The Euro in danger

A strange story emerged on the Der Spiegel website last night: that Greece had decided to leave the euro and was in talks with eurozone finance ministers. It was denied by Brussels, but then it would be.

Greece - together with most economists - has concluded that it is not going to be able to pay back its debt. There are riots on the streets, and the Government is threatened.

Lending it more money is not the answer. I have been saying for several years that the Eurozone needs a mechanism for countries to go bust within it, or to leave it.

The financial markets have kept the euro strong, because they believed that the system of bailouts would work, and nobody would lose out by lending to the poorer countries. That belief is now under threat. Greece simply cannot make the repayments and maintain social cohesion. And if Greece is forgiven part of its debt, how long before Portugal and Ireland want the same treatment? And what will happen to the banks which are holding so much debt from these peripheral countries without having to write it down? If Greece leaves the euro its debts will be worth 60c per €, and the banks would have to make provisions.

Things are not looking good in the Garden of Eden.

Clouseau and integration

An interesting little vignette from François Fillon, Prime Minister of France, on a visit to the UK. M. Fillon, who unfortunately looks far too much like Inspector Clouseau, declared roundly that France and Germany 'will do everything, absolutely everything, to save the euro'.

He goes on
“In order to consolidate the euro we will need gradually to harmonise our economic, fiscal and social policies, hence we are going to go towards greater integration

“The question is is the UK ready to accept or encourage greater integration of the eurozone or is the UK distrustful of that and will it create obstacles and make it more difficult to happen?'

It sounded a little bit more of a threat than a plea, but that is the usual language of the integrationists so let it pass.

Britain, as Clouseau also pointed out, has a great interest in this. So assuming we don't wish to join (and the Government could never get a law passed, even if it wanted to), and that we, as the French always do, vote in our national interest on treaty change, where does that interest lie?

In one sense, what kind of a mess these people make in their own stables is a matter for them. But until we can redirect our economy towards the Far East, and away from the moribund 'Old Europe' it is in the interests of our exporters that mainland Europe be economically buoyant. Where Fillon goes wrong is to assume that that is the same as the full political integration which would be required to control the budget deficits of the new sinners (the first countries to breach the guidelines were of course, France, Germany and Italy but we have forgotten that).

But I think it is becoming clear that full integration is not the right road for Europe. It will cause massive political upheaval as those countries with an independent frame of mind dither and horse trade over a treaty change. And someone will always get round it.

The solution to Europe's problems lies either with the weak countries leaving the eurozone or, better, the strong countries leaving it. Europe's best hope is not to hold back the efficient by making them give a blanket guarantee of the inefficient. It is to let the best maximise their performace and help the weakest up that way.

We should say politely to M. Fillon that Britain's long term interest lies in the euro breaking up, and as friends, the best we can do for them is to save them from the insane, one-track minded political class that would prefer poverty to taking a step backwards politically.

We should oppose any treaty which will make Europe poorer.

Europe worse than Iraq

Further to my post a couple of days back where the propaganda from the European Commission claimed a success in '“Securing a sound economy and stronger financial markets", the latest quarterly report from the Data Services company CMA arrives over the airwaves.

Of the ten most risky state borrowers in the world, as measured by the cost of insuring their debt against default, four are in the eurozone: Greece (which slips into the No1 spot ahead of Venezuela, whose President is mad), Portugal, Ireland and Spain. In addition Hungary, which holds the rotating EU Presidency (as opposed to the permanent President, Rumpy, who is Belgian, and the President of the Commission, Barroso, who is Portuguese) slips in at No.9, the ninth worst international sovereign credit risk. Iraq is tenth.

The inability of any eurozone statesman, particularly Chancellor Merkel, to make any kind of decision, means things are going from bad to worse.

The reason for this is that the eurozone is a political construct, not an economic one, and they can't bring themselves to believe that it is a disaster, which is gradually impoverishing the people of Europe. At the moment all they are doing is lending these countries more money, which is not the solution to overindebtedness. They are wishing the whole thing would go away so they can get back to enjoying their lunches and their pousse-café in peace.

But it won't go away; it will get worse.

I have said it before but it is worth repeating.They have three choices: take control of the fiscal side of each member (politically unacceptable to the members), allow member states to go bust while in the euro, or allow them to leave. These last two are politically unacceptable to the bureaucrats, and this is why they told the lie (there is no other word for a statement made in the knowledge that it was untrue and with intent to deceive) that they were “Securing a sound economy and stronger financial markets". 

I repeat, if they don't do something, this will get worse in 2011

Farewell the kroon

Tomorrow Estonia joins the euro, the first former soviet state to do so. Its currency, the kroon, will disappear.

Estonia will be the poorest of the 17 states of the eurozone. It needs to grow dramatically to reach the levels of Greece and Slovakia, much less those of France and Germany.

Economic growth is best nurtured with an undervalued currency and low interest rates. When the European Central Bank starts to put the brakes on to prevent inflation in France and Germany the Estonians, already poor, will suffer. They are being encouraged to join because the euro is a political project and those behind it, none of whom are Estonian, want membership to look attractive.

I suppose it is the plight of countries such as Estonia to be caught up in the doings of greater nations, but this looks particularly unfortunate. God help them.

