A euro crisis… but also an opportunity for Britain

July 21, 2011

A new eurozone bond looks the most likely solution to stop the euro blowing apart.

 

By Daniel Hannan
9:03PM BST 20 Jul 2011

While Britain was chuckling about custard pies this week, the debt cancer was metastasising across the Mediterranean. Bond yields in Spain and Italy have surged, leading to doubts over whether those countries can meet their existing liabilities. For the first time since the euro turmoil began, EU leaders are panicking. While Greece takes up just 1.9 per cent of the EU’s economy, Spain and Italy account between them for 24 per cent. A default in Athens might be a controlled explosion, but Rome and Madrid cannot repudiate their debts without blowing the entire European banking system to smithereens. The effects of such a blast would be felt far beyond the eurozone. The Bank of England, dispensing with its normally staid vocabulary, describes the turbulence as a “serious and immediate risk” to the United Kingdom. The IMF frets that, if EU leaders carry on with hand-to-mouth bailouts, the resulting crash might trigger a global recession.

The markets are starting to anticipate a euro break-up. The reason that borrowing costs in Spain and Italy have shot up is not that those countries are inherently destitute, but that investors are demanding a premium to compensate for the possibility that they might revert to devalued and inflationary currencies. Such fears have a way of becoming self-fulfilling. Italy must roll over €69 billion in August and September; it needs €500 billion by the end of 2013. If it cannot borrow at lower rates, it will struggle to remain solvent, and the entire European monetary system might become unsustainable. This is the tempest long foretold, slow to make head, but sure to hold.

EU leaders are meeting in emergency session today, groping for a way to prevent an unplanned collapse of EMU. They have two options: one is to oversee an orderly unbundling of the euro into more manageable units; the other is to establish what José Manuel Barroso calls “fiscal federalism”. Economic logic points to the first option. The reason Europe is in this mess is that it turned out to be ruinous to apply uniform monetary policies to widely divergent economies. The low interest rates dictated by the needs of the core economies were calamitous for the periphery, encouraging an artificial boom and a crash. Now, as the wheel turns, those countries are getting high interest rates just when they need low ones.

Sundering the single currency would allow Spain, Italy, Portugal, Ireland and Greece to export their way back to growth. One idea doing the rounds in Brussels is that, rather than expelling the southern countries, Germany and its satellites might withdraw and establish a new, hard currency, bequeathing the legal carcase of the euro to the Mediterranean states (and possibly also to Ireland, though a currency link with sterling would almost certainly suit Dublin better).

Monetary union, however, was never about economic logic. Rather than admit that the euro was a mistake, EU leaders are preparing the mother of all bailouts. One-off grants are no longer enough. What Euro-federalists now plan – what, indeed, they have been demanding for years – is a single eurozone bond market. Holders of junk national bonds will be invited to exchange their debt for new EU-backed bonds. The European Central Bank, or perhaps some new legal entity, will assume the bad debts of some of the stricken governments.

Such a scheme will be expensive: it’s hard to see it costing less than a trillion euros. It will also be colossally unpopular: taxpayers in the donor countries will resent being made to pay for more profligate governments, while voters in the recipient countries are already protesting about the loss of economic sovereignty. Most serious of all, it will be illegal. Article 125 of the European Treaty could hardly be clearer: “The Union shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State.”

No one even pretends that such bonds are permitted under the existing rules. As Angela Merkel put it last year: “We have a treaty under which there is no possibility of paying to bail out states.” Now, though, she is taking a different line. “Europe,” Mrs Merkel declared on Tuesday, “is unthinkable without the euro.” One wonders what existed at the western tip of the Eurasian landmass before 1999, but leave that to one side. The Chancellor’s point is clear. The survival of the single currency is a political goal for which she is prepared to pay any economic price – or, rather, to make her people to pay.

Some analysts believe that Germany has an interest in keeping the euro going, so that its exporters continue to benefit from an artificially cheap exchange rate. What suits Germany, they argue, is for the euro to struggle on, battered and cheapened. This underestimates the reverence that politicians of Mrs Merkel’s generation have for the European ideal. They are so used to citing the EU as the antidote to fascism and war that they cannot bring themselves to re-examine the premise. Younger Germans don’t fall for it, but their constitution was more or less explicitly designed after 1945 to be immune to public opinion.

Many EU leaders see economic integration, not as an emergency response, but as a desirable goal in itself. As J M Keynes put it: “Who controls the currency controls the government.” Where, though, do such plans leave Britain? While keeping the pound saved us from Ireland’s fate, we risk being drawn into the maelstrom. Our EU budget contributions rose by 74 per cent in 2010, and we have additionally taken on liabilities of £12.5 billion – some £500 for every family in the land – to bail out Greece, Portugal and Ireland.

The Government’s first objective must be to end this exposure. While some British banks are vulnerable to sovereign defaults in Europe (just as Brazilian, Canadian and Taiwanese banks are), there is no need for our taxpayers to prop up a currency that we declined to join. More than this, we ought to establish ourselves as a haven for those fleeing the uncertainty of the euro – a position which, despite our advantages of size, geography, language and global commerce, we currently cede to the Swiss.

We need to withdraw from EU regulations that inhibit our recovery: burdensome employment laws, rules on mutual access to social security which inhibit welfare reform, the Common Agricultural Policy, the 48-hour week. We should, in short, aim for a form of associate membership, an amplified free trade deal as enjoyed by Norway and Switzerland. And we should make our agreement to the legal changes which the eurozone leaders want contingent on securing such a deal.

The trouble is that we have no list of demands. In the run-up to the general election, politicians in all three parties convinced themselves that even to talk about renegotiating our membership was extreme, swivel-eyed, blah blah. That, of course, was before the crisis hit; but they are now trapped by their decision not to quarrel with the EU in any circumstances. Our officials encourage this attitude, having confused their personal stature in Brussels with the national interest.

The events of the past week ought to have jerked us from our torpor. The calculations made before the election have been overtaken by events. A perfect opportunity is presenting itself; yet we remain convulsed in a row about events which took place under the last government. It is our besetting national vice to ignore what is happening on the Continent until almost too late. We shall pay a price for our complacency.

Daniel Hannan is a Conservative MEP for South East England


Daniel Hannan on the EFTA

July 21, 2011

A modest proposal for eurozone break-up

July 19, 2011

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.


What is worse than war?

August 18, 2008

Watching your country (and fellow citizens) being raped by an aggresive foreign power. Of whom do I speak? Russia raping Georgia. Don’t worry! The EU has arranged for a surrender akin to marrying a rape victim to her psychotic rapist. It will bring peace, honest!

Right, repeat magic word to get peace…”what do you want and I surrender”. Imagine if this lot had been in charge against Hitler…


They went and surrendered

August 15, 2008

Excellent article by Gerard Baker in today’s Times, explaining precisely what the EU achieve through “soft power” during the Georgia-Russia war… They went to Moscow and gave the tyrants everything they wanted. And called it peace.
No, John McCain is right. That is not peace. It is surrender.