EUROPEAN UNION: by Colin TeeseNews Weekly
A way out for Europe, but not for the euro
, November 26, 2011
The state of the eurozone at the moment resembles those serial movies we saw as kids on Saturday afternoons. The hero faces a life-threatening crisis at the end of every episode only to be miraculously saved at the opening of the next episode.
At the conclusion of the final episode, he prevails and saves the day.
The way things are going, that is not the most likely outcome for the European Union. We are talking about a grave problem here. Unless the EU finds a feasible way to fix its problems, the world economy will be dragged down.
A solution is certainly possible, but only if the EU leadership can get a grasp on reality.
As J.M. Keynes once famously observed, “Owe your banker £1000 and you are at his mercy; owe him £1 million and the position is reversed.” Recognition of this truth by the EU leadership, in both Brussels and in the key member-states (most notably France and Germany), is a starting point for any real solution.
The facts are clear. The key European banks are owed embarrassingly large sums by the so-called PIIGS countries, Portugal, Italy, Ireland, Greece and Spain. And still more member-states within the eurozone might be on the brink of disaster.
For the moment the focus is on Greece, perhaps because it is seen as most imminently likely to default on its debt, but also because it happens to be a soft target in the popular EU pastime of nation-bashing.
If Greece defaults, so the reasoning goes, the contagion will likely spread to the other indebted countries. Following that, the EU economic and monetary union which created the euro will be destroyed. Associated with that assumption is the proposition that without monetary union the European Union itself could be at risk.
Not all members of the EU are part of the monetary union. Britain is one of those countries which chose to keep their own currencies. Curiously, its current government also happens to believe that the EU itself may collapse if the eurozone is dissolved.
There is no objective evidence to support the notion of an indissoluble link between monetary union and the survival of the broader EU. Moreover, it is quite possibly being used as a scare tactic by the Brussels bureaucracy, along with France and Germany, for self-serving purposes.
Both groups have much prestige and power tied up in monetary union. But for France, Germany and certain other member-countries with indebted banks there is an even more pressing, practical political consideration. Given the unmanageable problems within the poorer indebted member-countries of the eurozone, the wealthier member-countries are, not unnaturally, interested mainly in determining how best they can give their banks the best chance of getting their money back.
In the best of all possible worlds, the indebted countries might be expected — under a combination of coercion and persuasion — to repay the loans. But we are not in the best of all possible worlds. If we were, there would not now be a crisis. The fact is, the debts are so large, and the complicating factors so significant, that simple payback is highly unlikely.
In trying to cut through the many complications, two new words have been introduced to the debt crisis vocabulary: “bail-out” and “haircut”. Taken together they are intended to have us believe that over time the bank debts can and will be repaid, by writing off some of the debt (the haircut) and by devising more liberal payment terms for what remains (the bail-out).
Something like this has superficial appeal, until we realise it does not really fix the problem of the indebted banks. They need money now, if they are to continue lending.
If they cannot be recapitalised, Europe’s lending could dry up, thereby jeopardising its entire financial system.
The most recent bail-out plan took aim at this problem. It attempted to construct a fund, sourced from outside lending, large enough to refinance the banks. Thus far, though, these efforts seem to have been unsuccessful.
Meanwhile, what remains has been the problem from the start. Who is likely to provide what is essentially risk capital for the banks with nothing substantial standing behind them? The banking industry can’t, the European Central Bank won’t, and neither will the governments of Germany and France where most of the bank debt is located.
Here is where self-interest and politics intersect. If money to refinance the banks can’t be found from outside sources, then it will have to come from national treasuries — in the last resort, from French and German taxpayers. As we have all gathered from the debates about the crisis over the past year, that is an enormous and essentially unsolvable political problem. It has the capacity to bring down governments.
Is it any wonder that scare tactics about survival of the EU have been trotted out? But who, really, should foot the bill for the imprudent lending of European banks and private investors? Don’t forget, much of the benefit of this lending accrued to French and German exporters.
This embarrassing reality is most easily covered up by blaming, for example, Greek profligacy and incompetence. But can anybody really believe that those making the loans were unaware of Greece’s shortcomings?
Of course they were known; but the banks, at least among the investors, always believed — and still believe — that when things go badly wrong there are central banks standing ready to bail them out.
Inside the eurozone there is no such facility, and the full responsibility for bank bail-outs ultimately rests with individual governments.
So, is there a solution? Yes, but we can only get there by facing up to all, not merely some, of the realities.
Certainly, first of all, the banks must be recapitalised.
Second, the indebted countries certainly won’t ever be able to repay more than a small proportion of their debt unless they can escape the straitjacket of the monetary union.
Indeed, the EU itself probably cannot survive unless this second reality is faced and the monetary union dissolved. Up there at equal par with the recapitalising of the banks is the need for the indebted countries to rebuild viable economies. That cannot happen within the eurozone because they are all shackled to an overvalued currency.
To become competitive again they must adjust their currencies and their economies to allow them to compete with their stronger economic partners within the EU.
Their debt must be written off because, whatever the circumstances, in or outside the euro, it can never be repaid. Without a return to steady economic growth their survival is threatened.
Whatever is done, the transition to economic health will not be easy; but it is impossible unless the seriously indebted economies (Portugal, Italy, Ireland, Greece and Spain) are able to leave the eurozone. And without them monetary union will not survive.
Observing the example of Britain and the United States perhaps makes it easier to understand why. Though these countries’ debt problems are formidable, both of their economies retain the capacity to accelerate growth and to re-invigorate their economies, because most of their debts are in their own respective currencies.
By devaluing — which both are doing — they actually reduce their debt obligations. In effect, they too are defaulting on part of their debts — presumably to the extent they believe they must.
Lenders have no option but to accept whatever losses these entail. In any event, this is the way indebted countries have traditionally dealt with unmanageable debt.
Britain and the US also have another advantage. They each can borrow at favourable interest rates because each has a central bank standing behind its debt.
This combination of advantages will further help in resettling their economies on a better growth path. Yet, even with all these advantages, the way ahead will not be easy for Britain or the US. What they might yet have to face is the need to stem the flow of imports to sufficiently rebalance their trade flows. For both of them trade flows remain seriously out of balance.
Europe’s problems are no less troubling. The economic health of the heavily indebted member-countries has no hope of being restored unless the EU experiment in monetary union is abandoned. Economic reality and common sense also require that most or all of the debt be written off.
All of that is a necessary pre-condition to securing the future of the EU.
The important remaining question is: where does this leave the vital matter of bank recapitalisation? That at least is already recognised as a necessary condition if the EU is to survive. How to achieve it remains the sticking point.
The main financial burden of recapitalisation must be born by the member-states in which the banks are located — with perhaps some help from the International Monetary Fund and, just possibly, some additional help from the Asian surplus countries, notably China.
If all of that cannot be made to happen, then the EU is indeed seriously under threat.
Even so, the EU probably cannot re-emerge from the crisis completely unscathed. For example, trade within the EU is also seriously unbalanced in the same way as world trade. Surplus and deficit countries exist uneasily side-by-side.
Very likely, correcting this will be impossible without revisiting some of the agreements which currently hold together member-states of the EU.
Hopefully, this can be achieved without undermining the essential elements of the Treaty of Rome which created the original European Economic Community. The Customs Union and the notion of a margin of tariff preference for member-states over the rest of the world must be retained.
Colin Teese is a former deputy secretary of the Department of Trade.