One just cannot get away from the Euro and its woes. Not a day goes by without more talk of gloom and doom. Greece and Italy face the prospect of severe economic meltdown which could lead to an imminent break up of the Euro. There has even been talk that Greece might have to leave the EU, not just the Eurozone. Clearly something pretty bad is going on, but just how bad is it? In this post I want to try and clarify a couple of questions about this ongoing crisis. Not sure if I can come up with any answers.
There are two questions I find perplexing and rarely, if ever raised in the media. The first is why are the undoubted difficulties of Greece and Italy presented as a crisis for the Euro and the Eurozone? The second and related question is why has a crisis in private banking become a sovereign debt crisis?
As regards the first question, to get an idea of why all this talk of a crisis for the Euro is perplexing it may be useful to compare the situation in the Eurozone with the situation in the USA. Now the two are not directly comparable, but they do have in common that in each there is a single currency - the Dollar for the USA and the Euro for the Eurozone. There is also the fact that states in USA as in the Eurozone can get into financial difficulties, quite severe difficulties. However in the USA there is never any suggestion that financial problems in say, California, will cause anyone to question the survival of the Dollar. There is also no suggestion that California or any other state would be required to leave the USA.
Jacques Melitz, professor of economics at Heriot-Watt University in Einburgh has written an article about the lessons for the Euro from the USA. Talking about the situation in 2010, he writes: “The crisis brought about dire financing problems for many lower-level government units in the US and some national governments in the Eurozone. According to the spreads on credit default swaps, California and Illinois now have a higher probability of non-performance on public debt than Portugal and Spain. This has been true for months. Consider next the difference in response in the States and Europe. Recently Illinois simply stopped paying $5 billion of bills. In June of last year California issued vouchers for wage payments. In addition, savage cuts in public services have begun and are now threatened in various states in difficulty, not only these two. Nevada has made startling reductions in spending on higher education and welfare. “
So, in the USA when a state engages in irresponsible fiscal conduct it is the creditors and taxpayers who bear the brunt of the consequences. This is what was supposed to happen in the Eurozone. At its creation the ECB was explicitly forbidden to act as a lender of last resort and instead it was to be the financial markets that would ensure that member states kept to the true and narrow when it came to national debt. So why was Greece not just allowed to default way back in 2009? It could still be in the Eurozone, but it would have had to take very, very harsh measures to bring its public finances into order. Which it is having to do anyway. Oh, and there is also the small matter that creditors - the banks and other financial institutions - would have to take a full haircut on their loans. Not good for the banks.
What about Italy, the current country in the firing line? There are a couple of points to make here. One, though Italy’s national debt is pretty high at around 120% of GDP, it is not alone in this. Japan’s national debt represents 220% of its GDP! And yet Japan can borrow money at around 1%. Second point is that Italy is not remotely a basket case. As the Guardian usefully points out Italy is the eighth largest economy in the world and the fourth largest in Europe. Its gross domestic product (GDP) was over $2tn in 2010. Greece, Europe's other basket case, has a GDP of $305bn – an economy about the same size as Dallas, Fort Worth and Arlington in Texas. The Italian government clearly needs to implement some serious reforms which will no doubt be painful for lots of Italians. However the country can afford this. And it is surely a matter for Italians how they go about sharing the pain.
Daniel Gros, Director of the Centre for European Policy Studies, Brussels, has an interesting article entitled What is holding Italy back. His conclusion is that it is primarily the lack of good governance which is the biggest hindrance to economic growth. As he puts it: “This implies that it will be difficult to organise a sustained effort to combat corruption, foster adherence to the rule of law, and improve the efficiency of the administration in general. However, progress on these fronts might in the end be more important for growth than the reforms now being imposed by the EU.”
My second question was How has the crisis become a sovereign debt crisis instead of a banking crisis? For let us remember that this particular crisis originated way back in 2007 with the exposure of financial malpractice, irresponsibility and corruption by privately owned banks in Iceland, the UK, the USA and Ireland. Note also that only one of these countries, Ireland is in the Eurozone. Now one of the key virtues, supposedly, of capitalism and the free market is that there are winners and losers. Captains of finance get huge, some would say obscene rewards, but this is because they take huge risks. So, how come when it was time to take a loss, it was the taxpayers who had to step up to the plate? In most countries the big rise in government debt is primarily due to bailing out private banks. The ongoing saga of emergency loans to Greece, Ireland and Portugal is to prevent a default and the exposure of banks to meltdown. Why?
Why are all countries and this includes the so-called virtuous ones like Germany, Austria and Finland, so frightened of bank failures? After all the failure to tackle the root cause has already led to great suffering in Greece, Ireland, Portugal and Spain as a direct result of the harsh austerity measures. This will almost certainly spread to Italy very soon. However all these austerity measure just add to the downward pressure on the whole EU economies. Growth for the Eurozone in 2012 has been downgraded to 0.5%. This will have serious repercussions for Germany and the other so-called virtuous countries. The loss of exports to the rest of the Eurozone can only lead to higher unemployment in these countries. And all to prevent a collapse of private banks?
A collapse of the banking and financial sector would be pretty calamitous, but it would provide the basis for governments to nationalize the banks and ensure that they were brought under proper regulation and control. Finance is far too important to be left to bankers. It would also ensure that all countries shared in the pain of rebuilding a sound and sustainable economy.