By Ian Holt- North West Reporter-Europe faces a crisis that is no longer confined to individual countries. It has become all consuming for the citizens of the EU and challenges the viability of monetary union in its current form.
It is obvious to all that the crisis has to be resolved and that future crises must be prevented.
The first and most obvious step was to contain the crisis.
How has this been achieved?
With an ‘EU Money Tree’, already reaching the staggering amount of over €1 trillion courtesy of The European Financial Stability Facility (EFSF).
However, the ‘money tree’ will not buy Europe a lasting solution to the crisis.
As Mervyn King frequently states: ‘all that can be bought is time’, time that must be used to address the root causes of the crisis.
The way I see it, the crisis has two major causes:
• The macroeconomic imbalances that have built up in recent years and,
• Public and private debt that has ballooned in some member states.
Both problems must eventually be addressed. Europe is running out of time.
Europe’s most prominent symptoms are diverging current accounts.
An adjustment has to be made but from where and who?
Countries such as Greece run persistent current account deficits, while countries such as Germany run persistent surpluses.
So, which countries have to adjust?
Is it those with a current account deficit?
Is it those with a surplus?
Or is it both?
De or Re-value accounts?
Normally, exchange rate movements are an important means through which unsustainable Current Account positions are corrected.
Eventually, deficit countries devalue, while surplus countries revalue their currencies.
The response in imports and exports then helps to bring the current account closer to balance.
Here lies the problem. In a monetary union, this is no longer an option. Spain no longer has a peseta to devalue and Germany no longer has a deutsche mark to revalue.
Alternatives must therefore be found: prices, wages, employment and output.
So, just who should adjust?
Angela Merkel’s position seems to be
• Deficit countries must adjust.
• They must address their structural problems.
• They must reduce domestic demand.
• They must become more competitive and
• They must increase their exports.
But this position has not gone uncontested.
The fear is that it would be too much of a burden for the deficit countries alone to adjust. They consequently suggest that surplus countries should shoulder at least part of the burden.
It is true that surplus countries have benefited through higher exports.
Ultimately, it was the deficit countries that operated an unsustainable model defined by a credit-fuelled boom in domestic demand, and this model has to be reformed.
Not every deficit country needs the same reforms, of course, but all require some sort of adjustment.
It is sometimes suggested that rebalancing should be undertaken by ‘meeting in the middle’, that is by making surplus countries such as Germany less competitive.
Unfortunately Europe is part of a globalised world.
At the global level, it is competing with economies such as the United States or China.
To succeed, Europe as a whole has to become more dynamic, more inventive and more productive, not less.
Such an adjustment would initially place a huge burden on the people in deficit Countries, (as already seen through the Greek model) even taking into account the extraordinary boom in the years prior to the crisis.
Will the burden be too heavy to bear?
A central fear is that of deflation. Unless productivity growth increases miraculously, it is certainly true that prices and wages will have to fall in many cases.
As the deficit countries import less and become more competitive exporters, surplus countries will run lower surpluses
The key issue is whether this happens as a result of market processes or as a result of efforts to fine tune aggregate demand in the euro area.
Austerity and public budgets
What about consolidation or austerity?
The general consensus is that it would be too much of a burden for EU countries to correct macroeconomic imbalances and consolidate public debt at the same time.
A vicious cycle of falling demand and slowing economic growth could only ever be the outcome.
An ever expanding and costly public sector or very generous pension system are both a drag on growth and a burden on the budget. A wide-spread lack of trust in public finances weighs heavily on growth.
There is uncertainty regarding potential future tax increases, while funding costs rise for private and public creditors alike.
It is said that to contain a financial crisis, central banks have to act more flexibly and accept more risks on their balance sheets. This is particularly pertinent in a monetary union where member states retain their autonomy in fiscal and economic policy. In such a setting, governments have an incentive to accumulate debt; this is known as a deficit bias.
This is not the answer. Risk without control is what almost caused a full on collapse of the banking industry.
To import this into fiscal and monetary policy is staring the reaper in the face.
If central banks went down this route, they would be redistributing fiscal risks and costs among the taxpayers of the whole euro area not isolated to one or two states.
However, this is the prerogative of national parliaments.
If central banks’ balance sheets are used to bring about redistribution and if the implied costs become apparent, this could have a highly corrosive effect on the credibility of central banks and on their independence.
Credibility and independence are indispensable to maintain price stability and to ensure the acceptance of monetary union as a whole. This would be too high a price to pay, and again would merely be buying time.
Is there an endgame?
Countries with current account deficits and excessive public debt must act.
They must implement structural reforms and they must consolidate their budgets to get back onto a stable growth path.
This is clearly the plan of the German Federal state.
We should know very soon exactly what involvement China has to play in this game of Euro Monopoly but whatever the involvement it will be too late for Greece and with Italy and Spain following closely China will need one almighty ‘money tree’ to bail this lot out.
The current system is clearly unsustainable, flawed in its monetary policy system, flawed in its inception as a union.
The austerity measures (consolidation) being forced upon the citizens of European nations will not be well received.
We have already seen, both in Spain, Greece and Germany itself, the tentative protests of disgruntled citizens on both sides of the ever widening divide.
It is highly unlikely that Market influences will bring about a return to a productive Europe.
Confidence is at an all time low and the jittery fluctuations continue the roller coaster ride of major markets.
So the EU is quite simply left with very few options whilst all the time the debt mountain compounds.
I believe it’s time to call in the receivers!