that in 2008, Germany was one of the two biggest net creditors within the eurozone (after France). Its positive positions were exact mirrors of Portugal, Greece, Italy, and Spain's negative ones. Of course, as the financial crisis began to escalate in 2009, Germany abruptly closed its wallet. Now Europe's periphery needs long-term loans more than ever, but Germany's enthusiasm for extending credit seems to have collapsed.

And what about the third public good, stable exchange rates? By definition, the euro gives the countries that choose to join it a common external float, the credibility that comes with banking in a potential global reserve asset, and the credit rating of its strongest member. This is both true and where the problems begin. At the core of the eurozone lies a belief that, if countries adhere to a set of rules about how much debt, deficit, and inflation they can have, their economies will converge, and the same exchange rate will work for all members. This is true in theory, but only so long as countries obey the rules. And, despite being the author of many of those rules, Germany showed a singular lack of leadership and responsibility when it came to following them. When it broke the Stability and Growth Pact (SGP) in 2003, it sent the signal to the smaller countries that fiscal profligacy would go unpunished. The result was heightened public sector borrowing and increased public spending. Germany's enthusiastic lending to the periphery only exacerbated the problem.

Fourth, economic health requires the stabilizer to coordinate macroeconomic policy within the system. In this domain, Germany failed spectacularly, by insisting that the rest of the world follow its peculiar ordoliberal economic philosophy of export-oriented growth. By ignoring long-established ideas such as the Keynesian "paradox of thrift" or the "fallacy of composition," Germany is advocating a serious dose of austerity in the European periphery without even a hint of offsetting those negative economic effects with stimulus or inflationary policies at home. German growth, after all, was partially fueled by demand in Southern Europe (made possible by excess German savings). By the iron logic of the balance of payments, one country's exports are another country's imports and one country's capital inflows are another's capital outflows. So, the eurozone as a whole cannot become more like Germany. Germany could only be like Germany because the others countries were not. Insisting on ordoliberal convergence is guaranteed to produce economic instability, not stability.

Finally, Kindleberger would want Germany -- or, rather, the ECB, which is dominated by Germany -- to act as a lender of last resort by providing liquidity during the current crisis. Germany instead insisted on IMF conditionality for the bailout countries and on severe fiscal austerity measures in exchange for limited liquidity, thus failing Kindleberger's final test. The most obvious example is German obstinacy against letting the ECB play the role that the Federal Reserve played in the United States in 2008 and 2009. By lending heavily, the Fed was able to arrest the United States' slide into despair. Only a couple of days ago, Jens Weidmann, the president of Germany's powerful Bundesbank, flat-out rejected the idea of using the ECB as "lender of last resort" for governments, warning that such steps "would add to instability by violating European law." It is hard to see how yet one more violation of European code will add significantly to the already horrendous levels of instability, when brushing democracy aside is considered good for the euro.

It looks as if there's a plan in the works for the ECB to do a legal end-around by loaning money to the IMF and then having the Fund loan to the GIIPS economies.  If that happens, however, it won't be announced until next month.  And the way credit markets are playing out right now, I'm not sure the eurozone has that much time.

Now is usually the point in the post at which the instinct to provide some sweeping narrative about the state of the eurozone -- a la David Brooks -- is very compelling.  What's the point, however?  The eurozone is in contagion mode right now, which means it doesn't matter which countries were virtuous and which countries weren't during the last decade of binge borrowing.  They're all on the same sinking ship, and the Merkel Algorithm seems to be playing out again. 

Developing.... in a way that truly scares the living crap out of me. 

My latest Bloggingheads diavlog is with NSN's Heather Hurlburt.  We discuss Greece, Palestinian recognition, and the state of the foreign policy debate among the GOP 2012 candidates. 

Given those topics, be warned:  I might have been liberal in my use of profanity in the diavlog below.

Enjoy!

[NOTE:  the following reads much better if you read it using the voice of Rod Serling!--ed.]

There's a subtle art to reading broadsheet American journalism.  Reporters strain for objectivity, and in the process, strain to avoid anything that smacks of the prejorative.  If you squint real hard at the text, however, you can occasionally detect moments when the reporter is dying, just dying, to state their blunt opinion on the matter at hand. 

