For the eurozone, the worst is yet to come
This euro crisis is now getting extremely serious. Events are happening quickly, closing-in on policy makers and threatening to engulf us. Across the single currency zone, fears are rising and, even in the most moderate nations, populations are becoming more restive. History is locked on fast-forward. Some say that seemingly arcane economic policy debate doesn’t matter. In the UK, in particular, but across much of the rest of Western Europe too, the political and media classes have long displayed a tendency to roll their eyes whenever anybody with even a smattering of economic insight has had the audacity to show it.
For the bien pensants, ignorance of financial issues has been a badge of honor. Economics has been dismissed as a “trade”. To hold well-researched views about commerce and asset markets has been to be a suspect arriviste “striver”. Such is the prejudice of those cosseted from economic reality, their minds dulled by generations of inherited wealth. Well, such minds created the euro and what a disaster the euro has been. And the greatest disaster could yet be to come.
Let what is now happening in Europe serve as a reminder, a 28m decibel wake-up call, that serious economic debate matters, and matters a lot. Attempts to dismiss or even suppress it, because it’s “hard” or “boring”, have very real human consequences. In the run-up to the eurozone’s launch, there was almost no popular discussion of its inherent technical flaws. Those of us who tried to air such concerns, to wield the lessons of history, were dismissed as “xenophobes” and “cranks”. So we’ve ended up with a eurozone so replete with inherent contradictions that it threatens now to spark financial meltdown across Europe and serious civil unrest.
Global financial markets are in a trance, a paralysis of fear and confusion. With politicians and policy-makers now finally admitting that the jumped-up dismal scientists are correct, and “Grexit” could happen, investors in Europe and elsewhere are slashing their euro exposure.
During the first quarter of 2012, bolstered by German growth, and with eurocrats scoffing at those who said Greece might leave, the single currency rose 3pc. Since that indecisive 6th May election, though, and Athens’ subsequent inability to form a government, fears of a fully-blown default, and eurozone-wide contagion, have spooked global markets. On Friday, the euro fell below $1.25 to a 22-month low and is now down over 4pc this month. Traders are contemplating the financial turmoil if Greece leaves, to be followed by who knows who?
Equities, meanwhile, have gyrated, on very low volumes. Institutional investors, clueless as to what will happen, have stock-piled cash. Having endured crisis after crisis since 2008, financial markets in general have volatility-fatigue. With trading thin, investment isn’t happening, so compounding the broader growth-stasis. That cranks up welfare payments, lowers tax-takes and makes European sovereign balance sheets look even worse. And so, on an axis of printed money, the bank-government-bank negative feedback loop spins faster and faster. How long before the gyroscope finally topples, and comes crashing down, with investors dumping the euro altogether?
With “break-up” becoming ever more plausible, monetary union is showing structural cracks. Germany’s 30-year bond yield last week dipped below 2pc, as the borrowing costs of embattled “peripheral” countries shot-up. Investors are so desperate for a haven, they’re now lending Berlin short-term money for free.
A single currency can be maintained if no-one worries if they’re holding German, Spanish or Greek euros. Well, savers are worrying now. An “intra-euro bank-run” has been happening for months, with deposits heading for the Teutonic core. Mediterranean firms and households are petrified their cash could be converted into devalued drachma or pesatas on any break-up. And what of all those mortgages, corporate loans and other commercial contracts?
Despite all this, European policymakers languish in denial. Last week’s “informal” European Union summit in Brussels focused on yet another “rescue scheme” – this time “project bonds”, to be launched for a trial period this summer. Some €230m has been earmarked from the existing EU budget to help the state-backed European Investment Bank provide infrastructure loans. This initiative will apparently attract €4.6bn in private investment, so helping the eurozone grow its way out of trouble.
The latest growth news is bad, to be sure, with even Germany on the skids. Survey-based PMI indicators fell in May from 50.5 to a six-month low of 49.6 pointing to falling GDP. Germany’s IFO Business Climate Indicator, lately resilient, also endured its sharpest drop since August, reversing five months of gains. Eurozone PMI measures are consistent with a 0.5pc quarterly GDP contraction, the region on the brink of another recession.
As policy responses go, though, “project bonds” are like attacking an inferno with a water pistol – and a water pistol squirting petrol. The only “private” investors willing to invest in such a scheme will be state-dependent commercial banks and heavily-regulated pension funds ordered to do so by their political masters. To hell with the debasements dangers and losses then foisted on long-suffering depositors and policy-holders.
“Project bonds”, of course, are designed to be a step towards the “Eurobonds” being promoted by new French President Francois Holland – a euphemism for Germany under-writing everyone else’s debts. That would amount, in essence, to fiscal union. It seems to me pretty obvious that, for all the hopes being pinned on such an outcome, it isn’t going to happen
The tacit plan seems to be that Berlin will accept full-on European Central Bank debt monetization in return for a German-directed fiscal union, with powers to raise taxes and make large-scale transfers between countries, while issuing joint Eurobonds.
The trouble is that Greece is a democracy, Spain 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? I don’t think so. The German population, too, would accept neither the cost, nor the deeply uncomfortable position of superiority. While floating such political fantasies, though, this latest EU summit, quite incredibly, offered almost nothing in way of preparation for a likely Greek departure. No wonder the markets are afraid and confused.
As this eurozone meltdown deepens, a chronic lack of “periphery” bank capital raises the risk of acute liquidity crises. Spain’s fourth largest bank has just asked for a €19bn bail-out. Catalonia, the country’s wealthiest region, says it is bust and central government must pay its bills.
The central problem, compounded by the eurozone’s deep flaws, is that many of the region’s banks are fundamentally insolvent. The only way to address that is to lance the boil and, while protecting depositors, let these rancid institutions go bust. How long will it be before we face up to this unavoidable truth? How bad must the riots get, how volatile the financial markets, how many jobs and lives must be destroyed, how intense the global and diplomatic fall-out?
For now, it’s all eyes on the Greek election on 17th June – which, it seems, really could go either way. The economically-illiterate eurocrats, having insisted euro-exit was impossible, must now insist it could all too easily happen. That’s the only way they can threaten to pull the plug if the Greek votes the wrong way. Yet for all the summitry and posturing, their credibility is shot to ribbons.