I’ve watched the Eurozone’s “dance of death” with increasing disquiet. And this is in spite of the fact that I have had deep misgivings about the project from the very start. At the time of the Maastricht Summit (1991) I scarce believed that the EU’s politicians would be so unwise and careless of economic stability and prosperity to proceed with Economic and Monetary Union (EMU) given the structural disparities in the EU’s economies. After the debacle, turned salvation, of Britain’s eviction from the ERM in September 1992 I was even more certain the project would fail. And it is now failing as the gulf between the competitive northern Eurozone economies and the painfully uncompetitive southern ones is tearing the Eurozone apart.
When the Eurozone debt crisis blew up last year, the Europe’s politicians treated it as a temporary liquidity crisis. The strategy was to tide these countries over a “difficult period of financing” (blamed on the markets) with very large bailout loans, giving them time to rectify their public finances with a good dose of Germanic austerity and return to the financial markets to raise funds when normality returned. This strategy always involved wishful thinking and has already failed for Greece – and is also likely to fail for Ireland and Portugal. It was assumed as part of Greece’s May 2010 package that the country would return to the markets in 2012. Once it was clear that this was not on the cards, negotiations began for a second bailout and on 21 July a complex fudge of a package was unveiled, much to bemusement and bewilderment of some commentators. Greece wasn’t experiencing a liquidity crisis at all. Greece was insolvent. It couldn’t fully finance its debts, a situation exacerbated by its dreadful growth prospects.
Two aspects of the 21 July package have proved toxic in recent days. The first was the agreement to extend the remit of the Eurozone’s bailout fund (the European Financial Stability Facility) so it could provide pre-emptive financial support for countries in trouble (i.e. Spain and Italy), recapitalize the banks and buy bonds of troubled sovereigns. Perhaps the Eurozone leaders felt that this was “job done” as they headed for their holidays. But as hapless Commission President Barroso pointed out last week these “enhancements” of the bailout fund are not yet operational as they need to be ratified by the 17 individual member parliaments. (And they are on holiday.) In candid mood, he also confirmed that the bailout fund was “inadequate” to deal with any potential bailouts for Spain and Italy. Given that the probability of bailouts for these two countries was rising as he spoke, his statement was indeed courageous. Under these circumstances, no-one can believe that the Eurozone leaders have a real grip on events, why should the markets? The leaders are muddling through, bickering between themselves and shirking permanent solutions.
The second aspect was the “selective default” of Greece in which private bondholders are to take losses. If there were losses for Greece, the markets reasoned, so there could be losses for other vulnerable sovereigns in bailout situations – including Spain and Italy. Spanish and Italian bonds were duly sold, driving up yields to dangerous trigger levels and thus increasing the probability of bailouts.
The contagion of the debt crisis from Greece, Portugal and Ireland to Spain and Italy is extraordinarily dangerous. To get some sense of proportion Greece, Portugal and Ireland together account for about 6% of Eurozone GDP. Spain accounts for nearly 12% and Italy about 17%. In addition, Italy’s total government debt is the third biggest in the world after the US and Japan, reflecting years of overspending. It amounts to an eye-watering €1.8trillion, over 120% of GDP.
But what should the Eurozone leaders do to solve the Euro’s problems?
There are really only two basic options for a “permanent solution” to the travails of the Eurozone:
- The first is the development of a fully-fledged economic government, with Eurozone bonds, a Eurozone Treasury which can dictate tax and spending terms to the member states and large enough fiscal transfers from the better off north to the less well off south (including Ireland) to hold the fiscal union together. But, politically, this would surely be a non-starter. Germany and fellow “northerners” would baulk at the costs involved and the southern countries would find the loss of their sovereignty unacceptable.
- The second is an orderly division of the Eurozone into, say, two currencies: a northern euro for Germany and economic allies and a southern euro for the rest. The southern euro would then depreciate, giving a much-needed competitiveness kick to the southern economies. But the politics could prove intractable.
If these options are rejected as too politically difficult, then muddling through seems to be the policy option of default until there is a crisis. We can only speculate as to the precise nature of the crisis or indeed the outcome. Perhaps some countries, including Greece, would simply leave. Perhaps the whole currency would disintegrate and the legacy currencies would be disinterred – a messy end to the EU’s flagship project.
And what should Britain’s response be to this dysfunctional shambles? The plan to renegotiate the repatriation of certain policies whilst remaining a member of the EU appears to be back on the table. It is a complete non-starter. The clear choice, whatever happens to the Eurozone, is to leave the EU, negotiate a free trade arrangement (they’d love to have us, don’t believe anyone who says otherwise) and develop mutually beneficial bilateral agreements.