2012-05-21 00:09:02
Guardian 20/5/2012
by Larry Elliott
The spectre of Lehman Brothers looms large in the world's financial markets. Memories of the chaotic days of September 2008 came flooding back as Alistair Darling appeared on TV amid reports of capital flight and bank runs.
Forget the idea that Europe's policymakers are better prepared this time than they were back then. Take with a pinch of salt the idea that they have a big enough war chest to cope with the consequences of a Greek exit from the single currency. The much-vaunted firewall is a Maginot line.
Events have moved quickly since the French and Greek elections a fortnight ago. Greek departure from the eurozone is now pretty much priced in by the markets, with the focus of attention on how bad the collateral damage will be. Expect the worst. Last week, pressure was mounting on Spain and its troubled banks. The idea that the European leaders who have been like rabbits in the headlight for the past two years can mastermind a clean break for Greece is utterly fanciful. The crisis will be messy, painful, prolonged and probably terminal.
Even now, there is a failure or an unwillingness to grasp a basic truth about the single currency: it doesn't work. Monetary unions only succeed if there is economic flexibility, financial solidarity and cultural homogeneity. If those three factors are in place, as they are in the United States, there is a chance that a common interest rate and a single currency can encourage economic convergence, up to a point. Europe's problem is that it has none of these things. Countries such as Greece cannot become German overnight. The European Union lacks the resources to help poorer nations adjust. Most crucially of all, the crisis has exposed the fact there is no sense of common purpose beyond a desire to ensure the "project" continues.
The survival plan, such as it is, involves countries embarking on a long process of structural reform to make them more competitive, a fiscal pact to ensure that governments live within their means, and perhaps a bit of extra pan-European infrastructure spending to satisfy voter demands to soften the impact of austerity.
There is little prospect of this blueprint working. Take Ireland, one of the three countries subject to harsh bailout terms. Does it have a competitiveness problem? As Dhaval Joshi of BCA Research notes, Ireland accounts for 0.3% of global GDP yet accounts for 3% of world trade in services and 6% of trade in pharmaceuticals. Ireland ranks third in the world for foreign direct investment, on which the return is 17%, compared with 6% in Germany. "As a trading economy in key sectors, Ireland is punching 10 or 20 times above its weight. This is hardly a sign of an economy that needs to become more competitive," Joshi says.
Nor would the proposed fiscal pact, on which Ireland votes in a referendum later this month, have prevented the crisis that has reduced GDP by 15% and prompted a fresh exodus of the young and talented. Ireland, like Spain, had healthy public finances in the years before the crisis broke. The problem in both countries was not too much public debt but too much private debt. The reason there was too much private debt was that borrowing was too cheap in economies that were growing fast and at risk of overheating. And the reason borrowing was too cheap was that Ireland and Spain had given up the right to set their own interest rates and were subject to the one-size-fits-all dictates of monetary union.
To their immense credit, this fundamental flaw was recognised by Gordon Brown and Ed Balls, which was why they resisted the siren voices of those who pressed hard for Britain to join the single currency. All the UK's worst economic tendencies – speculation, housing bubbles, the live-now-pay-later mentality – would have been amplified by euro membership and the result would have been an even bigger crash than the one suffered between 2007 and 2009, a bigger budget deficit and an austerity programme imposed not by David Cameron but by Angela Merkel.
It was not fashionable to voice these fears a decade or so ago, when the euro was seen as exciting and cutting-edge. The irony is that monetary union was really the last gasp of the mid-20th-century vision of economics: top down, bureaucratic and based on the notion of western economic hegemony.
Despite this monetary chaos, there are still some in Brussels or Frankfurt who argue that the euro has been a success and will go from strength to strength. They sound suspiciously like the members of the politburo who in the 1980s said the Soviet Union was working and would last for ever. The undoubted political commitment to the euro means that there are now calls for a fast-track approach to full political union, but this means repeating the top-down approach used for monetary union and – at a time when the markets are talking about a Greek exit within weeks or months – would take years to finesse.
Instead, the realistic options for the euro are that it breaks up or staggers on in a zombie-like condition, with low growth, high unemployment, growing public disenchantment and widely divergent views in Europe's capitals about what needs to be done. As a company, the euro would have gone bust by now. It had a duff business plan, which has been poorly executed. The experiment survived in the benign conditions of the early 2000s but only the core business, Germany, has been able to cope with the much tougher climate of the past five years. There is boardroom squabbling, the workforce is in open revolt and there are no new product lines.
The euro, in short, is ripe for what Joseph Schumpeter called creative destruction. Capitalism, according to Schumpeter, was the story of constant, normally gut-wrenching change, in which innovation put established firms out of business and made whole sectors obsolete. Anybody working in the music industry, publishing or newspapers in the past decade understands what Schumpeter was talking about.
Does Schumpeterian theory apply to the eurozone? In a way, it does. The centre of gravity in the global economy has moved from Europe, which looks old-fashioned and lumbering in a world of rapid innovation and loose networks. Tweaking the flawed model in the way François Hollande is suggesting will not do the trick. The only real solution is to rip up the blueprint and start again with the small group of countries that could hack it together. Making the eurozone work is like finding a long-term business model for HMV or Thomas Cook. Like them, monetary union is the past, not the future, an analogue construct in a digital world
youpayyourcrisis
by Larry Elliott
The spectre of Lehman Brothers looms large in the world's financial markets. Memories of the chaotic days of September 2008 came flooding back as Alistair Darling appeared on TV amid reports of capital flight and bank runs.
