The Greek crisis continues to develop. After the implosion in their public finances which was revealed after they stopped faking the numbers, the markets have taken fright at the scale of the problems in Athens. So far so unsurprising: Greek public finances have been weak or very weak for decades. However, there is now a strict discipline that Athens must adhere to: membership of the Euro. Instead of printing money and getting out of trouble by devaluing the Drachma, the Greek government must now impose tight fiscal discipline, despite the grim outlook for economic growth.
Many Anglo-Saxon commentators do not believe that the Greek government: beset with strong Unions and a poisonous legacy of corruption will be able to do so. Several others do not think that they should even try. The problem is that without cutting the deficit, the country faces a stark choice: either fail to repay their debts- i.e. to default- or to abandon the Euro altogether. The Anti-Euro cheerleaders are hopeful that Greece will choose the latter road, and that the single currency will be crippled as a result.
The problem is that introducing a new Drachma would be creating a literally worthless currency- it would have little resources and less confidence to back it. Greek businesses would probably be unwilling to be paid in New Drachmas, and the Euro would continue in general circulation. There would be a real risk that Greece would enter hyper-inflation in the new currency and create crippling economic damage for itself. There really is no alternative but for Greece to continue to use the single currency- so the focus is now on trying to plug the hole in the economy and create some kind of international bail-out. In that sense, Greece is probably "too small to fail". The Greek economy is a relatively small part of the Eurozone and co-ordination between the ECB, the IMF and World Bank should be able to give the Greek government enough breathing space to start the process of reordering their public finances.
The problem will become far more serious if other Eurozone economies begin to suffer the Greek meltdown: and the huge instability in the markets last week shows that fears are gathering around Spain. Spain is a significant part of the Eurozone, and any rescue would require the real commitment of Germany in order to happen- and the mood music in Berlin suggests that there is a limit to German patience and understanding.
The reasons why Germans are imposing limits are not hard to see. Germany, over the past decade, has imposed upon itself a large scale structural reform of the labour market: it has been a difficult and at times painful process. However the Club Med states have not imposed such structural changes: in the name of social cohesiveness, jobs became permanent but unemployment rocketed. The productivity of Germany improved dramatically, but that of Italy, Spain or Greece fell dramatically. The Germans learned the lesson that the fixed currency demands much greater flexibility in every other area of the economy. The Greeks and the Spanish did not learn that lesson- and now the burden of that failure is crushing the life out of their state budgets at a time of general economic gloom.
However, the smugness of many British commentators is ill founded. "Look" they say "how lucky we are not to be members of the Euro, because we too could have been in the same position as Greece- and unable to devalue our currency". Yet the fact is that our much vaunted "currency flexibility" is as much a curse as a blessing. Leaving aside the morality of whether governments should be allowed to debauch the value of the currency it issues, the fact is that even the 30% fall in Sterling has not been enough to avoid the longest and deepest recession in the developed world. Despite maintaining an independent currency, the British economy has massively lost competitiveness- and for the same reasons as Spain and Greece. We have created a massive state sector of startling inefficiency, and after the fall of our largest industry- banking and finance- Britain has very limited competitive advantage. The national debt has doubled in two years, the deficit- at around 16%- is actually worse than Greece. The fact is that even while the devaluation of Sterling has reduced the impact of our folly- the UK is on the road to ruin, independent currency or not.
The Greek and the Spanish crisis is not about the impact of the single currency, it is about a failure to implement necessary economic and strategic reform. It is about a failure to deal with huge pension deficits in an ageing population, it is about a failure to diversify the economy and to create a more flexible micro-economic environment. Whether or not the single currency survives is really beside the point: the fact is that these changes have been delayed too long, and therein lies the root of the problem.
As for the UK? Well almost all of the same questions apply. The failure to address pensions has destroyed the competitiveness of the British Economy: British Airways being the most obvious example. The massive increase in the power of the state, and the expansion of state economic activity to the levels of East Germany is beyond the long term capacity of the State to finance. Placing so many of our best brains into the accounting and City underlines the lack of diversity of our own economy- and looks way too much like putting all our eggs in one basket.
In my view- however reluctantly- the Germans will try to steady the Euro ship. The price will be high: make the necessary reforms or else leave the single currency. The so-called PIIGS states have little option but to comply: indeed Ireland already has done so.
As for Britain? We have given ourselves a breathing space at the expense of a third of our nominal wealth. Unless we address our structural weaknesses and wean ourselves from our dependence on the state sector, then the outlook is very bleak indeed. Higher inflation, lower competitiveness, and continued decline.
In the end the crisis of 2010 is not a currency crisis- it is a fundamental economic crisis. Without truly addressing our deficit and the imbalances that caused it: being "tough on the deficit and tough on the causes of the deficit", then the value of the Pound versus the Euro will continue to drain away. We have gained an advantage from possessing an independent currency- the breathing space to reform. The price is that unless we use that breathing space to enact radical restructuring across the economy we will be permanently poorer, and clutching a currency that no one trusts or uses.
Comments
The rational response to negative real interest rates is to take out the most debt that you can and use it to invest in some other asset. Taking out loans for creating buildings is the obvious way to do this, and many people did. A construction boom commenced, with construction peaked at about 30% of economy, and then came the inevitable bust.