The endgame for the eurozone is approaching.
Markets have grown intolerant of European leaders' half-measures and non-solutions. With time running out, the choice for those in control seems to have become black or white – full fiscal union or splitting up the eurozone. Both choices are dangerous, but the status quo is unsustainable, not just because of the heavy indebtedness of the southern Mediterranean countries but also because they have become wholly uncompetitive against Germany and the Netherlands.
As the former chief economist of the European Central Bank Otmar Issing recently observed, fiscal union without democratic support would do Europe more harm than good. Taxpayers in Europe's northern core resent underwriting what they see as their profligate southern neighbours, while voters in the periphery are equally resentful at the prospect of economic austerity imposed upon them by foreigners, without an end in sight.
Far from binding nations together, the EU's one-size-fits-all monetary policies are driving member states apart. Nationalism is on the rise in several countries. Thankfully, it is still relatively benign but its increasing strength is a symptom of the depth of popular disillusion. The sight of the EU flag's 12 peaceful stars distorted by Greek protesters into a golden swastika triggered horrible memories of a US presidential candidate pleading for a dollar devaluation during the Depression: "Would you crucify us on a cross of gold?"
Member states' leaders, fearful that the EU itself would fall apart if the euro were to splinter, favour fiscal union. Yet even if they come clean with their electorates and manage to sell to them the necessity of large, permanent cross-border fiscal transfers, will those subsidies ever put the weaker economies back on track? History says no. Two decades after reunification, no part of eastern Germany is as wealthy as the poorest part of western Germany, and a century of transfers from northern Italy to the Mezzogiorno has merely entrenched poverty and Mafioso rule. America's Deep South was impoverished for half a century before labour mobility enabled it to cope with a strong dollar. If subsidies within a single nation fail, what chance have they of success when applied to societies with different languages and profoundly different ways of life? That is why the tried and tested formula for recovery always includes devaluation.
For both political and economic reasons, therefore, the time has come to consider how to arrange a eurozone break-up with the minimum collateral economic damage.
One much-canvassed approach is to cut the problem off at its root by pushing Greece, and perhaps Ireland and Portugal, out of the single currency. The simplicity of this solution is deceptive. With no access to international financing, those countries' under-resourced central banks would be forced to print money to stop bank runs and finance government deficits in the face of capital flight and collapsing currencies. Economic and social chaos would set in. Nationalisations across the financial sector would swell already excessive sovereign debt. The knock-on effects of these moves would probably trigger a new flight to safety and a seizing-up of credit markets. The risk of contagion spreading to Italy, Spain and Belgium would intensify. Even France, whose banks are heavily exposed to weak countries' debt, could be dragged in, with incalculable consequences.
So is there a workable alternative to the dilemma of long-term depression in the EU's periphery, or uncontrolled currency disintegration? There is. Germany could leave the eurozone instead, taking Finland, the Netherlands and Austria with it to form a new triple-A German-mark zone. Exiting from the top in this manner would lead to far less panic, reducing the threat of bank runs and contagion. Many legal, structural and technical challenges would remain, but the reputation of the Bundesbank would buy time to erect the necessary structures and controls. Such a move would be a tough sell to powerful German exporters, which have thrived on the back of the undervalued euro and the credit-fuelled boom of the peripheral economies. However, they lived with a strong German mark for years and they should be persuadable that permanent handouts to the weak EU economies or their expulsion from the eurozone would be even worse. The split would bring apocalyptic forecasts of "the end of Europe" from the political elites, but there would at least be electoral consolation as nationalistic movements could no longer gain support in the polls on the back of opposition to bailouts.
What about France? It looks as if, at least initially, it should stay out of the German-mark zone – an explosive prospect. The current state of the French economy, with a large public debt and heavy contingent liabilities from its bloated public sector, pensions and social security, makes the country ill-suited to share a currency with Germany.
France also suffers from a loss of competitiveness, albeit on a notably lesser scale than the southern Mediterranean economies. However, a period of modest devaluation, structural reform and deficit cutting could see France ready to join the new German-mark zone within, say, five years – an important prospect if the plan is to gain traction in Paris. A similar proposal could be drawn up for Ireland, over a longer timescale and with the inclusion of an orderly debt restructuring. Its catastrophic banking sector aside, the Irish open economy has more in common with the northern EU states than with Greece or Portugal.
As for the remaining euro countries, they would gain an immediate lift from the devaluation of the slimmed-down eurozone. Freed from its anti-inflationary mindset, inherited from the Bundesbank, the ECB would likely ease its monetary stance, following a debt restructuring for Greece and Portugal aimed at restoring the public finances and promoting conditions for growth. In time, if their economies continued to diverge, some countries could consider a return to national or dual currencies, with the distant possibility of an ultimate return to a single currency held out as a spur to discipline.
Eurozone leaders have expended much political capital and economic credibility on misdirected policies over the past year and a half, including the triply illegal bailouts, in breach of the EU treaties, the German Basic Law and the statutes of the International Monetary Fund and the ECB.
The potentially self-fulfilling threats over Italian and Spanish national solvency and over the soundness of once-undoubted banks prove that the choice between break-up and radical fiscal centralisation can no longer be postponed. That choice is not ultimately technical or even economic, but political. It goes to the heart of the existential question – what sort of countries do the EU's member states wish to be?
On the one side is democracy, with its untidy edges and its acknowledgment of national self-interest driven by public discourse. Democracy points to the break-up of the eurozone. On the other side is Utopia, a post-modern Europe in which the national interest is subordinated to the interests of a federal entity run by an appointed elite – an oligarchy, if you will. In such an order the wishes of citizens are secondary to technocratic expertise, since the people cannot be trusted to vote "the right way". Oligarchy demands fiscal union.
Britain is not aloof from this choice. We have a powerful economic interest in the least bad financial outcome. We also have a deeper political interest in the democratic solution, which would go a long way to bringing Britain and the Continent into mutual sympathy. Britain has always wanted a Europe based on friendship and co-operation, not on forced and often unwelcome elimination of the diversity that has marked Europe's most enduring achievements. Rather than look on a eurozone break-up as a failure, it should be looked at as a harbinger of a new European settlement in which the wider interest is expressed by allowing citizens and parliaments to choose their own path, sometimes merging institutions, sometimes keeping them separate, as enlightened democracy dictates.
That would be a Europe which could welcome Turkey without having to open its borders to the free movement of 85 million new citizens; which could welcome Norway without demanding that its fish be designated a common European resource; which could welcome Switzerland without demanding an end to its banking secrecy. A Europe, in short, in which Britain could at last feel at ease.
The writer is chairman of Open Europe and former chairman of Business for Sterling. He is also director of strategy for Jardine Matheson