Europe's fragile bonds

Europe’s fragile bonds

Greece is heading for default. If France and Germany decline to help, the eurozone—and Europe—could face disaster

by Wolfgang Munchau / June 22, 2011 / Leave a comment

Published in July 2011 issue of Prospect Magazine

Riot police guard the National Bank of Greece, Athens. Violent protests against the government’s austerity measures have paralysed the city

The eurozone is based on three pillars: loopholes, fudges and lies. They made this crisis inevitable. The propensity to fudge now makes any real resolution all but impossible, even if it contains the problem.

The fudges and loopholes stretch back to the deals that created the euro in the early 1990s. The Maastricht Treaty, in force from 1st November 1993, committed signatories to the new currency, which came into existence on January 1999. The eurozone’s advocates made promises that were inconsistent, but irresistible. The Germans were promised that monetary union would not oblige them to pay their tax revenues to other countries, and that it would create a currency at least as strong as the Deutschmark. The French perceived the euro to be a tool to strengthen Europe’s global reach. For the Italians and the Spanish, the new currency offered permanently low interest rates. Given their deregulated banking systems it also brought sudden wealth by way of a housing bubble.

These inconsistent promises were reflected in the governance of the currency bloc. There was no attempt to co-ordinate countries’ tax and spending policies other than through broad budget rules (soon broken). The most important was the famous 3 per cent ceiling: the maximum budget deficit that a country would be allowed compared to its gross domestic product (GDP). The philosophy was that monetary and fiscal discipline should be sufficient for the euro’s long-term sustainability. The independent European Central Bank (ECB) would adjust interest rates to contain inflation. The “stability and growth pact,” which aimed to co-ordinate national policies within the euro area would enforce fiscal discipline. And that was it.

The lies, loopholes and fudges gave rise to another trinity: no exit, no default, and no bailout—a logically inconsistent set. The pledge not to bail out troubled economies was enshrined in European law. The no exit principle is an indirect consequence of Maastricht: there is simply no procedure for a country giving up the euro once it has joined. In theory, the country could leave the euro only by the “nuclear option” of withdrawal from the EU. The principle that a eurozone country will not default—fail to make payments on its debt—is not in the treaty. But it followed once the ECB accepted each country’s collateral on the same terms—that is, treated their debt as equally risky, even though the economies were so different.

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Comments

philodoc
June 24, 2011 at 10:08
I think you are right that the Eurozone will try to muddle through the present crisis. There is not a leader in the community with any stature to carry off any alternative response, and too many wealthy European countries are looking inwards to their own national political concerns. What interests me is the bigger picture which seems to be gnawing away at the North/South divide in Europe: Germany is lukewarm about NATO and showing signs of looking to encourage a N.European prosperity zone which would include the Scandinavian countries and would have a resourse rich (and hugely underpopulated ) Russia as it's focus; China is investing heavily in Mediterranean Europe and Africa and may help save Greece from catastrophe. America is backing away from all kinds of involvement and does not have any interest any longer in a united EU. I cannot see the EU as it currently stands lasting many more years; geopolitical pressures are now so overwhelming that a new alignment is inevitable.
Edward Harkins
June 24, 2011 at 22:29
As someone who is disposed still towards the great European unification vision, it dismays me that there remains one enduring, and undeniable, deficit at every level and in every domain of the European Union. That deficit is not financial. The truly crucial and critical deficit is in meaningful democratic accountability. The collective of bureaucrats, politicians and business leaders seem blighted by a myopia whereby they see their sectional interests and the interplay between them as being what the whole European Union entity is about. As for the European citizens (or in the case of the UK, subjects)? Well, they can be much disregarded. That myopia has currently rendered the entire European Union focus as being on a rescue of international bond holders: not a rescue of Greek public financial sustainability; not a survival of the Greek economy in anything like its existing form; not Greek sovereign dignity; and certainly not the society of ordinary Greek citizens. Across the Atlantic, the USA is in an even more extraordinary and immediately self-imposed deficit crisis – a deficit of any responsibility whatsoever in public financial, fiscal and budgetary matters. The USA seems to be like the Greek institutions. They both appear to maintain an insouciant belief that others elsewhere in the world will provide deficit-supporting, unending, bond financing regardless of economic reality - so that all the while they (the USA and Greek institutions) can go on playing with cash as though they had actually produced enough of things sufficiently tangible to earn it.
Tarik Toulan
June 25, 2011 at 08:07
I think the best way to address the current economic crisis in Greece is to primarily adopt austerity measures, including spending cuts at the individual and government levels. This should, of course, be in parallel with focusing on raising GDP.