Hamish McRae: How Europe can shore up its rescue of the single currency

Economic Life: In the early days being in the euro enabled countries to borrow more cheaply... now the reverse has happened, even for the AAA-rated

The long agony continues. The outcome of Europe's sovereign debt crisis is no nearer, nor indeed any clearer. But the scale of the problem is, if anything, growing and the damage caused by the weak official response is looming larger, even for non-euro countries such as the UK.

The element that has become clearer this week is that eurozone membership now carries an interest-rate burden for all members bar Germany. There was a bit of a kerfuffle yesterday as Spanish 10-year debt rose towards the 7 per cent crisis level but you can see this most clearly in the case of France. France managed to get away some five-year debt at 2.8 per cent yesterday, which does not sound too bad, but that is half a percentage point higher than it had to pay a month ago. More tellingly, the yield on French 10-year debt is now nearing 4 per cent – more than 2 per cent points higher than the equivalent German debt. (You can see this divergence in the top graph.)

Britain, by contrast, would have to pay around 2.2 per cent on 10-year debt. Yet the overall fiscal positions of Britain and France are broadly comparable. Both have AAA ratings and while France has higher debt levels, Britain has a larger deficit. So you could say that the penalty France is paying for being in the eurozone is about 1.5 per cent, maybe a bit more. What has happened is that in the early days of the euro, being a member enabled countries to borrow more cheaply than they otherwise would. But now the reverse has happened. Being a member carries a cost, and a cost even for countries with a AAA credit rating.

This loss of confidence in any bonds issued by eurozone countries, bar Germany, has weakened the ability of the region to help the weaker countries. I had not quite realised how bad things were until I started looking at the finances of the European Financial Stability Facility. (I am grateful to Louise Cooper at BGC Partners for these alternative interpretations of its initials: Europe's Flawed Survival Fund; Euro's Fund Smells of Failure; Expected to Fail, Sure to Fail; and Every Fumble Speeds Failure.)

Technically the EFSF has a AAA rating, thanks to the similar ratings of its two largest contributors, Germany and France (see second graph), and the idea is to gear up its core funds by making bond issues on the markets. So far it has raised €18bn this way. But in recent weeks it has really been struggling to raise the money as the price of its bonds has been falling since September. It had to postpone an issue and there are even rumours that it had to buy its own debt to shore things up, which rather defeats the object of the exercise. The notion that the EFSF can borrow hundreds of billions seems for the birds.

If the EFSF cannot borrow significant amounts of additional money it can only be a marginal player. So how else can Europe shore up its rescue operation? There are really only two broad options. One is that in some way or other Germany uses its borrowing strength to help the rest of Europe. The other option is to print the money.

The realisation that only Germany is strong enough to tackle – let's not say solve – Europe's sovereign debt crisis has led to the sharp change in German policy evident over the past 10 days. As Angela Merkel has sketched, to save the euro Europe has to move to a fiscal and political union. This is not the place to comment on the various political difficulties in the path of such a venture; they are obvious. But from a narrower mathematical perspective, it is worth noting that the scale of European sovereign debt is such that there is a danger that even Germany is not strong enough to provide enough of a back-stop.

No one can prove it but it seems to me that German debt is trusted for two reasons. One is because there is such resistance in Germany towards guaranteeing other countries' debt that anyone buying German bonds feels that the full ability of the German economy is behind them. The other is that if the eurozone breaks up you know you will get either a strong euro run by Germany, without the weaker members, or even a return to the Deutschemark. In other words, German euros are better than Spanish, Italian or even French euros.

In any case, this will all take time. Even if there were to be agreement on the path to fiscal union, it would take years to implement. So what happens in the meantime? You move to the option to print the money. I have been looking at a paper by Hans-Werner Sinn, president of the Ifo Institute in Munich, The Threat to Use the Printing Press. His is the clearest analysis I have yet seen of the power struggle going on over the role of the ECB in supporting the eurozone sovereign debt market and it starts with this: "Fortunately, Nicolas Sarkozy is not getting his banking licence for the EFSF. The Luxembourg rescue fund is not to buy government bonds of endangered countries with freshly printed money. The ECB, however, may continue to do this."

Professor Sinn notes that two German members of the ECB council have resigned in opposition to the ECB's purchase of bonds of European countries to shore up their price in the market, and that German MPs are also hostile to this policy.

But: "The Bundestag may indeed threaten to block the use of the EFSF rescue funds with further decisions in future should the ECB continue its bond-purchase programme, but ultimately the ECB is in a stronger position. It is the master of public finance in the euro area, and it can always start up its own rescue machinery if it deems the rescue efforts of the international community insufficient. It determines who is rescued and when and where, not the Bundestag or any other authority in Europe."

He notes that the ECB has been supporting Europe's periphery for four years by printing the money to support their banking systems and to finance much of their current account deficits. Since September it has actually been withdrawing funds from the German banking system, while continuing to flood money towards the periphery. He concludes: "The European parliaments have no control over this game. The European Central Bank Council is the true economic government of the euro area. As long as it retains its power, it can threaten the parliaments of the eurozone with the printing press and enforce comprehensive rescue measures, up to and including a transfer union."

The markets, of course, know all this. The danger is that the ECB ends up with more and more dodgy sovereign debt on its books and the eurozone faces an even greater catastrophe as and when these countries default.

