The outcome of last week’s euro zone summit meeting is not quite as positive as the immediate equity market reaction suggested. For a comprehensive dissection read this week’s Economist, which lays out in stark terms what further work is needed from euro zone leaders.
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The announcement from the Greek prime minister that there will be a referendum on the plan has thrown everything right back into turmoil and uncertainty, which suggests volatility and falling markets into the New Year.
Taking all of this one level higher, this boils down, like so much of the euro zone’s political and economic issues, into a philosophical debate about where exactly the European Union (EU) wants to go. The role of the European Central Bank (ECB) is central to this debate. Wasn’t the euro project merely one step further towards ever closer union? Then the ultimate end-game is surely fiscal union to make the monetary union work.
Today’s crisis was predicted by (among others) Professor Milton Friedman, who stated at the outset that a currency union without central budgetary control would unravel the instant one or more members started to run unsustainable budget deficits – which is precisely what we are seeing now.
Hence our low scorecard. Twice-yearly meetings of euro zone finance ministers does not a centralised budgetary authority make. The other reasons for our “must do better” report are (i) the inordinately long time it took for euro zone governments to realise that the Greek economy was insolvent and that debt restructuring was necessary (ii) trying to maintain market confidence with measures such as the European Financial Stability Fund (EFSF) without putting in the necessary infrastructure to demonstrate how it would actually work (iii) not settling on the full role of the ECB in this crisis and (iv) not saying a word about fiscal policy integration.
The market needs to see all this done and dusted before it feels the euro is viable in the long term in its current form. And the good news is, all of the above is certainly do-able. The hard part is the political unity required to achieve it, which is the philosophical debate we mentioned above.
Fiscal union isn’t something that can be arranged overnight. Even after an agreed approach has been settled on, there will need to be government legislation pushed through. Some countries will refer the question to their electorate in a referendum. But it isn’t the actual step of putting in place the infrastructure that is needed to restore market confidence, it’s just the acceptance that such a step is necessary for the euro to work as desired. Either that or a change in euro membership, which will be even more painful. Euro zone governments should be addressing this issue now, with a view to having the debate concluded once and for all.
And please can we stop talk about an “orderly” exit from the euro… a country may well leave the euro zone, but it will be anything but orderly. Any country trying to restore its domestic currency will find there is an instant run on its banks, which will become insolvent overnight. Cue another bank crash, wider EU and worldwide contagion and severe economic recession. Whatever the cost of trying to save the euro in its current form, it is worth paying because it will be dwarfed by the cost of dealing with the effect of a country leaving the euro.
Finally, lets hear a “hurrah!” for the credit default swap (CDS) market. If we didn’t have CDS prices showing how expensive it is to insure certain countries sovereign debt, how much of an impetus would there be to restructure said economies and reign in spending that governments can’t afford? As is evident to neutral observers, market prices don’t create an economic condition, they simply reflect it. It’s socially useful to have a transparent indicator showing how insolvent governments stack up against better run economies.
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Prof Moorad Choudhry is Head of Business Treasury, Global Banking & Markets, Royal Bank of Scotland, and Visiting Professor at London Metropolitan University. The views in this article represent those of Moorad Choudhry as a private individual, and do not represent the views of Royal Bank of Scotland or London Metropolitan University.