A brilliant article worth saving from archive oblivion. This could be prophetic, even if the suggestions are not acted upon. It is sensible and straightforward.
The eurozone can in theory still be saved, if two sets of conditions are fulfilled; if the leaders of Germany, Austria, Finland, and the Netherlands accept fiscal union and a common pooling of debt, and can persuade their parliaments and courts to ratify such a revolution.
If the Germanic bloc agrees to tear up the mandate of the European Central Bank, letting it switch from inflation-targeting to job-targeting (“Unemployment must not exceed 10pc in two or more EMU states, or some such formula), effectively instructing the ECB to embark on Fed-style stimulus for three to five years.
This might allow Spain to work off a total debt load now topping 300pc of GDP without having to deflate wages and tip further into a Fisherite debt-deflation spiral. It might allow Italy at 250pc of GDP to claw back lost competitiveness without self-defeating perma-slump.
Yet such ECB stimulus would have a nasty side-effect: inflation threatening 5pc or 6pc in Germany. Berlin would find itself in much the same trouble as Madrid and Dublin six years ago: expected to twist itself in knots by undertaking massive fiscal tightening and financial repression to offset a massively inappropriate monetary policy.
I strongly doubt that the Bundestag, Tweede Kamer, or Finland’s Eduskunta will accept such conditions. Why should they? The citizens of the German bloc never voted for an EU treasury, tax union, or debt pool, or for the emasculation of parliamentary prerogatives that this implies, if they were allowed to vote at all. Indeed, they were told this would never happen. Germany’s Social Christian leader Edmund Stoiber japed after Maastricht that a future German rescue of any EMU state was as likely as “famine in Bavaria”.
Given that these sovereign diets will not efface themselves lightly, the wise course is to prepare for an orderly break-up of monetary union.
Only one option can be orderly. Germany and its satellite economies must withdraw from EMU, leaving the Greco-Latin bloc with the residual euro and the institutions of monetary union. Let us call the legacy group the “Latin Union” in memory of its 19th Century forebear.
The Latin euro would fall sharply against the yuan, yen, won, zloty, etc, as well as the new Teutonic Mark, allowing the Latin Union (with Ireland) to regain economic viability and largely honour existing euro debt contracts. The IMF should stand ready with flexible credit lines to tide Latins through the first weeks of this rupture.
Once the dust had settled, it would become clear that Italy, Spain, Ireland, and perhaps Portugal had regained enough competitiveness to hope to grow their way out of debt traps. Fear of domino defaults would recede.
The alternative is to impose austerity and debt deflation without offsetting relief – à la grecque – on a string a countries until their polities shatter, and capital flight sets off disorderly EMU exit by the weaker states, with a concomitant chain of defaults reaching Italy, the world’s third biggest debtor. As the bond jitters of the last two weeks have shown, we are already uncomfortably close to this.
France is of course a stumbling bloc. The country is not a hopeless case within EMU, though deteriorating trade and debt figures are slowly eating away at French viability as well.
The Élysée would view any separation from Germany as a catastrophe. Yet this is surely outdated thinking in the 21st Century. Germany no longer needs to be tied down by silken chords of EU statecraft. It is a pacific democracy in an aging continent on the margins of the Sino-American global order.
France might instead find a new role as leader of a Latin Union with 220m people and over 60pc of the eurozone’s GDP, with economic sway over North Africa. The ECB headquarters could transfer to Marseilles, that great millenial hub of civilization, to be renamed the Mediterranean Central Bank. The currency bloc would quickly become a force in Europe.
Ireland has no place in this venture. It should bide its time and then break away when the Latin euro is weakest — and therefore Ireland’s euro debts most devalued — to launch its own Punt Éireannach. This currency would arguably rise, not fall. Ireland should henceforth run monetary policy in its own interest as Israel, New Zealand, Chile, and Sweden all do successfully.
How low would the Latin euro fall? HSBC has crunched variants of this scenario. It calculates that the “peripheral euro” (EUP) would crash to $0.65 against the dollar, while the “core euro” (EUC) would replicate the recent moves of the Swiss Franc and surge to $1.83.
I think this overstates the case, but the fact that HSBC’s currency team reckons that the South would see a two thirds devaluation against the North if market forces were not supressed is a harsh indictment of EMU’s existing structure. How has such misalignment come to be?
HSBC places France in the core. If France opted for the Latin Union it would be a very different story. The rate might stabilize at a 30pc discount after the initial overshoot.
The Teutonic Union might naturally comprise Germany, Netherlands, Finland, Austria, Slovakia, (and Flanders?). It would be a formidable bloc, but the smaller part.
Temporary capital controls might be needed to smooth the break-up. Teutonic area banks would suffer big and instant paper losses on holdings of devalued euro-Latin debt. Governments would have to recapitalize and perhaps nationalize some of these lenders to preserve the financial system, but that would be cheaper than the €2 trillion to €3.5 trillion sums now being floated by analysts as the likely cost of staunching the eurozone crisis, and easier to justify to their parliaments. The North would in any case enjoy a windfall gain on the implicit reduction of national debts denominated in euros.
If EU leaders instead allow events to run their current course they risk a euro-Lehman and a repeat of the meltdown that occurred from May to October 1931 when central Europe’s banking system was allowed to disintegrate (due to lack of leadership and a rigid adherence to a fixed-exchange Gold Standard that had long since gone haywire). The crisis ricocheted back into London and New York, set off the second phase of the US banking crash, and turned recession into global depression.
It is worth reading The International propagation of the financial crisis of 2008 and a comparison with 1931 by William Allen and Richhild Moessner, a hair-raising account just released by the Bank for International Settlements, if you wish to understand what happened to the nexus of global banks and interlocking counter-parties during the Lehman crisis. Only Washington (Fed, Treasury, White House) prevented collapse.
A euro-Lehman would be worse because there is no Washington in Europe and creditors have in the meantime lost a degree of confidence in sovereign states themselves. It would instantly embroil London and New York through multiple channels. A study by Fathom Consulting found that German, French, Dutch, and Belgian banks have insured much of their Club Med debt with Anglo-Saxon peers through credit default swaps (CDS) . Gross CDS contracts are $292bn on Italy, and $168bn on Spain.
If a euro break-up was properly planned and handled, with all back-stop measures in place, it might prove less traumatic than assumed. As Czech premier Vaclav Klaus once said, it is surprisingly easy to end a currency union: the Czechs and Slovaks did it calmly in a morning.
There is no necessary reason why the EU could not weather such a crisis, continuing such useful functions as competition enforcement and global trade talks. A more modern EU shorn of its great power pretentions and 20th Century imperial nostalgia would be a healthier organization. The Schengen system of open borders could continue. Life would go on. Citizens would soon wonder what the fuss was about.
Will any EU leader grasp the nettle? Unfortunately, most of Europe’s governing elite is ideologically compromised by the Project and will attempt to defend an unreformed EMU with scorched earth policies. We can only hope that the less compromised judges of Germany’s Verfassungsgericht bring matters to a swift head in September.