Time is running out to prevent a euro zone catastrophe


ECONOMICS:THE END is nigh for the euro zone as it currently exists. The status quo is untenable. Consensus is emerging that the only way to prevent meltdown is to create a banking and fiscal union.

In short, Europe’s only choices are an unprecedented collapse or an unprecedented union among sovereign states.

Among the many questions to be answered in deciding which path to take are: what is the worst-case scenario in the event of collapse; and what are the chances of a much closer union working?

Those who downplay the consequences of a euro break-up point to the break-up of other currency unions, such as the Soviet one, and the falling apart of Argentina’s currency board (the closest exchange rate regime to a currency union). They say that things were bad for a while but within a few years GDP started growing again.

These analyses ignore completely the effects on wealth. That is akin to thinking about an individual who goes through a personal financial crisis, but considering only what happens to his income while ignoring the loss of some or all of his life savings.

In the former Soviet Union and Argentina banks collapsed when the currency regimes disintegrated. Many people lost their life savings. If the euro were to collapse, Europe’s banks would collapse too. People would lose their savings. And because Europeans are much wealthier than people in the former Soviet Union or Argentina, the amounts involved would be much greater.

More wealth would disappear as bank shares and bonds became worthless and as sovereigns defaulted. This would have massive knock-on effects, not least for pension funds in which much wealth is tied up. Many Irish pension funds are already in precarious positions. Massive bank and sovereign defaults would destroy them.

Parallels with past currency break-ups also break down because the economies involved were very different from Europe’s highly financialised economy. Financialised economies suffer more from financial crises – compare Japan’s still-reverberating crisis two decades ago to the almost-forgotten Asian crisis of the late 1990s.

I cannot but conclude that if the euro collapsed it would be the most destructive event in Europe since the second World War.

Preventing such a cataclysm by integrating much more closely comes with its own very serious risks, albeit ones that are far less immediate and more slow-burning.

The EU has a legitimacy deficit in that people identify much more closely with the national governance than European level of governance. There is no bottom-up people’s movement demanding deeper integration. Moving in that direction now could result in fragmentation down the line if people become alienated from a euro-level government.

If circumstances were normal I would not support such deeper integration. But they are not normal, and the choice now is between the unacceptable and the unappealing.

The real problems of deeper integration would arise on the fiscal rather than the banking side (financial regulation is a technocratic function that is unlikely to concern most voters). But creating a fiscal union may not alienate voters if they continue to decide on overall tax and public spending levels and if fiscal union does not become a transfer union. Both are achievable.

Swiss cantons and US states differ very considerably in size of government. There is no reason – in theory or practice – to suggest that fiscal unions limit electorates’ choices about levels of taxation and public spending.

What about a “transfer union” where resources flow automatically from richer to poorer regions? If taxpayers in one country have to give their money to others in perpetuity they are likely eventually to revolt. But a fiscal union does not have to mean a transfer union. A European fiscal union to accompany its monetary union would be to deal with the “asymmetric shock” problem. This involves automatic but temporary inflows of federal cash to a region that is suffering a deeper recession than the average.

That is not the one-way street that Germans, in particular, fear. It could mean that Bavaria, for instance, would benefit from big transfers of cash if the global car industry crashed, causing that auto-making region to go into deep recession.

There are many other issues. But fiscal union could work. At this juncture almost any price is worth paying to prevent collapse.

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