Humpty Dumpty cannot be put together again

A couple of interesting articles featuring George Soros in Friday’s Irish Times. They serialise an extract from The Soros Lectures where George argues that the current global financial system is broken – and can not be fixed, at least in it’s current form, he discusses the risk of a double dip recession (likely in 2011), the Euro and European integration – of particular significance as his hedge fund played a major role in the collapse of the original ERM. He argues that a divided West Germany was the driving force behind European integration. German reunification has left the European project without an engine and a half-baked currency Union.

In another article they report that Soros’ argues that “if member states cannot take the next steps forward, the euro may fall apart” and that “So makeshift assistance should be enough for Greece, but that leaves Spain, Italy, Portugal and Ireland. Together they constitute too large a portion of euroland to be helped in this way. The survival of Greece would still leave the future of the euro in question.” Although he does mention Ireland, and the ECB bailout of the Irish banking system coupled with the resounding second Lisbon vote as evidence that there is hope for the European project, and perhaps the world. After all if the European Union struggled act together to solve the the problems underlying the crises, and we have, what chance is there that global consensus can be reached and appropriate measures put in place?

There is a growing belief that the global financial system has once again escaped collapse and we are slowly returning to business as usual. This is a grave misinterpretation of the current situation. Humpty Dumpty cannot be put together again. Let me explain why.

The globalisation of financial markets that took place since the 1980s was a market fundamentalist project spearheaded by the US and the UK. Allowing financial capital to move around freely in the world made it difficult to tax it or to regulate it. This put financial capital into a privileged position. Governments had to pay more attention to the requirements of international capital than to the aspirations of their own people because financial capital could move around more freely. So as a market fundamentalist project, globalisation was highly successful; individual countries found it difficult to resist it. But the system that emerged was fundamentally unstable because it was built on the false premise that financial markets can be safely left to their own devices. That is why it broke down and that is why it cannot be put together again.

The point I am trying to make is that regulations must be international in scope. Without it, financial markets cannot remain global; they would be destroyed by regulatory arbitrage. Businesses would move to the countries where the regulatory climate is the most benign and this would expose other countries to risks they cannot afford to run. Globalisation was so successful because it forced all countries to remove regulations, but the process does not work in reverse. It will be difficult to get countries to agree on uniform regulations.

This can be seen in Europe. During the crisis, Europe could not reach a Europe-wide agreement on guaranteeing its financial system; each country had to guarantee its own. As things stand now, the euro is an incomplete currency. It has a common central bank but it does not have a common treasury – and guaranteeing or injecting equity into banks is a treasury function. The crisis offered an opportunity to remedy this shortfall but Germany stood in the way.

Germany used to be the driving force behind European integration but that was at a time when Germany was willing to pay practically any price for reunification. Today Germany is at odds with the rest of the world in fearing inflation rather than recession and, above all, it does not want to serve as the deep pocket for the rest of Europe. Without a driving force, European integration has ground to a halt.

Fortunately, Europe had the benefit of the social safety net. It was held responsible for holding down European growth rates in good times, but it served its purpose in the downturn and the recession in Euroland was less severe than expected. Now that the fears of an economic collapse have subsided, the EU is showing some signs of political revival. The ECB has effectively bailed out the Irish banking system and Ireland has resoundingly endorsed the Lisbon Treaty. So I may be too pessimistic about Europe.

No bio, some books worth reading – The Rational Optimist: How Prosperity Evolves – Matt Ridley .

Crisis Economics: A Crash Course in the Future of Finance -Nouriel Roubini, Stephen Mihm