Monday, May 28, 2012

Crying Wolf

Viewed from the perspective of the Euro's newest member state, the British political and media narrative still seems completely off the point with regard to the single currency.

To reiterate: this is not a currency crisis, it is a debt crisis. The majority of the members of the Euro zone have controlled their deficits and are retrenching their debts. It is where deficits are not being controlled- in Greece and in the Latin bloc that the crisis has its centre.

There are two sources of deficit pressure: one is fiscal incontinence, that is to say that the structure of debt is wrong or as the result of welfare or other general calls on the public purse government expenses are not being controlled versus government income. The second is the need to recapitalize the banking systems following a largely property inspired meltdown. The scale of the recapitalization is so large, because governments have undertaken not merely to compensate depositors, but all those, including bond holders, to whom banks owe money. In my view, that has been a serious mistake. The -originally Irish- plan to give a blanket guarantee to the banks was intended to maintain confidence in the sector, but has also has removed the moral hazard of owning bank debt and increased the burden on the public purse one hundred fold.

The impact of the banking crisis has been multiplied if the home nation of the bank, for whatever reason, has lost control over public spending and therefore debt. This largely applies to Greece and the Latin bloc: In Greece,a mixture of corruption and a weak state tax system has left the country with a huge hole in its economy, and the meltdown in confidence is creating a feedback loop where public debt is now unsustainable: Greece passed a point of no return and therefore required a rescue. As we know, the risks are increasing that Portugal, Spain and even Italy may also require rescuing.

Despite the doom laden pronouncements of British newspaper columnists, the route to a general rescue of the Latin bloc is actually pretty clear: Boost the powers of the ECB to include banking oversight, and backstop the banking system with full intervention by the ECB on the one hand, while on the other creating, in however limited a way, a common Euro treasury that can issue common government bonds. 

So why has this not yet happened?

The answer clearly lies with Germany.

The fact is that the Euro was created without such powers for the ECB and without a treasury because the Germans believed that the benefits of the single currency would be so clear that no government would want to break the rules: following German discipline would bring German prosperity. In fact for the majority of the Eurozone members, that is precisely what it has done. 

Meanwhile, it has not been politically acceptable in Germany to provide an open credit line to countries where business and political ethics have been a major cause of the crisis. . Instead of German discipline creating general European wealth, the fear is now that Latin indiscipline could create inflation and instability in Germany.The question for the Germans is whether the countries requiring rescue have the political will to bring their government spending under control

We are about to find out.

Far from "Germany" -or "Brussels", in the British media speak- ramming through measures against the popular will, there is real concern over the issues of democratic accountability. Probably the single greatest reason for not including greater powers for the ECB and a common treasury at the outset of the Euro project was the concern over whether these institutions could be held to democratic accountability- and if they could not, then that would contravene the German Basic Law which, for obvious historical reasons, rests on a complete commitment to democratic rules. If the Greek election chooses a workable government, committed to spending control, then Germany has already signaled willingness to fund a rescue for Athens. Meanwhile later this week Ireland is poised to vote in a referendum as to whether they can accept the proposed- more limited- measures currently on the table, again that signal of democratic assent is what European leaders are waiting for.

Germany has not yet made up its mind. However, the outline of a solution that permits the rescue of Greece and the Latin bloc is now clear. The question is whether, for political reasons, Germany is free to take that path.

But the alternative is not- as the UK media would have you believe- the total and chaotic break up of the single currency. The fact is that at least 9 countries: Finland, the Netherlands, Austria, Slovakia, Slovenia, Luxembourg, Malta, Germany and of course Estonia are perfectly capable of complying indefinitely with the currency regime as it currently stands, and they may be joined by Latvia and Lithuania within a matter of 18 months or so. Ireland too has demonstrated that it can maintain its membership, despite the crisis they have endured. A single currency can certainly survive- indeed in Estonia the idea of a return to the Estonian Crown is dismissed with a laugh.

The key question is France. If newly elected President Hollande chooses fiscal indiscipline, it could be the parting of the ways for the Franco-German "motor". However, the pressure on him not to do so will be immense. Likewise, despite the breakdown of the Belgian government system over the past 20 years, the pressure on the country to solve its crisis would probably lead to the EU seat of administration ultimately retaining its Euro position. With France and Belgium in, then the lifeline to Italy is also set to remain in place. The Euro in more or less its current composition survives- but that survival depends on common political will.

The crisis is coming gradually to a head. The choice is whether to proceed with the Latin/Greek rescue on the basis of a renewed political commitment to reform, or whether to endure the exit of Greece and possibly other states from the single currency. That choice depends on the voters of Greece (and Ireland).

Meanwhile, the UK seems increasingly incapable of addressing their own deficit/debt crisis. The idea that the debt crisis can be solved with increased debt is simply false. The demonstration outside Nick Clegg's house over the weekend was a not very subtle form of intimidation, and will certainly be resisted. However, the fact remains that the British tax system is a very expensive burden on the state. Without a root and branch reform and simplification of the tax code (which is, as I have mentioned before, five times longer than the German code and about fifty times more expensive to administer per person than the Estonian tax code) then British structural reform is still dead in the water, despite the modest signs of hope in the private sector.

David Cameron should resist the temptation to lecture the rest of the EU, when his own crisis is in many ways more severe than the Eurozone- even some of the worst of the members. Although the country has taken short term benefit from devaluing its currency against the Euro, without greater government discipline, the UK will simply end up with higher inflation- and a poorer population. The waste and inefficiency of the UK has lead to the squandering of billions- and the coalition so far has been only very tentative in tackling this- and Labour, the source of so much waste when in office, refuses to even acknowledge the question.

Meanwhile the British media should also resist the temptation to give into to anti- EU prejudice. The panic stories such as "Immigration guards in place for Euro collapse" are more or less absurd. The crisis may well continue for some time yet, but that does not mean the collapse of European civilization as we have known it- even under most of the worst case break up scenarios, the Euro economy recovers within 4 years-, indeed most of the Europhobes want the currency to break up for precisely this reason.

Meanwhile the outline of different solutions for the survival of the Euro are already on the table. 

The more foam flecked doom-sayers have been predicting disaster for years. I think they are going to be wrong this time too. 


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