Tuesday, 16 November 2010

Will The Euro Break Up?

A couple of weeks ago, I asked the question Is Ireland About To Go Bust?. The last few days have seen the main news channels begin to ask the same question. But, its also becoming clear that this question is no longer confined to Ireland. In the Spring, markets began to worry that the financial crisis, that began in the realm of the commercial banks, had now spread to the Sovereign debt of entire states, as increasingly those states had become seen not only as standing behind those banks, but whose own creditworthiness was called into question. That led to the interest rates that international Bond markets required from some of these states such as Greece, Ireland, Italy, Spain and Portugal spiking. The problems of these peripheral economies was always different from the “core” EU economies such as Germany, France, the UK, and the Benelux countries. Their potential for being able to deal with their debt by internally generated growth was limited.

But, the alternative to austerity to deal with their deficits was then growth generated by yet further stimulus financed by the EU as a whole, i.e. by core Europe. The EU simply is not geared to such a course of action. Only a Federal Europe with central control over economic policy and management i.e. not just Monetary Policy via the ECB, but Fiscal Policy, Regional Policy, Bond Issuance etc. could achieve that. A Europe still dominated by the mentality of individual nation states is inimical to such a development. In fact, even within nation states such as Spain, the stresses that arise during a period of economic weakness are provoking centrifugal forces such as those in Catalunya demanding separation from Spain, because they feel that money is being drained from them to support the rest of Spain. It was inevitable that under those conditions politicians in core Europe would have to respond to popular sentiment, and demand that the peripheral EU economies sort out their own problems by severe austerity. Yet, in a sense that was a betrayal of those same peripheral economies who gave up their own financial autonomy to join the Eurozone on the basis that membership of such a larger community would be compensated by the kind of support that they are now being denied.

But, having joined the Eurozone the costs of leaving would be immense. Not only would each country that left have to shoulder itself all of the costs of producing its own currency once again, of repricing everything in its shops etc. accordingly, but outside the Euro, and having left under such conditions, the markets would punish such economies even more. The yields demanded on their Bonds would probably soar even higher, and their currencies would collapse to levels way below those at which they entered the Euro. The consequences of that would probably be, for those economies that are reliant on imports, that inflation would soar, and living standards collapse. Nor would core EU countries be keen on such a development because it would be a huge setback to the Euro as an international currency that was developing as an alternative to the dollar. It would significantly increase internal costs of trade within the EU, reducing its competitiveness with the US and China. For these reasons the idea of countries leaving the Euro has largely been discounted. But, the question is once more being put on the table.

Last weekend, as yields on their Bonds began to rise towards those of Ireland, the Portuguese Foreign Minister, Luis Amado, raised the question of whether Portugal would have to leave the Euro, if it proved impossible to form a Coalition to deal with its crisis. It is now becoming clear that Ireland is under pressure from core Eurozone countries to accept a bail-out now rather than wait until it runs out of money in a few months time, because the crisis in Ireland is spreading to other PIIG economies as markets begin to ask the questions who will be next to need a bail-out, how much more in the form of bail-outs will be required, and can the core EU economies finance that without affecting their own economies, and more importantly, at a time of telling their own electorates of the need for austerity could they build a political consensus to divert resources to other countries?

The reality is that the only short term solution is one in which the problem of debt is resolved through growth, and that growth can only come under current conditions from an EU wide policy of fiscal stimulus, and the monetisation of existing sovereign debt. But, the experience of the EFSF shows that in return for any bail-out, the core EU economies will demand increasing control over the budgets and economies of the countries bailed out. As a country that prides its own independence, Ireland is keen not to hand over the level of control that would follow from a large-scale bail-out. Indeed, for Ireland to be seen to be being forced into taking a bail-out that it does not immediately need, simply to meet the wishes of the EU, would have to be seen as Ireland having effectively given up sovereignty over its economy.

