From a small northwestern observatory…

I like Forbes magazine, and while I’ve only met Steve Forbes once, he’s seems to be a terrifically engaging fellow.  That having been said, while he and I are probably not very far apart in our core political thinking, I DO disagree with him on many key points (gold standard being the top of the list).  However, he wrote an excellent op-ed piece back in December about Angela Merkel and the actions/inactions which permeate European decision-making today.  Recent events, particularly in Greece, suggest that Ms. Merkel may have read Mr. Forbes and followed suit.  Nonetheless, I think some of Forbes conclusions may be ill-founded.  (For a full copy of his article, click here.)

Forbes draws an analogy between the European actions of this past Fall with the draconian anti-inflation actions of the last days of the Weimar Republic during the great depression.  Students of history may recall that those actions led to the fall of the German republic and the rise of Hitler.  Forbes suggests that Merkel is frightened of the inflationary impacts of European central banks buying up Italian and Spanish bonds (thus pumping lots of Euros into the economy).

Forbes points out that banking is very different in Europe than in the U.S.  He does not explicitly note — but seems to assume his readers would know — that Europe doesn’t have a system analogous to our Federal Reserve, but rather the major money-center banks serve that same purpose.  (In practice, the European banks are joined at the hip with U.S. banks, and thus have an implicit liquidity guarantee from the U.S. Fed.)  Forbes notes that liquidity is already strained in Europe, with U.S. money market funds having already withdrawn about $1 Trillion. In addition, European businesses look more to banks than bonds for raising long-term capital.  In the U.S., industrial bank loans to nonfinancial corporations totals about $1.1 Trillion, while in Europe the corresponding number is about $6.4 Trillion.  Contrast this with the bond market — in the U.S., corporate bonded debt is $4.8 Trillion, but only $1.2 Trillion in Europe.  European banks are also the primary buyers of European government debt, while in the U.S. the banks are only one set of many sets of buyers.

I think where Forbes misses the point in his criticism is his failure to recognize that liquidity for this bond-buying spree would come not from a central source such as a Federal Reserve system but rather from German taxpayers.  The Germans have bent over backwards already to bear the financial brunt of this crisis, mainly because they are apoplectic at the idea of the collapse of the Euro.

Forbes is also implicitly paying some homage to the Hamiltonian idea that a centralized, Federal Europe (which does not yet exist) could buy up bonds from member countries and issue a new “Euro Bond” which would take its place.  The first U.S. Treasury Secretary came up with this idea for two reasons — first, the individual states were heavily in debt to pay for the Revolution, and second it would create a much stronger central government, which would issue a uniform currency and raise money through Federal taxes.

However, Europe of 2012 isn’t nearly as well organized as the U.S. of 1790 (amazing, but true).  Plus, even if Angela and Nick (remember — Sarkozy gets a vote, too!) could wave Harry Potter’s wand and create a unified Federal Europe, the burden would still be borne disproportionately.  Northern European countries (and even Northern Italy, which is more like Germany than pundits recognize) are quite healthy with the status quo.  The peripheral countries (the “PIIGS” for short) are the principle problem right now.  Back in the 1790’s, the debts of the various states were actually fairly well-distributed.  (And yes, the irony of using Harry Potter as an example — a British wizard who still uses the Pound rather than the Euro — was on purpose.)

So, Forbes gets it half right.  The model we now see in Greece may be the answer — a compromise on the bonds, with fiscal restraints borne by the countries that are in trouble.  Will Europe ever see a Federal system with the same sort of fiscal and monetary controls we have here in the U.S.?  Probably not for a long time.  In the meantime, Angela has to play the cards she’s dealt, not the ones Forbes would like to imagine she has.