Sunday, 14 November 2010

Who wants to kill the euro

The Malta Independent on Sunday - 14.11.2010

Who wants to kill the Euro?

“Will the euro be around in 20 years” was the title of this column on 21 March. I followed this up with a contribution entitled “Plan C for the Euro” carried by The Malta Business Weekly on 10 June. On 24 June, in a letter to the Financial Times, I suggested that some euro members ought to “Revert to old currencies temporarily” to save the euro. There can be no doubt: I consider the current euro set-up as unsustainable, and unless some thorough restructuring is carried out pretty soon, the euro’s days, months, or at best years, are numbered.

I am not alone in reaching such conclusions. A prominent British economist Samuel Brittan wrote a piece in the Financial Times on 5 November starkly entitled “The futile attempt to save the eurozone”. Many other leading economists share these views but are less dire in their prognosis. They argue that the Euro is mainly a political not an economic project and that while the economic structure for the single currency is unsustainable, the political commitment to change it, probably in the face of a deep crisis during some marathon weekend meeting where failure would force markets to rip the euro apart, would not fail when it matters.

 It is however difficult to feel positive about such political commitment considering events happening around us. It is as if the Germans are determined to destabilise the euro and bring about its early demise. Last May, at the peak of the Greek sovereign bond crisis, the EU agreed to set up a €750 billion rescue fund to help euro members who were having difficulty managing their debt through normal capital markets at anywhere near sensible interest rates. Primarily, this concerned Greece but other members like Ireland, Portugal and Spain were in the queue right behind it. At the same time, the European Central Bank (ECB) stepped in through market operations purchasing sovereign bonds in a direct measure aimed to create demand and narrow the interest rate spread over the benchmark German Bund. The ECB also continued its programmes of extending nearly unlimited credit to euro area banks, particularly Irish and Spanish banks, which were finding it difficult to fund themselves normally on the wholesale financial markets. This rescue brought some calm to debt markets and provided valuable time to countries in crisis to conduct extensive and painful restructuring in order to win back the confidence of international investors.

Even the Greek colonels, Franco and Salazar would have had problems pushing through the sort of pay and benefit cuts, the abolition of subsidies and tax increases that are being implemented in Greece, Spain and Portugal. Yet nothing compares to the harsh measures with which Ireland is forced to punish its people, not only to address the sudden deterioration in public finances but also to save its main banks from outright bankruptcy.

Amid all this restructuring pain and valiant efforts by the ECB to calm the markets and rebuild confidence on the feasibility of the painful and harsh adjustment programmes adopted by Ireland, Greece, Spain, and Portugal, the Germans seem to be working at cross purposes and seem to be doing their damn best to blow the whole system apart. How can one otherwise explain why the President of the Bundesbank, Axel Weber, who the Germans are promoting to take over from Trichet the presidency of the ECB this time next year, is rocking the boat by openly dissenting and criticising ECB’s policies as decided in a collegiate manner by its central board of governors on which Weber himself sits as a prominent member?

 How can one explain the change of heart on Germany’s part to dismantle the Rescue Fund agreed last May as soon as possible to replace it by a permanent crisis mechanism, which would force losses on investors holding sovereign bonds of euro area governments, even though this would require a laborious change to the EU treaties in order to set it up?  While the ECB works hard to reassure sovereign bond holders that there will be no default and therefore should not demand high risk premiums for lending to periphery euro members, the Germans promote the setting up of a mechanism to enforce default costs on sovereign bond investors. Little wonder that the spreads for Greece, Ireland, Spain and Portugal have gone back or exceeded the levels at the peak of the crisis last May and this in itself puts obstacles on the path of their tough adjustment programmes.

 Wolfgang Schauble , the German Finance Minister is quoted as saying: “Should a eurozone member ultimately find itself unable to consolidate its budgets and restore competitiveness, this country should as a last resort exit the monetary union while being able to remain a member of the EU.” Certainly Schauble should realise that if a weak member is forced out of the euro the market will inevitably ask who’s next. The whole system will disintegrate before there is time to suggest an answer.

If any country should exit the monetary unit without risking its disintegration, it has to be strong countries that are running a strong balance of payments surplus with other euro area countries. It has to be countries whose economic performance can sit well with a much higher foreign exchange value of their currency. So Ireland, Spain, Portugal and Greece should tell Minister Schauble that “Should a eurozone member ultimately find itself unable or unwilling to run down its structural surplus with other member states and with the rest of the world because it has become extremely competitive, then this country should, as a last resort, exit the monetary union to allow its domestic currency to appreciate reflecting its level of competitiveness, while being able to remain a member of the EU”.

 A recent research study I have access to, shows that while Germany will remain competitive with an exchange rate of US$1.50 for each euro, Greece would need a rate of 1:1, while Portugal, Italy and Spain would need a rate of 1.18. The nearest to Germany would be France and Austria with a rate of 1.25. So if Greece is an outlier on the negative side, Germany is an outlier on the positive side and outliers from both ends should embark on adjustment programmes.

 The eurozone, and by implication also the EU, is at a crossroad. It must choose between a Germanic Europe or a European Germany. The former is unacceptable, flies in the face of what the EU stands for and resurrects painful memories of German arrogance in the first half of the last century. A European Germany should understand that it is the main beneficiary of the euro monetary union and that it has much to lose if its irresponsible acts lead to its disintegration. A European Germany would understand that benefits from the euro monetary system come with a responsibility to keep the rest of the pack moving forward in sync through policies that bring about sustainable restructuring rather than force the weakest through a sausage machine.

Lest they forget, the Germans should remember that along with the French they were the first to throw away the euro rule book when it suited them and that Ireland is partly suffering due to a lax monetary policy adopted by the ECB to accommodate Germany when it was suffering the pain of integrating the former East German economy, at a time when Ireland needed much higher interest rates to prevent the real estate boom that nearly killed it when the bubble burst. Rather than destabilise the euro, German leaders should remind their electorate of the huge benefits they are getting by being a European Germany.

They should remember the distaste they would generate if Germany continues with its march to enforce a Germanic Europe.

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