I bring this up because Liz Alderman of the New York Times, in her story on the possibility of a big deal in Europe to enlarge the European Financial Stability Facility, appears to be ever-so-subtly banging her head against her keyboard: 

The rally in American stock markets was set off by a report late Tuesday on the Web site of The Guardian, a British newspaper, that France and Germany had agreed to increase the size of the rescue fund — the European Financial Stability Facility — to as much as 2 trillion euros to contain the crisis and backstop Europe’s banks. But almost as soon as those hopes soared, European officials quickly brought them back to earth, with denials flooding forth from Brussels, Paris and Berlin.

This latest round of rumors and rebuttals about a European solution was a repeat of earlier situations. Such episodes have played out several times since the debt crisis intensified this year. Most recently, investors have been pegging hopes on a meeting of Europe’s leaders set for this coming Sunday in Brussels, anticipating that a comprehensive solution to the debt crisis might be unveiled (emphasis added).

Ms. Alderman has filed more than one story this week on this theme -- and she's hardly the only writer stuck in this rut. 

It would appear that Ms. Alderman has discovered that there is a fifth dimension of reporting, beyond that which is known to ordinary economic journalism. It is a dimension as vast as developed country sovereign debt and as timeless as currency itself. It is the middle ground between austerity and stimulus, between national sovereignty and supranational authority, and it lies between the pit of man's fears and the summit of his knowledge. This is the dimension of European political economy. It is an area which we call... the eurozone. 

Ms. Alderman is clearly yet another victim of.... the Merkel Algorithm.  And all I can say is, welcome to the club, Liz.  Welcome to the club. 

[WARNING:  THE FOLLOWING IS A VERY PESSIMISTIC GLOBAL POLITICAL ECONOMY POST] 

So, just to sum up the past week or so of global political economy events: 

1)  U.S. government debt got downgraded by Standard & Poor;

2) Global equity markets are freaking out;

3) The eurozone appears to be unable to solve its sovereign debt problem

4) London Britain is burning;

5) The Chinese are pissed that they appear to be underwriting downgraded, debt-ridden train-wrecks... and this is on top of being pissed about their own train wrecks.

This all sounds very 2008, except that it's actually worse for several reasons. First, the governments that bailed out the financial sector are now themselves the object of financial panic and political resentment. Second, the tools used to try and rescue the global economy in 2008 are partially to blame for what's happening right now. Despite all the gnashing of teeth about the Fed twiddling its thumbs, it's far from clear that a QE3 would actually stimulate anything besides a rise in commodity prices.

With both Europe and the United States unable to stimulate their economies, and China seemingly paralyzed into indecision, it's worth asking if we are about to experience a Creditanstalt moment.

The start of the Great Depression is commonly assumed to be the October 1929 stock market crash in the United States. It didn't really become the Great Depression, however, unti 1931, when Austria's Creditanstalt bank desperately needed injections of capital. Essentially, neither France nor England were willing to help unless Germany honored its reparations payments, and the United States refused to help unless France and the UK repaid its World War I debts. Neither of these demands was terribly reasonable, and the result was a wave of bank failures that spread across Europe and the United States.

The particulars of the current sovereign debt crisis are somewhat different from Creditanstalt, and yet it's fascinating how smart people keep referring back to that ignoble moment. The big commonality is that while governments might recognize the virtues of a coordinated response to big crises, they are sufficiently constrained by domestic discontent to not do all that much.

So... is this 1931 all over again?

There are three aspects of the current situation that make me fret about this. The first is the sense that developed country governments have already tapped out all of their politically feasible methods of stimulating their economies. This is the time when both politicians and voters start to ask themselves, "Why not pursue the crazy idea?"

The second is whether the Chinese government will do something to satiate their nationalist constituency. Neither Joe Nye nor James Joyner thinks this is likely, and I tend to agree that any effort at economic coercion will hurt China as much as the United States. When autocrats are up against the wall, however, then they might take risks they otherwise would never consider.

The third is this working paper on what causes societal unrest in developed economies (h/t Henry Farrell). The abstract suggests more trouble on the way:

From the end of the Weimar Republic in Germany in the 1930s to anti-government demonstrations in Greece in 2010-11, austerity has tended to go hand in hand with politically motivated violence and social instability. In this paper, we assemble crosscountry evidence for the period 1919 to the present, and examine the extent to which societies become unstable after budget cuts. The results show a clear positive correlation between fiscal retrenchment and instability. We test if the relationship simply reflects economic downturns, and conclude that this is not the key factor.

So... there are, unfortunately, numerous reasons to think that we're headed down a bad road... which is the pretty much point of this post.

Readers are encouraged in the comments to offer counterarguments for why things aren't as bad as 1931. I'll be offering some thoughts about why 1931 won't happen again later in the week.

