This is no time to give up on the euro
All the signs of the eurozone crisis are that quite soon there will be just two currencies still in
British political divisions on Europe have, for half a century, run long and deep. Opinion within the coalition parties, however, is coalescing around a hardline position as the eurozone crisis intensifies. David Cameron muses that powers ceded to Brussels should be reclaimed. Nick Clegg declares that, had Britain adopted his party's policy a decade ago and joined the euro, it would have been a "huge, huge error". Yet Labour under Ed Miliband and Ed Balls appears to have little to say on Europe, other than to insinuate that Euroscepticism is a consensus view.
Labour's reticence is economically misguided and politically pusillanimous. There were design flaws in the euro that were predictable and need to be remedied rapidly: that much is clear. Yet the notion that the necessary reforms will lead to a European superstate and that Britain should redefine its constitutional position with the EU is absurd and damaging. There are big economic costs to the Conservatives' dogmatism and the Lib Dems' failure to restrain it.
The crisis of the euro is severe but there is no reason that it should be terminal. Right-wing pundits who see in it the collapse of the integrationist scheme are, like the old militant seers of the collapse of capitalism, letting ideology run ahead of reason. Monetary union is not the cause of the crisis. Done properly, it may help insulate member states from disruptive volatility in the international capital markets.
The reason for the crisis goes back to the collapse of the western banking system between 2007 and 2009. The cause is the same - too much debt. The downgrading of Italy's credit rating by Standard & Poor's reflects a long-standing problem. Italy's public debt is equivalent to roughly 120 per cent of GDP. Political failure to deal with it and a weakening outlook for growth have caused investors to demand higher returns to compensate them for the risk of holding Italian government bonds.
Greece is an exceptional case, where public accounts were wildly inaccurate and too few paid the taxes needed to support an extensive public sector. But the ructions in other indebted economies, notably Ireland and Spain, have ominously familiar characteristics: the liberalisation of financial and property sectors, prompting a construction boom and an explosion of bank lending. There was nothing inevitable about these developments. They might have been anticipated and curbed; and they did not occur in other countries of the eurozone periphery. They are prominent features, too, of the recent economic history of the UK.
The indebted eurozone economies now face a prolonged squeeze on living standards. Because the option of external devaluation is not open to them, their only option is to cut costs and spending. However, it would be a mistake to suppose that if Greece were able to devalue its currency, that would resolve its crisis.
Devaluation can work by raising import prices and thus cutting real wages, provided that nominal wages remain constant. The postwar experience of the UK is not an encouraging precedent. Membership of the euro is imposing on Greece a much-needed discipline to resolve its problems directly. Leaving the euro would make the position of these weaker economies worse, as their debt is overwhelmingly priced in euros. Nor is the suddenly fashionable notion that Germany will leave the euro likely to happen. The resulting exchange-rate appreciation would damage Germany's export growth and prove far more expensive than the cost of the eurozone bailouts.
The fundamental problem of the euro is the lack of a fiscal dimension. Successful currency unions, such as the US, have mechanisms for fiscal transfers from members that are thriving to those that are struggling. The eurozone does not have a credible set of fiscal rules or an emergency lender. Hence, the crisis is being dealt with using inadequate expedients that are unsustainable, because the debt burdens of indebted countries are rising as living standards fall. For the long term, more permanent arrangements are needed. In the short term, there will need to be a lot of debt restructuring and monetary stimulus from the European Central Bank.
Debt crises are a known problem. In the early 1990s, a series of 18 agreements, known as the Brady Plan, defused the Latin American debt crisis through debt forgiveness and some new lending. European policymakers will have to come round to something similar but this will hardly substantiate the Eurosceptics' nightmare of a European state. Nor would a sovereign default necessarily undermine the euro, any more than a default by California on its nearly $50bn of municipal bonds would spell the end of the dollar.
On the home front
In the meantime, there are problems closer to home. The IMF recently slashed its UK growth forecasts to 1.1 per cent this year and 1.6 per cent in 2012. British policy combines extremely loose monetary policy, in which inflation is tolerated though it is far above the target rate, and very tight fiscal policy. The weakness of growth means that something will have to give. If the targets for deficit reduction are not met, investors may suddenly start to demand a higher-risk premium for holding sterling-denominated assets. The idea that a floating exchange rate is some sort of axiom of left-wing policy is unlikely to survive the experience.
Meanwhile, whatever economic pain the eurozone periphery faces, its members can at least be confident of one thing. They can implement reforms without fearing a run on the currency. The euro has gained the status of a reserve currency. The great sovereign disasters of the financial crisis have been Iceland and Hungary, outside the euro. Their experience is one reason that smaller European nations will continue to seek entry to the euro. In another generation, it is plausible that only two currencies will remain in western and central Europe: the euro and sterling. Labour, having done little for the European project in the past 60 years, will doubtless still be trying to make up its mind.
Oliver Kamm is a leader writer on the Times
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