The parameters of the Eurozone crisis are really very straight forward. Investors are unwilling to buy Southern European Government bonds, partly because these Governments are manifestly over-borrowed but, particularly, because they perceive a major exchange rate risk, in due course, as these economies have become some 35% uncompetitive against Germany since the Euro was launched. This has happened, in part, because Germany has made particular efforts to exploit its position by making itself super-competitive within the Eurozone and, partly, because Southern European economies have not done this. Rather as they have become less competitive, their economic growth has dwindled to little or nothing, resulting in higher unemployment, higher Government spending and lower tax revenues. This is why Germany and “Germanic” Northern Europe are enjoying the biggest boom in jobs for 20 years, while Spain’s jobless has risen to 22.9% (with 48.7% for Youths) while Italian unemployment is lower at 8.8%, but climbing steadily.
There is, at least in theory, a European fiscal integration solution – making the Eurozone like the USA. This would require one Central Government debt borrower, (issuing Eurozone Bonds); a Central Bank which can buy and monetize Government debt on a limitless basis, and regular transfer payments from the prosperous to the less prosperous member countries to keep them afloat. It has been estimated that the required transfer payments would amount to some 35% of German GDP, p.a. It is clear that Germany is not just playing politics but is implacably opposed to all 3, as these would cost too much. Germany’s solution – to force major, internal devaluation on Southern European economies is both impractical and economic nonsense, reminiscent of the Gold Standard in the 1930’s. Starting from where we are, this would simply increase their fiscal deficits and borrowing requirement and drive their economies into downward spiral. Given that Germany is not willing to finance (or risk) real fiscal integration, she must face up to the need for these economies (and Ireland) to devalue.
But Germany is loath to do this, partly because it conflicts with its “European dream”, but, also, because this would be damaging to Germany – not only would her banks, pension funds and life companies lose substantial amounts on the Southern European Government Bonds they hold and Germany would have to re-capitalise the ECB – but, also, it would mean that Germany would lose its “China-like” competitive advantage in the Eurozone. The necessary currency adjustments/devaluations could be achieved by either Southern European economies returning to their own currencies (messy) or dividing the Euro into two currencies – a soft currency for Southern Europe and a hard currency for Northern Europe, as I have advised over a year ago.
Massive “money printing” injections from the ECB via cheap 3-year loans to Southern European banks, with which they purchase the Bonds of Southern European economies, merely “puts off the evil day” and increase the banking problems down the line yet further. Where we are now is that it looks increasingly inevitable that Greece will shortly default and be kicked out of the Euro; this will be followed by Portugal and, possibly, later on Ireland. The big issue is as to whether Italy and Spain can stay within the Euro. Their overall indebtedness (public and private combined) is not as bad as Greece, Portugal and Ireland, but, as evidenced by Spanish unemployment, their uncompetitiveness is a major problem which can only be addressed, in practice, by currency devaluations.
Behind all this there is, however, an even larger issue from which the UK is suffering. The fact is that the socialist, EU model has been an economic disaster, leading to sclerotic economic growth. Particularly with the rise of the BRICS, it is obvious that Europe, including the UK, are not attractive economies in which to do business, given the excessive regulatory costs, high taxation and top-heavy public sectors. The European companies which are performing well are those which have made major investments in more competitive parts of the world. If the UK economy is to return to growth and prosperity in the much changed world order, it is clear that it needs to escape from all of this and put itself on a more competitive “supply side” basis with the new, successful parts of the world.
It looks as if the coming major row between the UK and the EU will be about the EU’s attempts to damage Britain’s major industry – financial services. With this employing over 1 million people, contributing around £60bn of tax revenues and with an external surplus of around some £60bn (helping to pay for the Asian imports), it is self-evident that no UK Government can afford to see this industry materially damaged by EU initiatives. This was the real significance of the Prime Minister’s veto – he was putting down an extremely important marker. It follows that the UK must now needs consider how it will withdraw at least from those aspects of the EU which are condemning its economy to stagnation.