Sunday, 30 May 2010

The Euro Austerity Club

The Malta Independent on Sunday - 30 05 2010

In an article I wrote in this series two months ago, I posed the question whether the euro monetary union would still be around in 20 years’ time. I had answered my own question stating that “it could disappear much sooner than 20 years unless the whole structure under-pinning the euro is urgently and thoroughly reformed.”

Two months ago this seemed rhetorical. Events since then have brought the issue to the forefront following the emergency bailout euro countries had to organise for Greece to avoid a sovereign default, which would have brought financial chaos that would have made the Lehman debacle look like a walk in the park. Doubts about the sustainability of the euro monetary union are being expressed openly as never before. The foreign exchange value of the euro has fallen by nearly 12 per cent against the US dollar over the last two months and, notwithstanding Greece’s bailout and a pledge for a trillion dollar stability fund as a defence against market assault on the next weakest links in the monetary union, instability remains.

The instability is not so much sourced by the fall in the foreign exchange value of the euro. On the contrary, this could be a stabilising factor offering some sort of solution as it renders euro countries more competitive on the global scene. What is generating instability is that the bailout of Greece, and the promise of bailout for other weak links, addresses only the liquidity problems of such sovereigns but does pretty little to address the underlying and more serious solvency problems.

 If Greece is over-indebted, switching its existing debts to banks and private investors to loans from fellow sovereign countries in the euro system and the IMF does little to solve the underlying problem. It just swaps one debt for another. The liquidity problem is addressed but the underlying solvency problem remains. This has kept international bond markets jittery about Greece’s long-term ability to service its debts, to whomever they are due, and about the ability of the next weakest links like Portugal, Spain, Italy and Ireland, the countries mostly exposed to international investors’ swings in risk appetite, to have unhindered access to finance to bond markets for smooth operations of their debt management programmes. And international investors have good reasons to be concerned.

The euro monetary union can only survive if the member states operate a harmonised fiscal policy alongside the common monetary and interest rate policy. Members of the monetary union are like runners in a three-legged race whose legs are tied together with a somewhat elastic rope. They have to move forward in harmony if not in perfect synchrony. The bailout packages augur the exact opposite. Given the conditions associated with such bailouts, the phenomenon of a two-speed Europe will be made even worse. Greece, Spain and Portugal will be suffering deep recessions while Germany continues to rev its export engines without apologies, aided as it is by the fall in the euro’s external value.

The two-speed nature raises problems for setting a common ECB monetary and interest rate policy. These problems already existed but will become more accentuated. Spain, Portugal and Ireland are suffering the consequences of the ECB keeping low interest rates to accommodate the German economic recovery programme when domestic conditions in the periphery countries would have necessitated higher interest rates to avoid dangerous speculation and bank exposure to an artificially inflated real estate boom. The property bubble has exploded with a vengeance in Ireland, Spain and Portugal, causing gummed up financial markets, a shaken banking sector, high unemployment, a deep recession and a sudden and huge increase in public budget deficit, mostly due to loss of revenue from subdued economic activity at a time when social triggers of unemployment and social payments are activated.

The gap in two-speed Europe grows wider. While Germany, France, The Netherlands and other Nordic EU members gain a competitive advantage from a devalued euro, which make their exports more competitive, the Euro-Med members of the monetary union, forced as they are by bailout conditions to address their public finances, will see their economies move in reverse gear into a recession. Will Europe tolerate rising unemployment and austerity measures (including wage cuts, wage freezes and reduced entitlements) on the periphery while Germany continues its export driven economy? Will the elastic rope binding together the euro members in a single monetary union be stretched to the point of rupture?

When pressure builds up beyond a certain level something will have to give. In an effort to avoid such rupture, many Euro-Med members are taking harsh austerity measures that were considered politically suicidal before the Greek near-death experience. Greece’s problems seem to have conditioned public opinion in Spain, Portugal and Italy to accept austerity measures before it is forced on them by bailout conditions.

The question we should be asking ourselves is whether Malta needs to join this austerity club?  It is true that our saving ratios permit us to finance all public deficits internally without any access to international bond markets. But a debt is a debt and it is never inadvisable to follow good financial housekeeping policies. 

Firstly, we desperately need to establish what our true deficits are by bringing on balance sheet all the off-balance sheet financing. Secondly, we need to take a pretty hard look at entitlement and payroll costs and see what is sustainable and what is not. Nobody is suggesting wages or entitlement cuts but in these troubled conditions, where we could very well be forced to import a recession, freezes of public payrolls and entitlement programmes should be on our agenda too. But most of all, it is well overdue that our politicians stop selling us pipedreams with unrealistic expectations for universal free health care, early retirement on the flimsiest of excuses, and state funding of students’ stipends on top of free college educations which cost citizens of richer countries an arm and a limb. It’s a pious hope!

If our politicians can’t even properly manage an EU-funded education programme, shattering the dreams of several hundred of our students who were practically packing their bags to attend overseas training programmes, just imagine how much they can plan for long-term sound public financial housekeeping. In the end, for politicians, long term is till the next general election. Regretfully, this is often too short to make serious structural adjustment programmes.

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