Germany holds the key to the euro's future

Angela Merkel is the most powerful and most vulnerable player in the debt crisis.

We have had yet another day of turmoil on the markets and yet another example of "kicking the can" by the eurozone's leaders. This morning, with great reluctance, the European Central Bank (ECB) started to buy Italian and Spanish government bonds to pacify panicked financial markets. It has worked today -- bond yields on Spanish and Italian paper have reduced -- but it won't hold for long.

In the last few days, the likes of Herman Van Rompuy and Economic Commissioner Olli Rehn have taken to the airwaves to state that the markets should not be attacking Italy and Spain. On paper, their credit-worthiness looks reasonably sound: Spain's debt to GDP ratio of 60 per cent is lower than that of Britain, Germany and France, while Italy runs, at 4.6 per cent in 2010, one of the lowest budget deficits in the EU.

But this doesn't matter. The banking sector crisis in Spain may not be finished yet, and the country is suffering from chronic unemployment levels. Italy's debt burden is 115 per cent, second only to Greece. More importantly, the markets know that the 21 per cent haircut on Greece's debt burden is probably just the start of large private sector losses, the price of reckless lending. A significant restructuring of Italian or Spanish debt would bankrupt numerous European banks. In particular, Franco-German banks are exposed to nearly €1 trillion of Spanish and Italian debt.

The bond market won't stabilise until the financial sector is satisfied that eurozone debts, or at least most of them, are underwritten. With Germany the largest and richest country, the responsibility for the eurozone's future lies with them, and with the choices facing the eurozone being expensive and politically toxic, this makes Angela Merkel the most powerful and most vulnerable player in the debt crisis.

Maintaining the current eurozone arrangement can only be achieved by swallowing some very bitter pills. Firstly, the funding capacity of the European Financial Stability Facility (EFSF) would need to be increased from €440bn probably to around €1.5-2 trillion so that it could, if required, underwrite a large chunk of Spanish and Italian debt as well as the smaller EU nations.

Secondly, the euro area countries will have to issue common eurobonds. Eurobonds have suddenly become very popular in the UK -- George Osborne, Ed Balls and Nick Clegg now all think they're essential, even though the Treasury was implacably opposed to them a couple of months ago -- and they enjoy support from most centre-left and some liberal parties across the EU. Merkel's Christian Democrat party and their coalition partners, the neo-liberal Free Democrats, view eurobonds with terror. During negotiations on the EU's economic governance package, government ministers and the European Parliament demanded the establishment of a European debt agency to issue eurobonds. Germany was totally opposed, although the European Commission will submit draft legislation on eurobonds to the Parliament and Council this autumn.

Both measures make economic sense. With bond spreads on 10 year paper at over 6 per cent, Italy is not far away from being unable to fund its debt, while Greece, Ireland and Portugal may need to restructure their debts. Guaranteeing a large chunk of that debt and allowing the EFSF to buy Italian (or indeed other country's) bonds would ease the fears of large sovereign defaults. Moreover, with the markets becalmed, EU leaders could reform the governance of the Eurozone and try to resolve the bank capital crisis that has helped create the government debt crisis.

But the costs of these measures are very high, both economically and politically. Germany has already committed guarantees of €119bn out of the €440bn EFSF. Increasing the EFSF's funding capacity to €1.5 trillion or more would require a contribution of up to €500 billion. If that isn't enough to make the German taxpayer's eyes water, then common eurobonds, even with an AAA credit rating, could still be more expensive than Germany's current bonds. To borrow the language of Yes, Minister's Sir Humphrey Appleby, forcing these measures through the Bundestag would be 'brave'. In other words, it would cost Merkel the next election or lead to the collapse of the coalition.

The other alternative is for the eurozone to divide between, broadly speaking, the north and the south using a "hard" and "soft" euro. The economic consequences would be unknown and, to all intents and purposes, this would end the euro project launched less than twenty years ago by Germany and France.

So Chancellor Merkel has the fate of the euro in her hands and we will soon find out how much Germany is prepared to pay for the euro. Don't expect swift resolution of the crisis because kicking the can down the road for a few more months is theoretically possible, even though it is an increasingly expensive exercise in futility.

Ultimately, saving the euro will be expensive and unpopular, but the costs are known. The price of the euro's demise doesn't bear thinking about.

Ben Fox is chairman of GMB Brussels and political adviser to the Socialist vice-president of economic and monetary affairs.

Photo: Getty
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The Future of the Left: A new start requires a new economy

Creating a "sharing economy" can get the left out of its post-crunch malaise, says Stewart Lansley.

Despite the opportunity created by the 2008 crisis, British social democracy is today largely directionless. Post-2010 governments have filled this political void by imposing policies – from austerity to a shrinking state - that have been as economically damaging as they have been socially divisive.

