Will the Eurozone or the EU break up under the strain of the financial crisis?

 

Family harmony is easy when times are good.   Breakdown threatens when money is short.  Jean Monnet knew this when he put economics ahead of politics in founding the EU. Fifty years of prosperity and peace have followed.  Now that the economy has turned sour will the rudimentary political framework of the Union hold?  Could the Eurozone break up?  Could one country walk out of the EU? Could there be a divorce?

 

In any extended family attitudes differ.  But even the best run do not prepare well for if dad loses his job.  When German export orders were cancelled it was a shock to the system.  Confidence  plummeted.  Other families are used to scraping by, borrowing too much and putting off difficult decisions.  Italy and Greece come to mind.  When the different parts of the extended family survey the scene, do they resolve to help each other?  The immediate answer is No: they look first to saving themselves.  Sauve qui peut!  Chacun pour soi! Protectionism is the first reaction.

 

As Joschka Fischer, former German foreign minister, recently said “The global economic crisis is relentlessly laying bare the EU’s flaws and limitations.  Without common economic and financial policies, coordinated at a minimum among eurozone member states, the cohesion of European monetary union and the EU – indeed, their very existence – will be in unprecedented danger.”  The basic problem of course is that in these uncharted waters the direction to go is uncertain.  In the European context another problem is that authority is fragmented: leadership is divided.  Is it the Commission who should be giving the lead?  Is it the rotating presidency?  Is it the ECB?  In guarding against a Caesar, a Napoleon, or a Hitler we have a unique version of democracy.  It is being tested as never before.

 

As a pro-European I see green shoots of what needs to happen if the eurozone at least is to be preserved.  The ECB for example is having a good war.  It has not panicked like the Bank of England and the Federal Reserve in lowering interest rates virtually to zero.  The ECB has dropped them enough to encourage borrowing but not as far as to discourage lending and saving.  Eurosceptics like to believe that Ireland and Spain are frustrated with the ‘one size fits all’ interest rates of the Eurozone, but they themselves emphasise other causes of their difficulties and say there would be different difficulties if they were outside the zone.  While the German government has been criticised in the UK for not allocating Anglo-Saxon levels of bail-out money, their argument that they want to see how the first tranche works before committing more seems perfectly reasonable.  The German finance minister, Peer Steinbruck, has signalled that if any Eurozone country was in real difficulties then help would be forthcoming, despite the “no bail-out clause” in Article 103 of the EU’s governing treaty.  As a senior German diplomat said, it is the difference between theory and practice.    Another pragmatic move in the Eurozone has been to quietly forget the strictures of the Growth and Stability Pact while governments increase borrowing to deal with their problems.  

 

While the Eurozone countries have not had the time, nor perhaps seen the need, to coordinate economic and financial policies in a formal manner hitherto, they have been meeting and discussing issues now for many years.  The language of economic stability is familiar; they have swapped experiences; relationships have been built up. Though the current strains are new, I think one can be optimistic that the framework for dealing with the situation is in place.

 

If for no other reason, the eurozone will hold together because no country can afford a divorce.  It is just as it is with most families under strain at the domestic level.  In the case of the Eurozone, any defection would seriously damage the credibility of the currency.  No one will let it happen.  The euro has been a great success, recognised around the world for its strength, second only to the dollar as a reserve currency.  It gives the full benefits of the common market to those inside the zone.

 

What of those outside the eurozone?  Those in the EU, some of whom may leave, and those on the periphery, some of whom may join.  They have no compass in these uncharted seas.  ‘All at sea’ is indeed an apt analogy.  Take the UK for example.  

 

It is ironic that the only industry whose welfare was considered in Gordon Brown’s five conditions for joining the euro was financial services.  Now that we ourselves have well and truly damaged the reputation of the City and cannot blame the euro, we are resolutely flailing about for an answer to our problems.  The flexibility of interest rates policy outside the eurozone did not help us avoid the housing bubble on the upside, nor is it boosting the economy on the downside.  Will we eat a bit of humble pie and get closer to Europe?  On the one hand we have David Cameron effectively ending democratic engagement for his party in Europe by leaving the EPP, but on the other hand we have Lord Turner, chairman of the FSA, reversing all previous policies and calling for a Europe-wide regulatory framework for financial markets.  At the very heart of the City and the British economy perhaps we are seeing a reality check.  Are we at last seeing that splendid isolation is a route to irrelevance?

 

As in the UK, so elsewhere in Europe, forecasting events at this time is a real gamble.  Enlarging the Eurozone must be off the agenda as economies in Central Europe implode.  Enlarging the EU itself will be resisted as unemployment goes up.  The strains of shadowing the euro in Denmark and Lithuania etc are becoming unbearable.  On the other hand, not shadowing the euro, in countries like Hungary, is equally traumatic.  Western states are finding it difficult to find the money to help the countries who joined in 2004, but there is hope the IMF and the EIB can fill the breach.   

If the EU is to survive and thrive adopting the Lisbon Treaty to ease coordination is the minimum move that is needed.  We will have to go further: even the common market is not truly complete yet.  There is a lot of unfinished business.   We must not waste the crisis that is upon us.

 

 

What can Europe do when the financial crisis is global.

