EUROPEAN UNION: by Colin TeeseNews Weekly
Cyprus the symptom of deeper eurozone crisis
, April 27, 2013
Small though it might be, Cyprus has made headlines across the world as the most recent casualty of what seems to be the European Union’s march toward destruction.
In ordinary circumstances, the problems of Cyprus might pass almost unnoticed. But after all that has happened, they further serve to illuminate what is becoming a policy and management disaster.
As the eurozone crisis deepens, it is worth reminding ourselves that the economy of Cyprus is by no means the biggest potential problem in the EU. After Cyprus, the other crisis-stricken EU member-states rank, in more or less ascending order of importance, Ireland, Portugal, Greece, Spain and Italy. The last mentioned, it should be noted, is the eighth biggest economy in the world, only slightly behind Britain.
Taken together, they account for a sizeable percentage of the eurozone’s income. More importantly for Germany, they account for — or rather did account for — some 40 per cent of its exports. This latter point seems not to have registered with German Chancellor Angela Merkel, who seems behind the push to drive many of her country’s important export markets into bankruptcy.
Readers of News Weekly over the last couple of years will be aware of this writer’s views on the emerging European Union crisis. From the outset the problem for the EU and its eurozone economies has been two-fold — an overvalued currency, the euro, and severe bank indebtedness.
The banking problem derives from the fact that the EU’s exporting powerhouse Germany and the banks of other northern European countries have been bankrolling German exports to importing countries which otherwise could not have afforded to pay for them. In the process, the countries concerned have racked up private and public debts far in excess of their capacity to pay.
Greece is a particular example. The orthodox view emanating from northern Europe is that the south is full of lay-abouts surviving on welfare, and of businesses unwilling to pay tax.
In fact, Greece’s welfare is less generous than Germany’s. But of course all of this dodges the uncomfortable question. Southern Europe’s shortcomings were well known to northern European banks. That being so, why were they so keen to lend the Greeks money to buy German goods? Most likely, the banks believed that ultimately their respective governments would stand behind them.
So much for Greece. Others, notably Spain and Ireland, borrowed recklessly to sustain property bubbles in their respective countries. These bubbles ultimately burst, wrecking these countries’ banks and economies. Ireland especially squandered billions on its property boom.
Ill-considered austerity programs, imposed by the Brussels bureaucracy — presumably on behalf of the northern banks — have had a disastrous impact on the domestic economies of all the troubled economies. All are wrestling with unemployment levels of around 20-25 per cent of their workforces, including up to 50 per cent of youth without jobs.
In the case of Ireland, its dire unemployment has been eased by significant emigration.
The currency problem helps explain much of the plight of these economies. All are locked into what is, for them, a seriously overvalued currency — the euro — which makes their exports dearer and their imports cheaper. While that situation persists, it becomes impossible for them to export their way out of debt. In any case, all of them cannot simultaneously export their way out of trouble since one country’s exports are necessarily another’s imports.
Meanwhile, the position of the eurozone banks is terrible. Those in the indebted countries owe sums they can’t pay to banks in the northern countries, notably France, Germany and the Netherlands. These banks somehow hope to recover the debts by means of a combination of the EU’s successive bail-out plans and austerity programs that we are constantly reading about.
In addition to what they are owed by the southern European member-states of the EU, these banks have, by other means, accumulated further debt burdens. Induced by additional reckless borrowing, these are less frequently mentioned. Very heavy debt burdens rest on the shoulders of most of Europe’s major banks as a consequence of their having bought much of the toxic debt unloaded by United States banks during its housing bubble.
The governments of the EU member-states concerned, along with their taxpayers, have had to stand behind this debt. Regardless of their EU membership, what they cannot do politically is load their taxpayers with debts incurred by eurozone countries. Put differently, the EU cannot function as a quasi-federation because its stronger economies are not prepared to support the weaker.
Compare this with the United States, which unlike the EU, is a genuine federation. The stronger states — notably New York and California — contribute towards the weaker. At the same time, a central government enjoys sovereign power over, and exercises responsibility for, US state governments.
The EU has no central government with this sort of control over its member-states; neither does it have its currency, the euro, issued by such a central government. Without a true federal system, the EU member-states, whether or not in the eurozone, retain some control over domestic economic policy.
