In December 2011, I wrote a blog entitled ‘Eurozone Endgame ? ’. Within this blog a number of possible eurozone scenarios were outlined and discussed, and these scenarios are still real possibilities. Events during the past few weeks suggest that the endgame strategy for the long-running eurozone crisis will shortly be reached.
The eurozone crisis and the pressing need to resolve it are currently dominant global economic concerns. Alongside the continuing worries about a possible exit of Greece, Spain has now become a major issue. Home to some of Europe’s most vulnerable banks (who lent extensively to property developers in the build-up to the 2007/2009 financial crisis) and worries about unemployment and growth have sent Spanish ten-year bond yields above 6 per cent. These high bond yields, in turn, make it harder and more expensive to carry out the badly needed re-capitalisation of Spanish banks (to match their increasing bad loans). As more bad news helps to fuel an already risky position, Spain becomes ever more exposed to a bank run.
The problems of Spain and their potential consequences have added another dimension to the eurozone crisis, dominated up until recently by the spectre of a Greek exit from the euro. ‘Greek tragedy’ has been joined by severe ‘pain in Spain’.
Spain is a major economy by international standards and the consequences of a default of any kind are practically unthinkable. Some estimate that it could cost in excess of £240bn to keep Spain afloat. The Spanish crisis adds more fuel to mounting speculation about the future of the euro.
How will events unfold for the eurozone in the weeks ahead ? No one knows for sure, but there are some significant milestones. Much will depend on the impending Greek vote (June 17) – the outcome will show whether the needed austerity programme for Greece to stay in the euro is supported by the Greek electorate (as it has been recently by the Irish electorate). At one level, this vote is for giving up some democracy in favour of more ‘federalism’ (however one likes to label the need for greater economic and political ‘integration’ or ‘cooperation’ within the eurozone). In effect, this increased ‘democracy deficit’ is about greater control from Brussels and Germany.
The two basic alternatives facing the eurozone countries and the wider Europe are simple ones – separate states or a superstate, a kind of ‘United States of Europe’ ? There are variants on these two alternatives (as outlined in my blog of December, 2011 ’Eurozone Endgame?’), but these are the two polar models. They also underscore the challenging political questions that are inevitably raised in solving the eurozone crisis.
The Economist (May 26) and others have argued that to halt the euro’s downward spiral requires most importantly for:
- European banks to be re-capitalised
- The ECB (European Central Bank) to stand behind solvent European countries with unlimited support
- And to curb Germany’s obsession with austerity
Some moves have been made in these directions (at least on the first two of the above bullet points), but not enough. Whatever happens with Greece (whether it exits from the eurozone or not), the eurozone must use all of its resources to stand behind its big banks. Acting in this way as the ‘lender of last resort’ to the banking system is a recognised principle of modern central banking and a real need to keep the system safe, especially at a time when fear and rumours stalk financial markets. Eurobonds should also be issued to share the debt burden across countries.
So where is the eurozone heading ? Will it, should it, break up ? On balance, The Economist and many others fear the huge costs and unknown consequences of a eurozone break-up. Even an optimistic scenario (where there is some kind of ‘orderly retreat’ back to national currencies) for such a break-up appears horrendous. Other possible (less orderly) scenarios are practically unacceptable to the global economy and the major international financial institutions (led by the IMF).
These hypothetical, but possible scenarios lead to three related conclusions:
- The break-up of the euro and even the exit of Greece produce scenarios that are to be avoided at all costs
- But to save the euro and make it work, the structural and other problems that have led to the present crisis have to be addressed. ‘Any kind of ‘patching up’ of the ‘eurozone as is’ is not acceptable and will ultimately lead to future problems and crisis.
- And this leads to the inevitable conclusion (that is widely accepted by many economists and other informed observers) that to make the eurozone work, the eurozone countries will have to accept a greater degree of economic integration, more austerity for some (at least in the short term), an equitable sharing of the debt burden across countries and the development of structural and economic conditions for competition and growth across the entire eurozone.
These are not easy targets to achieve. They raise questions about any resultant ‘democratic deficit’, but they do emulate in part the initial ‘vision’ that drove the euro.
The political challenge is likely to centre on lessening any ‘democratic deficit’ within the new, more integrated eurozone model. Many believe that this challenge is not insurmountable. Most believe that it is the only scenario that can save the eurozone and, thereby, avoid the almost unthinkable costs of a break-up. The ‘unthinkable’ costs are also unknown ones, since such a break-up would be a new experience for the global economy.
During the next two weeks, the increasing pressure on Germany to lead an acceptable solution (a main purpose of David Cameron’s talks with Angela Merkyl this week), the impending (June 17) Geek vote and staving off a Spanish banking ‘meltdown’ will be dominant concerns. They all demand a fast, decisive and committed solution to the eurozone crisis.
There are influential voices in financial markets that believe that the euro is doomed (and always was). The UK and other governments have to be prepared for such an eventuality. But the markets will not have the final say. In the end it will come down to politicians and political will that will decide how the eurozone crisis will be resolved.
What is now clear is that time is fast running out. The problem is that as time runs out, the options and lead time for solving the crisis also close down. As this happens, the prospects for some kind of orderly and controlled solution inevitably decay.
Professor Ted Gardener