If It Wants the Euro, the EU Must Pay for It

Try as one might to stay away from discussing the euro zone crisis, if only because debating it endlessly is getting really boring, one finds one cannot avoid it because the markets keep coming back to it. And who can blame them?

European Central Bank
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European Central Bank

Every single measure taken by theEuropean Unionto try and stabilize the currency and assuage investors’ fears on its prospects has only ever bought time; there is never a solution. The European Central Bankhas more than done its bit too; we all know that the decision to supply three-year funding to EU banks had more than half an eye on the euro crisis behind it.

But that measure too was just more time-buying. Its soothing effects are now beginning to wear off - witness the media comment on the Spanish government bond auction last week and how a yield of over 6 percent, as its 10-year paper is now trading at, is somehow “unsustainable”.

Let's start by reiterating our position of the last two years: it is not possible to have sustainable monetary union without either (i) political union, or at least some sort of centralized budgetary control that we will call “fiscal union”, or (ii) an understanding, and acceptance, that countries running persistent budget deficits will need to be bailed out by the countries running surpluses. In other words, the north would have to pass over large fiscal transfers to the south for years to come.

The consistently excellent David Wighton got this spot on in The Times today. He did provide another option, and one that is theoretically a solution: deficit-ridden countries could improve their productivity relative to the rest of the EU (and the world), principally by reducing labor costs.

But the reason this is only a theoretical solution is because in practice it would take too long to take effect, and in any case, are southern EU workers really going to take a 30 percent pay cut to make this feasible?

It may be more than 30 percent, or less, but the bottom line is that the labor force in crisis economies (read Greece, Portugal, Spain and potentially Italy) would have to work longer hours for less pay, and start raising more taxes after creating more jobs, for this option to be viable. And it would have to do this very quickly, otherwise investors will simply get stressed again.

Flawed Thinking

That is why it is not really an option. The consistently thoughtful Economist seems not to have grasped this fact, when this week it called for Eurobonds to be issued, by a central EU authority, as a solution to the euro crisis. But isn’t that just more of the same flawed thinking that has got us this far and no nearer a solution than we were in 2010?

Why are Eurobonds not a “good idea”? Well, they aren’t a bad idea, but on their own they are just like the ECB’s LTRO funding facility. They buy some time. No matter what form of Eurobond one ends up issuing, unless one makes an explicit commitment that the north will keep bailing out the south, until the south does start reaping the benefits of productivity gains arising from labor market reforms, then investors will remain unconvinced that the euro has a long-term future in its current form and current membership.

Unless Eurobonds cover 100 percent of Spanish or Italian or Portuguese debt (and we know they won’t), then one is not addressing the problem by issuing them. These countries need to address their productivity and their working practices, and the level of their government spending. These areas all require urgent attention and structural reform. A Eurobond is none of these things.

Eurobonds are yet more papering over the cracks. Maybe not as flimsy a covering as the unconvincing EU government assurances of 2010 and 2011, but a paper covering nonetheless. Each passing day and each passing new blow-up of the crisis, and more and more investors and taxpayers are realizing that if the EU wants the euro to stay as it is, then it will need to pay for it. Or otherwise announce fiscal union. Everything else is just time buying. As the legendary Joe Louis once put it – you can run but you can’t hide.

The author is Professor Moorad Choudhry, Treasurer, Corporate Banking Division, Royal Bank of Scotland.

The views expressed in this article are an expression of the author’s personal views only and do not necessarily reflect the views or policies of The Royal Bank of Scotland Group plc, its subsidiaries or affiliated companies, or its Board of Directors. RBS does not guarantee the accuracy of the data included in this article and accepts no responsibility for any consequence of their use. This article does not constitute an offer or a solicitation of an offer with respect to any particular investment.