Your humble blogger has not been contributing to the Osama-a-thon here at FP blogging all that much, because he was busy being a moosehead attending the 2011 Estoril Conference.  Many Important topics were covered at this conference, including: 

1)  The eurozone crisis;

2)  The global governance crisis;

3)  The crisis in the Middle East;

4)  Other global security challenges;

5)  The life and times of Larry King. 

It was that kind of conclave. 

Actually, that really doesn't do it justice.  Here's a link to the opening video.  Even that doesn't do it justice -- the opening ceremonies featured a sporano suspended 50 feet in the air, a gospel choir, a drum corps, and what I can only assume are the backup dancers for Lady Gaga's music videos. 

For a rundown of what the Big Cheeses said at the conference, check out my Twitter feed.  The major substantive takeaway I got from the conference is that Portugal would like to do a serious hurt dance on Fitch, Moody's, and Standard & Poor.  Half of the conference presenters were Portuguese, and most of the audience was as well.  Here is a sampling of the questions the Portuguese asked anyone talking about anything remotely related to economics: 

"Why do the bond rating agencies still influence markets after they failed so badly in 2008?"

"Shouldn't the bond-rating agencies be punished for their malfeasance last decade?"

"Aren't the bond-rating agencies to blame for everything bad that has happened since 2008?"

"What do you think of the idea of creating a European standard-ratings agency?"

"Say, has anyone thought about taking the heads of the bond-rating agencies and putting them in a duffel bag?" 

OK, I made that last one up, but not the others. 

Obviously, the Portuguese have very good reasons to be stressed out.  And the bond-rating agencies deserrve an awful amount of flack.  Still, the idea that they -- and they alone -- triggered both the 2008 financial crisis and Europe's sovereign debt crisis is absurd.  They are far more the symptom than the cause of the crisis. 

More blogging after my eyes adjust to not seeing Lady Gaga's backup dancers everywhere I turn the weekend. 

Hey, remember the rest of the world?

The Financial Times' Ben Hall and James Blitz  report on a surprising degree of defense cooperation between London and Paris:

David Cameron, British prime minister, and Nicolas Sarkozy, French president, hailed their summit in London on Tuesday as an unprecedented move towards closer integration between Europe's pre-eminent military powers brought on by budgetary austerity but also a closer alignment of the two countries' foreign policies.

They signed two treaties: one covering the sharing of technology used to maintain nuclear warheads and another on initiatives about conventional forces.

Mr. Sarkozy said the agreement to share a new research facility in France for the testing of nuclear warheads was testament to a "level of confidence between our two nations unequalled in history".

Until now, France and Britain have closely guarded the secrets of their nuclear deterrents, regarding them as the bedrock of their independence.

Mr Cameron said the two treaties would commit the French and British armed forces to working "more closely than ever before".

Paris and London also agreed to set up an "integrated carrier strike group", allowing each to fly combat aircraft from the other’s carrier once Britain has an operational ship equipped with its U.S.-built Joint Strike Fighter jets, by the beginning of the next decade. In the next 10 years, the French and British navies would centre co-operation on the Charles de Gaulle, France’s only carrier.

What's interesting about this is not the military effects -- in the end, this is about trying to do more with less -- but the political ones. In a world of austerity, there is some logic in close allies working together to eliminate redundant platforms and/or other fixed costs that could be pooled across countries. Furthermore, this kind of defense integration, once started, would strike me as very hard to reverse. 

This year has seen a lot of people predicting the end of the EU and NATO as Europe struggles with its economic misfortune. I wonder, however, if hard times are actually having the opposite effect of forcing European and NATO countries closer together. This might not be popular, but it's the only viable policy option in some instances.

This week Japan has provoked the ire of the United States and Europe by unilaterally intervening in currency markets to depreciate the yen against other major currencies. Japanese Prime Minister Naoto Kan has responded to these criticisms by telling the US and EU to go suck a lemon stating that further "resolute actions" would be taken on this front. 

This comes on the heels of mounting U.S. frustration with China's "go-slow" policy on letting the yuan appreciate against the dollar. [What do you mean by "go slow"?--ed. Let's put it this way: the tortoise thinks that China is being pokey on this question.]

So, is this the beginning of beggar-thy-neighbor? Will other countries start intervening in foreign exchange markets to gain a competitive advantage for their export sectors? 

