MERVYN KING said the UK is facing the worst financial crisis for 80 years when he announced that the Bank of England was adding another £75bn to quantitative easing after the October Monetary Policy Committee hearing. The IMF takes a similarly downbeat view of the dangers to the global economy and the US Treasury secretary added his voice to those warning of the risks. At the heart of all their concerns is the long-running debt crisis in Europe. Although the short-term focus is on Greece, there are several larger countries on the danger list and the collateral damage of a sovereign default extends far beyond the 17 members of the eurozone.
While the crisis is now financial with huge economic implications, the root of the problem is political. What the Greek situation highlights is the obvious point that a monetary union requires tight fiscal controls. This implies a Eurozone Finance Ministry, a central authority making tax and spend decisions for each of the member states. But the Maastricht Treaty which set up the euro contained only bland conditions with weak sanctions that were over-ridden, even by the bigger countries.
The price of fiscal union is a loss of sovereignty, a price which may have been too high for electorates. A system of fiscal transfers works in a country the size of the UK, where those in the prosperous South East accept that their tax revenues are redistributed to other parts of the country where unemployment is higher and growth slower. On a European-wide scale, however, the democratic deficit, and the lack of accountability, could have proved an electoral barrier to the euro’s acceptance.
And the political weakness at the heart of the currency union continues. When the first credit crunch occurred in 2008, the response of the affected countries was speedy and effective. Problems were identified, solutions agreed, and policies implemented. While this remarkable international co-ordination did not prevent the crisis, it certainly helped mitigate the impact. No such unity of purpose is evident among the key eurozone countries. Since the summer, the risks have intensified but the individual countries are still discussing the details of an agreement reached last July, which is totally inadequate to meet the scale of the problem.
There are two challenges for the authorities. The immediate issue is to end the uncertainty in Greece and stop the speculation spreading. Secondly, mechanisms have to be put in place to ensure there is no repetition, which means Germany and France must spell out a timetable for closer fiscal union. The size and structure of the eurozone will be high on the agenda. But it will only matter if they get beyond the current impasse, and time is running out.
It seems likely that any Greek default will be bigger than the 21% agreed in July. To ensure this is orderly and to reduce the risk of contagion, the lenders must be in agreement. They will need support if a large chunk of their lending has to be written off and banking collapse averted. A rescue fund in trillions of euros may be needed. The question of how this is funded reveals the limits of European unity.
A vacuum in policymaking will be exploited by markets and default(s) will be disorderly. As November’s G20 Summit approaches, the way forwards is far from clear. The message from European leaders is a commitment to maintaining the euro and its members, as if stating the ends explains the means.
When the euro was discussed in the 1990s, it was called EMU, which many thought meant European Monetary Union. It actually stood for Economic and Monetary Union and the issues avoided back then now have to be addressed – with interest. There is no pain-free solution and the greater the delay, the greater the pain. ?
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