The efforts of those trying to repair the faulty handiwork of the eurozone designers are constantly undermined, writes Colm McCarthy
Government policy has been based on an expectation of economic recovery, with regular postponements of the commencement date. The IMF World Economic Outlook report released last Tuesday admits that expectations were too optimistic for Ireland and that the prospects for early recovery in the eurozone generally are poor.
Irish policy also assumes that the eurozone will survive and that the larger member states, especially Germany, are committed to ensuring its survival. Accordingly there is no need to contemplate, in public or in private, the policy options which might be available in the event that a proper monetary union cannot be constructed and the experiment has to be abandoned. There have been further installments these last few weeks of the one-step-forwards, two-steps-back routine which has characterised German policy since the crisis broke. Germany commits repeatedly to the objective of a successful monetary union while ruling out every step necessary for its attainment.
The large interest-rate differentials which persist in bond and banking markets reflect serious risks of a euro break-up. Should the policy paralysis continue, the euro can hardly survive, particularly with a further period of weak economic growth.
The four-year recession in Europe has a number of unique features. Critically, the downturn is not over and could easily last for several more years. While the European recession is part of a worldwide pattern, it is deeper in Europe than elsewhere. Several eurozone countries have become insolvent. Unemployment rates have soared (25 per cent in both Greece and Spain) and there have been double-digit falls in real income in several countries. There has also been a massive sovereign default in Greece, costing private investors over €100bn, and there is an ongoing risk of further defaults in Greece and elsewhere. The European banking system remains fragile and under-capitalised. The monetary system has de-integrated and lenders have retreated behind national frontiers.
The resulting economic dislocation is much worse than a cyclical recession. The extent of the social and political wreckage visible in some European countries is comparable to the aftermath of the First and Second World Wars. Nobody has been killed (well, very few people) but an inspection of the macroeconomic data for Greece, Ireland, Portugal and Spain would lead an observer from Mars to conclude that there must have been another war.
The premature decision to commence the common currency experiment in 1999 is the factor explaining the severity and duration of the European crisis. The common currency was poorly designed, a political project from the beginning, and it has been poorly managed. Primary responsibility for the poor design rests with France and Germany, specifically with Francois Mitterrand, Helmut Kohl and their advisers. Countries which had viable alternatives to joining this Franco-German adventure should envy EU countries like Sweden, wise enough to stay on the sidelines.
Two significant developments in recent months had encouraged those who predict success in constructing a durable monetary union in Europe. The first was the communique issued on June 29 after the European Council meeting in Brussels committing to the essential step of building a banking union. The second was the follow-up decision of the ECB governing council on September 6 offering a backstop to countries struggling to borrow in the sovereign bond market.
The decision of June 29 proposed to 'break the vicious circle' between struggling sovereign states and their bust banks, through direct support for banks from the European rescue fund. The possibility that Spain, a 'too-big-to-fail' country, would follow Ireland into the black hole created by the bank-sovereign doom-loop finally provoked a rethink. The communique also proposed a centralised system of bank supervision at European level and contained an explicit promise of further but unspecified measures to assist Ireland in achieving debt sustainability. This breakthrough was followed by the ECB decision to purchase government bonds of countries in difficulty, with a view to driving down their interest costs.
The measures necessary to turn the half-baked currency union into a proper monetary union are well understood. First, the banking system needs to be European and not national. That means centralised supervision at European level, with strong capital adequacy and liquidity standards. National governments need to be removed from any role in bank supervision. Next, there needs to be bank resolution, that is, procedures for early wind-up of failing banks, at the expense of their creditors and not at the expense of taxpayers. Retail depositors need to enjoy credible deposit insurance on a centralised basis, ending the deposit runs which have already fragmented the supposed common monetary area. Finally, the sovereign states need to be relieved of the contingent liability for failing banks headquartered in their jurisdiction, with compulsory resolution and supervision the sole responsibility of the European-level institutions. Subject to fiscal responsibility, the central bank needs to become a last-resort lender to sovereigns. A currency union plus a banking union, along with restraints on excessive borrowing by sovereigns, will yield a monetary union with a good chance of survival.
The EU Council decisions of June 29 coupled with the ECB bond-buying announcement on September 6 appeared to be solid steps on the path towards undoing
the mistakes of 1999 and finally constructing a proper monetary union for Europe.
The Spanish government interpreted the Council communique of end-June as meaning that, once the new bank supervision deal was implemented, the EU would shift the burden of re-capitalising bust Spanish banks from Spain to the ESM rescue fund. In Ireland, where unsecured bank creditors have already been paid off under threats from the ECB (Ireland was 'small-enough-to-fail'), the understanding was that this arrangement would extend retrospectively to Ireland. The ECB bond-buying programme was also expected to get going quickly. The ECB appeared to have accepted that, when it purchased sovereign bonds in future, it would share losses with private buyers if things went wrong. Recent statements from ECB president Draghi have undermined this perception and unnerved bond investors.
Most worryingly, the German authorities have been backsliding on each of the announced components in a eurozone reconstruction. German central bank president Jens Weidmann dissented publicly from the ECB governing council bond-buying decision without resigning his membership of that body. Both Chancellor Angela Merkel and finance minister Wolfgang Schauble have indicated opposition to a proper banking union. They want centralised supervision only for Europe's 25 biggest banks, and are not enthusiastic about locating responsibility where it belongs, at the ECB. They are opposed also to Europe-wide deposit insurance and have been seeking a watering-down of proposals for tighter bank capital standards.
Most damagingly, they appear to oppose the critical decision of June 29, to which chancellor Merkel was a party, to break the bank-sovereign doom-loop. The German position is that no legacy sovereign debt is to be relieved and the involvement of the Eurozone rescue fund in recapitalising banks cannot commence until the banking union is up and working. It will not be up and working for a very long time indeed, given current German obstructionism.
Taken together, these recent policy statements from German politicians signal a clear unwillingness to abide by what was agreed on June 29. More importantly, they indicate that the steps necessary to turn the malfunctioning currency union into a proper monetary union are not acceptable to Germany, the largest state in the EU and the co-designer of the euro.
It would be a more honourable course if those in Germany who regret the loss of the Deutschmark and regard the euro as not worth saving would simply say so and advocate an orderly break-up. Instead, German leaders engage in a destructive charade of keeping the project on some kind of financial life-support while continually undermining the efforts of those who seek to repair the faulty handiwork of the eurozone's designers. The common currency is the biggest and most difficult project undertaken since European economic integration commenced back in the Fifties. If it fails, and it is likely to fail without full commitment from Germany, the real gains of the 60-year European integration project will be placed at risk.
The eurozone will either be reformed decisively or it will break up in acrimony and recrimination. Current German policies, expressed by the chancellor, finance minister, Bundesbank president and numerous other leading politicians in recent weeks, are not consistent with survival of the eurozone. The pretence that Germany favours the measures necessary to secure a durable monetary union for Europe is wearing thin.