Bill Emmott - International Author & Adviser


Default or deeper union? Whatever. Just do it
The Times - September 26th 2011

So now we know: “They have six weeks to resolve this crisis”, declared George Osborne, while in Washington, DC, for the mass meetings of finance ministers that have just been held to coincide with the International Monetary Fund’s annual get-together. The crisis he had in mind, of course, was that of the euro, and “they” are the eurozone governments, who no doubt were grateful to have been set a strict deadline by Britain’s firm-but-fair chancellor of the exchequer. His interest, attention and indeed concern, though, are entirely correct.

            It is a bit odd to use “crisis” and “six weeks” in the same sentence, since if the first were to be taken literally the second would seem a tad short on urgency. Since he is not directly responsible for the eurozone, however, it was a reasonable stance to take, since had he said six days he could have been accused of precipitating the very crisis he wants resolved.

            Some in his party might have welcomed that, given their view that plagues should be put on all Euro-houses.  He, however, is right that Britain’s interest is that the euro should survive and be stabilised, and not just for reasons of diplomatic nicety.

            What is abundantly clear is that, in an admittedly wobbly world economy, the euro specifically, and the European banking system more broadly, present by far the biggest threat. The IMF’s latest economic forecasts for 2012 are actually fairly healthy: 4% global GDP growth would, if it were to come to pass, be still one of the stronger years the world has seen in the past few decades, even if slower than last year’s 5%. But that growth is made up of robust expansion, at 6.1%, in Asia, Africa, Latin America and other emerging economies, and anaemic growth of 1.1% in the euro area, 1.6% in Britain, and 1.8% in America.

            Even that would prove Panglossian if Europe’s sovereign debt problems were to cause a new banking collapse. Slow American growth, or even a new recession there, would be painful but not disastrous, a distinction which would not be true of the collapse of a big German, French or indeed British bank. And the dynamics of financial markets, especially of the money markets that provide funding for banks, mean that six-week deadlines for political negotiations can be made instantly obselete.

            The problem of the euro is simple to describe, hard to resolve. It is that when the single currency was designed, during the 1990s, governments felt their voters would accept a monetary union based on a common set of rules, for that is the way the European Union has always worked since 1957, but not one that required collective responsibility for public debts, a fiscal union or an overall EU finance ministry.

            The trouble is that the rules, about levels of public debt and budget deficits, were not enforced. And now another rule, the principle that no member country could be bailed out by the others or by the European Central Bank, has also been broken. At a time when investors quite reasonably doubt whether the big debtors—Greece, Ireland, Portugal, Spain and Italy—can really afford to service their debts without rescue or default, it has put the currency, and all banks who have lent to its member governments, in the worst of all positions.

            The choice is clear: use enforceable (and enforced) rules, or exercise collective responsibility. The middle position, where the euro now is, of doubtful rules and semi-collective responsibility, combined with hoping for the best, is not sustainable.

            It is often said by eurosceptics that neither of the choices can work: that countries need the ability to devalue to get themselves out of nasty economic holes. That is not true: Ireland on Thursday produced cheering figures showing that its economy has grown for the past six months, as cuts in wages and other costs have enabled its exports to revive. Latvia too, a country that is outside the eurozone but tied its currency strictly to it, looks like having 4-5% growth this year following its ghastly slump of 18% in 2009. As both would testify, adjustment without devaluation is painful.

            In fact, this is exactly what the euro was intended to achieve: the forced liberalisation of clogged up, over-protected, heavily state-run economies, especially in southern Europe. If that were to occur, it would advance both the British argument, for more liberal economies, and its interest, by deepening the single market and thus the free trade area that Britain has always said it wanted from the then EEC which it joined in 1973.

            More than 40% of our exports go to the eurozone countries, so a stronger integrated market would be to our benefit. The City of London is, in effect, the financial centre of Europe, which is also why London-based banks are heavily exposed to euro-denominated investments, especially government bonds. A crash of the euro would therefore also be a crash of the City.

            That is why George Osborne is right both to call for, and to wish for, a solution of the euro crisis. Britain can be fairly indifferent about which direction the solution should take the currency—rules or collective responsibility—since it would not itself be involved.

            What we should care about, however, is whether the solution is sustainable. The financial markets will determine the speed with which the choice must be made, but the selection will essentially be determined in Germany, by the interplay between a beleaguered, dithering chancellor, Angela Merkel, the country’s constitution, and its voters.

            The political instinct will be for collectivisation, offered at the price of greater powers over other countries’ spending, taxing and borrowing. This could also be the most sustainable option, for common eurobonds and a common finance ministry would offer greater clarity to the markets. But the German constitution and the voters both lean the other way: neither favours taking on unlimited liability for other countries’ debts.

            In which case, the solution would have to be the much-mooted default by Greece and, in logic, that country’s exclusion from the euro as it has broken its rules. Then Ireland, Portugal, Spain and Italy, to name but four, would have to show that they are not insolvent, do not need to default, and can abide by the currency’s rules, by bringing in a credible mixture of liberalisation and fiscal austerity. Neither option would be nice or easy. The choice had just better be made quickly, preferably sooner than in six weeks.


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