Last Friday gave us a glimpse of the biggest danger facing the eurozone in the next decade: a period of sustained deflation. Eurozone core inflation – without energy prices and other volatile items – tumbled in October to an estimated annual rate of 0.8 per cent.
I would hope the European Central Bank would cut interest rates further this week. But I doubt even a marginally negative interest rate would avert a slide into deflation. Its deep cause lies in the way the eurozone responds to its debt crisis – through austerity and falling real wages in the periphery and a lack of adjustment in the north.
The existential danger to the euro is no longer a speculative attack, a bank run or the rise of extremist parties, but sheer exhaustion. Benoît Coeuré, a member of the ECB’s executive board, warned last week that the eurozone might suffer a Japanese-style lost decade. But at least Japan maintained near full employment. The eurozone faces a far worse prospect: a lost generation.
The political consequences of this scenario are the subject of an important book published in France by François Heisbourg, chairman of the International Institute for Strategic Studies and the Geneva Centre for Security. In La Fin du Rêve Européen, he says the situation has become so intractable that the only way to save the EU is to abandon the euro.
The author, who is as pro-European as they come, fears the eurozone crisis could destroy the EU – a project he regards as far more worthwhile than the dysfunctional monetary union. He says a UK exit from the EU could act as a potential trigger for its dismantlement. I do not share his conclusion but his analysis is spot-on. The EU, with its legal treaties and its step-by-step crisis-resolution tactics, is not compatible with a functioning monetary union in the long run.
The way the eurozone is trying to solve the crisis – without debt forgiveness, without transfers and without joint liability debt instruments, and on the basis of fiscal adjustment alone – has produced a deflationary debt crisis with no end in sight. A resolution would require a political union with strong, central decision-making powers. The EU institutions, however, have been created with a corporatist mindset – geared towards dealing with trade conflicts or competition issues but not with the big issues of macroeconomic policy.
The core of Professor Heisbourg’s argument is that we are stuck in a vicious circle. Electorates blame Europe for the crisis, and are unwilling to transfer more powers to the centre. Yet such a transfer would be necessary to solve the crisis.
This is all true but I disagree that a decision to abandon the euro would solve the problem. Even if a dissolution of the euro were well managed, which it may be, I think Professor Heisbourg underestimates the economic and financial chaos it would create – not just in Europe.
I am also sceptical about his enthusiasm for a euro-free EU. Without the single currency, the EU would be a pretty dull place, which it was not in 1998. The common foreign and security policy is going nowhere. Without a single currency, the EU would roll back the single market. And, with only so many countries left to accede, the enlargement process cannot go on indefinitely. Whatever may drive the UK to remain in the EU or to quit is probably not related to the euro.
I once proposed the opposite course of action – to recognise that the eurozone is now the true kernel of European integration – and to continue from there, changing the treaties with a view to turning the EU into an organisation fit to manage a complex monetary union. Such a political union would need to include a framework for the resolution of existing debt, joint liability instruments for future debt, a banking union firmly anchored at the central political level, and additional fiscal transfers as well.
I acknowledge Professor Heisbourg’s argument that this course of action would be unrealistic if electorates reject those treaty changes indefinitely. In that case, we would have to accept the eurozone was doomed. But it is less clear to me why electorates would choose this course of action indefinitely if the status quo locks the eurozone into permanent deflation and low growth.
Politics is about choices. Failure to choose is a choice, too. In that case, the crisis will continue, and we will enter Professor Heisbourg’s nightmare scenario of a European electorate turning against Europe. That would be the end of the EU and the euro.
Of the options pursued and under discussion, I believe two are unrealistic. One is the attempt to solve the crisis through communication policy – which is what we are doing now, with a banking union that excludes any form of joint liability, or with endless protestations that the crisis is over or that the eurozone is recovering. The second set of unrealistic options, I fear, would be to go back to 1998 and start again.
I would not give up on genuine political union just yet. But if we do, the set of options available to us becomes depressingly narrow.
Copyright The Financial Times Limited 2013.