On the eve of the latest Eurozone bail-out, I listened to a panel of four central bankers (an American, a Japanese, a Cypriot and a Dutchman) discuss the outlook for the global economy. The context was a conference hosted by a global banking group. The panellists were a bright foursome and all commanders of their subject and they set off in good order but before long they got snagged on the sharp edges of the Eurozone’s difficulties, and struggled to get free. As they tried, an interesting dynamic emerged: the Japanese explained that he was impressed, after 18 months in Europe studying the subject in detail, by the sheer intransigence and determination of the political class determined to make the euro work. The Cypriot, who was ex-ECB, explained carefully what needed to happen next, detailed the ECB’s achievements and strategy, and was of the opinion that it was now the turn of the politicians and the voters to move things forward. The American and the Dutchman (who is based in London) were both more sceptical. I don’t think they had any reason not to want the Eurozone to work, but they both posed difficult questions around what was, and was not, politically possible which the other two did not try to answer.
[By the way, and not for the first time, I had the eerie feeling that the audience – investors and bankers from Europe and the US – were caught between hope and expectation. I could hear teeth gnashing and minds whirring. These people hate not being able to call things clearly.]
The discussion made me think how far the Eurozone’s problems are from resolution; and that in fact the really hard phase is just beginning. This, I believe, is because the initiative is passing from the hands of the policy makers and into the hands (and minds) of the voters. The acute crisis – during which northern European governments leant on insolvent governments from the south to exact spending cuts in return for massive bail-outs, and the ECB effectively underwrote the bust balance sheets of many of Europe’s banks – is over. So, for the time being, is the day-by-day lurch from fear to euphoria, as markets saw the risk of default and further crisis loom and fall away. Instead we have entered into a chronic phase of the crisis, in which policy-makers turn to the knotty challenges of rebuilding national balance sheets, persuading voters in member states to endure years of austerity and give their permission for a massive shift of power from to Brussels.
As the Eurozone grapples with these challenges there is a structural tension between the politicians and the central bankers. Each side complains that it is the other which is preventing resolution. Here is something like the central banker’s perspective: “the politicians are too short term and populist to risk the sort of spending cuts and higher taxes that the straitjacket requires if it is to, year after year, effect fundamental change. So whenever the voters get really fed up, or when there is an election to win, the politicians push the problem back to the ECB and demand more liquidity, or that it loosens the jacket. Reluctantly, the ECB agrees to help by releasing more liquidity, or as one of the bankers called it “using the ECB bridge”. This extra cash doesn’t solve the problem (of course many believe it makes the prognosis worse by creating inflationary pressures), but it does buy the politicians more time to persuade the voters that there is no alternative (the can gets kicked down the road). But the politicians don’t use the time properly, because they are short term and populist, and before long – and because it worked last time around – they are coming back to the ECB for more help”. I think it’s called a negative feedback loop.
The injections of liquidity by the ECB evaded disaster in the dark days of 2010/11. But the Eurozone now faces huge chronic difficulties. The Eurozone / European Commission / ECB won’t countenance a devaluation of the euro (it’s not the German way, and fundamentalists still hold onto the idea of one day replacing the US dollar as the world’s reserve currency), nor will they allow weaker members (Greece, Portugal, Spain, Italy) to default and leave the Eurozone for fear that this will bring the project crashing down. So the only alternative is “twenty years” (said the Dutchman) of grinding austerity; a generation trapped in a straitjacket. But is this politically feasible? Evidence, and human nature, and precedent all suggest it isn’t.
So here are four reasons why I don’t expect the Eurozone to survive as we currently know it:
1. Most currency unions in history have failed – typically after 20/30 years – as a result of asymmetric shocks.
2. Unions which have been successful in history (Italy, Switzerland, the US) have first created economic and political integration (these achievements tend to be hard won over decades) before they set about creating a currency union. This is widely seen as the smart way to do it. The crazy, risky and hair-raising way to do it is to create a currency union first and then try and keep it going by forcing through economic and political union. This approach has never been tried before.
3. The three essential ingredients to the smooth running of the United States of America (the world’s most successful currency union and the template for the Unites States of Europe) are (i) an accountable and mandated central authority with tax raising and spending powers (ii) labour mobility across the union and (iii) fiscal transfers from wealthy parts of the union via the centre to the poorer parts of the union. Well, Brussels is a long way off emulating Washington. Labour mobility in the USA is enabled by a common language, and a shared sense of nationhood, both factors which we won’t see in Europe in the foreseeable future. And the refusal of German voters to bail-out the Eurozone’s southern members is exactly where the Eurozone’s chronic phase is currently stuck – a recent poll revealed that 26% of German voters would support a party committed to take Germany out of the euro (the figure was 40% for 40-49 year olds). Europe’s currency union is built upon economic and political integration which is paper thin.
4. The politicians who maintain that the Eurozone will survive simply because they are committed to making this happen (ie. their political will beats everything else), are meanwhile reluctant to come clean about what political and economic union actually requires from their voters. Instead they build their fighting talk around talk of “more Europe”, and argue that the correct response to this difficulty is to show the courage to “move forwards”. This is a time for solidarity. There is no alternative. Etc. But the measures needed to bind the Eurozone’s diverse economies together, and convince the markets that the project is sustainable, appear to be politically impossible to sell: debt mutualisation, nations ceding control over taxation and spending, common regulations for anything important. Look at how difficult it has been for the Eurozone members to find common ground on Banking Union. In the aftermath of the financial crisis, new rules for Europe’s banks should be a no brainer, enabling Eurozone politicians to take a first, easy step towards “ever closer union”. But in fact it has proved very difficult to achieve consensus, because rich member states don’t want to accept liability for bad loans made by banks in the poorer states. Thus the political will driving Eurozone integration collides against the political will of the very same politicians obliged to represent their national interests and persuade voters to re-elect them next time around.