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|Imagine that the Euro will die|
L´Espresso - July 18th 2011
Throughout the global financial crisis and then more recently the euro-zone government debt crisis, actions and events that were described as unthinkable or inconceivable have suddenly come to be called normal. It is now time to consider another unthinkable idea: the death of the euro itself. The reason is not to predict it—for I do not, at present—but rather to understand how and why it could happen.
London is in many ways a bad place from which to observe the euro, for our city is so full of politicians and commentators who were viscerally opposed to the project from the beginning, making their criticism of it now look just like wishful thinking. But they are and were correct in one important way. They always emphasised that the European currency was a political project, not an economic one. This is right: if it ever dies, it will do so for political reasons.
Nevertheless, during its 12 years of life, the euro has generally seemed to be of interest mainly to economists, who could bore everyone to death talking about common monetary policies and debating whether the eurozone is technically an “optimum currency area”. This was a delusion. The question of whether the currency could work in economic terms was always a question really about politics: whether countries were willing to shape their domestic political choices in order to make the currency work.
For many years, this question was hidden. For the countries where the political choices threatened to be toughest—chiefly the southern European nations of Portugal, Spain, Greece and Italy, where state intervention and the interplay of public money and politics have been greatest—were the ones that benefited most at first from joining the euro.
With the threat of inflation dramatically reduced, interest rates fell and all these countries were able to borrow easily and cheaply. The basic argument in favour of the euro, namely that once the ability to devalue currencies was removed, countries would have to reform their economies to make them more flexible and dynamic, proved to be a myth. Cheap borrowing made reform look unnecessary. The politics of the euro looked great.
The sovereign-debt crisis since 2009 has changed that, as every government now knows. The three already insolvent borrowers—Portugal, Greece and Ireland—have been forced to make tough political decisions about reform and budget cuts in order to be able to borrow from the International Monetary Fund and the new European Stability Fund. That is necessary because they can no longer borrow from the financial markets at an affordable price. Faced with the spectre of the same thing happening, Spain too has begun some tough reforms, and in response crowds of angry protesters have filled its streets.
The Italian question, shared in the financial markets, has always been whether Italy too is vulnerable. Thanks to its already tight fiscal control since 2008, it should not be, for although the public debt is, at 120% of GDP, second only to Greece within the eurozone, Italy is running a budget surplus before counting interest payments, one of only two European countries to be doing so (the other is Germany). Yet it is still vulnerable, if domestic politics, in the form of the desperation of Silvio Berlusconi and the Lega Nord to cut taxes, over the opposition of Giulio Tremonti, destroys the credibility of that tight fiscal control.
So far, the politics of the crisis have been simple. Insolvent countries have had to resist strikes and violent opposition in the piazzas and make tough budget cuts. Stronger, northern European countries have had to be willing to finance new loans to keep the southerners afloat and avoid them defaulting. In effect, those loans have been a means to support their own banks, especially in Germany and France, because in a Greek or Portuguese default those banks would suffer big losses. But doing so has not yet been politically controversial.
That is what could now change, and with it the politics of the euro would change dramatically, too. When the crisis surrounding Greece, Ireland, Portugal and Spain began, one of the main cliches that were said about it was that even if the economic situation looks bad, the leaders of the eurozone’s most important countries clearly have the political will to make sure that the currency will survive. Angela Merkel of Germany and Nicolas Sarkozy of France will do “whatever it takes” to preserve the euro, as politically they cannot afford to allow it to die.
That is now in serious doubt, for the first time. For the time is now approaching when the toughest political choices will be faced by Germany, France and other northern European countries, not the southerners. This is because what was once unthinkable—a default, or rather debt restructuring, by Greece, aimed at reducing its burden of debt interest and repayments—is now being planned, by German bankers and officials.
This is a welcome development, because some sort of debt restructuring was inevitable. However tough its domestic fiscal and reform policies, the Greek government still could not afford its debt burden, and only by a miracle would its economy revive. During the next month or so, negotiations over how to manage this restructuring will take place. Yet welcome though it is, it is also politically dangerous.
The political danger comes first from the fact that for the first time, the fiscal costs of the euro to German and other northern European taxpayers will be made real and explicit, when banks have to write off their losses, when they therefore pay fewer taxes, and when, quite possibly, some will require taxpayer-funded rescues. If the restructuring is limited to Greece, then that danger is fairly small: Greece accounts only for 3% of euro-zone GDP and any losses from lending to it are manageable.
No, the true danger comes from a more difficult issue: how to limit a restructuring just to Greece. Markets will immediately start to speculate on whether similar deals will be necessary for Portugal, Ireland and even Spain, which is the world’s 12th-largest economy. And if any of those get relief on their debt payments, how about Italy, the world’s seventh-largest economy?
At that point, the domestic politics of the euro in Germany threaten to become poisonous. German voters know they benefit from the euro, that their economy is strong, and that a stable and well-functioning European Union is good for them. But they do not want to pay a high and direct price for it, transferring money through debt restructurings to southern Europeans.
So what needs to be done to preserve the euro is to find a way to define Greece as different from the rest. To do that requires the imposition of new forms of punishment for Greece in order to discourage Portugal and the others from wanting to follow the Greek deal. Which implies that the real choice will be this: to expel Greece from the euro in order to prevent others from receiving the same deal, or to risk offering debt-reduction deals to all the southern Europeans and causing a violent anti-euro backlash in Germany.
If Chancellor Angela Merkel gets that choice wrong, that is when the euro could die, in a storm of political recriminations.