The New York Times' Hiroko Tabuchi thinks not, because Japan can't unilaterally devalue its currency like in the old days:

It is unlikely, though, that intervention by Japan alone will sway currency markets in the long term. The global volume of foreign exchange trading has grown rapidly in recent years, which prevents intervention by a single government from countering bigger market trends.

Other countries are unlikely to help Japan’s cause, because they need to keep their own currencies weaker to bolster exports. A weak currency makes a country’s exports more competitive and increases the value of overseas earnings.

Much of the yen’s weakening came from investors selling the currency on expectations that the Japanese government would be more active in keeping the yen in check. Japan did not disclose how much it had spent in currency transactions, but dealers put the initial amount at 300 billion to 500 billion yen ($3.5 billion to $5.8 billion).

But as Switzerland found this year, a single government’s efforts to weaken its currency can prove futile. Switzerland abandoned that effort, after its central bank had lost more than 14 billion Swiss francs ($14 billion) in foreign currency holdings in the first half of the year, after a fall in the euro’s value ate into the bank’s reserves.

The Swiss franc is also seen by investors as a relative haven and has also strengthened amid global financial unrest. This month, the franc hit a record high against the euro.

Hmmm.... maybe. Japan's economy is much larger than Switzerland, so I'm not sure the comparison holds up. The real problem, however, appears to be that countries perceived of as "safe havens" wind up with overvalued currencies. 

This little parable also makes me wonder whether we might see beggar-thy-neighbor policies in a different guise this time around. This is going to sound a little crazy, but here goes: rather than explicit exchange rate intervention, what if countries decided to play fast and loose with Basle III and other measures to strengthen financial integrity? 

This really does sound crazy -- it suggests that governments would be willing to tolerate a higher risk of domestic banking collapse in order to avoide being a "safe haven" status for capital. That said, think of how much Europe benefited from the depreciation of the euro due to the Greek crisis. Basle III, by taking so long for banks to meet standards allow those countries with more insolvent financial institutions **cough** Germany **cough** to take their own sweet time in having them meet new capital adequacy standards.  This would allow Germany to have the euro stay relatively cheap without abandoning its anti-inflationary zeal. 

Now, in all likelihood, not even the Germans would purposefully do this. This is crazy talk. What I'm suggesting, however, is that there is more than one way for a country to have its currency depreciate, and these policies are substitutable. Looking only at explicit exchange rate intervention might be just a bit too narrow. And if more countries find more ways of keeping their currency undervalued, well then, the days of beggar-thy-neighbor would have arrived.

Developing....

Last week I predicted that, contrary to expectaions, the Greek crisis would force the European Union to abandon their "muddling through" approach to security regulation volcanoes everything under the sun economic policy and start some serious centralization.  Not that this was a great option -- but all the other options were even less palatable. 

So, did the weekend package confirm my hunch?  Well, Anne Applebaum seems to think so: 

Though the European Union has always required a partial surrender of sovereignty from its member states, Greece no longer has much sovereignty at all. IMF agreements also impose conditions, but the language is somewhat different: The indebted country requests help, the IMF responds. In this case, the EU has decided what Greece "shall" do. I don't believe anybody knew that the EU had so much power over its member states, least of all the Greeks.

Well, yes, but on the overall question of the centralization of eurozone decision-making, I think the weekend's events actually prove me wrong.   Indeed, this New York Times story by Steven Erlanger, Katrin Bennhold, and David Sanger suggests that the member states have managed to come up with yet a new way to muddle through without arrogating power to the Commission: 

Germany was insisting on a solution that involved bilateral loans from European member states, similar to the much smaller Greek bailout agreed to a week earlier. But countries like Italy and Spain feared that they would be unable to raise the amounts required and lobbied for loan guarantees on funds raised by the European Commission.

As the evening unfolded, Germany, Britain and the Netherlands all opposed the commission’s proposal to raise money on capital markets guaranteed by member states. The British and Dutch said the proposal was tantamount to giving a “blank check” to the European Union’s governing commission, according to a European diplomat who spoke on condition of anonymity.

Near midnight Sunday night, the talks appeared deadlocked, these participants said. “The deal is exploding,” read the text message of one French official to Paris, where Mr. Sarkozy was demanding regular updates and was pushing for a bigger agreement.

Then came the deal-making idea — put together, according to different officials from different countries, by the French, the Italians, the Dutch and a crucial German banker.

