By Andrew Moffat. In his article, Andrew Brons MEP explained in clear and concise terms the economic difficulties that confront the 17 countries imprisoned within the confines of the single currency, known as the Eurozone.
Those of us who have opposed the European Union, some of us presciently since the days it was termed the EEC, have long warned of the disaster and economic upheaval that would befall those who promoted and engaged in fiscal and monetary union.
Such a union was prescribed in the negotiations that led to the UK’s membership of the then Common Market on 1st January, 1973, and this was discussed in Cabinet by the then Conservative administration.
Both it and the various proponents of pan-European governance took particular care to disguise from the public their real intentions, deliberately passing off the Common Market as an innocuous free trading zone.
The current spectacle of economic distress and dislocation, troubled financial markets, high debts, fiscal imbalances and high unemployment may be attributed to the ‘one size fits all’ policy of the Eurozone.
When the European Central Bank (ECB) raised interest rates earlier this year, it did so to reflect the relative health of the German economy. The reverse policy, ie diminished interest rates, was actually required to take account of the recessive conditions in Portugal, Italy, Ireland, Greece and Spain – often referred to as the Piigs.
The 17 countries that joined the Eurozone relinquished the authority of their Central Banks to set interest rates according to the conditions that prevailed in their individual economies.
They also joined a single currency and abandoned their own currencies. By so doing, they became a part of an international currency over which they exerted little or no control. The value of that currency reflects the general conditions that prevail within the bloc instead of the conditions that prevail within their own economies.
So far, the UK has remained outside the single European currency. Both the previous Labour and now the Conservative – Lib-Dem coalition have refused to rule out eventual membership of the bloc. Indeed, it is a little known fact that British economic policy, overseen by the annual budget, must dovetail its policies to facilitate ultimate membership of the Eurozone – a process known as ‘convergence’.
The closest the UK has come to monetary union was membership of the Exchange Rate Mechanism (ERM), also under a Conservative administration.
Tied in to artificially high interest rates and an inappropriately valued currency in the early nineties, property prices plunged, unemployment soared, businesses crashed and the economy collapsed into recession.
On 16th September 1992, the government was forced to withdraw Sterling from the ERM. In consequence, released from its corset, the London stock market boomed, interest rates collapsed and the currency fell. Within a couple of years the economy strongly rebounded and the UK became a relative powerhouse compared with the sluggish conditions that appertained in the EU.
THE FLAWS BEHIND THE SINGLE CURRENCY
A typical economy reflects, inter alia, the culture, politics, trade, history, education, debt, productive capacity and dynamism of the people behind it.
Whilst by no means the sole criterion, the dynamism of the workforce reflects the productive capacity of an economy. Who would equate, for example, the relatively lethargic and inefficient economies of the Southern Eurozone with those of the Benelux nations and Germany?
The latter economies reflect a degree of dynamism, productivity, innovation and inventiveness that is less evident in the Mediterranean periphery. That helps explain why, before the advent of the Euro, the German economy only ever experienced upward revaluations of its currency whilst the Italians, Greeks, Portuguese and Spanish economies frequently devalued their currencies so as to compete with their more productive and dynamic Northern competitors.
Such currency adjustment is not feasible within the newly established Eurozone. So long as the Northern Eurozone nations remain more dynamic, productive, efficient, innovative and inventive than those of the South, then it follows that there will develop economic imbalances, uncorrected by any currency adjustment.
This has well suited the Northern nations, particularly Germany and the Netherlands. They have avoided any upward revaluations in their currencies and they have seen their exports to the South boom, albeit curtailed by the current crisis.
At the same time, disadvantaged by the inability to devalue, the Southern nations have descended into stagnation, debt, double digit unemployment and – in some cases – economic depression. Youth unemployment in Spain exceeds 40%.
Compared with the Northern nations, the countries within the Southern periphery have consistently demonstrated poor productivity and higher unit labour costs to each unit of production.
Afflicted by high unemployment, these countries must cut public expenditure and raise taxes to finance their public debts, as represented by their national bond markets.
The Greek economy has already lost the confidence of the bond markets, which have now factored in a 90% probability of default. To buy time and because Greece has been locked out of the bond markets, the IMF and European authorities have provided emergency loans to keep the Greek government afloat until October when, quite literally, Greece will run out of money unless a further transfusion of €8bn Euros is forthcoming to pay pensions and salaries.
That transfusion will depend upon the Greek Government providing assurances that it will slash further its public expenditure and raise taxation, according to the demands of the European Commission, the IMF and the ECB.
To compete, effectively, Greek employees must be prepared to slash their wages – with obvious implications for those burdened by debts and mortgages, quite apart from the implications for local and national commerce and industry that rely on healthy consumers. Equally, there must also be a sustained fall in nominal prices, a development that will lead to deflation and the consequential rise in the value of existing debt.
Who would wish to invest in Greece in such conditions?
The Greek electorate might justifiably look North to Iceland, whose plight was not dissimilar three years ago albeit for somewhat different reasons. Free from the restraints within the Eurozone, Iceland devalued its currency, took over the domestic operations of its banks and defaulted upon the debts owed by them to foreign creditors. The Icelandic economy is now expanding and again a participant in international debt markets.
