It is time to accept that the eurozone crisis may end with an extreme outcome. On the one hand, it is possible that European leaders will get a grip on the region's sovereign debts and that in a couple of years' time the crisis will be "under control, if not overcome". Those words come from Jürgen Stark, the German board member of the European Central Bank and, in effect, its chief economist. On the other hand, it is possible that the eurozone will have broken up by Easter.
Common sense suggests the outcome will be somewhere in between, and that is my own view. I have long felt that the eurozone would get through its first major crisis but not its second: the break-up of the eurozone will occur, though not for some years. But if the recent past has taught us anything it is that outcomes that seem to be at the outer limits of the conceivable can and do occur.
The views of Jürgen Stark are interesting for a number of reasons. One is that they represent what might be called the "cool head" judgement on the future of the euro. He acknowledges the scale of the problems but believes these can be contained. But they have to be contained by austerity. The ECB should not, so to speak, print the money and let the weak countries off the hook.
Stark recently announced that he would resign from his ECB post – because, it is understood, he opposes its propping up of the sovereign debt market by buying excess amounts of the weak countries' bonds. Despite the opposition of Germans on its council, the ECB has bought €183bn of such bonds since May last year.
So how might these pressures be contained? In the short term, the ECB will have to prop up the bond markets. That has been happening in the case of Italy. However, in the past couple of days, the ECB seems to have scaled back its purchases of Italian debt – perhaps to put pressure on the Government – with the result that the interest rate shot up to more than 6.5 per cent. The interest rate on French debt has also risen sharply, leading to a further tightening of the French austerity programme.
But while you can justify such purchases in the short run, you cannot have the ECB financing European sovereign governments in the longer term. Right now the eurozone financing ministers are struggling to agree on how to beef up the central rescue fund, the European Financial Stability Facility, promising to get it running next month. But how it will be bulked up, perhaps by offering partial guarantees on debt, perhaps by attracting more funds from China, India and the like, is still to play for. And even in an expanded form, the EFSF would hardly be big enough to rescue Italy.
So over the next few weeks we will get a revamped EFSF. The new Greek government will be bullied into accepting the terms of its rescue. Whatever happens in Italian politics, there will presumably be some sort of further austerity programme there. France, as noted above, has just tightened fiscal policy more. Portugal remains in intensive care, while Ireland, fingers crossed, may just struggle through. But, and this is the real problem, much of the eurozone will slip into recession.
It is possible that in a couple of years' time the debts will seem under control and that most governments will be able to borrow without any central guarantees. It is possible that Greece and all the other countries requiring help will be prepared to cede authority over their budgets to some kind of central European authority. All that is possible but it will be very difficult. The "good" outcome is actually pretty bad.
The other possibility is that events will take over. For example, Italy will not be able to borrow on acceptable terms. Or French banks find they cannot fund themselves. Or that people in the eurozone simply open bank accounts in Germany and shift their money there. The "bad" outcome could take many forms. One might be a splitting of the eurozone into two, a north and a south, though it is hard to see how that would work. Another would be Greece and maybe others leaving the euro. We cannot see the detail; but we can't go on like this forever.
No one listens to economists any more
The economics profession has not come out of the downturn with an enhanced reputation. Most mainstream economists did not give sufficiently loud warnings about the housing bubbles that occurred in many countries, nor did they understand enough about banking to point out the instability of the world banking system.
But now economists are hardly listened to at all. Look, for example, at the warnings many are giving that fiscal policy is too tight – advice that not one developed country I can think of is taking. President Obama has launched his jobs strategy and Germany has eased up a little on some taxes, but neither country is giving a significant fiscal boost. We are sticking to our deficit reduction programme, while France and Italy are actually tightening policy in the face of recession.
So what has happened? You could say that the views of economists don't matter and I suppose that is right. But there is something else. In reality, economic policy is being run by financial markets – an uncomfortable thought given their recent record.Reuse content