Talk about re-arranging deck chairs on the Titanic. The economic news
from Europe is alarming, no doubt, but it is also ludicrous. At a time
of the most severe economic and financial crisis that has affected the
region since the early 1930s, politicians from the major countries involved
rush around to meeting where they agree, once again, to disagree, and
to put forward more of the same policies that are manifestly failing.
There is now almost no doubt that the collapse is imminent, of the economic
and monetary union that took over half a century to evolve. At least,
the eurozone as it now exists is not likely to exist in future. The
more likely scenario is that it will have to lose one or more members,
and fairly soon at that. This will not be an easy process, of course,
and the associated pressures on banks in the core countries will necessarily
create all kinds of other problems, especially as the design of the
monetary union contained no exit clause and there are no legal and institutional
formulae for this eventuality. But unless drastic and ambitious action
is taken to avert it, this is what will happen.
The alternative scenario to this involves a major restructuring of the
very basis of the monetary union, to create even deeper integration.
The countries within the eurozone will have to work towards some sort
of fiscal union that also prevents large imbalances from building up
between its constituent parts. To avoid breaking up, the eurozone will
have to reconstruct itself to become a real fiscal union in which transfers
from surplus to deficit regions will be almost taken for granted. In
particular at present, Germany will have to agree to a significant increase
in its own external liabilities to deficit countries in the eurozone.
And a genuine single market would have to be created, in which not just
commodities but also labour move freely across borders within the zone,
so that national price differences cannot persist as they have done.
This is unlikely to happen, because the political will to do this is
currently missing, to the point where it is almost unthinkable at the
moment. In any case, to build up such a consensus will take more time
than the region has. Even if such a process can be gone through, it
simply cannot occur with the speed required, because the eurozone is
not simply one large and unwieldy animal, but a confusing mixture of
many different animals of different sizes. Well before the governments
concerned are able to mobilise, meet and converge on a new institutional
framework for the eurozone that allows more fiscal federalism, get the
framework passed within their own countries through whatever process
is nationally mandated, and so on, bond markets will have driven at
least one and probably several countries to unsustainable positions.
The attempts to create a fiscal union on the sly, without going through
all the complex and lengthy procedures legally required, is unlikely
to work as long as financial markets remain so openly cynical about
it.
For outsiders, the eurozone has always been an extraordinary experiment,
indicating the triumph of an integrating vision over divisive tendencies.
Its survival over the past decade, with some measure of stability and
success, has been no mean achievement. To be sure, the process was corporate-driven
and the macroeconomic rules associated with the union did not emphasise
productive employment generation and better living conditions, but actually
constrained those goals.
But as it turned out, these rules (as written in the Growth and Stability
Pact of the Maastricht Treaty) were barely followed by any country.
It is common to point fingers at Greece and Italy today, but the early
rule-breakers on the fiscal front were actually Germany and France.
That ability to ''work around'' the rules was in fact the source of
success for the eurozone, but inevitably also led to the imbalances
that now threaten the currency union’s very existence. Public memory
is short, but only four years ago, at the height of the boom before
the US financial crisis transmogrified into the global Great Recession,
the great economic success stories in the region were seen as Ireland
and Spain, celebrated by the IMF and the European Central Bank alike
for their ability to pull in private capital to finance rapid expansion
in construction and other activities.
The comparison made frequently is with the United States - another large
region with a currency union that is controlled by one federal authority.
The states of California and Florida have budgetary problems that exceed
those of Greece, but since they are part of the US, the starkness of
the Greek situation is not repeated there. Further, labour is much more
mobile within the US than it currently is in the eurozone, where differences
in language and culture persist in preventing significant labour mobility
even when there are no official restrictions on people’s movement.
So, faced with these starker choices that are growing even starker by
the minute, what do European leaders do? They meet, of course, with
increasing frequency. Some leaders do so in a way that indicates their
clear sense of urgency and priority, such as Nicholas Sarkozy, who put
off attending the birth of his daughter by Carla Bruni so as to meet
with Angela Merkel. And what do they do at these meetings?
First of all, they agree to meet again, fairly soon - which is always
useful, of course, and also keeps the financial media occupied. Then
they agree to have even larger meetings with more countries involved,
such as G20. Sometimes they set deadlines for decisions by the next
meeting, which are usually superseded at the last moment, just before
the meeting concerned, by another deadline for a strategy by the time
of the meeting to follow. Occasionally, they read the riot act to leaders
from problematic deficit countries like Greece, Italy or Spain, insisting
that they have to do much more to enforce austerity and suppress domestic
consumption. (At no point do they seem to remember that surplus countries
also have a responsibility for adjustment.) Every now and then they
point to a faint glimmer of hope on the horizon: Look, yields on Irish
bonds have fallen by a fraction of a per cent! Look, China says it will
buy Spanish and Italian bonds so we can still scrape by!
The governmental activities that can be most easily ridiculed are those
directed at financial markets. Instead of putting forward serious and
careful measures to regulate finance and make it safe for the real economy,
European governments persist in thinking that they can somehow trick
financial markets into behaving well with sleight-of-hand tricks, shadows
and mirrors. The so-called ''stress tests'' that are supposed to reveal
the required recapitalisation of major banks are probably the most classic
example of this.
These stress tests were recently conducted, and revealed that major
banks would require recapitalisation amounting to less than 100 billion
euro - almost one-third of the amount estimated by the markets. Of course
the stress tests themselves rest on assumptions that all but preclude
real stress, of the kind that is clearly on the cards. What happens,
for example, if French government bonds get downgraded by credit rating
agencies? How would that play out in terms of the viability of the banks
in general?
Similarly, there is a plan to allow the European Financial Stability
Fund to borrow from the markets, so they will have even more funds available
to provide countries in distress, effectively making the EFSF a monoline
insurer for sovereign debt. But this only adds to the fragility, rather
than reducing it - just as the Special Investment Vehicles produced
by US banks in the run up to their financial crisis did not actually
reduce risk but simply added another layer of intermediary in the effort
to disguise it.
None of the proposed solutions addresses the heart of the problem: the
only way the eurozone can now be economically tenable is if it involves
a significant increase in fiscal integration (including funds transfer
to deficit regions) which in turn necessarily involves a significant
loss of national sovereignty within the union. Immediately this must
involve fiscal transfers that enable the deficit countries to grow their
way back to sustainability, rather than persist in the self-destructive
pattern of austerity that lowers economic activity and worsens debt
and deficit ratios.
At the moment, it is evident that the major players do not have the
stomach for even making the attempt to pursue this line, which is why
they are playing these mindless games in the hope that the whole tangle
will somehow just sort itself out with time.
And so, until the denouement (which may now be just a few months away)
we will have more and more of such meetings among the eurozone leaders.
On the Titanic, at least they played music with gay abandon as they
approached the iceberg.