But, the problem for Ireland is that it has little choice. Ireland claims to have enough money to last until June. Others believe it will have to go to the international markets as early as next Spring, whilst others have argued that it might run out of funds in as little time as 60 days! Today, the Irish Finance Minister has accused the markets of acting irrationally on this basis, and has rather remarkably claimed that they are confusing Irish Banks with the Irish State! That is an exercise in self-delusion, because the Irish State has effectively nationalised the Irish Banks, and even within the last few weeks has shown that it will stand behind them with whatever finance they require to stop them going bust - Sham Rocked. The choices are fairly stark. Ireland could step back from that position. It could announce that it will no longer finance those banks, and will let them go bust. That would probably cause an international financial crisis because those banks are tied into the global banking network. As I set out in the above blog there are workers solutions to such a development, but no Capitalist State is going to pursue those solutions. In the absence of that Ireland has to either accept a bail-out soon, and the central EU control over its economy that will ultimately go with that, or it will have to withdraw from the Euro. If that were to happen then its pretty inevitable that Portugal, Greece, and probably Spain would join it.

The precedent would be the UK's exit from the EMS in the early 1990's. At that time, the UK's exit resulted in its interest rates falling overnight from 15% to 5%. The pound fell rapidly. It provided a big stimulus to UK economic growth in the 1990's. Today, with interest rates already close to zero, no further benefit from lower interest rates could be obtained – on the contrary, in their borrowings on the international markets they would face higher interest rates. But, their currencies would plummet, and that would give some competitive advantage, making their exports cheaper, and imports more expensive. But, there are also problems with this. The economies in Spain, Ireland, Portugal and Greece have benefited from property bubbles over the last decade or so. That not only brought in income from foreigners buying holiday properties, and from the attendant tourist income, but also led to booming construction industry. Whilst a collapsing currency would mean these properties became much, much cheaper, its not clear under the current economic conditions that this would lead to a pick up in foreign purchases of these properties – in fact, as other economies such as in the former Yugoslavia, and in Central and eastern Europe become more integrated into the EU, Southern Europe is facing competition from even cheaper property and tourism.

In addition, we are already in a Currency War that is raging between the major economic blocs, and which threatens to spill over into more wide-ranging protectionist measures. If all of these countries left the Euro, and their currencies collapsed that would bring that trend into the heart of Europe itself, and intensify it. The economic policy solution to this problem is not that difficult as I have set out before. But, the problem is that in the real world economics cannot be divorced from politics, and the economic solutions will face political roadblocks, both from the individual interests of national Capitals, of nation states, and from the electoral bases of those countries called upon to ultimately finance the bail-outs. As Paul Mason put it in a recent blog,

“They are also learning that democracy and recession are great drivers of trade and currency war: though the central bankers form an unelected global club, the politicians they technically serve have to get elected every five years or so. There is a chance, sooner or later, that a party will come to power in a western democracy committed to overt trade and currency competition with other countries, whether it's the Greek KKE with its desire to leave the Euro or the Teaparty wing of the Republicans with their desire to declare trade war on China.”

Why To Avoid A Re-Run Of The 1930's.

In the 1970's, similar conditions led to the US withdrawing dollar convertibility with Gold. Nixon argued that there was not enough Gold in the world for Gold to act as a world currency. In the last week head of the World Bank, Bob Zoelick, has once again raised the idea of a return to a form of Gold Standard. Again, the argument is being raised that this is not possible because at $1400 an ounce there is not enough Gold to finance world trade. Its a false argument. As Marx demonstrated, it is never necessary to have as much of the money commodity as the actual value of total transactions. But, it is false for another reason. In the 1970's, the price of Gold was artificially fixed against the dollar at $30 an ounce as part of the Bretton Woods agreement. At that price there was not enough Gold. But, as the global currency system came close to collapse, and Gold once again began to fill its historic function as global money, its price soared from $30 an ounce to $800 an ounce by 1980. As one trader put it the other day, there might not be enough Gold at $1400 an ounce, but at $7,000 an ounce there is.

1 comment:

frolix22 said...

You might find this post, by the Australian economist Bill Mitchell, informative.