Crisis in the currency club

Greece’s financial problems have been a disaster for the eurozone, and there could be much bigger shocks to come.

Good clichés stick in the mind and will not be stifled. Groucho Marx’s lapidary statement that he would not wish to belong to any club that admitted him as a member must have slithered into the consciousness of officials in more than one eurozone capital in recent weeks. Greece has not behaved like a trustworthy member and deserves to be slung out of Europe’s single-currency club. This is impossible, but lessons must be learned and applied to the future governance of the eurozone.

Cooking the books, blowing air into the numbers, however you want to characterise it, is a betrayal of trust, apparently by successive Greek governments. Greece probably presented phoney accounts in the run-up to its (late) admission to the eurozone in 2001 and appears to have been doing so ever since. They slipped past Eurostat, which collects national accounts and ensures they are presented on a common basis. Eurostat has never been allowed to audit them, although one positive outcome of the Greek debacle is that it may be given the task of doing so in the future.

The reported readiness of eurozone members to provide emergency support for the crippled Greek economy is not altruism but calculated self-interest. The credibility of the euro, and of the institutions behind it, is being severely challenged. The currency will not go down the drain, but if this crisis is not handled properly the euro will lose the confidence of markets and the solidity that has placed it second only to the dollar as a global currency.

The euro was struggling to hold its own against the greenback last week not only because of worries about Greece’s financial ills, but also because of severe weaknesses in the economies of Portugal, Ireland, Greece and Spain (labelled PIGS by Daniel Gros of the Centre for European Policy Studies). All are struggling with low or non-existent growth, soaring debt, yawning budget deficits and lengthening queues of the jobless.

All have made severe mistakes over many years and all face truly horrible policy options – to cut public spending, services and wages. Higher taxes and rising unemployment are starting to erode their social and political stability. Membership of the eurozone rules out any resort to currency devaluation to win back some growth and competitiveness. All in their various ways highlight fundamental weaknesses in the political management of the eurozone.

As soon as the Treaty of Maastricht was signed, doubts were raised about the success of a currency union without a framework of political union. Sometimes these doubts were cloaked in technical worries about whether the eurozone would be an optimal currency area. If it was, then the impact of external shocks would be broadly symmetrical among its members, said the experts.

But the impact of the global financial and economic crisis has clearly not been symmetrical, partly because before it hit the celebrated ‘one size fits all’ monetary policy fed asset bubbles in Spain and Ireland and eroded their competitiveness.

The bubbles burst and systemic crisis is afflicting policymakers in these countries. Public finances in those two countries – and also Greece and Portugal – are being wrecked by falling tax revenues and stimulus spending to cushion the effects of recession. Their governments are now trying to claw back some credibility (without it, financing their deficits will be very expensive and, perhaps, impossible) by committing themselves to extraordinarily ambitious fiscal policies.

Last week, Nouriel Roubini, the doomsday soothsayer who predicted the financial crisis of 2008-09, identified Spain as the country that will eventually pose the most serious threat to the eurozone’s stability. Within days, Madrid joined the pack of countries publishing deficit-reducing plans, in its case from close to 12% in 2009 to below 3% in 2013. Greece is committed to an even more ambitious fiscal consolidation, while Portugal and Ireland have also put themselves on very steep deficit-reduction paths.

There are very good reasons to doubt whether any or all of them will make their numbers. They will be under pressure from the European Commission and fellow members of the eurozone to do so, but after more than ten years of the stability and growth pact it is clear that peer-group pressure is only mildly effective at persuading governments to stick on the straight and narrow.

Both Germany and France have contemptuously ignored its disciplines in the last decade. The Commission may well ask Greece to toughen its fiscal consolidation plan even more, but that will not guarantee delivery.

The markets may – just possibly – be more successful in keeping Greece honest. But if investors will not buy its debt without an exorbitant premium, it will default and require propping up by other eurozone members. Even without that Armageddon, emergency support will be needed.

Crisis frequently breeds change in the Union. A repetition of the eurozone’s current ordeal is inevitable – probably involving a much larger member state – unless members accept that their currency partners need to be much more politically involved in the designing and adoption of national budgetary policies.

This requirement was obvious well before the European Monetary Union’s launch. If the euro is to have a long-term future, it cannot be shirked any longer.

John Wyles is a former Brussels bureau chief of the Financial Times.