Time to break up the eurozone?
by Nick Hayns
09 September 2011
One thing the eurozone doomsayers always knew was that a 'one-size-fits-all' monetary policy was totally impractical for diverging economies. Political will must now face economic reality
Writing an article on the fate of the eurozone in recent times has been something of a fool's errand. No sooner has the ink dried on the page, or the printer whirred into life, than a news bulletin will sound out, announcing another fall in the markets, another eurozone member to be downgraded, another political statement aimed at restoring confidence. It is hard sometimes to keep up.
The irony, though, is that any number of people predicted this exact scenario over two decades ago, when the euro was little more than a dream for the most ardent of Europhiles. Even while the rules for the euro were being created, they were simultaneously being broken. The Treaty of Maastricht set out five requirements for member states wishing to join the euro – of the 11 countries to join; only Luxembourg passed all five. Then came the stability and growth pact, soon jettisoned when it got in the way. And the no bail-out clause? Well, it almost seems comical in light of recent events. It is exactly this kind of fiscal indiscipline that has led us to our present parlous state. A political project, powered by political will, to achieve political ends. If the economics get in the way, dump the economics.
What the eurozone doomsayers knew when they were making their predictions back in the nineties was that a "one-size-fits-all" monetary policy was totally impractical for a group of such diverging economies. Take Ireland, for example, whose economy was already booming when it adopted the euro. With accession to the eurozone came low interest rates and a flood of cheap money, a housing and construction boom, and the eventual catastrophic bust. High interest rates would have made money more expensive and would have cooled the overheating property market, averting disaster – but the Irish exchequer had given up all control of its monetary policy in order to dance to the tune of the Germany-focused European Central Bank.
All across the eurozone, the story is repeated – in Portugal, which managed to skip the boom and go straight to bust and where cheap money was used to hose the public sector with cash and fund an unsustainable welfare state; or in Greece, where cheap money was used as a substitute to any kind of fiscal conservatism or labour market reform. It is these large-scale "mal-investments" which are still hanging over Europe – and indeed the whole financial system – where governments and banks try to play pass-the-parcel with potentially worthless debt. How exactly does one get one's money back when it has been spent by politicians on winning votes through promises of higher state pensions? President Barroso complained the other day that the downgrading of Portuguese bonds was unjustified. Does anyone believe him?
At some point, political will must face economic reality, and that involves acknowledging that the money simply is not there. It is an illusion. This means at least a partial default by a number of eurozone countries – Italy, Ireland, Greece, Portugal and probably Spain. It is highly unlikely that they will ever be able to pay back their existing debts, and to keep bailing them out is just to throw good money after bad. So what does this mean for the UK? And what are the solutions? For the UK it is important that we do not get any further involved and do not contribute to any further bail-outs. It is true that our banks are exposed to bad euro-denominated debt and that a high percentage of our trade comes from Europe, but neither are reasons for prolonging the death spiral of such a moribund political edifice. And, of course, bailouts only serve to increase the moral hazard – what incentive does a country such as Greece have to get its economic house in order when it implicitly knows that it will be bailed out if it fails to do so?
A slow-down in trade with a eurozone in turmoil will, of course, have a dampening effect on the UK, but the choice is clear: some bitter medicine today or some more money spent living an expensive lie and whole load of bitter medicine tomorrow. It is the agony of choice, but far better to just get on with it. For the eurozone, it is harder to predict. As with all political creations, there is often a yawning chasm between what should happen and what will happen. An orderly break up of the eurozone is what should happen, with those southern belt countries defaulting, adopting their own currencies and putting themselves on the road to recovery. What will possibly happen, however, is a fiscal centralisation, where individual countries find their spending decisions made for them by their northern European neighbours. A fiscal union to match the political union. It will surely not be sustainable – how long will already aggrieved German taxpayers be willing to fund less competitive Mediterranean economies? But that is not to say that the political will does not exist for it to be tried. We have been here before of course – economic reality against political will – and, as is often the case, political will triumphs, at least in the short term. The same may happen again; but it is not the solution, and the UK should not get any further involved.
Nick Hayns is communications officer at the Institute for Economic Affairs think-tank, in the UK. This article was first published on publicservice.co.uk , a sister title of PublicServiceEurope.com
Writing an article on the fate of the eurozone in recent times has been something of a fool's errand. No sooner has the ink dried on the page, or the printer whirred into life, than a news bulletin will sound out, announcing another fall in the markets, another eurozone member to be downgraded, another political statement aimed at restoring confidence. It is hard sometimes to keep up.
