Thursday 19 July 2018

Politics created the euro - will they doom it as cracks spread?

'Italy is a member of the euro. A threat to the single currency threatens everything.' Stock image
'Italy is a member of the euro. A threat to the single currency threatens everything.' Stock image
Brendan Keenan

Brendan Keenan

The European Union is fundamentally a political project. This is the explanation commonly given when the economics behind policy look dubious, and certainly it is true. Behind it lies the idea that politics can override economics - but that presumes the politics work.

Europe is gripped by the fear that the politics have ceased to work. This came close to panic as the liberal order, which lies at the heart of the EU project begins to dissolve in Italy - the third-largest economy in the EU 27.

Hungary's prime minister Viktor Orbán actually boasts of his "illiberal democracy".

He led the way with his election in 2010, but has since been joined to varying degrees by the governments of Poland, Czech Republic and possibly Slovenia in providing various combinations of autocratic rule, xenophobia and - incredibly, given their history - pro-Russia policies.

Much of this is down to the refugee crisis. This is also the case in Italy which, along with impoverished Greece, finds its geography condemns it to be the major recipient of this tide of human misery, while its fellow member states effectively close their borders.

Last week's bitter exchanges with France were a dramatic illustration of how the politics are failing. But their failure in Italy poses a threat to more than the liberal order. Italy is a member of the euro. A threat to the single currency threatens everything.

Perhaps that sentence is the wrong way round, and should read: "The single currency threatens everything."

That is the remarkable thesis propounded by former IMF official Ashoka Mody. For him, the refugee crisis is so dangerous because it comes on top of an inherently unstable system, where the main cause of the instability is the euro itself. Mody, of course, led the IMF team to Ireland and became famous enough to have an ice-cream named after him by a Kenmare gelateria during the annual economists' conference. We like to think that is how we do things in Ireland but it is easy to imagine the political effects (or maybe not so easy) if, like Italy and Greece, there had been no recovery since the crash.

Or, in the case of Italy, no growth before the crash either. That extraordinary fact goes to the core of Mody's new book, 'Euro Tragedy: A Drama in Nine Acts', whose contents he outlined in Dublin yesterday at the Institute for International and European Affairs (IIEA).

Whatever about ice-creams, it seems his experience of the Irish and Greek bailouts sparked Mody's disillusionment with the IMF and the loss of any belief he may have had in the merits of the euro.

There is nothing brand new in his account of those experiences, but at least it is on file as an antidote to the current process of turning the history of the Irish drama into popular fiction.

He recalls that the late Brian Lenihan was determined to burn bank bondholders but was over-ruled by the ECB and the US Treasury. So too was the IMF, so we really ought to stop fantasising that that particular episode could have been any different.

What could have been different was how the resulting burden was shared. That is where the nature of European politics met the nature of the single currency with, in Mody's view, inevitable tragic consequences.

One of his most striking anecdotes tells how the urbane Jean-Claude Trichet abandoned his fluent English to berate his compatriot from the French finance ministry in their native tongue for daring to suggest that banks carry the losses rather than citizens.

The dramatic idea of creating political union through a currency has instead stoked bitterness and contempt between creditor and debtor member states.

Mody accepts that the internal politics of the southern states (and France) must bear much of the blame, but argues that a currency without a government made everything worse.

For him, Italy is "Europe's fault line" - and the lava is already bubbling through the cracks. It is more fundamental than bad politics, however, whether in Italy or in Europe as a whole. Even the best politics cannot fix a monumental intellectual mistake made decades ago.

The basic theory about currencies is simple and has historical evidence on its side. Even in small countries like Ireland, never mind sprawling federations, productivity will vary between regions. The income gap between them will grow in the absence of some adjustment mechanism.

In nation states, such adjustments are mostly through tax and welfare systems, with occasional direct transfers or extra public investment.

Between nations, it is achieved through changes in the relative values of their currencies and, thereby, of their incomes and costs.

Not only are there no such systems in the eurozone, the idea of transfers from the more productive to the less is an absolute red line running through the history of the single currency from its first birth pangs in the 1960s.

It remains the Teutonic and Nordic nightmare, which bedevilled the rescue plans of 2010 and left such a poisonous legacy.

If all this is correct, there is no politically feasible obvious solution. Arguments about budget deficits and structural reform have merit on their own terms, but they have little to do with divergent productivity or inappropriate interest rates, except in a timescale so long that, to use the Keynes analogy, the euro may be dead first.

Mody charts what such a fatality might be like, if the Italian fault line erupts. It makes one glad we have only to deal with Brexit. Thinking about how disaster might be averted, he writes an imaginary speech for German Chancellor Angela Merkel setting out a change of direction for Europe, where lenders to euro countries carry their own debt risk, national governments have more freedom to set their internal policies and all start to deal with chronic European weakness in areas such as education, technology and social cohesion.

Progress is being made, ever so slowly, in creating a better system for risk-sharing in future financial crises in the eurozone, but little or none in his other suggestions. Even the efforts to make the euro more stable are stalled precisely because every idea is examined forensically for fear that transfers from the more successful to the less might be hidden within it.

Nor does Mody's vision of "open Europe" instead of "more Europe" really answer his basic assertion that a single currency simply cannot work for such a disparate group as its present membership; never mind the whole 27 that are, officially, obliged to join.

One of the book's shortest sections is where he explains that having indebted countries leave the euro would be a disaster for them, and everyone else, but a return to national currencies by Germany and the creditor states could be a workable solution - perhaps the only one.

One suspects the section is short because, the more one thinks about that scenario, the more it becomes clear that there is only one way it could ever happen; and it will not be pleasant.

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