The death of the euro is more likely than its survival
ECONOMICS:It was once unthinkable that post-1945 Germany would ever turn its back on Europe
AT THE beginning of each year, this newspaper publishes a preview of the coming 12 months. In the 2011 preview, I put the probability of the euro breaking up at 15 per cent. One year later, in the 2012 preview, it seemed close to – but still below – 50 per cent.
Now, more than halfway through 2012, I find it impossible to avoid the conclusion that the probability of break-up has gone above the 50 per cent threshold. In other words, the single currency project is more likely to collapse than to survive in its current form. Financial, economic and political problems appear too great to be overcome by a group of 17 countries that have proved unable to end the crisis.
Most developments so far this year have been negative. Spain and Cyprus have joined the bailout club and Slovenia is about to bring to six the number of euro zone countries that cannot sustain themselves unaided.
A €1 trillion liquidity injection into the financial system by the ECB failed to bring lasting calm. Banks across the continent are now more fragile than ever and the system’s impairment is a major contributing factor to renewed recession in the euro zone. Yet again yesterday, Frankfurt under-delivered, having over-promised in the days leading up to its monthly meeting.
The bifurcation of the euro zone sovereign bond market has reached new extremes, with some countries able to borrow almost for free, while a growing number are unable to borrow at all.
The potentially very important agreement among euro zone leaders on June 29th to move towards a banking union has yet to live up to any of its potential. Big questions remain about how fast and how comprehensive a euro zone banking union will be, if it ever materialises.
That is where we are now. The short-term future looks worse.
The Greek economy may be showing tentative signs of stabilising, but the worst is not over and recovery is a long way off. The new government continues to seek concessions before proving its ability to implement reform measures.
Given the economic and political trends, it is difficult to see Greece in the euro area one year from now. While its ejection would make the zone stronger in the long term, in the short term the effect could be to trigger panic in the rest of the periphery, thereby precipitating a disorderly unravelling of monetary union. Talk of building a credible firewall around Greece has come to nothing and, given the record to date of euro zone policymakers, no solid ring-fencing of Greece appears likely, if that is even possible.
Italy being locked out of the bond market is an even bigger and more immediate risk than a Greek exit. The public debt of the world’s eighth-largest economy is very high and rising fast – €1,946 billion at last count. The euro zone’s bailout mechanisms have nowhere near the resources to bail out Italy if it cannot raise the tens of billions it needs each month.
The Italian state’s cost of borrowing remains below the peaks of the end of last year, but the economy is now much weaker, and getting weaker still. Consumer spending and confidence are falling more precipitously than during the Great Recession of 2008-09, and unemployment is rising more rapidly. The collapse in investment is not much shallower than during that period.
Without growth, Italy’s debt dynamics will become unmanageable. Growth looks unlikely over the next year. Deep recession is far more likely.
As if that were not bad enough, there is enormous political risk. An election must be held by April.
Opinion polls show support for the reforming caretaker government falling from 71 per cent last November to 33 per cent in June. The polls give no indication that Italians are uniting behind any effective alternative. A political vacuum looms in Rome.
Without a radical change in euro zone structures and its policy response, Italy is headed for default. The decision to allow that to happen – or to prevent it – will ultimately be taken in Berlin.
When once it was unthinkable that post-1945 Germany would ever turn its back on Europe, most voices from that country talk of what Germany dislikes, opposes or refuses to countenance.
While few of the points made by German opponents of more radical policy responses are wrong, the way they frame the options is grossly misleading. Germany does not have a choice between doing more and status quo. The status quo has failed. Sooner or later its failure will manifest in an unprecedented financial shock which will plunge the European economy into depression. The only choice is to integrate further or accept the horrendous fallout from that shock.
But even if Germany’s political leadership does take the leap, and agreement can be reached in short order on a big step towards closer union, would public opinion follow? Given the magnitude of the integrative step, referendums would be inevitable in many countries. European voters have frequently opposed more Europe when asked.
In 2005 French and Dutch voters shot down the European constitution and Irish voters have said no to two treaties over the past decade. Under current circumstances, it is hard to see increasingly eurosceptic electorates all favouring a change as historic as political union.
Europe’s economy is weak, its financial system fragile, its leaders divided and its peoples sceptical of further sovereignty pooling. One can only conclude that disintegration is now a more likely outcome than further integration.