 

If it was not obvious before, it surely is now – that finance is global.  Money can move around the world at the press of a button.  National governments have little or no control as the current crisis has hit every part of the world.  If it was not obvious before, it surely is now – that if there is any hope of avoiding future cataclysms it is necessary to have an international effort to find out what is going on and international agreements seeking to control systemic excess.

 

However, the meltdown has occurred so quickly that there has been no time to have international agreements and each country has had to scramble to try to control its own situation.  How often is a crisis forecast and avoiding action taken: we learn from our mistakes.

 

While the limitations of national supervision of the financial markets are well recognised, the chances of international agreement must be slim.  Certainly in the short-term.  The EU has been trying to achieve a true common market in financial products for fifty years and we are not there yet.  There has been no progress at all in instituting common supervisory standards and so financial companies are encouraged to migrate to the laxest regime while still retaining their right to free movement of capital within the Union.   The global nature of the current crisis suggests that supervision standards need to be international but if the EU could in fact agree a regulatory framework there is a good chance it would be accepted as a blueprint for wider application.

 

Jacques de Larosiere, a former managing director of the IMF, has come up with a plan which may prove a breakthrough.  With EU leaders agreeing at their recent Berlin meeting [21.2.09] that something needs to be done, this plan is timely. It sensibly suggests a start can be made by simply bringing together regulators from around the Union to coordinate standards.  There is no suggestion of a single regulatory body: that would be rejected by the UK for a start.  Indeed, while the money for bailing out banks is only available from national coffers, individual states have an incentive to keep a close watch on their own bailiwick.

 

As the global crisis has unfolded however it has surely become questionable how far we can expect to avoid future problems through better regulation.  We can have a certain amount of faith that new regulation might at least produce more information as to what is going on in financial markets.  The unexpected nature of the current crisis has been put down to sheer ignorance amongst even financial journalists as to the scale and nature of some of the financial instruments peddled around the world. Yet there will be resistance to any effort to get participants in the market to divulge what they will see as commercially confidential data.

 

More fundamentally there is little chance of agreement on where to draw red lines in our capitalist system.   The UK faith in “light touch” regulation has arguably led to the massive losses in the banks, as freedom to take risks became licence, and Lord Turner, the new head of the FSA, has promised a “revolution” in regulation hoping to stop excess.  But at then end of the day is anybody in the UK or across Europe in a position to stop businesses taking risks which turn out to be unfortunate.

 

Will the Eurozone survive the recession better than the UK?   [24.2.09]

 

It was easy to see why the financial problems started in 2007 in the UK and the USA.  Financial services had come to dominate the UK economy, hand in hand with Wall Street. They were riding for a fall, based on an inordinate amount of credit, coupled with a blind faith that it would always be available.  Banks started to borrow 20 or 30 times their reserves in order to expand their loan books.   Building Societies demutualised in order to join in the fun.  The money generated fed the frenzy.  Hedge funds and private equity companies were formed to channel money into the stock exchange and mergers and acquisitions.    The longer the band played the wilder the dancing became.  People confidently invested with the likes of Madoff and Allen Stanford.  Families borrowed more than they could afford on the principle that house prices would go on rising.  Companies lent more than a house was worth on the same principle.  

 

Surely none of this happened in the Eurozone!  Anathema to America, wariness towards perfidious Albion, resistance to hedge fund “locusts” surely saved the Eurozone from the logic of anglo-saxon capitalism.  Apparently not.  The caution generated from past financial melt-down, the tradition of renting rather than buying a home, the closeness of the banks to local business – all this surely would save the eurozone countries from contagion.  Apparently not.  The recession seems to have arrived across the continent and indeed across the globe as it has in the UK and the USA.  There was supposed to be decoupling, but apparently not.  Why?   [to be continued]

 

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A report in the FT says that productivity in Europe dropped last year in comparison to the US.  The reason given is that American companies were more ruthless in sacking people in the recession than European companies.   That says a lot about the two power blocks.

 

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EDF finally lands British Energy for £12.4 bn and the UK is now dependent on the French state-owned utility for its future in nuclear energy.   Another sell-out of British industry to a foreign firm.  Yet it is the right thing to do: the French have the expertise.  Why the British have not got the expertise and cannot compete is another matter - and annoying. [25.9.08]

 

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The Eurozone is now in recession according to a survey of purchasing managers.  There are various measurements claiming to measure economic activity; technically, a recession is when there is a decline for two consecutive quarters.  It is not surprising that eurozone industry is affected like our own by rising commodity prices and a slowdown in export opportunities.  So far they have avoided the financial crisis that the US and UK are suffering.  In two years time who would you bet on for a healthy economy - the UK or the eurozone? [24.9.08]

 

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Viviane Reding, the EU telecoms commissioner, [a lady from Luxembourg], is ruffling feathers again.  Excellent!  Her determined pursuit of operators to get a Common Market  for mobile phone users is not making her popular with them.  So far she has achieved reductions in charges for cross-border phone calls [capped at €0.46 per minute].  Now she is tackling the cross-border email,  surfing and text message charges [proposing a cap of €0.11 for the average text message from next July as against the current charge of €0.29].  Even if the operators recoup the costs of reducing these prices in their charges elsewhere, the principle of reducing barriers to trade across the Common Market is being upheld.  The fact that the general public will notice these initiatives as they go on holiday is a definite plus for EU PR.  [24.9.08]

 

The dollar has been steadily declining in value against the euro for some time though there are fluctuations along the way.