“There’s no such thing as an orderly break-up”, argued my friend, a perceptive and highly-educated man, as we discussed the eurozone over dinner. His argument was that a down-sizing of the single currency should be resisted at all costs.
“The prospect of one or more countries leaving, or being forcefully ejected, is now very real, whether you like it or not,” I replied. “So we should face reality, take the decision, prepare for it now, and do what we can to manage the transition, rather than enduring the horrendous consequences of a market-imposed outcome”.
This is the conversation, the tortured debate, now taking place among policymakers, financial analysts and, increasingly, the general public, across Western Europe. Nowhere is this ghastly dilemma – tough-it out, or move to a smaller, more stable eurozone – more keenly felt than in Germany. While Chancellor Angela Merkel instinctively supports the “European project”, she also needs to placate an increasingly restive electorate. Berlin doesn’t know what to do.
The world’s financial markets, the British and American governments, and practically every non-German eurozone politician, are united. They’re watching and waiting, convinced that Merkel will eventually relent. Should Germany sanction the European Central Bank to guarantee the sovereign debts of all and sundry, with “printed money”? Global equity markets would certainly rally if so, at least for a while. And eurozone bond yields would fall.
Taking this route would contravene European Union treaties, as Merkel well knows. Far more importantly, once the ECB has bailed-out profligate governments once, the same countries will over-borrow all over again a few years down the line. The markets will eagerly lend to them too, such loans combining a lucrative yield with a de facto ECB guarantee.
The job of any central bank, the ECB included, is to act as “lender of the last resort” to commercial banks in its jurisdiction that are solvent, but in need of temporary liquidity. Central banks aren’t meant to dish-out free money to governments that have spent themselves into insolvency. “Moral hazard” isn’t some kind of intellectual indulgence. It’s a stark fact of life, a reminder that actions have consequences and those consequences can’t be ignored.
What’s probably uppermost in Merkel’s mind, though, is that allowing the ECB to let rip, buying-up eurozone bonds with abandon, while back-stopping the European Financial Stability Facility with credits created ex nihilo, would be electoral suicide. The ghosts of 20th century history loom large. Post-Weimar Germany was so traumatized by spiraling inflation that the country’s entire political culture remains deeply affected to this day.
The current prosperity, too, of the eurozone’s economic engine-room was built on the bedrock of fiscal prudence and “sound money”. Germans know what works and they know all about rolling-up their sleeves and facing the economic music. Those who insist that “Merkel will print, she has to” under-estimate the resolve of the nation which created the Western world’s most successful large economy.
Anglo-Saxon politicians are getting impatient and increasingly shrill. Their friends on Wall Street and in the City, pens poised over campaign donation cheque books, are desperate for the markets to surge. After all, end-of-year results and Christmas bonuses are now at stake. But convincing Berlin that “quantitative easing” is the answer will be a very, very hard sell.
Hang on! Germany will give eurozone QE the nod, the argument goes, if proper safeguards are put in place. From now on, Berlin can get in the face of less prudent governments and, suitably revised EU Treaties in hand, prevent profligate “Latin” governments from flouting the eurozone’s spending rules. For many, this is a more likely, and far more desirable outcome than a break-up. The deal will be that Berlin accepts full-on ECB debt monetization and, in return, a German-directed fiscal union will be created, with powers to raise taxes, make large-scale transfers between countries and issue joint eurobonds.
I appreciate that we’re all sick and tired of financial turmoil. I also accept, given that I’ve been making the argument for my entire adult life, that “fiscal union” is the only economically coherent system under which the eurozone can possibly survive in its original form. I’m starting to lose patience, though, with those who expect to be taken seriously when they venture that such an arrangement can actually be implemented in Europe.
Greece is a democracy. Spain is a democracy. Italy is a democracy. France, the world’s fifth-largest economy and one of the most powerful countries on earth, is a democracy – and a pretty feisty one at that. Are all these countries, their electorates supplicant, their future politicians content, really going to subscribe to and live under, for decades to come, a system based on Berlin telling them how much they can borrow and spend?
Anyone who thinks that such a situation is sustainable needs to examine not only a few history books, but also their conscience. For the reality is that “fiscal union” is being touted as a solution by those who are desperate to convince themselves, and everyone else, that Germany will ultimately fire-up the ECB’s virtual “printing press”, so sparking the mother of all year-end relief rallies.
Let’s say that Merkel does crack, and takes the monetization route, with Germany laying-down terms to the eurozone profligates. Such conditions would need to be non-negotiable and loudly stated, so as to placate an outraged German public. What then? How long before Southern European leaders start routinely blaming “the Germans” for domestic woes? How long before new, more extreme politicians come to the fore, pandering to base human prejudice? How long before a system that’s supposed to promote free trade and European co-operation ended up, instead, promoting protectionism, hatred and conflict?
These are the questions that the cheer-leaders of “fiscal union” need to answer. Such a system can theoretically be imposed “by Treaty”, but if it is, then its backers must be prepared to do what it takes to suppress democracy. “Fiscal union” advocates will also need, when the time comes, to send out the eurozone riot-police. Voters get angry, and sometimes violent, when their own politicians let them down. But when they feel controlled and humiliated by foreigners, they become totally enraged. That, I’m afraid, is the undeniable lesson of history.
The eurozone is sleep-walking towards a cliff-edge. The all-important spread between the 10-year French government bond and its German equivalent touched yet another euro-era high last week. Spain, also, despite its relative fiscal strength, just paid a crippling 6.9pc on 10-year money. Yields on paper issued by the EFSF, the bail-out fund meant to reassure eurozone creditors, are spiraling out of control. Investors beyond Europe, deeply disturbed at the region’s economic incoherence, are even questioning German bonds. How much louder do the alarm bells need to ring before time is called on this absurd monetary experiment?
There may be “no such thing as an orderly break-up”. But there is a very big difference indeed between embarking on a tough transition to a smaller eurozone with a coherent plan agreed by respective governments on the one hand, and massive systemic meltdown on the other, to be followed by years of pan-European loathing and mutual recrimination.
Maybe Merkel will attempt to “muddle-through” – printing a bit here, a bit there, trying to keep it all under wraps. If so, she will learn that the status quo really isn’t an option. The euro in its current form is incendiary and explosive, a macro-economic weapon of mass destruction. It simply must be defused.