Monday, May 9, 2011

Crash of the Euro

Christian Reiermann, Spiegel Online, 5 May 2011. 

The debt crisis in Greece has taken on a dramatic new twist. Sources with information about the government's actions have informed SPIEGEL ONLINE that Athens is considering withdrawing from the euro zone. The common currency area's finance ministers and representatives of the European Commission are holding a secret crisis meeting in Luxembourg on Friday night.

This is very reminiscent of the crash of the Austrian Bank Credit-Anstalt, that some have argued is what brought the Great to the Great Depression.

Slouching Towards Utopia?: The Economic History of the Twentieth Century

-XIV. The Great Crash and the Great Slump-

Brad Delong

Austria's major bank, the Credit Anstalt, was revealed to be bankrupt in May 1931. Its deposits were so large that freezing them while bankruptcy was carried through would have destroyed the Austrian economy, hence the government stepped in to guarantee deposits. The resulting expansion of the currency was inconsistent with gold-standard discipline. Savers liquidated their deposits and began to transfer funds out of the country in order to avoid the capital losses that would have been associated with a devaluation.
In order to keep its banking system from collapsing and in order to defend the gold standard, the Austrian central bank needed more gold to serve as an internal reserve to keep payments flowing and an external reserve to meet the demand triggered by incipient capital flight. The Bank for International Settlements began to host negotiations to coordinate international financial cooperation.
It is possible that rapid and successful conclusion of these negotiations might have stopped the spread of the Great Depression in mid-1931. Austria was a small country with a population well under ten million. There was not that much capital to flee. A sizable international loan to Austria's central bank would have allowed it to prop up its internal banking system and maintain convertibility. A month later those whose capital had fled would realize that the crisis was over, and that they had lost a percent of two of their wealth in fees and exchange costs in the capital flight. Other speculators would observe that the world's governments were serious in their commitment to the gold standard, that the potential foreign exchange reserves of any one country were the world's, and thus that the likelihood of a speculative attack succeeding in inducing a devaluation was small.
Perhaps investors would then have begun returning gold to central banks in exchange for interest-bearing assets, would have begun to shrink down their demand for liquidity, and would have begun to boost worldwide investment. The Economist's Berlin correspondent thought that it might well have done the job:
It was clear from the beginning... that such an institution [as the Credit-Anstalt] could not collapse without the most serious consequences, but the fire might have been localized if the fire brigade had arrived quickly enough on the scene. It was hte delay of several weeks in rendering effective international assistance to the Credit Anstalt which allowed the fire to spread so widely.
We don't know because it was not tried. The substantial loan to Austria was not made. Speculators continued to bet on devaluation, investors continued to hoard gold, the preference for liquidity continued to rise, and investment continued to fall.
The substantial loan to Austria was not made because French internal politics entered the picture. At the beginning of his political career French Premier Pierre Laval had styled himself a politician of the left: the Clarence Darrow of France. But by the early 1930s he was shifting to the position of a strong nationalist. He blocked the proposed international support package for Austria, insisting that if France was to contribute France had to get something out of it. The price that Laval demanded was made up of a series of diplomatic concessions, most important of which was the renunciation of a prospective customs union with Germany. To Laval, playing the nationalist card in French politics, nothing that benefited Germany could be allowed by France.
I am not sure why DeLong lets the Austrian’s off the hook for the customs union issue.  Some have argued fairly convincing that this is what caused the crises in confidence in the first place.  The customs union was a gradualist approach to what Hitler did in a more aggressive way in 1938 with the Anschluss.

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