Time to put the doomed euro out of its misery
Time to put the doomed euro out of its misery
Eurozone deficits have been sustained via the backdoor of the ECB printing press and bail-outs from the eurozone and IMF
By Jeremy WarnerLast Updated: 8:49PM BST 12/04/2012
Europe can’t accept that the economics of the single currency condemn it to failure.
There is no mess quite so bad that official intervention won’t make it even worse. Nowhere is this old saw more applicable than in the eurozone, where only a month or so back, leaders were warmly congratulating themselves on having seen off the worst of the debt crisis. As is apparent from the events of the past week, these hopes were not just premature, but naive. The crisis is once again intensifying, with the focus of attention switching from Greece to Spain.
The European Central Bank’s flooding of the banking system with cheap money didn’t solve the problem, or provide more than short-term relief for its symptoms. After a brief period of remission, they are returning. At best, the ECB bought a little time. This has not been used well. Instead, the eurozone has just ploughed on with the same old set of failed policies.
The Spanish government, for example, recently announced 29 billion euros of spending cuts and tax increases. It failed to do the trick, so this week a further 10 billion was added to the tally. This only succeeded in unnerving the markets even more, forcing the ECB to concede that it might have to engage in further purchases of Spanish government bonds.
By promising virtually unlimited liquidity, the ECB may have prevented a Lehman-style meltdown of the banking system. Yet it also accentuated the underlying problem. Virtually free central bank finance has enabled Spanish and Italian banks to engage in a highly profitable arbitrage, borrowing money from the ECB and then reinvesting it in government bonds. This, in turn, helped ease the fiscal travails of the European periphery. But it also increased the banks’ underlying solvency problem, since they have been buying bonds that may eventually have to take a haircut.
Already, many are facing losses on their purchases. Yields have been rising again, as investors worry about the sustainability of Spain’s debts. What’s more, the preferential treatment given to the ECB and other “official” purchasers has concentrated the risk of default among the remaining investors, acting as a further deterrent to holding sovereign debt.
The inadequate, piecemeal nature of Europe’s approach to the crisis stems from a wanton refusal to face up to its causes. Europe can’t bring itself to accept that the economics of the single currency doom it to failure. Instead, “Anglo-Saxon” finance is still quite widely blamed, as if Europe would be just fine but for the wicked bankers of Wall Street and the City.
Failing that, EU leaders tend to regard the turmoil as a crisis primarily of excessive public indebtedness, so focus on strengthening the political constraints on government borrowing. Repeated rounds of self-defeating austerity have become the order of the day. Still others see the crisis as one of confidence, which can be addressed by setting up a rescue fund large enough to convince markets that they cannot undo the euro – a “big bazooka”. This, too, is just wishful thinking.
The real cause, as long argued by Sir Mervyn King, Governor of the Bank of England, and now accepted by most leading economists, is a simple, old-fashioned balance of payments crisis. Europe has long been divided into surplus and deficit nations: those that manage to pay their way in the world and those that have to borrow and import from abroad to sustain their standard of living. But since the advent of the euro, these imbalances have got very much worse.
Normally, they would be corrected through the natural market mechanism of free-floating exchange rates. Deficit nations would devalue against surplus ones, bringing trade and capital flows back into balance. But in a monetary union, this cannot happen. In fact, the exact opposite has occurred. A low interest rate designed to help Germany deal with the costly aftermath of reunification encouraged a consumer and construction boom in the underdeveloped periphery. This in turn caused differences in prices, wages and industrial competitiveness to widen.
Data compiled by Germany’s CESifo Institute show that, relative to the median, the “Giips” – Greece, Ireland, Italy, Portugal and Spain – have seen a 30 per cent appreciation of prices since the euro began. Germany, the leading surplus nation, has by contrast seen real depreciation of 22 per cent. In other words, the Giips have suffered a massive loss of competitiveness. They have appreciated while the Germans have devalued – the very reverse of what would have happened in a system of free-floating exchange rates.
When countries live beyond their means by running big current account deficits, they borrow from abroad to square the circle. In effect, the surplus country lends the deficit country the money to buy its goods. During the boom, German banks were happy to do this. Come the bust, they understandably stopped. Since then, the deficits have been sustained via the backdoor of the ECB printing press and bail-outs from the eurozone and IMF.
To correct the problem, either the Giips must suffer years of nominal wage cuts, deflation and depression-style unemployment, or Germany must accept much higher inflation. Since neither of these possibilities looks even remotely acceptable politically, there’s really only one way this can end. Europe hoped the single currency would be an instrument of growth and political unity. Instead – as I and others have warned – it’s turned out to be a doomsday machine. The tragedy is that no one will admit it’s time to turn it off.