The euro is dying a slow death
June 13, 2011 1 Comment
The euro is dying a slow death. Political leaders are unlikely to take the steps necessary to address the underlying factors creating the current euro crisis, and the eurozone will eventually break up as a result.
To highlight the severity of the euro crisis, one only needs to glance at credit default swap (CDS) spreads for the peripheral euro area countries. CDS is a form of insurance against default or restructuring. The higher the CDS spread, the more likely investors think a sovereign default is.
In the first week of June, five-year CDS spreads for Greece were a whopping 1495 basis points, for Portugal 708, for Ireland 650 and for Spain 255. This compares with only around 200 for Iceland, a country that underwent a private default only two and a half years ago.
The euro crisis is just as much underpinned by politics as it is by unbalanced economies, rigid labour and product markets, burst property bubbles and unsustainable public and private debt levels. This has been particularly evident in recent weeks, as a cacophony of voices has emerged at the EU level on how to handle Greece.
Ultimately, it is politics, more than unsustainable debt, that will threaten the very existence of the euro.
With persistent imbalances within the euro area and the inevitable restructuring of Greek, Irish and Portuguese debt, there are two possible endgames for the euro crisis: fiscal union or eurozone breakup.
Two resolutions: fiscal union or breakup
Fiscal union, which involves harmonising aspects of fiscal policy across the euro area, would be a bold move and essentially result in a treasury department for the entire eurozone.
It would create a built-in shock absorber for divergences between eurozone countries. This could take the form of creating a small budget for fiscal transfers from wealthier to poorer nations, issuing a eurobond or creating a European finance ministry.
One of the only visionary leaders in the EU, European Central Bank (ECB) chairman Jean-Claude Trichet, suggested in a speech on 2 June the creation of a common European finance ministry, which could intervene in ailing member state economic policies if necessary.
Trichet was free to make this proposal in part because he is one of the only EU leaders who is not concerned about re-election. Even so, he expressed some doubt about the acceptability and timing of his idea, asking “in this Union of tomorrow, or of the day after tomorrow, would it be too bold … to envisage a ministry of finance of the Union?”
The words had barely left his lips before commentators worldwide declared the idea to be madness.
If fiscal union is not on the cards, the only other option is eurozone breakup. Imbalances in the euro area will pull the monetary union apart. This could either take place all at once, or it could involve peripheral or core countries peeling off from the eurozone individually.
A eurozone breakup would result in a widespread series of defaults, bank runs, capital controls and periods during which countries (and their banks) would be frozen out of the markets. It would be extremely messy.
Furthermore, the world would lose one of its major markets, with the euro area collectively accounting for around 15% of global GDP (compared with just under 20% for the US).
From an economic standpoint, a fiscal union seems less painful overall than a rupturing of the eurozone. However, establishing a fiscal union and leaving the euro area are ultimately political, not economic, decisions.
Fiscal union: current views from the core and periphery
It is hard to imagine current core and peripheral euro area leaders making the political decision to pursue an agenda of fiscal union. Of the core euro area countries, this has been most evident in Germany and Finland.
In Germany, chancellor Angela Merkel’s ruling coalition has been repeatedly hammered in regional elections over popular opposition to the bailout packages. This is particularly surprising given that Germany’s economy has been a virtual wunderkind in terms of economic growth this year.
Given the opposition of German voters and the junior coalition partner, the Free Democratic Party (FDP), to peripheral euro area country bailouts, it is inconceivable that Germany would sign up to a fiscal union any time soon.
A further impediment to Germany agreeing to fiscal union is the German constitutional court, according to which it would be illegal to transfer control over fiscal policy to Brussels.
Finnish leaders are also vehemently opposed to fiscal union. In a general election in mid April, the populist True Finns emerged as the biggest winners on an anti-bailout platform. Their opposition to a bailout programme for Portugal was also shared by the Social Democratic Party (SDP).
Fiscal union would be anathema in Ireland
Bailouts and fiscal union are also increasingly unpopular in the peripheral euro area countries as austerity fatigue sets in.
This has been most apparent in the past two weeks in Greece, where protesters have gathered in Constitution Square in front of parliament to peacefully protest against plans by the EU, ECB and IMF (the so-called troika) for a way to end the crisis in Greece.
In a departure from the norm, the demonstrators in Greece over the past two weeks have not displayed any political or trade union affiliations, but instead have been unified by their opposition to the government’s austerity measures.
Ireland would require a local referendum for the sort of treaty change required to establish any degree of fiscal union. Given how disenchanted the Irish electorate is with European politics, it would be extremely unlikely to vote in favour.
Every government in eurozone will be claimed by crisis
Current leaders in the core and peripheral countries are clearly unwilling to pursue an agenda of fiscal union. Most of these leaders are unlikely to remain in power for long, but this is most likely very bad news for the euro project.
This euro crisis has already claimed governments in Ireland, Finland, Portugal and the Netherlands over the past year, placing opposition parties in power.
And I think this crisis will claim virtually every major government in the euro area before it is over.
The Greek government is hanging by a thread and Spain is scheduled to hold elections by March 2012. According to opinion polls, the centre-right opposition party is due to defeat the ruling PSOE Socialist Workers’ Party for the first time in eight years.
Sarkozy might just pull through in France’s elections next year following Dominique Strauss-Kahn’s arraignment, but Angela Merkel – who is due to go to the polls in Germany in 2013 – is less certain to win. A centre-left coalition government between the Social Democratic Party (SPD) and the Greens in Germany may display more patience for bailouts than the current coalition in the short term, but it is unlikely to swing in favour of fiscal union.
Environment of anti-bailout sentiment will prevail
With so many governments toppled by the euro crisis, a new generation of leaders will come to power over the next few years. These leaders in both the core and periphery will be coming into government in an environment of anti-bailout sentiment.
The new political class in the core countries, brought to power by electorates that are fed up with their taxes being used to bail out what they consider to be feckless peripheral countries, will have even less appetite for bailout programmes and fiscal union than the current leaders.
Among new leaders in the periphery, austerity fatigue and resentment over losing sovereignty to the troika will be even more pronounced following a few more years of retrenchment.
It is difficult to see the current eurozone leaders making the political decision to pursue fiscal union, but it is even more difficult to imagine this looking forward a few years. In the absence of fiscal union, eurozone breakup – while extremely messy – is the only other option.
I first published this post as a guest writer on the Guardian’s business blog and have reposted it here with permission from the Guardian.