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Avalanche3 : 

Is the assault on the euro an 'unintended consequence' of the US toxicity bailout?

Posted on 14/07/10

Over a year ago, my commentary warned about

'the result of President Barack Hussein Obama’s policy of pouring some 4.5 Trillion dollars into the US system. The aim is to buy out toxic assets created by toxic financiers and decades of toxic government policy. The problem is that it is likely to have major unintended consequences for Europe. It is not clear whether the US administration has fully considered the non-US consequences … or even cares. That may sound harsh. But much of the origin of the crisis dates from this persistent Beggar my neighbour attitude. In fact the origin of the euro derives from wishing to avoid being taken for a ride by careless and self-serving US administrations'
Since then, some Europe governments and the euro have been under intense pressure. Some speak of the break-up of the euro, though this seems too often to come from over-hopeful speculators. It is rather like a purchaser of apples in the market who asks for as price reduction on the basis that he imagines one apple looks a little over-ripe. One should always distinguish between impartial analysts and greedy speculators whose wish-fulfillment brings massive rewards. 

How has the trans-Atlantic mechanism been working? When in the 1970s under President Richard Nixon, the US government unleashed the Federal Reserve printing press, a largely divided, weak Europe got the back-wash. The Community of Six each with their own currency could only complain separately at the dollar inflation. Nixon’s Treasury Secretary John Connally responded famously: ‘It is our currency, but your problem.’ Europe created the Euro to deal with their problem

The US dollar was long considered the world currency and the USA the world banker. That is why Europeans should keep a close watch on what is happening and how the debt drama will affect them. 

Recently the US administrations tried to replace 'toxic' assets of derivatives and sub-prime loans with newly-minted dollars from the Fed. As a consequence, the federal deficit has now risen more quickly than expected, touching 9.9 per cent of GDP already, according to the US Government Accountability Office. That is the largest since 1945. The Public debt-to-GDP ratio could reach and exceed the highest historical levels of 109 per cent by 2020. That is two years earlier than previous GAO estimates. 

The federal government is staring at 'an unsustainable growth in debt.' The GAO had already warned in 2007 that this could 'spiral out of control.' Previous projections by the GAO indicated that debt-to-GDP ratio would rise from 60 percent to 'only' 90 percent by 2020. The debt-to-GDP ratios would double by 2040 and double them again by 2060, reaching 600 percent by 2080. This crisis may be underestimated. Without effective remedial action, the USA could reach a debt-to-GDP level of 200 per cent by 2030. 

Toxic is merely a polite way of saying that a dishonest or fraudulent practice has been exposed. However, the new flood of dollars to help wash out fraudulent assets in the US economy is already having a major effect abroad. As the commentary here recalled such action has known deleterious effects on the European economy. More than two thirds of US dollars are held outside the US. When the Federal Reserve boosted its money supply it surged onto the external markets. It was looking for solid, non-toxic assets to avoid the same trap again. This wash of dollars has a major tsunami effect on what previously appeared as stable markets. 

That's when the PIGs, the suspect Mediterranean economies, came under extra scrutiny. Previously, Portugal, Italy, Greece and Spain had proudly boasted of their safe monetary credentials as euro-members. Why did they then become less secure? Statistical blemishes had previously been forgiven by some indulgent politicians in other euro-states. Now the search is on for what is real, honest, quality money. 

Consider a market trader selling apples. He has 27 apples to sell each week. The customers have 27 dollars with which to buy their fruit. The trader sets up a notice: 'A dollar an apple'. They are available on a first come first served basis. 

All of a sudden the buying group now have 80 dollars credit for apples. What happens? The trader immediately sets up several notices 'Top quality apples now only 5 dollars an apple'. Another says: 'Excellent quality apples only 4 dollars an apple'. 'Good quality apples for 3 dollars.' And so on. 

The Fed's money surge has an effect of differentiating the quality by expanding the price fork. This price fork accentuation was blunted before the money surge. It also sharpens the analytical skills of the potential purchaser (looking for profits). The surge no longer respects governmental quality labels on the apples but the buyer makes his own judgement. 

Why shouldn't he? The US administrations, specifically the party machines, were complicit fraudsters. Honest efforts in Congress to correct the looming disaster failed. Political oligarchies who should not be meddling refused to change their crony capitalism. The crisis deepened. Politics are discredited on both sides of the Atlantic. It is equally of no use for the apple trader to say that 'All my apples come from the top quality eurozone. Each is worth ten dollars.' Some of the European governments do run a clean shop. Others supported by party cartels are known to be playing tricks. 

The discriminating buyer sees through that con. Why spend extra money on an apparently rotten apple (where politicians have a finger on the scales) just because it has a eurozone label? He will avoid it or expect the seller to change the category and price. Despite the eurozone label, the purchaser can discern perfectly well for himself what is a quality product and what is corrupt practice.

