By buying Italian and Spanish debt, the European Central Bank has certainly done the right thing. The rise in Italian yields over the summer was less a play on Italy’s own difficulties – high levels of government debt, a bit too much “bunga bunga” – and more a reflection of existential concerns over the euro’s future.
By intervening in the eurozone’s bond markets, the ECB has become a lender of last resort following the precedent set by the Federal Reserve in late 2008 and through 2009. In a world characterised by growing financial panic, that has to be good news.
Yet the ECB can only take things so far. A single currency can only survive if its political foundations offer coherence. The crisis suggests that, in the absence of further reforms, the euro simply lacks the appropriate underpinnings.
The break-up of the Soviet Union at the beginning of the 1990s might seem only tangentially connected to the euro zone’s current plight, but the hemorrhaging of political unity that followed the Soviet Union’s collapse led eventually to the destruction of a single currency which, for a short while, had been the sole legal tender across a large number of newly-formed republics. The post-Soviet era – a period during which the rouble area shrank dramatically – thus provides a template against which the risks to the eurozone can be gauged.
With the exception of the Baltic states – which made no secret of their desire to leave the clutches of the Moscow mothership – most republics seemed to be perfectly happy being part of a rouble area.
Through 1993, however, the rouble area imploded: new currencies came into play from Armenia to Azerbaijan and from Belarus to Georgia. Whereas, once, there were roubles, there were now drams, manats and menatis.
Why, from a single currency perspective, did it all go so wrong? For some republics, a new currency was seen as an independent badge of honour. For others, it was much more a story about the inconsistencies of fiscal policy. While the Baltic states were balancing their books, the likes of Georgia and Ukraine presided over budget deficits approaching 30 percent of gross domestic product, partly because the fall of the Soviet empire had left industry – and, hence, government revenues – in a state of collapse.
Because these countries had no access to international capital markets, they had to fund these deficits either through loans from other parts of the former empire or by resorting to printing money. At first, they did this through the back door, creating so-called rouble “supplements”.
Yet, following the Central Bank of Russia’s summer 1993 currency reform – which abolished all rouble banknotes issued between 1961 and 1992 – the back door abruptly slammed shut. Countries instead chose to issue their own currencies: printing money was the only way in which they could finance their by now ludicrous borrowing needs. Inevitably, many of the fledgling republics succumbed to hyperinflation.
It would be crazy to suggest that fiscal misbehaviour within the eurozone is anything like on the same scale as it proved to be within some of the former Soviet republics. Yet European nations have experienced significant revenue shortfalls, weak growth and, in some cases, a loss of access to international capital markets. Those countries with heavy debts – mostly in the south – are finding it increasingly difficult to get a sympathetic hearing from their more creditworthy partners in the north.
And, in many instances, austerity isn’t working: fiscal consolidation plans are being met by a higher cost of borrowing, creating an increasingly unstable environment both financially and politically.
So might the eurozone head the same way as the rouble zone? Could the inconsistencies of fiscal policy and the disagreements between creditors and debtors eventually trip the whole system up? It might seem unlikely but, then again, no one at the beginning of 1992 thought the rouble zone would fall apart.
If the euro is not to share the rouble’s fate, its member nations will have to agree on a lot more than just the level of interest rates. They will also have to create a fiscal framework that allows for cross border transfers, resolves conflicts between creditors and debtors and supports the Bostonian principle of “no taxation without representation”.
Some monetary unions work well. Sterling, after all, is the common currency of England, Scotland, Wales and Northern Ireland. Others, such as the rouble area, did not.
Buying Italian bonds is a good first step but the ECB, on its own, cannot solve the eurozone’s problems.