The futile attempt to save the euro

FT.com

To some who went through the unsuccessful struggle from 1961 to 1967 to stave off sterling devaluation, the series of crises surrounding the euro will be drearily familiar. First there is a surprise loss of confidence. Then there is a series of rescue operations, usually taking the form of international guarantees of one kind or another. These are backed up by domestic restrictive measures leading to a domestic recession of sorts. In time the financial pressures ease and near-normality is seen to return. But then, when few are looking, there is another crisis, another set of international rescues and another set of domestic restrictions. And so on. Eventually the struggle is abandoned, and political and financial leaders work to pick up the pieces.

As the countries in the eurozone have abandoned their own national currencies, the pressures have been felt in widening interest differentials between German government securities and those of peripheral member countries. The series of rescue operations has already begun and the euro is said to have been "saved”. We can guess the rest of the story. The disintegration is likely to be a messy process and it will take time to clarify whether there will be a reversion to national currencies or whether two or three successor zones will emerge. Indeed, the insistence of the German government on impossibly severe fiscal policies makes one wonder if it really wants the euro to continue in its present form. Wolfgang Schuble, the German finance minister, has said: "Should a eurozone member ultimately find itself unable to consolidate its budgets or restore its competitiveness, this country should as a last resort exit the monetary union while being able to remain a member of the EU.” It is not a very profound insight that if one country were to exit, the financial spotlight would turn on the most vulnerable of the remaining members.

The fundamental instability of the present eurozone has been exhaustively analysed by the economist Christopher Smallwood in a Capital Economics paper (Why the euro needs to break up). Mr Smallwood, who was for several years policy director of the pro-EU British Social Democratic party, is unlikely to have an anti-European bias. He has no difficulty in showing how unrealistic are the spending cuts and tax increases to which the Mediterranean governments have pledged themselves in return for support from their euro partners and the International Monetary Fund. Immediate fiscal tightening in Greece amounts to 7 per cent of the country's gross domestic product and makes George Osborne, Britain's chancellor of the exchequer, look like a cooing dove. Attempted tightening on this scale would dampen the economy and risk creating a vicious cycle of debt and deflation.

But even if fiscal and debt obligations could be negotiated away, we are far from out of the woods. Mr Smallwood reproduces some telling charts showing how unit labour costs have risen in the decade of the euro's existence by about 30 per cent relative to Germany. It could be that these indices give an excessive weight to manufacturing, but this is too slender a thread on which to base an optimistic outcome. I admit to having thought it possible that the euro itself might have prevented these historical differentials from reasserting themselves. But they are back. Even the Greek colonels, Franco, Mussolini or Salazar would have been hard put to reduce nominal wages on the scale required.

Euro-federalists will fight tooth and nail to prevent a disintegration of the eurozone. They are powerfully reinforced by banks with investments in the peripheral countries. But if something is unsustainable it will not be sustained. Currencies have left monetary unions in the past, a recent example being Ireland's departure from the UK monetary union in 1979. Mr Smallwood discusses an interim period of high interest rates to encourage Greek deposits to stay put, reinforced by lender-of-last-resort drachma credits from the Greek central bank.

During the period when sterling devaluation was known as "the great unmentionable” a tiny band of Treasury officials kept "a war book” on how to deal with the unmentionable if it nevertheless happened. Harold Wilson, the prime minister, ordered that the "war book” be physically burned, which it was of course not. It is difficult to believe that such a manual does not exist in Athens, Frankfurt and perhaps other European centres.

Many German citizens would love to have the D-Mark back. Southern Europeans no doubt share the human desire to have their cake and eat it; but in the end they will surely welcome the chance to regain control of their own destinies rather than face an indefinite period of stagnation and falling living standards. I cannot speak for France. But surely one day even its leaders will realise that none of the ingenious currency plans they have been producing for the last few decades will give them the whip hand over Germany they so desire.

Copyright The Financial Times Limited 2010. Republished with permission.