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In early 2011, the eurozone debt crisis looks likely to take a dramatic turn for the worse – raising the intensity of the search for enduring solutions as the markets now price six states as ‘risky’.
In a little-noticed pre-Christmas statement, the eurozone leaders collectively affirmed “that they stand ready to do whatever is required to ensure the stability of the euro area as a whole. The euro is and will remain a central part of European integration.” Chancellor Merkel of Germany and President Sarkozy of France also sent New Year messages to their citizens that cast the issue in terms that were both stark and historic.
Since the decisions at the fateful crisis weekend in mid-May 2010 which created a structure to resolve the situation in Greece, it has been increasingly clear that the eurozone was going to take tough collective action on the economic governance of its members. Its leaders have committed to enacting by June 2011 the European Commission’s detailed proposals – even if the many critics regard them as still lacking in effective sanctions. But they do contain truly radical plans to intervene in the domestic economic affairs of members – if it becomes apparent that serious imbalances are brewing that could infect their fellow members via financial contagion.
It was also made dramatically clear to private lenders to ‘imbalanced’ states that they will face default risk in the future. This precipitated an immediate re-assessment of the creditworthiness of some states – exemplified by the run on Irish banks to the tune of about 100% of GDP once their guarantor was itself doubted. In parallel, the eurozone took upon itself, rather than the EU as a whole, the task of financing its members that were unable to access market financing – provided they agreed to ‘strict conditionality’.
If the eurozone does indeed do “whatever is required”, then it will survive. A political entity will emerge that will be characterised by a centralised funding of public debts that result from a collective oversight of many detailed aspects of economic life designed to improve competitiveness. “The policy prescriptions could potentially address fiscal, wage, macro-structural and macro-prudential policy aspects”. Many observers will describe this as a loose federation called ‘Eurozone’.
The leaders described the risks in their New Year messages in dramatic, even cataclysmic, terms. Failure of the euro is seen as unacceptable because it would lead to an unravelling of ‘Europe’. Why do they say that?
A glance at the evolution of the European Union once it moved on from being a ‘gleam in the eye’ of far-sighted statesmen shows that the political goals were always to be reached “through concrete achievements which first create a de facto solidarity”. Those practical achievements were the steps to create a single market giving “free movement of people, goods, services and capital”. The single market is by no means complete but is universally seen as delivering enormous benefits to the citizens of Europe – not only in terms of growth and employment, but also the quality of life.
If things happened that smashed the concrete achievements, then it is a fair bet that the solidarity would vanish soon afterwards as the blame was spread around for the destruction of the benefits. The existence of the euro – together with a financial system that enables its daily use by 330 million people – is a major component of delivering the benefits of the single market as goods and services can now be purchased very easily across borders. But its existence also enables citizens to protect themselves very quickly against the risk of break-up by moving their money away from risk and towards safety.
So the eurozone – acting collectively – must move swiftly and decisively to convince lenders who have grown sceptical after a decade of failed promises from finance ministers. The lenders need to be sure that sound fiscal policies are put in place and will be adhered to – no matter what the short-term unpleasantness for citizens. It is now clear that without that reassurance, they will take their money elsewhere.
But there remains a scenario that has a good outcome. It requires a truly credible policy framework in combination with a collective financial facility that is manifestly big enough to fund all states at risk until the benefits of the new policies come through. That may require a quadrupling of the existing European Financial Stability Fund (EFSF) facility so that it has the capacity to disburse €1 trillion of loans that will be repaid if the recipients perform as they have promised. The potential recipients have agreed already to the principles, and must swiftly turn them into detailed plans that they are seen to implement. Then the option for the core states of issuing guarantees they have good reason to expect not to be called will seem much better than facing actual cash losses from defaulted bank loans that are twice the guarantees.
Eurozone will have emerged from the financial crisis as a political federation – loose in some respects, but with tightly centralised economic governance at its heart. The proven commitment to fiscal probity may even make it attractive relative to alternative investments around the world.
© Graham Bishop
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