The future of the euro

Well, what are they going to do?

A look at the recent history of the eurozone does not make happy reading.

When Greece suddenly admitted it was bust it seems Eurozone leaders were caught on the hop. An all embracing package was quickly put together with the Eurozone contributing €440 bn. This was supposed to be so large, particularly with handouts from the IMF, that it acted like America’s ‘Shock and Awe’ military strategy. Two unfortunate things then happened. The first was that Chancellor Merkel had to explain it to the German voters who seem to think - imagine this – that the Greeks are idle, dishonest and overpaid.

The second thing that happened was Ireland. The Irish banks fuelled a property boom and when the bubble burst were insolvent. They had to be guaranteed by the Irish State which is now itself insolvent.

I often complain about the knee-jerk reaction in Europe that any problem can be solved by more regulation. But the first thing a regulator needs to have is market knowledge. In Britain this was held by the Bank of England which spoke regularly to the banks on its patch and knew what was going on in the international markets. That is why it was such a disaster when Gordon Brown replaced it with people who had no idea. What was the Irish Government doing, while its banks piled up their balance sheets with dodgy property lending? What was the European Central Bank doing? They must have had access to the figures – the banks have to publish their accounts. The problem wasn’t that nobody did anything, it is that the people who might have done something didn’t know what was going on.

The coming together of the two problems – Ireland and the German voter – forced people to start admitting the existence of the elephant in the room. I posted about it on Nov 2nd. Merkel needed to reassure her voters and said that of course if there were another bail out the bond holders would have to take a haircut. That meant that a country (Ireland) could be permitted to be actually going bust and not paying its creditors. And it seemed fair: why should investors be allowed to buy high yielding Irish debt confident in the knowledge that those hard working Germans would rescue them if anything went wrong?

But it was something better left unsaid. Investors, naturally, priced Irish debt even higher, because of the risk of not being repaid in full. The Irish borrowing rate went up to 7% when I last posted and upwards to nearly 9%, which Ireland can’t afford to pay, so it is more likely to go bust.

So what will they do, the Irish, the ECB and the Germans?

One problem is that lack of market confidence is contagious. The ECB knows that Portugal, Spain and perhaps Italy are waiting in the wings. Another is that this is going to get worse. German productivity is so much greater than in the peripheral countries that the wealth gap will widen.

Chancellor Merkel said yesterday that ‘If the euro fails, Europe fails’ – somewhat hyperbolic, but it might reassure the markets that there is some determination to resolve this. The only thing which will satisfy the German taxpayer is if failing economies are properly supervised. That means a loss of sovereignty: their budgets will be imposed by the ECB. Ireland doesn’t like the idea, and who can blame them?

So we are in the ridiculous position of countries being forced to accept handouts whether they like it or not, and the creeping shadow of what in truth was always going to happen: monetary union leading to political unification under the hegemony of Germany.