The IMF’s latest downgrades to GDP forecasts made for gloomy reading but were wholly to be expected. As if to dramatise the gloom, the IMF said “the global economy is in a dangerous new phase. Global activity has weakened and become more uneven, confidence has fallen sharply recently, and downside risks are growing.” But even this negative prognostication depended on a number of key assumptions that may yet be unfulfilled, not least of all the containment of the Eurozone’s problems.
As the financial markets rollercoaster, there are increasing criticisms of the Eurozone’s leaders for their apparent dithering and lack of resolve when faced with the current sovereign debt crisis. US Treasury Secretary Timothy Geithner, for example, has called for Europe’s politicians to take stronger steps to prevent “the threat of cascading default, bank runs and catastrophic risk” if some European nations default on their debts. One has great sympathy with this sentiment, though there is an element of the kettle calling the coffee pot “sooty face” given the unedifying saga of the US Budget talks. Perhaps Mr Geithner did deserve the put-down from François Baroin, France’s new Finance Minister, who said that it was “very difficult for Americans to understand” how a currency could work with so many parliaments, adding that the US seemed to be having trouble with just one. But Mr Baroin should not be so complacent. The Euro is not working and, worse, its troubles are threatening global recovery and financial stability.
Of course, Greece remains the current focus of attention in the Eurozone. It is now all but a foregone conclusion that Greece will default on its huge and unaffordable debts. Even the normally diplomatic, bordering on the Trappist, central bankers seem to be breaking cover on this point. Klaas Knot, the president of the Dutch Central Bank and member of the ECB’s governing council, has speculated openly about a Greek default.
The Dutch, as one of the most creditworthy EU nations, are generally earning a reputation for speaking out about the shambles. Mark Rutte, the Dutch Prime Minister, declared earlier this month that profligate nations should leave the Eurozone. Putting aside the issue of the legality of countries exiting the currency union without leaving the EU (mind you, EU treaties are there to be broken), this suggests that European political “solidarity” is comprehensively fraying at the edges. Indeed it is now abundantly clear, if it were ever doubted, that national loyalties in the EU are stronger than any common European loyalty by many factors. There is no European “Demos” and there never was.
Where does the Eurozone go from here? Of course, there will be more sticking plaster. Greece, trapped in a downward spiral of falling GDP and an intensifying popular rejection of austerity, will remain on life support for some time yet. It needs the next tranche (€8bn) of the first IMF/EU bailout by mid-October if it is not to run out of money. It will probably get it. In the meantime the second Greek bailout package as agreed in July, along with the expanded powers of the European Financial Stability Facility (EFSF), is wending its weary and rather leisurely way through the Eurozone’s 17 parliaments. The Bundestag, Germany’s lower house, is due to vote on it next week (29 September), delayed by a week to accommodate the Pope’s visit.
But these policies do not get within shouting distance of a “permanent solution” for the Eurozone. There really are only two solutions. The first is 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 competitive northern countries to uncompetitive south to hold the fiscal union together. But, politically, this is a non-starter. The electorates of the northern countries will not accept the costs involved and the electorates of the southern countries will not accept the loss of sovereignty. Under these circumstances politicians cannot deliver. The second solution could be a “dual currency” or a similar orderly reconfiguration of the currency union which could prove sustainable. But the politics could prove intractable.
So what happens next? Greece will default, probably sooner rather than later, and may then head for the exit door. The real worry then is that a Greek default (and possible departure) could trigger panic elsewhere in the Eurozone as intimated by Mr Geithner. Given the depth of financial integration, the Eurozone offers scope for contagion on an epic scale. There could, almost certainly would, be contagion to Portugal, Ireland, Spain and Italy and concerns that they too will default (and possibly leave). And then there is the issue of banks’ losses, especially those of Greek and French banks, if Greece defaults. The Eurozone governments, either individually or collectively, must be prepared to support the area’s banking systems if the need arises. This may be unpalatable, it could well prove costly, but it is necessary.
It is impossible to know how the catastrophic and politically irresponsible experiment that is the Eurozone will eventually resolve itself. And it is quite impossible to know what the costs will prove to be. UBS offered some blood-curdling estimates recently as if to stiffen the resolve of those, metaphorically, at the tiller whilst the ship heads for the rocks. If Germany were to leave, they claimed it would incur costs worth 20-25% of GDP in the first year and then roughly half that amount in each subsequent year. If Greece were to quit, the first year cost would be 40-50% of GDP, and subsequent annual costs would be around 15%.1 I’m not sure I believe these figures. In fact I don’t. Economic history is littered with examples of fixed exchange rates that became unfixed and, though rarer, currency unions that became disunited. Even in the case of collapsing currency unions, the USSR comes to mind, the post-currency union countries eventually recovered well, though there was initially very significant disruption and hardship.
As one Herb Stein, a US economist noted for his aphorisms, said: “if something cannot go on forever, it will stop”. This surely applies to the Eurozone in its present configuration. Given the high probability of some sort of break-up, the key issue now is planning for this contingency. Such planning must surely be happening now in Berlin, Paris and Brussels, indeed throughout the Eurozone – and in London too.
1 Economist, “After the fall”, 17 September 2011.