The irony, though, is that any number of people predicted this exact scenario over two decades ago, when the euro was little more than a dream for the most ardent of Europhiles. Even while the rules for the euro were being created, they were simultaneously being broken. The Treaty of Maastricht set out five requirements for member states wishing to join the euro – of the 11 countries to join; only Luxembourg passed all five. Then came the stability and growth pact, soon jettisoned when it got in the way. And the no bail-out clause? Well, it almost seems comical in light of recent events. It is exactly this kind of fiscal indiscipline that has led us to our present parlous state. A political project, powered by political will, to achieve political ends. If the economics get in the way, dump the economics.
What the eurozone doomsayers knew when they were making their predictions back in the nineties was that a "one-size-fits-all" monetary policy was totally impractical for a group of such diverging economies. Take Ireland, for example, whose economy was already booming when it adopted the euro. With accession to the eurozone came low interest rates and a flood of cheap money, a housing and construction boom, and the eventual catastrophic bust. High interest rates would have made money more expensive and would have cooled the overheating property market, averting disaster – but the Irish exchequer had given up all control of its monetary policy in order to dance to the tune of the Germany-focused European Central Bank.
All across the eurozone, the story is repeated – in Portugal, which managed to skip the boom and go straight to bust and where cheap money was used to hose the public sector with cash and fund an unsustainable welfare state; or in Greece, where cheap money was used as a substitute to any kind of fiscal conservatism or labour market reform. It is these large-scale "mal-investments" which are still hanging over Europe – and indeed the whole financial system – where governments and banks try to play pass-the-parcel with potentially worthless debt. How exactly does one get one's money back when it has been spent by politicians on winning votes through promises of higher state pensions? President Barroso complained the other day that the downgrading of Portuguese bonds was unjustified. Does anyone believe him?
At some point, political will must face economic reality, and that involves acknowledging that the money simply is not there. It is an illusion. This means at least a partial default by a number of eurozone countries – Italy, Ireland, Greece, Portugal and probably Spain. It is highly unlikely that they will ever be able to pay back their existing debts, and to keep bailing them out is just to throw good money after bad. So what does this mean for the UK? And what are the solutions? For the UK it is important that we do not get any further involved and do not contribute to any further bail-outs. It is true that our banks are exposed to bad euro-denominated debt and that a high percentage of our trade comes from Europe, but neither are reasons for prolonging the death spiral of such a moribund political edifice. And, of course, bailouts only serve to increase the moral hazard – what incentive does a country such as Greece have to get its economic house in order when it implicitly knows that it will be bailed out if it fails to do so?
A slow-down in trade with a eurozone in turmoil will, of course, have a dampening effect on the UK, but the choice is clear: some bitter medicine today or some more money spent living an expensive lie and whole load of bitter medicine tomorrow. It is the agony of choice, but far better to just get on with it. For the eurozone, it is harder to predict. As with all political creations, there is often a yawning chasm between what should happen and what will happen. An orderly break up of the eurozone is what should happen, with those southern belt countries defaulting, adopting their own currencies and putting themselves on the road to recovery. What will possibly happen, however, is a fiscal centralisation, where individual countries find their spending decisions made for them by their northern European neighbours. A fiscal union to match the political union. It will surely not be sustainable – how long will already aggrieved German taxpayers be willing to fund less competitive Mediterranean economies? But that is not to say that the political will does not exist for it to be tried. We have been here before of course – economic reality against political will – and, as is often the case, political will triumphs, at least in the short term. The same may happen again; but it is not the solution, and the UK should not get any further involved.
Nick Hayns is communications officer at the Institute for Economic Affairs think-tank, in the UK. This article was first published on publicservice.co.uk , a sister title of PublicServiceEurope.com
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COMMENTS
I don't see the European bureaucrats giving up their power over the continent without a fight. No breakup will be allowed until things get far worse. It's like "Cable Guy" and Brussels is Jim Carrey.
Joseph
All those "happy prophets" and doomsayers who have been predicting the break up of the euro zone ever since its creation must be thrilled now. Institutions like the monetary union that are the of spring of decades of cooperation and integrative efforts of states, driven by a variety of interests or contingent developments are not undone because some may think that this is a solution to a crisis.
Institutions and laws are always imperfect when they get entrenched in real life and politics. And, yes, there are problems with the economic fundamentals and the institutional design of the eurozone, and these cause the current crisis, but also the immense opportunities that it opens.
States and societies always evolve this way, even as the dynamics that each crisis unleashes are far from predictable or inexorably progressive. But we are right in the middle of it, and doomsayers like the author of this have little to contribute.
And something else -- who said that the goal is to repay sovereign debt in full? Is the USA, for example, ever expected to repay its own? The issue is for each state to manage its public finances and live with what its economic basis allows, not with "borrowed" prosperity.
Serena
