As discussed many times before on the blog the creation of the Euro (the world’s biggest currency) allowed counties to behave differently than when they had their own currencies. It gave them a higher credit rating so they could borrow more easily and at lower interest rates. To prevent excesses there was the Stability and Growth Pact (SGP) that limited each country to an annual budget deficit no higher than 3% of GDP and a national debt lower than 60% of GDP (oh how they wish these were the case now). With punitive penalties for breaking this. France then did break it and wasn’t punished which opened the floodgates for very badly managed countries to spend, spend, spend (much as Gordon Brown also did in the UK). Presumably with the assumption that ultimately the other member states of the Euro would bail them out.
But now the chickens have come home to roost, the markets realise that they have been sold one thing but have bought something entirely different. We stand on the very edge of default by the PIIGS countries of Portugal, Italy, Ireland, Greece and Spain with Belgium looking very unhealthy and France looking like it will go over the edge if the others fail. And the populations of these countries are up in arms because they can no longer enjoy the lifestyle that other people were paying for.
The response of the politicians has been a disgrace with abysmal leadership. Individual countries are “rescued”, sometimes repeatedly, just before they fall over the edge. But even with these rescues Greece will inevitably fail and already the world’s banks are writing down the value of the Greek bonds they hold. The question is what will the contagion be when Greece goes, how much of a domino effect will we see?
The IMF has come up with some bail outs, the European Financial Stabilisation Mechanism (EFSM) and the European Financial Stability Facility (EFSF) were set up but they were always too little too late. But the reality is that if the seven countries listed above start falling successively into default then all the money in the world won’t stop it. The debts are just unsupportable.
For a country going into default isn’t the end of the world. Those that have done it in recent times like Russia and Argentina have come out of it with far better and far stronger economies. It just hurts a lot at the time and that hurt is also felt by everyone who has lent to that country.
If the Euro countries had any sense they would have a simple rule that if any country defaults then it gets kicked out. This would work in so many ways to prevent problems and to handle them when they occur. But the EU politicians are doing the exact opposite, they are trying to keep everyone in, no matter what the cost. But it is something they may well not be able to afford or be allowed to pay for by their voters.
So another week, another crisis, this time in the middle of August when everyone is on holiday. Sarkozy and Merkel had to break theirs and meet up in Paris. Their solution is the idea of a Eurozone government, which basically means France and Germany telling the other Eurozone countries how to run their economies. It is the thin end of the wedge of fiscal union and of making Europe into a federal country like America, with what are now sovereign countries becoming mere states, something the population of Europe don’t want but something that many politicians have been working towards.
Meanwhile the market would probably like to see Eurobonds as the answer, borrowing jointly and severally guaranteed by all the Eurozone members. This would be fun with Greece going back to spend, spend spend with other people’s money.
The problem with the Euro is that it is fundamentally technically flawed. It tries to bundle together disparate countries with disparate economies and disparate attitudes to financial probity. The constituents are insufficiently heterogeneous for it to work. Sweden has been very sensible and very crafty in the way it has kept out of its obligation to join.
So it is time for us to break out yet more popcorn and watch from the sidelines as this story evolves. As it must because the current situation is impossible to maintain. We are in for some fireworks.