THE LATE summer and early autumn months are often turbulent times in currency markets. And while the deficit difficulties of the US occupied the headlines for a while in July and August, the real issue is Europe as worries continue about debts in individual countries and the future of the currency union itself.
This issue has been threatening to appear since the formation of the eurozone in 1999 but has now emerged with added intensity. The problem is easier to define than solve, and the efforts of the policymakers to date have offered short-term expedients rather than a long-term solution. There are no easy answers. Whatever course emerges, it will involve disruption to growth and trade, to which the UK, even as a non-member, will not be immune.
In a nutshell, the crisis has arisen because the fears that monetary union could not work without fiscal union have been justified. The problem with fiscal union is that it diminishes the sovereignty of individual member states. For countries to be told what taxes to raise, how much teachers should be paid, and at what age people can retire would have been a bridge too far. From fiscal union, it is only a short step to one European Finance Ministry, one European Inland Revenue and so on. In the 1990s, however, the single currency was referred to as EMU, which stood for Economic and Monetary Union and not, as many thought, European Monetary Union. Economic union may now indeed be necessary to save the single currency.
Conditions for joining the eurozone (the Maastricht Treaty) did contain provisions for fiscal responsibility, but these were loose and lacked effective sanctions. So when countries with rather flexible attitudes to public sector spending joined, with interest rates much lower than they were used to, the temptations were enormous. When the global economic slowdown from 2008 and the fragility of the banking system are factored in, this results in a dangerous currency cocktail. The debts incurred by several countries have become unaffordable and, short of defaulting, taking on even more debt is the only short-term palliative. But who will lend the money and at what rate, and what guarantees exist that the country won’t be back later for more?
As the economist John Maynard Keynes used to say, “If I owe the bank £100, I have a problem. If I owe the bank £1m, the bank has a problem.” And although Greece has the debt, the real problem is the risk of default to those who lent the money, French and German banks in particular. These risks multiplied as the number and size of the countries drawn into the crisis increased. The euro authorities gave the Greeks money to protect their banks but did not ease the debt burden. While discussions about Eurobonds and the facilities available through the European Finance Stability Facility will be high on policy agendas in coming weeks, moves towards fuller integration or a restructuring of eurozone membership are the only sustainable options.
For the UK, the risks of stagnation in our major export market (55% of the total) are all too obvious. As domestic spending wilts, the most likely alternative to recovery is blocked off. Although British banks are not heavily exposed, there will be some losses if a default should occur, and probably collateral damage through inter-bank lending. And, as a member of the EU and the IMF, the UK will have to bear some of the cost of any rescue package.
This is not a crisis of capitalism, but of elected politicians who refused to spell out the implications of monetary union. Now, the issue cannot be avoided. Staying out looks to have been a smart move for the UK, but we can’t afford to indulge in Schadenfreude. ?
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