Forget the idea that Europe's policymakers are better prepared this time than they were back then. Take with a pinch of salt the idea that they have a big enough war chest to cope with the consequences of a Greek exit from the single currency. The much-vaunted firewall is a Maginot line.
Events have moved quickly since the French and Greek elections a fortnight ago. Greek departure from the eurozone is now pretty much priced in by the markets, with the focus of attention on how bad the collateral damage will be. Expect the worst. Last week, pressure was mounting on Spain and its troubled banks. The idea that the European leaders who have been like rabbits in the headlight for the past two years can mastermind a clean break for Greece is utterly fanciful. The crisis will be messy, painful, prolonged and probably terminal.
Even now, there is a failure or an unwillingness to grasp a basic truth about the single currency: it doesn't work. Monetary unions only succeed if there is economic flexibility, financial solidarity and cultural homogeneity. If those three factors are in place, as they are in the United States, there is a chance that a common interest rate and a single currency can encourage economic convergence, up to a point. Europe's problem is that it has none of these things. Countries such as Greece cannot become German overnight. The European Union lacks the resources to help poorer nations adjust. Most crucially of all, the crisis has exposed the fact there is no sense of common purpose beyond a desire to ensure the "project" continues.
The survival plan, such as it is, involves countries embarking on a long process of structural reform to make them more competitive, a fiscal pact to ensure that governments live within their means, and perhaps a bit of extra pan-European infrastructure spending to satisfy voter demands to soften the impact of austerity.
There is little prospect of this blueprint working. Take Ireland, one of the three countries subject to harsh bailout terms. Does it have a competitiveness problem? As Dhaval Joshi of BCA Research notes, Ireland accounts for 0.3% of global GDP yet accounts for 3% of world trade in services and 6% of trade in pharmaceuticals. Ireland ranks third in the world for foreign direct investment, on which the return is 17%, compared with 6% in Germany. "As a trading economy in key sectors, Ireland is punching 10 or 20 times above its weight. This is hardly a sign of an economy that needs to become more competitive," Joshi says.
Nor would the proposed fiscal pact, on which Ireland votes in a referendum later this month, have prevented the crisis that has reduced GDP by 15% and prompted a fresh exodus of the young and talented. Ireland, like Spain, had healthy public finances in the years before the crisis broke. The problem in both countries was not too much public debt but too much private debt. The reason there was too much private debt was that borrowing was too cheap in economies that were growing fast and at risk of overheating. And the reason borrowing was too cheap was that Ireland and Spain had given up the right to set their own interest rates and were subject to the one-size-fits-all dictates of monetary union.
To their immense credit, this fundamental flaw was recognised by Gordon Brown and Ed Balls, which was why they resisted the siren voices of those who pressed hard for Britain to join the single currency. All the UK's worst economic tendencies – speculation, housing bubbles, the live-now-pay-later mentality – would have been amplified by euro membership and the result would have been an even bigger crash than the one suffered between 2007 and 2009, a bigger budget deficit and an austerity programme imposed not by David Cameron but by Angela Merkel.
It was not fashionable to voice these fears a decade or so ago, when the euro was seen as exciting and cutting-edge. The irony is that monetary union was really the last gasp of the mid-20th-century vision of economics: top down, bureaucratic and based on the notion of western economic hegemony.
Despite this monetary chaos, there are still some in Brussels or Frankfurt who argue that the euro has been a success and will go from strength to strength. They sound suspiciously like the members of the politburo who in the 1980s said the Soviet Union was working and would last for ever. The undoubted political commitment to the euro means that there are now calls for a fast-track approach to full political union, but this means repeating the top-down approach used for monetary union and – at a time when the markets are talking about a Greek exit within weeks or months – would take years to finesse.
Instead, the realistic options for the euro are that it breaks up or staggers on in a zombie-like condition, with low growth, high unemployment, growing public disenchantment and widely divergent views in Europe's capitals about what needs to be done. As a company, the euro would have gone bust by now. It had a duff business plan, which has been poorly executed. The experiment survived in the benign conditions of the early 2000s but only the core business, Germany, has been able to cope with the much tougher climate of the past five years. There is boardroom squabbling, the workforce is in open revolt and there are no new product lines.
The euro, in short, is ripe for what Joseph Schumpeter called creative destruction. Capitalism, according to Schumpeter, was the story of constant, normally gut-wrenching change, in which innovation put established firms out of business and made whole sectors obsolete. Anybody working in the music industry, publishing or newspapers in the past decade understands what Schumpeter was talking about.
Does Schumpeterian theory apply to the eurozone? In a way, it does. The centre of gravity in the global economy has moved from Europe, which looks old-fashioned and lumbering in a world of rapid innovation and loose networks. Tweaking the flawed model in the way François Hollande is suggesting will not do the trick. The only real solution is to rip up the blueprint and start again with the small group of countries that could hack it together. Making the eurozone work is like finding a long-term business model for HMV or Thomas Cook. Like them, monetary union is the past, not the future, an analogue construct in a digital world
youpayyourcrisis
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