Meanwhile, you can see why the premium demanded by buyers to hold all euro-denominated debt, bar Germany's, is climbing by the day. I know we are damaged by the cross-fire but the UK owes a huge debt to John Major for keeping us out of the euro in the first place and Gordon Brown for resisting Tony Blair's efforts to get us in later. Phew!

Suggested Topics
News
University Edible Garden, Leeds – a sustainable garden in the centre of the university, passers-by can help themselves to the home-grown produce
newsFrom a former custard factory to a Midlands bog and a Leeds cemetery
Arts and Entertainment
Rock band Led Zeppelin in the early 1970s
musicLed Zeppelin to release alternative Stairway To Heaven after 43 years
News
Sabina Altynbekova has said she wants to be famous for playing volleyball, not her looks
people
News
i100
PROMOTED VIDEO
News
i100
Life and Style
fashionHealth concerns and 'pornified' perceptions have made women more conscious at the beach
Arts and Entertainment
tv
News
media
Sport
Ojo Onaolapo celebrates winning the bronze medal
commonwealth games
Arts and Entertainment
High-flyer: Chris Pratt in 'Guardians of the Galaxy'
filmHe was homeless in Hawaii when he got his big break. Now the comic actor Chris Pratt is Hollywood's new favourite action star
Sport
Van Gaal said that his challenge in taking over Bobby Robson's Barcelona team in 1993 has been easier than the task of resurrecting the current United side
footballA colourful discussion on tactics, the merits of the English footballer and rebuilding Manchester United
Life and Style
Sainsbury's could roll the lorries out across its whole fleet if they are successful
tech
News
ebookA unique anthology of reporting and analysis of a crucial period of history
Travel
The shipping news: a typical Snoozebox construction
travelSpending the night in a shipping container doesn't sound appealing, but mobile crash pads are popping up at the summer's biggest events
Arts and Entertainment
'Old Fashioned' will be a different kind of love story to '50 Shades'
film
Arts and Entertainment
Tracey Emin's 'My Bed' is returning to the Tate more than 15 years after it first caused shockwaves at the gallery
artTracey Emin's bed returns to the Tate after record sale
Arts and Entertainment
Smart mover: Peter Bazalgette
filmHow live cinema screenings can boost arts audiences
Environment
Neil Young performing at Hyde Park, London, earlier this month
environment
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Project Manager (HR)- Bristol - Upto £400 p/day

£350 - £400 per annum + competitive: Orgtel: Project Manager (specializing in ...

Graduate / Trainee Recruitment Consultant - IT

£25000 per annum + OTE £40,000: SThree: Orgtel are seeking Graduate Trainee Re...

HR Business Partner - Banking Finance - Brentwood - £45K

£45000 per annum + Benefits: Ashdown Group: ** HR Business Partner - Senior H...

PA / Team Secretary - Wimbledon

£28000 - £32000 per annum + Benefits: Ashdown Group: PA / Team Secretary - Mat...

Day In a Page

Save the tiger: The animals bred for bones on China’s tiger farms

The animals bred for bones on China’s tiger farms

The big cats kept in captivity to perform for paying audiences and then, when dead, their bodies used to fortify wine
A former custard factory, a Midlands bog and a Leeds cemetery all included in top 50 hidden spots in the UK

A former custard factory, a Midlands bog and a Leeds cemetery

Introducing the top 50 hidden spots in Britain
Ebola epidemic: Plagued by fear

Ebola epidemic: Plagued by fear

How a disease that has claimed fewer than 2,000 victims in its history has earned a place in the darkest corner of the public's imagination
Chris Pratt: From 'Parks and Recreation' to 'Guardians of the Galaxy'

From 'Parks and Recreation' to 'Guardians of the Galaxy'

He was homeless in Hawaii when he got his big break. Now the comic actor Chris Pratt is Hollywood's new favourite action star
How live cinema screenings can boost arts audiences

How live cinema screenings can boost arts audiences

Broadcasting plays and exhibitions to cinemas is a sure-fire box office smash
Shipping container hotels: Pop-up hotels filling a niche

Pop-up hotels filling a niche

Spending the night in a shipping container doesn't sound appealing, but these mobile crash pads are popping up at the summer's biggest events
Native American headdresses are not fashion accessories

Feather dust-up

A Canadian festival has banned Native American headwear. Haven't we been here before?
Boris Johnson's war on diesel

Boris Johnson's war on diesel

11m cars here run on diesel. It's seen as a greener alternative to unleaded petrol. So why is London's mayor on a crusade against the black pump?
5 best waterproof cameras

Splash and flash: 5 best waterproof cameras

Don't let water stop you taking snaps with one of these machines that will take you from the sand to meters deep
Louis van Gaal interview: Manchester United manager discusses tactics and rebuilding after the David Moyes era

Louis van Gaal interview

Manchester United manager discusses tactics and rebuilding after the David Moyes era
Will Gore: The goodwill shown by fans towards Alastair Cook will evaporate rapidly if India win the series

Will Gore: Outside Edge

The goodwill shown by fans towards Alastair Cook will evaporate rapidly if India win the series
The children were playing in the street with toy guns. The air strikes were tragically real

The air strikes were tragically real

The children were playing in the street with toy guns
Boozy, ignorant, intolerant, but very polite – The British, as others see us

Britain as others see us

Boozy, ignorant, intolerant, but very polite
How did our legends really begin?

How did our legends really begin?

Applying the theory of evolution to the world's many mythologies
Watch out: Lambrusco is back on the menu

Lambrusco is back on the menu

Naff Seventies corner-shop staple is this year's Aperol Spritz