Eurozone nations are stuck in a “doom loop”
“These global economic problems have their roots in the fools’ paradise we all used to live in,” observed Peter Mandelson on Friday, to a packed seminar at the St Petersburg International Economic Forum.
“Pretty much everyone borrowed and spent beyond their means and that’s now catching up with us,” continued the former Cabinet Minister. “And it’s the inter-twining of the sovereign debt and banking crises that makes any eurozone resolution extremely difficult”.
On this point, Mandelson is correct. Years of extreme lending and reckless trading by Western banks brought serious sector weakness. The disgracefully cozy relationship between our political and financial classes, and the even more disgraceful use of banking blackmail, has meant, in Mandelson’s words, that massive banks losses “have, in one way or another, landed on sovereign balance sheets”.
Such is the reality that plagues the eurozone, with toxic bank liabilities raising deep concerns about sovereign insolvency and the resulting sky-high bond yields destroying commercial sentiment and throttling growth, making dodgy banks weaker still. This bank-sovereign-bank “doom loop” has brought Western Europe back to the brink of recession, with related systemic fears casting a very dark shadow over the entire global economy.
If only Angela Merkel would agree a big bail-out, we’re told, everything will be fine. The German Chancellor retorts that the only way Berlin could possibly agree to back-stop debts of more profligate eurozone members would be if Germany has more control over the spending of other governments.
On Friday, the latest round of this tortured debate took place in Rome, where Merkel met with her French, Italian and Spanish counterparts. The world’s most powerful woman once again dismissed calls for the eurozone to issue common debt and sprays more cash around to stabilize financial markets.
Just ahead of tomorrow’s implementation of a €100bn bail-out of Spain’s busted banks, Merkel closed this disastrous Rome meeting by crystallized her dilemma. “If I give money to Spanish banks,” she said, “I’m the German chancellor but I can’t say what these banks can do”.
That’s why Germany insists these latest bail-out funds are channeled through the Spanish government, which Berlin theoretically can influence. But that adds yet more billions to Spain’s state debts, intensifying the bank-sovereign-bank doom loop. Investors also fear bail-out loans will subjugate existing private sector creditors – another reason why, since this bail-out was announced two weeks ago, Spanish yields have spiked. Yet domestic political pressures mean Merkel can’t pay the cash directly to foreign banks – a move that would make a mockery of existing Europe Treaties, to say nothing of Germany’s constitution.
Our financial and political “leaders” desperately want “fiscal union”. If Germany agrees to “debt pooling” and a “banking union”, together with more QE-style measures by the European Central Bank, then bond yields elsewhere in eurozone would plummet and, across Europe and the world, equity markets would soar.
Yet sustainable fiscal union is never going to happen. Debt mutualization and “special monetary measures” could well snap the patience of German voters. The Bundesbank, too, is openly critical of such moves. Since Germany joined the euro in 1999, with no referendum, not a single national opinion poll has recorded a majority in favour of entry. I doubt one ever will. German citizens, prosperous by dint of their own hard work and skill, have a lot to lose. And money-printing and bail-outs of the profligate are anathema to the German psyche.
Even if Merkel does stitch together some kind of compromise on fiscal union, assuming she wants to, any bearable pooling arrangements will prove inadequate. To be sustainable in the long run, a monetary union also requires a “transfer union” – with explicit payments from stronger to weaker members. This is what happens in the US, with richer states financing poorer states, the whole edifice held together by hundreds of years of nation-building and a common identity. Europe doesn’t have that – and never will.
Back in 1977, the eurocrats commissioned the Scottish economist, Donald MacDougall, to examine what scale of fiscal transfers would be needed annually to hold together a stable monetary union. MacDougall’s report, based in part on US experience, suggested a level approaching 10pc of eurozone GDP – a massive figure that dwarfs even the already bloated EU budget. Will voters in the likes of Germany, Holland and Finland really accept that kind of money – almost a quarter of their total tax revenues – being transferred to Portugal, Greece and Spain, to fund Mediterranean welfare and pension payments? I think not.
These “strong” Northern countries anyway have fiscal problems of their own. For all the talk of Germany’s budgetary fire-power, Berlin is itself shouldering enormous sovereign debts – well over 130pc of GDP if you include the country’s ECB debts and other off-balance-sheet liabilities.
Fiscal union also won’t be enforceable. When it comes to something as fundamental as tax and spending, elected governments will always do what their local electorates want, rather than following strictures from Brussels – or Berlin. It’s as simple as that. A stiffer fiscal treaty will just mean the rule-breakers apply more fudge.
Are we really to believe, after all, that under “fiscal union” the voters of Spain, Greece – France! – are going to accept, month after month, year after year, what the German government tells them to do? Of course they won’t. Tensions will escalate, civil unrest will abound. Europe will become mired in conflict.
Having attended the St. Petersburg Forum, I can confirm that Peter Mandelson still possesses the oratorical ability, when he shoots from the hip, to electrify an audience. Having said that, like so many other ardent supporters of “the European project”, and the slew of craven City economists, he is wrong on fiscal union.
Mandelson now agrees that “currency union cannot exist without more unified fiscal and banking arrangements – and, in the long-term, the eurozone is not sustainable without those changes”. This is something he refused to acknowledge, as did practically all supporters of UK euro membership, during the bitter disputes on that subject during the New Labour years.
“The euro isn’t a failed project, it’s an incomplete project that doesn’t have the institutions and collective sharing of responsibilities needed to deal with this crisis,” Mandelson told the St Petersburg crowd, before going on to describe the need for “pooled funds” and “a transfer union”.
But then, while thinking aloud, he seemed to concede the point. “Populations are constantly being told that more Europe and more integration is required,” he said. “This quite often falls on deaf ears, given that the public have integration fatigue. They wonder if, in a union of democracies, the measures needed are a pipedream”.
Of course they’re a pipedream, Peter. Sustainable fiscal union in the eurozone won’t happen, not in my life-time, nor that of my children. That’s because it requires the reversal of 500 years of European history.
The euro was a very bad idea yet fiscal union is far worse. If attempted, if will fail, but not before it spreads bitterness across Europe. The idea of fiscal union is, anyway, nothing but a fig-leaf for yet more ECB money-printing – an action that would spark another asset price “sugar rush”, but do nothing to solve bank and sovereign insolvency, nor address the fundamental contradictions at the heart of the eurozone.
Monetary union must be scaled back. Those peripheral countries that want to should exit and devalue. Then we clean up the mess, and we all move on.