Thought for the Day

From Douglas Carswell MP:

"Fact 1: During 2011, Portugal must raise Euro 38bn, Belgium Euro 85bn, Spain Euro 210bn, and Italy Euro 374bn (Goldman Sachs report quoted in Telegraph).


Fact 2: Ireland, Greece, Spain, Portugal and Italy need consumer spending to fall by 15pc for their debts to become sustainable (Centre for Economics and Business Research report)

Guys. It's over. "

Sunday Thinkpiece: who will save the euro?

‘Can the euro survive?’ asks Lionel Barber in the Financial Times. ‘Who’s going to save the euro?’ asks Claude Nougat.


The answer is that the euro doesn’t deserve to survive. When the idea was first mooted, back in the Maastricht negotiations in 1992, the problems were clear. It wasn’t just eccentrics like me: a whole raft of economists and senior politicians pointed out that economies were going to be moving at different speeds, and that unless Europe had control of the fiscal levers the new currency was going to be subject to unbearable stresses.

In some respects the problems are the same as we see in England. I have lost count of the number of times I have heard or read some one say ‘Now the economic policy is in the hands of the independent Bank of England...’. But it’s not economic policy the Bank controls, it’s only monetary policy. The other strand of economic policy, fiscal policy, or control of government spending and taxes, still lies in the hands of the Treasury. So Gordon Brown, while muttering about prudence and reminding us that it was he who ‘made the Bank of England independent’, was able to increase government spending beyond the level of imprudence to the level of madness. Now every year the Governor of the Bank of England has to write to the Chancellor explaining why inflation will be over three percent again, despite both of them knowing it was Gordon’s fault. Before long interest rates will have to rise to deal with this inflation and that will slow economic recovery.

Now imagine this uneven mess multiplied by 16. Spending in the Eurozone is in the hands of people as different as the Greeks and the Germans. The Greeks were, as Greeks are, corrupt and greedy, while the Germans were, as Germans are, cautious and prudent.

The point I am making is that they knew all this, the founding fathers of the euro. They knew that there really should have been political unification (which would include Eurozone control over countries’ budgets) before monetary union, but at the time they wanted all members of the EU to join and there was no way Britain, Denmark and Ireland were going to accept that. So cunningly they embarked on the euro project knowing there would most likely be a crisis and believing that that would trigger political union. Now, in the midst of the crisis they’re still thrashing around, the European political class, trying to take away a country’s control of its own expenditure and taxes, and therefore its freedom. George Osborne was right to prevent them forcing a corporate tax increase on Ireland.

Ireland is now embarked on a downward spiral of reducing expenditure, thereby reducing the tax take, thereby necessitating lower expenditure. It will most likely default. The Eurozone is reaping the harvest of its own policies. It was conceived in dishonesty and doesn’t deserve to survive.

Germany and the euro

The Guardian today quotes Angela Merkel as saying 'if that is what the euro has become perhaps we should join some other club'. Naturally a host of commentators have rushed to mention that Germany derives great benefit from the euro, and indeed this is the case. Germany exports a huge amount to countries on the periphery of Europe and if it left the currency union the remaining euro currency would fall against the new Deutsche Mark, pricing those exports out of the market.

But I think people are missing something here. Europe, America and Japan are awash with cash, and as signs of the recession fade some of that is going to have to be hauled in. Germans are terrified of inflation; they have all heard of the experiences in 1923 and are going to push for a tightening of monetary conditions just as others need them to be kept loose. To control inflation they will either need hugher interest rates or a stronger currency. What will happen then?

The problems of the euro go beyond sovereign default.

The Euro

We had the Irish bailout on Sunday night, and it was no surprise, at least to me, that the euro fell against major currencies on Monday morning. The European Commission and the European Central Bank seem to be living in a world of their own.

First, announcing major events on a Sunday night. This is the clearest sign of desperation. Assuage the markets before Tokyo opens, in the hope of a bit of good press. Naive.

Second, they then all sit back and assume the problem has gone away, just as they did with Greece.

The nature of markets is this: if everyone knew, for example, that the dollar was going to fall, you wouldn’t make any money selling it. To make money you have to be the first, and this means constantly testing the accepted structure, just as the markets did against sterling and the lira in 1992 until the markets won and the status quo lost. It may not be tomorrow or next week, but it is clear, now the scare is out there, that the markets will have a tilt at Portugal, Spain, perhaps Italy.

The only way to prevent this is to have a long term plan. I wrote many months ago that the Eurozone either needed a procedure for a country to leave it, or it needed a procedure for allowing a country to default. At present there is neither

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.

Greece

The euro surged on the foreign exchange markets yesterday as Eurozone leaders announced a package of direct loans to bail out Greece.

Today a more sober note prevails. The Royal Bank of Scotland's economics team (you didn't think they had one, did you?) said

“Reaction to the Greek bail-out package can only be described as lukewarm. The market still has some doubt over Greece’s ability to turn its fiscal position around and some investors view the bail-out as only kicking the can down the road.”

As I have said before, unless Greece seriously addresses its uncompetitiveness vis-a-vis Germany, in a couple of years the whole damn thing will happen again.