Axel Weber, the president of the conservative Bundesbank, who is favored to succeed Jean-Claude Trichet as the next president of the European Central Bank, suggested a mechanism for Europewide loan guarantees that finally won support from a reluctant German government during a midnight call, participants said.

The idea was for a new mechanism euphemistically called “a special purpose vehicle” — essentially eurobonds created by intergovernmental agreement among euro zone countries. That vehicle, supposedly to last only three years, would raise up to 440 billion euros on the markets with loans and loan guarantees, depending on the need.

The Germans, together with other northern Europeans like the Dutch, British and Austrians, insisted that the European Commission not control the vehicle but only manage it — in conjunction, as with the Greek deal, with the International Monetary Fund. The fund would provide discipline, as well as roughly one euro for every two from Europe.

The “special purpose vehicle” finally broke the French-German deadlock.

Yeah, about that special purpose vehicle:

[F]or all the excitement about the scale of the effort, it is important to remember that the core fund does not now exist. The fund, known as a special purpose vehicle, would raise money by issuing debt and making loans to support ailing economies. The European countries would guarantee that fund.

So the package is merely a commitment for the vehicle to borrow money if a large economy like Spain, which represents 12 percent of the output in the euro zone, asks for assistance. The International Monetary Fund is pledging 250 billion euros to support the effort. Sixty billion euros under an existing lending program pushes the total to near $1 trillion.

The fund is therefore more a theoretical construct than the Troubled Asset Relief Program that was created in the United States, and that is where things get tricky.

By definition, if Spain came to a point where it could no longer finance itself, interest rates would be on the rise. The several hundred billion euros for the fund would not only come at a high cost, but would bring additional pain to already indebted countries like Portugal, France, Italy and the United Kingdom, which back the special purpose entity, thus compounding the region’s debt woes.

So, in other words, because Germany and others don't want to transfer either real power or real ability to borrow to the European Commission, the result is a jerry-rigged bailout fund that has some disturbing dynamics if things go further south.    

We'll see how the markets respond in the coming days and months.  For everyone's sake, I hope I'm wrong and the EU can muddle through.  But my fear is that this strategy is not going to be viable for that much longer. 

Steve Walt is pessimistic about the future of the European Union: 

There are in theory two ways that the EU could go in response to these events. One possibility is that these recent failures will eventually prompt a further expansion of all-European institutions.  This view is the modern version of old-style functionalism: if Europe needs certain institutions to work properly, it will eventually create them. 

The second possibility-which I'd deem more likely -- is that we have in fact seen the high-water mark of the EU project.  Nationalism is still alive and well in Europe, the Cold War is over and there is thus less need for unity against an external threat, Germany is gradually shedding its post-World War II reticence, and the consequences of over-expansion and excessive ambition have been fully exposed. I'm not saying the Union is headed for the dust-heap of history or anything like that (no bureaucracy goes out of business that quickly, especially when there are thousands of pages of laws involved), but a significant consolidation of power in the near future seems most unlikely.

Given that the EU Union has been one of the more interesting political experiments in recent decades, this is going to be fascinating to watch. Time for IR theorists to place their bets?

It's really in vogue to predict the downfall of the European Union, and for good reason -- they have had a truly awful 2010.  Steve, like any good realist, predicts the stalling out of the European project.  And he may very well be right. 

There are two things that hold me back from making a similar prediction, however.  First, the EU has had significant policy reverses in the past -- and the institution has always responded with further economic and political integration.  If I had said, the day after Black Wednesday, that the EU would create a single currency in less than a decade, all my realist IR friends would have bared their teeth in an effort to simulate laughter laughed.  Similarly, the failure of the EU constitution last decade did not deter the EU from creating new offices designed to centralize foreign policy coordination.  These offices haven't really been put to good use yet -- but new leadership could change that. 

Second, I'm not sure the eurozone can go backwards -- the common currency might be locked in.  There are suggestions that Greece needs to exit the eurozone for a spell, but there's no mechanism and/or infrastructure to make that transition (let me add here that the functionalist argument would predict that there should be a few departurues from the euro, for reasons that Paul Krugman laid out last Friday).  Since Greek debt is denominated in euros, and since I doubt the French and Germans will allow that debt to be devalued because it will kill their financial institutions holding Greek debt, Athens has strong incentives to stay in the euro fold. 

When going backwards isn't an option, and muddling through is no longer viable, the only thing left to do is move further along the integration project. 

It's entirely possible politics will get in the way of this -- but my 51/49 prediction is that come 2020, the European Union will look more centralized than it does today.  

What do you think?