Some commentators write about the disorderly collapse of the euro as if it would be an event somewhat more serious than the collapse of the ERM in 1992/3.
I regard it as an event somewhat less serious than the collapse of the Roman Empire.
Perhaps there could be a way of dissolving the euro, fairly rapidly, without inducing chaos and depression — the excellent Lord Wolfson clearly hopes so, and has offered a huge prize for the best suggestion. But what are the chances of Eurozone policymakers panicking and extending their four-year run of economic self-immolation? – sadly much higher than that they will, at the last, draw back and listen to sanity.
For the sad reality is that the vast majority of this problem is self-induced, current policies make it worse, and policy plans announced and floated double up the errors. To change course successfully now, policymakers would have to accept that virtually everything they have done these past four years has been a mistake. The loss of political face would be immense. And even if they did try to back out now, markets would assume that they would panic, again, at the first whiff of trouble and return to chewing off their own limbs – so even the path of restoration would be an extremely perilous one.
Until very recently I have been confident that, in the end, policymakers would see what had to be done to save the euro and would do it – once the Greeks had left. Now I fear otherwise, and am tempted by the speculator’s saying: “Stick a fork in it – it’s done.”
A disorderly collapse of the Eurozone would very probably induce a disorderly collapse of the European Union. We would see multiple sovereign defaults. There would be bank runs across much of Europe. Intra-European trade would collapse by perhaps a third. The UK economy would contract by perhaps a further ten per cent – and we would be amongst the least affected. Some governments would resort to the printing press, destroying their economies in a tidal wave of inflation. In other countries, nationalist and ethnic politicians would come to the fore, with populist tales of who was Guilty. Market-hating would go even further. The pictures of riots and burning buses would be from Paris and Amsterdam rather than Madrid and Athens. There would be a collapse of free movement of peoples, with stranded legacy populations becoming the target of hatred — don’t be a Philippoussis in Bohn, a Giovanni in Bratislava, or a Pereira in Brussels.
Perhaps the death knell of European cultural hegemony was sounded some time ago. But this would be its death rattle. Confidence in the ability of Europe to work together to form a cultural and economic counterweight to the US and China would be shattered.
There is still a way back, but a tough one. Policymakers need to understand that markets have not been getting things wrong these past four years. It has not been irrationality or wicked speculation. Rather, there were genuine risks. To accept this would obviously be a humiliation. But I suspect that, looking upon the markets, many Eurozone policymakers now secretly share Peter’s sentiment from Jesus Christ Superstar:
“I think you’ve made your point now / You’ve even gone a bit too far to get the message home / Before it gets too frightening, we ought to call a halt / So could we start again please?”
Policymakers need to comprehend how much their own actions are the problem, not the solution. Why have Italian bond yields rocketed recently? Italy has some sovereign debt, to be sure, but no more than it had in the 1990s, when it paid. And then it did not do so by inflating, or through especially rapid growth. And at that time the interest rates they had to pay on their debts were much higher than even recent elevated levels – some 8-12%. Why, then, the concern? I mention four reasons:
- Escalation in political tensions and in demands upon Germany make it increasingly likely that the euro will be destroyed in the medium-term as Germany leaves. If the euro collapses, then the New Lira would be likely to depreciate considerably against the New Mark, or there might even be Italian default. Selling Italian government bonds is a straightforward way of hedging against the risk of total euro collapse.
- Alternative ways to hedge, such as sovereign credit default swaps (CDS), have had their credibility seriously undermined by deliberate and explicit attempts by policymakers to prevent sovereign CDS being triggered in the case of Greece when it defaults – e.g. the 21% default agreed in July (when Italian bond yields started rising significantly) and the 50% default agreed a few weeks ago (which immediately triggered a large spike in Italian bond yields, as I happen to have said was likely the next day).
- In the Greek defaults, the loans given to Greece by Eurozone governments have been treated as senior to private debts – that is to say, even though Greece was defaulting on its private debts, it has not arranged to default on any of its debts to other Eurozone members. The consequence is that if Italy ends up being lent money by Eurozone members, the more such money is lent, then, if there were to be an Italian default, losses for private sector holders of Italian debt would be greater – so the yields rise.
- Even though in the 1990s Italy paid 8-12% on its debts, policymakers had started setting up detailed plans for huge €2tr-€3tr funds, so that Italy could be lent money by other Eurozone sovereigns instead of borrowing in private markets, at a time when Italian yields were only around 4.5%. The reasonable interpretation of this was that Italy would not be willing to pay 8-12% on this occasion, even though it had done so in the past, and so if yields started to rise towards that level it would resort to borrowing at lower rates from other Eurozone sovereigns. So the creation of the EFSF was a strong signal of reduced Italian will to pay. If it is less willing to pay, then it’s more likely to default and yields will rise. At the same time, the larger the burden on Germany through the EFSF, the more likely the whole euro project was to collapse as Germany withdrew — so see (1).
There is yet time to save this – just, alas I fear, not the will. Here is what I would recommend, would anyone listen:
- Embrace markets. Don’t fight them. Italy should stick to auctioning off its debts on schedule and eschew all short-selling bans and other anti-market measures (in recent days it has indeed done this). It should take no money from the EFSF or the IMF, and give no indication that it would consider doing so.
- The EFSF, along with all other schemes (e.g. Eurobonds, mass ECB purchases of Italian and Spanish bonds) intended to make Germany responsible for trillions of debts accumulated by other countries long before the euro even existed, should be abandoned.
- Governments should disentangle themselves from their banking sectors as quickly as possible (especially Spain and Ireland). Bailin procedures and depositor preference should be placed at-the-ready.
- Greece (and probably Cyprus) should exit the euro, and be left to its own devices. Finland, Slovakia, and Portugal should be asked whether they want to stay on a now-or-never basis, understanding what follows below.
- The Eurozone that remains should establish a set of Eurozone-only structural funds (“competitiveness funds”), initially supplying low-growth regions of Portugal and Italy with around €20bn per year of structural funds investment, sent via and managed from Brussels. The scale of structural funds should be extended as required. A plan should be announced for Eurozone taxes to be established, over the medium-term, to fund these Eurozone competitiveness funds.
- The administering Brussels authority should, over the medium term become the sovereign issuer of debt for the Eurozone, with the Treaties changed so that the ECB can provide last resort lending to the Eurozone sovereign, but not to the regional governments of the zone (i.e. Italy, Germany, France, etc.). These sovereign debt issuances should be forbidden from being used to pay off debts of regional governments (i.e. Italian, Portuguese, etc. debts).
- Versions of the “stability union” economic governance procedures should be enacted. Over the long term the regional government should, eventually, be required to have debts of no more than about 30% of regional GDP.
This scheme would follow through the logic of the Eurozone, into the establishment of a fiscal and economic union to accompany the monetary and political union that already exists. Note that there is no debt pooling under my scheme – Germans do not become responsible for Italian debts. Each Eurozone member pays its own debts.
Having waited so long, such a scheme would involve considerable ructions and perils of backsliding. Until very recently I would have been confident of its eventual success if carried through. Indeed, until recently there was a good chance that this crisis would be positive for the development of the Single European State over the medium-term, forcing policymakers to face up to the need for structural reform in their regional economies and to closer political union at the Single European State level – the construction of that state itself being the great political project of our age: inspiring; enriching; benign; protective; powerful. Alas, no longer. But let’s not despair. Perhaps, as with another verse in the song I referred to earlier, we can plead:
“I’ve been very hopeful so far / Now for the first time I think we’re going wrong / Hurry up and tell me this is just a dream / Oh could we start again please?”