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Ruth Lea

Ruth Lea: Eurozone leaders should stop trying to save the Euro, and move on to preparing for its breakup

I had intended that this week’s piece would be an “EU free zone”. But the Eurozone crisis staggers on and the latest Commission forecasts were shocking and merit further comment. The Commission, be praised, did not mince its words. They wrote “…the EU economy is moving in dangerous territory. The recovery has already come to a standstill…any further bad news could amplify adverse feedback loops pushing the EU economy back into recession”.

Eurozone GDP may increase by only 0.5% in 2012 (after 1.5% this year) compared with spring’s projection of 1.8%. Growth in Germany and France is expected to slow sharply in 2012 and Italy’s economy to flat-line. Spain will struggle and Portugal and Greece will face further economic contraction. But even these scenarios look optimistic, especially for Italy and Spain.

The southern economies are in for a torrid time, saddled with the twin burdens of an endemic lack of competitiveness and growth-draining, masochistic austerity packages as they either slide back into recession or contract further. The countries need an improvement in their relative labour costs of around 30-40% to regain to competitiveness, which they can do by either major deflation (in an extended depression) or devaluation. In the absence of the devaluation option, the deflationary route could take years of pain to achieve the required competitiveness. In addition they are highly unlikely to achieve the deficit reduction targets the tough austerity budgets are intended to deliver, if they have no growth. 

There are of course international ramifications of the Eurozone crisis. A “blame game” is now becoming a feature of international discourse. The Eurozone is an obvious target to attack for others in difficulties. President Omaba, a mere week after the Cannes Summit, apparently “read the riot act” to Angela Merkel, Nicolas Sarkozy and Italy’s President Giorgio Napolitano late last week, demanding faster action from the Eurozone’s leaders. Obama, facing presidential elections next year with an economic background of disappointing growth and high unemployment, has already started his campaign. And what better excuse does he have for an underperforming economy than the dysfunctional EU with its toxic combination of political grandstanding and impotence. Granted many of America’s problems are home-grown, but Obama can justifiably point to the global uncertainties and wild gyrations in the financial markets as important factors that are undermining confidence in the US economy.

Meanwhile here in the UK the Chancellor has warned of the impact of the Eurozone crisis on jobs and growth. Europe is again a helpful scapegoat ahead of the Autumn Statement when the growth prospects will almost certainly be downgraded significantly. George Osborne knows that poor growth risks derailing his wholly sensible deficit reduction package, much to the glee of the Shadow Chancellor.

The Chancellor has a just case. In addition to rocky financial markets undermining of confidence and investment, the EU is still our biggest export market - as we are endlessly reminded by those who seem to believe that this is “good thing”. Partly reflecting the downturn in exports to the EU, a record trade deficit of £9.8bn was recorded in September. The “export-led growth”, so relied upon by the Office for Budget Responsibility to drive growth, is falling short of expectations. Indeed, given the dire outlook in the Eurozone, there is a real risk of a “double dip” recession.   

The non-Eurozone leaders should now step up their game and brush aside accusations by Eurozone leaders that the crisis is “nothing to do with them”. It has all too much to do with them, sadly. The Eurozone’s politicians are not just endangering their own people’s livelihoods and prosperity, but the livelihoods and prosperity of other nations. Yet they remain stubbornly “in denial” about the state of their beloved project on which they have squandered so much political capital. The Euro is holed below the waterline. Without a major gear change (fiscal union), which looks exceedingly unlikely, the game is essentially up.

The Eurozone’s leaders have had more than enough time to “rescue the currency” if they had felt so inclined or domestically politically empowered, but it is becoming increasingly apparent they do not. And this will surely continue to be the case even though the Eurozone now appears to be run by a new-style cabal, the “Frankfurt Group”, comprising Angela Merkel, Nicolas Sarkozy, Commission President José Barroso, Economic Commissioner Olli Rehn, European Council President Herman Van Rompuy, Eurogroup President Jean-Claude Juncker, ECB President Mario Draghi and IMF director Christine Lagarde. Democracy has been hollowed out. And Britain, of course, is nowhere to be seen. We have been marginalised and the sooner the Europhile FCO gets to grips with the new reality the better.

It is surely time for non-Eurozone leaders, including our own, to start calling time on the project. Exhortations for fiscal union in the Eurozone, when it appears not to be on offer, will fall on deaf ears. The Eurozone’s leaders should be left in no doubt of their responsibilities to the wider international community. They should now address the key flaw in the currency bloc and fundamentally reconfigure the Eurozone. Who knows, perhaps they are doing this at this very moment - preparations would have to made in deepest secrecy. Rumours of a core Eurozone are already afoot. We can only hope. Interestingly the Treasury is already working on contingency measures and has not made the slightest attempt to hide the fact that it is doing so. 

Such a reconfiguration should be embraced as a sensible way out of the current impasse. Ignore the propaganda which suggests otherwise. This week’s Economist opined “…the failure of the euro would not benefit any of its members. Even if joining was a mistake [well at least they admit that], quitting would be a bigger one”. This is nonsense on stilts. But there again the Economist campaigned vigorously for Britain to join the euro. They’ve got form.  

If the southern economies were given their economic autonomy with floating currencies and independent central banks acting as their governments’ lenders of last resort, they would have a real chance of recovery after a period of disruption and difficulty. Whilst not exact parallels, Argentina in the early 2000s and Britain post-ERM were countries that recovered when freed.

Of course, southern countries would probably default big-time if they adopted their own (depreciating) currencies and Europe’s banks, under current accounting rules, would probably take damagingly sizeable losses. But the potential problems of the banking system should be tackled directly instead of being used as an excuse for inaction. There must be contingency plans in place for bolstering up Europe’s banking sectors in case of widespread default. Consideration should be given to relaxing the accounting rules, giving banks as much time as they need to write off bad loans and/or worthless sovereign debt. Japanese banks are noted for their reluctance to write off non-performing loans. Following the collapse of the bubble economy in the late 1980s non-performing loans sat on their books for years. And then there is always the option of bailing-out troubled banks. It may be politically unpalatable but it is preferable to the current impasse.

The Eurozone’s leaders must shift their thinking from trying to save the un-saveable (the euro as it is) to preparing for the aftermath and shoring up the financial system when countries leave the euro. It is called clearing up the mess. And the Eurozone’s politicians are wholly to blame for the mess. 


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