Debt crisis could lead countries to opt out of the euro

Quelle horreur! French President Nicolas Sarkozy was so alarmed by the panic in the financial markets last week that he even — briefly — abandoned his sacrosanct summer holiday to return to Paris and instruct his ministers to draw up new austerity plans. On Tuesday, he’ll meet Angela Merkel, who’s also having a less than tranquil August.

The markets’ concerns were partly fuelled by rumours about the fragile state of French banks and their hefty exposures to Greece, Italy and Spain, particularly Société Générale.

But they were also simply following the relentless logic of the ever-deepening sovereign debt crisis. If Italy and Spain are in the firing line and could eventually need bailing out, as bond markets have been signalling, then Germany’s taxpayers won’t be the only ones on the hook — France will have to pay its share of the price too.

Nothing in the latest rescue deal, to increase the powers of the European financial stability facility (EFSF) and arrange a bond-swap for Greece, provided an answer to the wider sovereign debt crisis. Leaders hoped it would buy them enough time to go on holiday; in the event, the peace deal with the markets lasted little more than days. Clearly, something more radical is needed — and it’s not banning the short-selling of bank shares.

George Osborne’s blithe insistence in the British Commons on Thursday that its European neighbours should examine the idea of issuing “eurobonds”: joint debts, guaranteed by all the governments in the single currency, glossed over deep issues of democracy.

Wholesale surrender
The eurobond may be what you get if you take the founding principles of the eurozone to their logical conclusion; but it involves a wholesale surrender of economic sovereignty. That sounds anodyne in theory, but in fact, as the Greeks have already discovered, it means your creditors — in this case eurozone partners — combing through every penny of your public spending plans, raising objections to how much you’re paying teachers, how many civil servants you’re prepared to sack, and which treasured national assets you put up for sale at knockdown prices.

That might be the consequence of living beyond your means during the boom years, but it’s still an affront to national democracy. Just as the voters of Argentina eventually lost faith in the unelected International Monetary Fund’s prescriptions for fixing their problems, the Greeks are already furious about the pain they’re having to go through; and there’s likely to be much more to come.

Jean-Claude Trichet, the outgoing head of the European Central Bank (ECB), who has been dragged kicking and screaming into rescuing Greece and Portugal, and now buying up billions of euros of Italian and Spanish bonds, has suggested a eurozone-wide finance ministry. (This at the same time as he was ratcheting up the pressure on struggling economies by increasing interest rates, in stark contrast to the more accommodating Bank of England and Federal Reserve).

More than they bargained for
But many taxpayers in the eurozone (both the German and French paymasters and the rueful debtors) are likely to feel this is a lot more than they bargained for when they signed up to the single currency.

Even if there’s little talk yet of ditching the euro, the cliched arguments about lazy Greeks and stingy Germans that have characterised the political clashes since the crisis began show just how far the public in many of these countries feel from being ready to surrender national, democratic control over tax and spending for the greater good of the European ideal.

If anything, there has been a resurgence of nationalism since the crisis, with the travails of the struggling states reigniting tired old prejudices.

It’s worth remembering that the French and Germans themselves didn’t stick by the targets in the “stability and growth pact” — the rules of the euro-game that were meant to prevent deficits running out of control.

Even before the expansion of the eurozone to include Slovakia, Malta and Cyprus, it was hard to identify a coherent “European model”, which would guide countries as to where and how to trim their spending — or much more importantly, generate sustainable growth. Tax and spending decisions are by their nature political (“no taxation without representation”, as the original tea partiers used to say; and we know how that ended.)

German taxpayers are, not surprisingly, none too keen on the proposed increase in the size of the EFSF, which would have to be ratified by national parliaments, as will the details of the July agreement. If rescuing the Greeks was a stretch, bailing out core countries such as Italy could prove too much for the German public to swallow.

The Greeks aren’t exactly brimming with confidence about their future in the single currency zone either, judging by the latest figures on bank deposits: they’re withdrawing almost €4-billion a month, to salt away, either out of the country or under the mattress.

Somehow, the clashing interests of Germany and its fellow creditor countries, and Greece and the other debt-burdened states, will have to be reconciled, or the single currency will blow apart.

As Sir Mervyn King pointed out in his quarterly inflation report briefing last week, the current turmoil is only the latest chapter in the long-running credit crisis. The debts that were run up during the boom years have never gone away; and as the governor also pointed out, the next phase will have to involve some sharing of the burden between creditors and debtors. That’s as true of Europe as it is of China and the United States.

Yet press reports last week suggested that even Germany and France have different visions of how the euro should evolve, with Sarkozy favouring something more akin to Trichet’s fiscal union, and German politicians extremely sceptical about the notion of a eurobond.

There’s no easy solution: Merkel and Sarkozy will no doubt come up with another of their “grand bargains” on Tuesday, with tough language about enhancing European economic governance. But as with every other such deal throughout recent months, it’s likely to evade the fraught question of who’s going to have to pay the bill. And piling fresh spending cuts on already fragile economies will only increase the burden by stifling growth.

Barring a political miracle, it looks like a toss up as to whether the Germans or the Greeks are the first to become so exasperated that they decide their future should lie outside the euro. –

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