Yet again, the EU is about to hold a summit to deal with the crisis in the eurozone. Yet again, it is likely to fall far short of a convincing solution. A heavy weight rests on the shoulders of weary and disillusioned leaders. The question is whether there is hope for success.
What is needed, as I have argued before, is a solution that is both politically feasible and economically workable. The former means an ability not only to achieve agreement among governments responsible to national electorates, but also to obtain at least toleration of that agreement among those voters, something that greatly worries Angela Merkel, the eurozone’s most significant politician. Economic workability means offering electorates enough hope for the future to persuade them to elect leaders prepared to stick with membership of the eurozone.
Against those criteria, let us consider three possible solutions: federal Europe; the status quo; and limited reforms.
The broad thrust of proposals for a banking and fiscal union, via eurozone bonds, along with greater fiscal discipline, is to solve the difficulties of today’s fragile eurozone. It is obvious that such measures attract supporters of the European ideal and those who want others to pay for the consequences of past mistakes. It is obvious, equally, that such proposals anger and frighten those who think they will then have to subsidise the improvidence of others.
If one wanted to sell such proposals, one would need to argue that the whole would be stronger than the sum of the parts. One would need to state that it is not a matter of forcing Germany or the Netherlands to bail out their profligate partners. It is, instead, a matter of making everybody stronger by banding together. After all, it can be argued, the eurozone as a whole is in better fiscal shape than the US (see charts). Together, all might benefit from the low interest rates the US enjoys. Similarly, if insurance is offered to banks collectively, rather than from weak governments that are no longer fully sovereign, the eurozone banking system would be stronger because counterparties in the weaker countries would become more robust. Finally, it can be argued, the worst of the current fiscal crises would then fade, giving embattled members the freedom to manage their immediate crises.
Even if one accepted the logic set out above, I no longer believe this could work, for three reasons. First, politics are national and, as the crisis unfolds, more so. Pretending this is not so could lead to a worse blow-up. Second, it is hard to argue that the costs would not fall on some more than on others. Yet much-needed solidarity is lacking. Finally, announced commitments might, for these reasons, fail to convince people the union is irrevocable. Thus, the envisaged leap into 'more Europe' is unlikely to be agreed and, if agreed, is likely ultimately to fail.
Now consider a continuation of the status quo, with no further reform. This would probably mean a series of crises: an early bailout of Spain; new problems with Greece; possibly, an inability to achieve a rollover of Italian public debt; and, at any point, faster flight from weak banks. Given adjustment needs in the eurozone, such crises may endure for years.
Would this misery at least be sustainable? On that one might dare to be optimistic. Leaving the euro would be very hard: it means an immense upheaval for uncertain economic and political gain. This should create much toleration of misery. But there are two (surely interrelated) threats to any such complacency. The first, already seen in Greece, is disintegration of the political system and the rise of extremism. The second is the possibility of a public sector default that brings with it a collapse in the banking system.
It is unlikely that significant European countries would remain committed to the euro in the midst of such a crisis, which would put them in monstrous depressions. The solution would have to include the willingness of partners to recapitalise banks, thereby allowing the European Central Bank to continue its role as lender of last resort. That would, it seems to me, be the minimum needed to sustain the current path. But, it should be stressed, this would be a journey of misery, not just in the affected countries but even in their partners, as they struggle on.
I regard the full federal option as too much and the current path as too little to meet my criteria. This leaves the question of whether it is possible to envisage something in between. That would seem to be in everybody’s interest, compared to a collapse of the euro. Here the crucial elements would seem to be: clear plans for resolution of banks largely at the expense of creditors, instead of relying on recapitalisation by fiscally stressed states – an approach that would automatically share more of the pain between creditors and debtors; a strong commitment to symmetrical economic adjustment across the eurozone, instead of today’s debtor-focused adjustment; recognition by the ECB of its obligation to sustain demand; and enough conditional financing to give governments committed to reform the ability to manage their economies without entering calamity. This could be described as 'status quo plus'. It would be far from a desirable path. But it might be enough to be politically acceptable and economically workable.
How do these three options line up against the positions of crucial states? Germany has a rhetorical commitment to federal solutions but, like Saint Augustine, 'not yet'. This approach could be seen as imposing an initiation ritual on its partners. Whether or not this works, more help is needed now. Willingness to accept losses for those who lent badly abroad would be a start; moral hazard starts at home.
So, too, would be more action on domestic policies that, as policymakers have admitted, make sense for Germany, such as higher wages, stronger demand and even higher inflation. But deficit countries should accept that a federal rescue is unavailable. They must look not to summits but to themselves for hopes of salvation.
Copyright The Financial Times Limited 2012.