Given these facts, the EU is caught in a bind. It must either move forward to become a United States of Europe, or retrace its steps in order to create a more workable system. The bureaucracy in Brussels wants complete federation; but most if not all EU member-states are thus far unwilling to surrender their sovereignty.
This, then, provides the backdrop to the endless series of “band-aid” fixes we have been observing in Europe over the last couple of years. Some have called it “kicking the can down the road”. To the outsider it does seem that the EU leadership, strongly influenced by Germany, is trying to buy time. These leaders seem to believe that time, along with applying pressure on the weakest links in the chain, will eventually see the problem solve itself.
Over the last century and a half, this has been Europe’s preferred way of dealing with problems; but in our modern, more complicated world, this is no longer satisfactory. The recent European experience tells us that, these days, problems left unresolved tend not to go away.
In one sense, Cyprus merely marks another step along the same road. In another way, it represents something of a shift in mood and direction.
Thus far, the policy push from Brussels has had two basic elements: a write-off of part of the debt of the dysfunctional banks in the south, and a rescheduling of the remaining debt with a plan for its ultimate repayment, on the basis of a program of government-imposed austerity measures, including cuts to wages and welfare.
Governments in the indebted countries have tended, reluctantly, to accept these programs, under the threat of expulsion from the eurozone. However, soaring unemployment, accompanied by government austerity, is generating social unrest, and the austerity strategy itself is not working.
Cyprus has become the point of departure. The Cyprus experiment is being called a “bail-in”. Austerity programs, having failed to deliver the desired outcomes, have given way to bail-ins.
Instead of asking for governments to generate surpluses to repay creditors, Brussels has chosen to seize the funds of bank depositors — including those holding under 250,000 euros. Cypriot bank deposits have hitherto been guaranteed by the government of Cyprus, in line with a guarantee policy which applies throughout the European Union.
The policy was not promoted in these terms, but the Dutch finance minister and eurozone chief, Jeroen Dijsselbloem, let the cat out of the bag in an unguarded comment. He declared that the Cyprus rescue plan should be seen as a template for the rest of the eurozone. He said: “If there is a risk in a bank, our first question should be ‘Okay, what are you in the bank going to do about that? What can you do to recapitalise yourself?’.
“If the bank can’t do it, then we’ll talk to the shareholders and the bondholders. We’ll ask them to contribute in recapitalising the bank, and, if necessary, the uninsured deposit-holders.”
In effect, he was saying, “If we can’t get our money back from the government, we must make the banks pay. In future this, rather than bail-out, will be the preferred option.”
It was rumoured, but nowhere officially confirmed, that this approach was especially appealing because Cypriot banks were loaded with hoards of Russian mafia money.
The Cypriot government was duly asked to back legislation to impose a levy on all bank deposits, including those covered by guarantee. The parliament refused after which a new deal was struck whereby guaranteed deposits would be protected and those over 250,000 euros would be heavily taxed.
It now seems that this policy will be applied in Cyprus. We must wait to see whether this will be a future template, as the eurozone chief implied.
It is, however, the latest example of “kicking the can down the road”, and seems no less desperate and misguided a solution than all earlier attempts.
The best its proponents can expect is that it will transfer funds owed by Cyprus back into the creditor banks — but at what price?
It is to be hoped that the Cypriot government is not anticipating a flood of foreign investment into its country.
It is hard to imagine a more provocative change in policy direction than one which demonstrates that deposit guarantees in EU banks may, in certain circumstances, be set aside by governments. Surely, markets and investors must be re-assessing the wisdom of holding EU assets, especially in eurozone countries.
Meanwhile, what Cyprus demonstrates is that the fundamentals of the euro crisis are far from fixed. The solutions to the structural problems facing the European Union remain as they have been from the start.
The eurozone, and indeed the European Union, cannot survive as a de facto United States of Europe. Either the EU leadership must persuade EU member-states to agree to the surrender of their sovereignty in order to allow the creation of a full federation, or else accept that the euro experiment has been a step too far and draw back.
It serves no useful purpose for European policy-makers to avoid facing these realities and to continue to believe they can muddle through. They must recognise that the EU’s economic structures contain their own internal contradictions (the euro itself is not a currency backed by a sovereign government, nor has it been universally adopted). What is more, these contradictions cannot be reconciled with the EU’s current stage of political evolution.
It is hard to predict how the crisis will end, but a happy ending already seems beyond Europe’s reach.
Colin Teese is a former deputy secretary of the Department of Trade.