Stephen King: Simply making debtors suffer is not a solution to the eurozone crisis
Economic Outlook: The eurozone is fast becoming enclosed in a straitjacket that was manufactured in Germany
Monday 12 December 2011
Mrs Merkel likes a bit of discipline. I'm not sure Mr Sarkozy shares her enthusiasm. The eurozone, however, is rapidly being enclosed in a Teutonic straitjacket – with perhaps a soupçon of French collaboration – designed to prevent countries from indulging in fiscal self-abuse. Whereas schoolmasters of old warned only of impending blindness, budgetary self-abuse in the eurozone will be met in the future by the imposition of automatic fines. Those who borrow too much will be given a sharp fiscal thwack.
There is, however, a limit to the amount of masochism a sane nation state can put up with. Under the proposed new rules, eurozone countries should strive to deliver fiscal positions close to balance, be subject to automatic punishments should their deficits exceed 3 per cent of GDP and, moreover, hit the so-called "golden rule" whereby they borrow only for investment purposes (in the UK's case, the golden rule introduced by Gordon Brown ultimately proved utterly useless). It sounds all so terribly mediaeval; it also sounds implausible.
People in the UK are already complaining about austerity but George Osborne, the Chancellor of the Exchequer, aims to reduce the budget deficit to 3 per cent of GDP only by the middle of this decade (and to hit the golden rule on a cyclically-adjusted basis by 2017-18). His case is helped by remarkably low bond yields and the Bank of England's willingness to print money (which involves buying second-hand gilts, helping to explain low yields).
Elsewhere in Europe, however, there is no such support. Spain enjoys arguably a better fiscal position than the UK yet its 10-year bonds yield 5.8 per cent, hugely increasing the costs of servicing Spanish debt. The European Central Bank (ECB), meanwhile, is steadfastly refusing to turn on its printing press in any kind of meaningful way, leaving debtor nations at the mercy of nervous investors. Compared to the problems faced by the eurozone's southern states, the UK's fiscal challenge is no more than a walk in the park.
The Franco-German plan is designed to make sure the eurozone will never again succumb to an economic and financial meltdown. The intention is honourable, but it's difficult to see how the plan can really work. The starting point is hopeless, raising doubts about whether the plan will ever be effective. And it is designed only to look after Europe's creditors. It offers little to help solve current systemic difficulties.
The debtors have been cast to one side in a fit of moral superiority from those who, understandably, want their money back. Those with large deficits – or persistently-rising ratios of debt to GDP – will have to deliver ongoing austerity for years. Their people will suffer collective punishment, even though many are innocent victims of the stupidity of their fellow-citizens, or of the blind greed of creditors from elsewhere in Europe who lent them so much money in the first place. Greece and Italy have technocratic leaders. Democracy, it seems, is under threat.
And markets are all-too-aware of the possibility of debtors simply being unable to pay. In coming months, eurozone governments will have to issue new government paper as existing bonds mature. Some of these bond auctions might fail, beckoning in a world of default and greater instability.
The problem lies with the creditors' adoption of the moral high ground. For every creditor, there must be a debtor. For every country with a balance of payments current account surplus (Germany, for example), there must be another with a current account deficit (Italy or Spain, for example). The idea that the creditors are "worthy" while others are "irresponsible" doesn't stack up. Creditors and debtors are two sides of the same coin and coins, in general, have no moral status.
Both sides have been caught out by a serious shortfall of income associated with the original financial crisis. Levels of economic activity across the West are much lower than either party assumed a few years ago. As a result, the ability of debtors to repay their creditors has been reduced.
Prior to the onset of the financial crisis, most eurozone countries appeared to have relatively healthy fiscal positions. They had no difficulty in looking after creditors. But this rectitude could not prevent them from being in a total mess today. Mrs Merkel's fiscal whip, if used, would lash countries already on their economic knees.
The political battle between the interests of creditors and debtors is a consequence of the economic paralysis engulfing the western world since "sub-prime" entered popular discourse.
The eurozone plan is no more than an attempt to create a new legal and political framework to look after the interests of creditors and to make debtors suffer. By doing so, it threatens to introduce Keynes's paradox of thrift on the grandest of scales. If the southern European nations end up like Germany, saving not spending, who in Europe will do the spending? It's not possible to have a one-sided coin. But it is possible to have economic collapse.
For those interested in the history of these political battles, a new book published at the beginning of the month is particularly illuminating. Philip Coggan's Paper Promises: Money Debt and the New World Order (Allen Lane) is a masterful history of financial crises, always with one eye on the situation unfolding today. The 19th Century Gold Standard debates, the reluctance to create an independent Federal Reserve, the battle between fixed and floating exchange rates in the 1970s and today's Sino-US exchange rate dispute are all linked to the differing interests of creditors versus debtors.
As Coggan notes, many of these crises were resolved in the interests of the debtor. We can see the same process at work today. When the US and the UK indulge in quantitative easing, the supply of dollars and sterling goes up. That threatens either higher domestic inflation or a weaker currency. A weaker currency, in turn, shifts the burden from domestic debtors to foreign creditors who discover that, considered in their local currencies, the value of their US and UK assets has gone down. Printing money is a stealthy way of default.
Within the eurozone, however, the opportunity for stealthy default has been removed. As a consequence, the risk of actual default has gone up. Yet demanding continuous austerity from the periphery to force them to "mend their ways" will only make matters worse particularly, as now seems highly probable, the eurozone as a whole plunges into recession.
Systemic abuse, it turns out, is far more harmful than any self-abuse.
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