8:27PM GMT 01 Dec 2011
The clock is ticking for the euro. After 11 years circulating in shops and bars from Athens to Zeebrugge, there are, it is said, just 10 days left to save it – or perhaps eight, since it was on Wednesday that Olli Rehn, Europe’s Economic and Monetary Affairs Commissioner, made his startling prediction of the euro’s imminent demise.
The fact that Rehn, an official at the heart of the euro project, came out with such a stark assessment has brought what many thought was unthinkable into the realm of the thinkable. So thinkable, in fact, that governments (including our own), central banks, lawyers, financial institutions and investors are making contingency plans for what is assumed will be an economic event of cataclysmic proportions.
But can the euro be saved? And if it does break up, what are the implications for the UK, a country that has stubbornly stayed out of the euro, but which can’t escape the consequences of events in the next week, culminating in another crunch meeting in Brussels next Friday? Sadly, a financial Flash Gordon doesn’t exist. There is no comic book hero to appear at the last minute to save the euro. To do that, the eurozone’s leaders must overcome entrenched political differences over how a rescue is mounted.
Scepticism that Germany, France and Italy can bury their differences, agree the measures necessary and bring the other 14 squabbling euro members to the table has left markets deeply unconvinced. After all, we have been here before.
There are two steps to saving the single currency. The first is a short-term bail-out of continental proportions, probably costing up to 1 trillion euros (£856 billion), for countries such as Greece and Italy which are about to run out of cash to pay their bills. By the eurozone governments agreeing to provide unlimited support for near-broke colleagues, the cost of borrowing for these stricken countries would fall, enabling them to borrow again and pay their IOUs to the region’s increasingly shaky banks.
It was the parlous state of these mainly European lenders that prompted Wednesday’s intervention by central banks, led by the US Federal Reserve. However, their action – to let loose an ocean of cheap dollars – was first and foremost about saving banks that are wobbling because of the euro, not to save the euro itself.
Anyway, assuming the inflation-phobic Angela Merkel and her German colleagues can agree to a massive bail-out, that should buy enough time for agreement on the second, long-term step to euro salvation. That is, an agreement for EU treaty changes, or possibly a series of bilateral agreements, that will bind the 17 member countries in closer financial union. The upshot would be a dilution of national sovereignty, submitting each parliament’s tax and spend policies to Brussels for approval under the watchful eye of the Frankfurt-based European Central Bank (ECB). But it would, in theory, stabilise the political system the euro relies on.
The arguments raging between Berlin, Paris, Rome and Brussels are over how all this is to be achieved in ways that are politically acceptable to everyone. The ECB’s president, Mario Draghi, has already refused to be the eurozone’s lender of last resort; anyway, the EU treaty bans it from lending to governments. Mrs Merkel again repeated her opposition to bail-outs yesterday.
On Wednesday, European finance ministers all but admitted they had failed to agree on ways to bolster the increasingly discredited European Financial Stability Facility (EFSF) and are turning to the International Monetary Fund (IMF) to step in and help overcome Europe’s political and legal barriers to delivering the short-term “big bazooka”. But if that is delivered then politicians such as Mrs Merkel will want to make sure Europe never goes through this again. She will want a clear understanding by the end of next week that fiscal union – in effect, much closer political union – is the quid pro quo for a bail-out. German voters are sick of seeing their prudence support the profligacy of southern Europe, be it Greece, Spain, Portugal or Italy.
This really is a defining moment. And not just for the eurozone countries. Preserving the euro, and convincing markets that there is a meaningful plan for the future, is central to the UK’s interests, too. Europe is our biggest trading partner and our wish for a more balanced, less City-dependent and more export-led economy relies on stability and growth on the Continent.
But politics moves at a snail’s pace, while markets are lightning quick to sense any weakness in a financial system. If there is no concrete and convincing action by the end of next week, it seems inevitable that the previously unthinkable will happen. The euro will start to unravel and any break-up in the short term would inevitably be disorderly.
Markets know that the combination of recession and austerity plans is leaving governments such as Italy and Greece short of cash to pay their debts. Between now and the middle of 2014, Italy must find 651 billion euros to roll over its liabilities, which stand at 2.4 trillion euros and growing. Without the massive cash support of a bail-out, Italy risks being unable to pay its bills and default would follow.
That doesn’t necessarily mean it would leave the euro, but countries that have suffered the catastrophic event of welching on their debts, such as Argentina, have devalued to restore competitiveness and, ultimately, credibility to their economies. The only way for an Italy or Greece to do that is to leave the euro. Markets may soon force their hand anyway, by instigating a run on their banks and repatriating euros into safer havens such as Germany, leaving these countries unable, and politically unwilling, to function within the eurozone.
Once out, according to economists, it would take a matter of days, rather than weeks, for a country to replace euros with another denomination bank note. Ideally, it would have a stock already prepared. In the interim, it could issue small denomination IOUs that would become a new form of cash, exchangeable for goods and services.
Leaving the euro would almost certainly see a country imposing capital controls. If Greece left, then a Briton with a holiday home on Kos, and presumably a bank account there, wouldn’t be able to liquidate assets and get cash out. That trapped cash would also be forcibly converted into new drachmas and would lose a chunk of its value as the new currency devalued. The same would happen to any financial or business contract struck in euros with a Greek counterparty. The break-up of the euro would keep lawyers busy for years.
Stinging investors also risks a country acquiring pariah status in capital markets, which might become reluctant to lend any more. But the advantage of adopting a much devalued drachma would be to make exports cheaper and the economy far more competitive, which could mean its fortunes start to look up. With a smile back on its face, Greece might become an advert for leaving the single currency, making it even harder to keep the euro together. Once one goes, others will follow.
In the short term, this would be bad for Britain, too. A disorderly break-up involving a large sovereign default would hit our banks. Credit would become more expensive, if available at all, and trade would shrink. David Cameron summed it up yesterday: “If the euro fell apart, what you would see is a very steep decline in the GDP, the economic growth, of all countries in Europe, including Britain.”
But then again, a country, or countries, free to set their own interest rates, and enjoying a cheaper currency, would make for potentially stronger export markets for us.
An alternative would be for Germany to exit the euro, perhaps with other relatively strong nations, including France, Finland and the Netherlands. This would leave the more stable economies with the problem of adopting a new currency and the weaker, peripheral members with the old euro. It would be worth less than a new “northern euro” but some of the worst disruption would be avoided.
Probably the best we can hope for is that next week ends with real action on a eurozone bail-out that buys sufficient time for its 17 members to agree, and plan, an orderly restructuring over the next two to three years. That way will allow some countries to leave – and the euro diehards to continue their perilous monetary adventure alone.