Tuesday 26 September 2017

If you're at end of the road you must think the unthinkable

WHAT to do with the can, when you've run out of road? That would appear to be the dilemma now facing the single currency area.

It certainly looks suspiciously like the end of this particular road. A new Greek government, whatever its composition, even after a second election, will lack authority and credibility if it comes to continuing the programme of fiscal correction unaltered from its present form.

Spain's banking problems have now been added to its fiscal problems. The Irish experience surely shows that compounding the fiscal problems by having government stand over the bank debts is not a credible strategy.

Suggestions of an alternative, such as collective eurozone investment in weakened banks are, so far, only suggestions. The first port of call will be, not taxpayers -- they come later -- but more debt.

The markets are also different this time. There is pressure, not just on bond yields, but on share prices and the euro itself, to an extent not seen in previous crises.

Resilience

The resilience of the single currency was always a puzzle. The most plausible explanation seemed to be a belief that, whatever happened elsewhere, the euro would remain the currency of Germany. There was no reason to bet against the euro, even while selling the bonds of peripheral members of the euro.

There is no reason to change the view that Germany will stick with the euro, but the euro itself will have to change, which means Germany itself may change.

Another sign that this particular four-year road has come to an end is the sudden talk of permitting higher inflation in Germany, spurred by bigger pay rises and, it is hoped, more consumer spending.

I noticed Chancellor Merkel was interpreted as being hard-line and unyielding in her speech to parliament last week, but I am not so sure.

She said she is against stimulating the economy with more government borrowing, but that is not necessarily what is being proposed. It is not yet clear, though, what exactly is being proposed.

The objective is clear. It is that Germany should reduce its surplus in its dealings with the rest of the eurozone; at the same time as the troubled countries try to reduce their deficits.

They would meet, if not exactly in the middle, at some point closer than the present yawning gap.

Uniquely in that group, Ireland has no such deficit with the world at large, but we should be under no illusions that this leaves us in the clear.

Tough though it is to contemplate, disposable incomes are still higher than economic output would justify and have further to fall to rebalance this economy.

Delusional

The calls for more demand in the Irish economy, or the other high-deficit countries, are delusional. The only argument is about the speed at which demand should be reduced to match income.

Agreement on that speed might involve some increase in the time over which the balancing of earnings and spending takes place.

The overall process might be expedited in a more positive way by Germany increasing demand to match its earnings.

Doing this while not cutting taxes and increasing public deficits -- which is Dr Merkel's preference -- is not so easy.

Among other things, it would require German companies to reduce their surpluses by paying higher wages. They may take a lot of persuading.

In which case, while a weaker euro may be a warning sign, of itself it is nothing to complain about. A cheaper currency would be more than helpful in the rebalancing task.

It would help German and Italian exports outside the eurozone, as the former were urged to reduce their competitiveness inside the euro area, and the latter struggled to improve it.

Perhaps the markets think a weaker currency will become policy at the European Central Bank. When one comes to the end of the road, thinking the previously unthinkable is required.

But then everything is pretty unthinkable right now. Whatever about Germany, a solution to Greece's woes requires flights of fancy. The first is exit from the euro but if I were a betting man, this would not be my nap.

It is far too risky. Another face-saving formula would seem preferable all round -- certainly to the Greeks, who would be utterly impoverished by a return to the drachma.

Not only is Greece's economic position worse than Ireland's; it is worse than Iceland's, or Latvia, both of which saw incomes fall by more than 30pc.

But the can still has to be kicked down a new road. This may well involve some easing of Greece's correction programme, and others will expect some leeway also.

That means more debt. It may be Greece which finally forces the introduction of eurozone debt. It will probably not begin with fully-fledged euro bonds of the kind which most analysts now advocate, but the principle will have been established.

The first collective action looks like being an investment programme, funded largely off government balance sheets, with the hitherto obscure (despite its best efforts) European Investment Bank playing the starring role.

Capital programme

SIPTU's Jack O'Connor was ahead of his time. The Government could have heaped coals of fire upon the unions' heads by maintaining the capital programme and saving the money by bigger cuts on current spending. As well as good politics, it would have been the right thing to do.

Now we may get capital spending on the EU books. It is unlikely to match the €15bn demanded by SIPTU, or even to make up for the cuts in the government programme. Its real importance will be if it can re-establish a consensus that the public finances are still badly broken, and a keener awareness that the present programme may not succeed.

It is a pity Ireland is not further down the old road, because the new one may be full of diversions.

There will be arguments over austerity versus more overt financial transfers to deficit countries, against a background of the emergence of what the Bruegel think-tank called "a de facto political union, with major economic policy areas transferred from the national to the euro-area level".

If Europe does take this road, however stumblingly, as the only alternative to chaos, it will need cool heads and clear analysis to succeed, there and here.

Both have been in lamentably short supply so far.

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