Quality is not necessarily synonymous with something that has a government label or has the apparent approval of government. Why? because the label sometimes means that politicians and others are meddling where they should not be present. Nor are statistics necessarily reliable when they have the stamp of an international accountancy firm. Some do not smell too fresh. Reputations have to be earned. 

We can compare the concept of quality apples to supranational values. These are the Charter principles on which the European Community was founded. They are based on your neighbour's evaluation of your actions. 

Honest money is one example. Governments are not ignorant of honest money and honest accounting. Supranational values indicate that accepting bribes from the rich so they do not pay taxes is bad economics. Forcing the poor to take on the extra burden is also recognized as an abuse according to such supranational values. Accountants should know when the books are in order. They should be firm to resist any bribery or twisting of arms to make them give approval to accounts that are falsified. 

In the early post-war period most western European countries had huge debts, high inflation and not too many scruples. They needed to reconstruct and also to outdo their neighbours. They engaged in a game of competitive devaluations and beggar my neighbour policies. 

That started to change in 1950 with the creation of the European Community, (9 May 1950) and the European Payments Union, created on 16 September 1950. 

Robert Schuman, who had been one of the most active Finance Ministers, commended Switzerland for having a solid currency and sound values. 'The participation of a country with a solid currency, like Switzerland, encouraged the expansion of the volumes of trade and commerce by providing sound money in the circuits of multilateral purchases. Everyone gained from this, without risks or sacrifices.' (Pour l'Europe, p130). 

For Schuman Switzerland was a model for Europe. It was not only a community of peoples and cantons based on geography but a community based on shared values and traditions. It had the inspiration, self-discipline and leadership (that is many people of good character) who acted in the long-term interest. Such achievements do not come from egotistical autocrats -- something that the Swiss opposed over the centuries. 

To create a European Community with sound money requires that all governments, people and associations have self-discipline or if not at least have the will to submit themselves freely to community supranational values. Good money is based on mutual trust. 

In community economics supranational values also clarify that the concept of 'Beggar my neighbour' is no longer acceptable. We are all each other's neighbour. In a globalised world we are all connected more and more. 

The unforeseen consequences of bad practice in one country reverberate worldwide. Successive US governments set themselves on the same toxic road as Enron. This energy firm tried to hide its bad debts in off-shore companies. The US did the same thing when it decreed that the poor should have access to mortgages they could not conceivably repay. 

The crucial question was where to hide the debts. This was a political decision, not an economic one. The politicians calculated that those who benefited from these crooked property loans would surely vote for them. They could also cream off some of the takings for party funds. Successive US administrations appointed pliable politicians to the bodies to enforce this unrealistic policy in the large mortgage firms. 

Politicians had the misconceived idea that that were on a higher plane or smarter than supranational values. Practically the whole American population went along with the scam. Why? Because they all thought they would gain something. The bubble felt fine while it was expanding. The property sector boomed. Businesses also expanded. Yet it defied logic. 

It was all patently false, starting with the giveaway term 'subprime loans'. Just about everybody was on the take. If the US public gave it some honest reflection to it, they knew that all this was a scam. The honest few said so. The politicians gained most of all. Their party coffers were filled from the 'crony capitalism.' 

Those mortgage-policy sellers who visited people and sold them deals knew there was little chance of recuperating the house-loan. It was a fairy tale. The house-buyers if they took any advice realised they really could not pay to the mortgage fairy. 

Others, whether businesses or individuals, profited indirectly from the property bubble. They had no reason, they said, to object. And above all the executives at the top and the politicians who knew all the figures were well aware that it was fraudulent. Who was kidding whom? 

When the Fannie Mae and Freddie Mac mortgage firms crashed out, as was inevitable, the politicians in Washington provided a means to bail them out. How? Out of public money. Who would pay the final bill if nearly the whole population was stealing from each other? 

They stole again via the Fed from the innocent, the voteless and speechless, the future generations, some yet unborn. And the foreigner.  

This nasty little bit of political corruption is not and cannot remain local. The neighbours across the Atlantic are also affected. Using public money to save political cronies in the USA now affects the whole world, and Europe in particular. 

This avalanche washed over into Europe. Europe's problems are correctable. Some Europeans had already learned their lessons: others are still learning. Competitive devaluations by accessing the monetary printing press bring no lasting solution. 

Europeans can act wisely. They have the freedom to choose how to correct their problems. So have the Americans. The secondary effect of the Obama avalanche is to test and prove whether the European governments are up to their job as honest guardians of the public good

Compare this to how some Mediterranean countries who for several decades have lacked the courage to set their house in order and who persistently apply bent practice have been differentiated recently. 

Europe is left with a clear choice. The Obama avalanche has contributed to the clarity. Europe can clean up its house or it can continue the old corrupt economics. This sad tale is not the only or even the main cause of Europe's monetary woes. 

It is hoped that we will return to this in the future.