Excessive freedom for markets has brought a society ever more divided between super-affluence and impoverishment, but also an increasingly fragile economy, and too often, as in housing, complete dysfunction.   Productivity is stagnating, undermined by a model of capitalism that can make big money for its owners and managers without the wealth creation essential for future economic health. The lessons of the meltdown have too often been ignored, with the balance of power – economic and political – even more entrenched in favour of a small, unaccountable and self-serving financial elite.

In response, the left should be building an alliance for a new political economy, with new goals and instruments that provide an alternative to austerity, that tackle the root causes of ever-growing inequality and poverty and strengthen a weakening productive base. Central to this strategy should be the idea of a “sharing economy”, one that disperses capital ownership, power and wealth, and ensures that the fruits of growth are more equally divided. This is not just a matter of fairness, it is an economic imperative. The evidence is clear: allowing the fruits of growth to be colonised by the few has weakened growth and made the economy much more prone to crisis.

To deliver a new sharing political economy, major shifts in direction are needed. First, with measures that tackle, directly, the over-dominance of private capital. This could best be achieved by the creation of one or more social wealth funds, collectively held financial funds, created from the pooling of existing resources and fully owned by the public. Such funds are a potentially powerful new tool in the progressive policy armoury and would ensure that a higher proportion of the national wealth is held in common and used for public benefit and not for the interests of the few.

Britain’s first social wealth fund should be created by pooling all publicly owned assets,  including land and property , estimated to be worth some £1.2 trillion, into a single ring-fenced fund to form a giant pool of commonly held wealth. This move - offering a compromise between nationalisation and privatization - would bring an end to today’s politically expedient sell-off of public assets, preserve what remains of the family silver and ensure that the revenue from the better management of such assets is used to boost essential economic and social investment.

A new book, A Sharing Economy, shows how such funds could reduce inequality, tackle austerity and, by strengthening the public asset base, rebalance the public finances.

Secondly, we need a new fail safe system of social security with a guaranteed income floor in an age of deepening economic and job insecurity. A universal basic income, a guaranteed weekly, unconditional income for all as a right of citizenship, would replace much of the existing and increasingly means-tested, punitive and authoritarian model of income support. . By restoring universality as a core principle, such a scheme would offer much greater security in what is set to become an increasingly fragile labour market. A basic income, buttressed by a social wealth fund, would be key instruments for ensuring that the potential productivity gains from the gathering automation revolution, with machines displacing jobs, are shared by all.  

Thirdly, a new political economy needs a radical shift in wider economic management. The mix of monetary expansion and fiscal contraction has proved a blunderbuss strategy that has missed its target while benefitting the rich and affluent at the expense of the poor. By failing to tackle the central problem  – a gaping deficit of demand (one inflamed by the long wage squeeze and sliding investment)  - the strategy has slowed recovery.  The mass printing of money (quantitative easing) may have helped prevent a second great depression, but has also  created new and unsustainable asset bubbles, while austerity has added to the drag on the economy. Meanwhile, record low interest rates have failed to boost private investment and productivity, but by hiking house prices, have handed a great bonanza to home owners at the expense of renters.

Building economic resilience will require a more central role for the state in boosting and steering investment programmes, in part through the creation of a state investment bank (which could be partially financed from the proposed new social wealth fund) aimed at steering more resources into the wealth creating activities private capital has failed to fund.

With too much private credit used for financial speculation and property, and too little to small companies and infrastructure, government needs to play a much more direct role in creating credit, while restricting the almost total freedom currently handed to private banks.  Tackling the next downturn, widely predicted to land within the next 2-3 years, will need a very different approach, including a more active fiscal policy. To ensure a speedier recovery from recessions, future rounds of quantitative easing should, within clear constraints, boost the economy directly by financing public investment programmes and cash handouts (‘helicopter money’).  Such a police mix – on investment, credit and stimulus - would be more effective in boosting the real economic base, and would be much less pro-rich and anti-poor in its consequences.

These core changes would greatly reform the existing Anglo-Saxon model of capitalism and provide the foundations for building support for a new direction for progressive politics. They would pioneer new tools for building a fairer, more dynamic and more stable economy. They could draw on experience elsewhere such as the Alaskan annual citizen’s dividend (financed by a sovereign wealth fund) and the pilot basic income schemes launching in the Netherlands, Finland and France.  Even mainstream economists, including Adair Turner, former chairman of the Financial Services Authority, are now talking up the principle of ‘helicopter money’. For these reasons, parts of the package are likely to prove publicly popular and command support across the political divide. Together they would contribute to a more stable economy, less inequality, and a more even balance of power and opportunity.

 

Stewart Lansley is the author of A Sharing Economy, published in March by Policy Press and of Breadline Britain, The Rise of Mass Impoverishment (with Joanna Mack).