THE FIRST DOMINO
The Greeks are the first in a queue of nations who are afflicted with problems that, prior to their Eurozone membership, would have been addressed by a falling currency and reduced interest rates.
So far it has been possible to administer sticking plasters and bandages in the form of financial assistance and the purchase of those countries’ debts by the ECB – a strategy of throwing plenty of good money after bad. As Andrew Brons has stated, the ECB’s pockets are limitless because they are guaranteed by the European taxpayer.
Euro-politicians are fearful of contagion, which briefly stirred during August when the price of Spanish and Italian government debt plummeted. If the price of government debt falls, then governments must pay a higher coupon to finance its expenditure and the redemption of earlier debts, as these mature.
Both the Spanish and Italian economies are far bigger than the combined economies of Greece, Portugal and Ireland combined. Indeed, the Italian economy is the third largest within the Eurozone.
The longer Spain and Italy remain within the Eurozone, the more uncompetitive they will become, with detrimental consequences for their economies and government revenues. As with Greece, costs per unit of production are far higher than those of Germany, which means that Spain and Italy become more uncompetitive as each month passes. High unemployment, high debts and debt servicing costs mean that these economies must run to stand still.
Last week, Italian government bonds traded at nearly 400 basis points (ie 4%) higher than their German equivalents – despite the recent support from the ECB, which has bought Italian bonds. The Italian economy also carries a debt to GDP ratio of 120%, some 50% higher than that of the UK, which remains outside the Eurozone.
Should the financial crisis, currently afflicting the Greek, Irish and Portuguese Governments lead to merely one of these countries defaulting or withdrawing from the Eurozone or both, then the markets will quickly focus upon the next likely dominos to fall. It may be Italy or Spain or both. Should that occur, there will be knock-on effects further up the Eurozone, especially for Belgium and France, as well as the banking sector.
Eurozone Central Banks, public banks and the ECB hold vast amounts of peripheral Eurozone public debt, whose value continues to diminish. As long ago as last December, data from the Bank for International Settlements showed German banks held $22.7bn of Greek Government debt and French banks $15bn. That debt is virtually worthless.
The European Commission and its advisors are adept as using crises as an opportunity to justify further integration. They are also aware that should they fail to halt the ongoing deterioration in the financial position of the PIIGS, the Eurozone will risk being overwhelmed in a series of debt defaults and the possibility of one or more withdrawals from the Eurozone.
Further integration, which will be countenanced to avoid economic calamity, will embrace closer fiscal union, so that the taxes of the Northern nations will be employed to guarantee the debts of the Southern periphery nations. That will include the proposal to guarantee, with taxpayers’ funds, the issue of Eurozone bonds to support the economies in the Southern periphery. Germany has consistently opposed the introduction of Eurobonds.
An alternative scenario is that the ECB will act as the buyer of last resort for the bonds of the PIIGS, with the full resources of the Eurozone taxpayer behind it.
Germany, which has prospered exporting its highly competitive goods into the Southern periphery within the single currency, has frequently expressed its irritation at having to bail out Greece. Any further bailout will be met with stringent demands for powerful oversight of the Greek economy and its budgetary measures. Greece will be reduced to financial and economic servitude.
The Eurozone cannot be maintained in its present format. The position of the periphery nations, including their competitiveness, is one of deterioration – not improvement.
Greece, in particular, is dependent upon the charity of the IMF and the EU bailout fund. A default on its insurmountable debt burden is certain to occur; alternatively, the Greek nation will be reduced to little more than that of an agrarian economy, with impossible debts heaped upon the shoulders of future generations.
Assuming an agreed debt default is reached, the next question is whether Greece will remain in the Eurozone.
Allied to the questions above is a further question: whether Greek politicians will place loyalty to their nation above loyalty to the European project. In the event of the former, the politicians – well pressed by public anxiety and civil disorder over job cuts, pension cuts and higher taxes – will unilaterally withdraw from the Eurozone and default on their debts, at least in part.
Any precedent of default, leave alone withdrawal from the Eurozone, will focus the financial markets’ attention on the next candidate nation within the Eurozone.
On 20th September, the credit rating agency, Standard and Poors, reduced the rating on Italian debt one notch. A bailout of Italy, the third largest Eurozone economy, would overwhelm the Eurozone’s resources.
Short of a massive injection of funds into the PIIGS, it is difficult to see how the Eurozone can continue. Any temporary bailout, moreover, will merely postpone the inevitable consequence of disintegration.
When that occurs, it remains to be seen whether the Eurocrats will seek to introduce two tiers of currency union: an inner core and an outer core. An alternative, which will not occur, will be the ejection of Germany from the Eurozone. That would cause the Euro currency to fall on world markets and the reintroduced Deutchmark to soar in value against the Euro currency.
Whatever occurs, there will be severe disruption to financial markets, a process which is likely to be long and drawn out, quite possibly over a period of years.