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Monday, July 25, 2011

Dust settles after eurozone summit: Europe and UK in for a nasty short-term ride

A version of this aritcle appeared in the Sunday Telegraph:

Eurozone leaders took some decisive action this week to save their currency. But while the deal agreed at an EU summit on Thursday looks decent on paper, it rests on some heroic assumptions. Moreover, with the confusion over figures and formulas that arose in its wake, Europe has again been left with a worrying feeling that its politicians do not quite understand exactly what they have signed up to.

The deal contained three main elements: reduced interest rates on the bailout loans to Greece, Ireland and Portugal, some losses for private investors to reduce Greece’s debt and a transformation of the eurozone’s temporary bailout fund, the EFSF, into a cash-point for banks and possibly Spain and Italy to tap (but so far without the sufficient funds). In addition, eurozone leaders finally came back to reality by accepting that Greece will enter some form of default given its huge debt mountain. For now, these seemingly radical results have appeased financial markets. To be fair, in that sense, the package on the table does go some way to stemming the risk of contagion to other eurozone economies. But scratch the surface, and the eurozone crisis is far from over.

For starters, the deal is a huge political gamble on the willingness of taxpayers throughout the eurozone, to continue to underwrite other countries’ debts. By expanding the scope of the EFSF the agreement is providing greater avenues through which risk can be transferred from private sector bondholders to taxpayer-backed institutions. In fact, the deal hints at nothing short of unlimited bailouts, which means that the EFSF has to be radically increased in size to serve as a credible backstop. This may sit well with investors who will continue to see their losses socialised, but convincing Dutch, Finnish, German, Slovakian or even French taxpayers (under the agreement, the latter’s government could face higher borrowing costs than those it is bailing out) to provide not billions, but trillions (think Italy’s €1.8 trillion bond market), in loan guarantees to struggling banks and governments around Europe will be a mighty task indeed.

This amounts to another step down the slippery slope towards debt union in Europe. If the EU Treaties’ infamous no bailout clause, once seen as a pillar for a monetary union based on fiscal prudence, was stretched before, it has now been broken beyond repair.

The hotly disputed topic of private sector involvement also seems to have provided more questions than answers. In the days following the summit, politicians throughout the eurozone have struggled to get to grips with the deal which they supposedly masterminded. The confusion was illustrated by a bizarre moment on Friday when the Commission and the Dutch government gave two completely different figures for the actual size of the bailout. €109 billion said the Dutch, €159 billion said the Commission (leaving the Dutch Parliament, that had already preliminarily approved the deal, utterly perplexed).

But beneath the complexity, the level of debt reduction achieved by involving the private sector falls far short of what is needed. To return Greece to solvency, at least a 40% haircut to the country’s debt is needed, while this deal achieves a mere 7.5% debt reduction according to most estimates. Where the rest is supposed to come from remains anyone’s guess.

The proposal also glosses over a couple of key problems which have remained since the first bailout: will the Greek population put up with continued austerity measures given the resistance already brewing in the country, and what happens if the austerity targets are not met? Even more fundamentally, will Greece ever be able to become competitive within the confines of the eurozone? The deal contains a commitment to economic growth and competitiveness. But it is still just as unclear as ever how to achieve this in a country stuck with a hopelessly overvalued currency, an ingrained entitlement culture, an inflexible labour market and a bloated public sector.

So where does all of this leave Britain?

Economically, since the agreement fails to cut to the core of the crisis, Britain remains exposed to future problems in the eurozone, not least via its banking system. Additionally, cutting too fast and too hard in the eurozone’s vulnerable economies under the new deal – while necessary in the long-term – could trigger a pretty nasty economic downturn in the eurozone in the short-term. Given the trading volume between the UK and the eurozone, this could have a hugely negative impacts on the UK, at a time when it least can afford it.

UK Chancellor George Osborne has said that further “eurozone integration” is in the UK’s interest, that is, if it means a functioning Single Currency. The problem is that few – if any - of the proposals on the table fit the bill. To make fiscal union economically viable, it is all or nothing. Either fiscal transfers (i.e. gifts) from the strong to the weak to compensate for huge economic divergences – which is not even remotely politically acceptable to most, if not all, eurozone electorates – or a scaled down eurozone consisting of a limited number of similar economies. Somewhere in the middle will ultimately be just as unsustainable as the current situation. At the very least, if the UK is going to encourage further integration, it must develop a clear and unwavering vision about its own relationship with this evolving EU. This should include a defined list of measures to push through in Europe, including powers that it wants returned from Brussels to Westminster. Far from derailing the efforts to save the euro, such a list, if it leads to a more competitive, economically vibrant and accountable Europe would do far more to save the euro – in whatever from it exists in future – than any of the proposals that were agreed this week.

The failure to address the fundamental causes of this crisis and a suspicion that the eurozone’s political leaders fail to understand what their new deal actually means, suggests that, sadly, we may well all be back here again before too long.


Rollo said...

No one believes that this rescue is any more than kicking the same can further down the road. There is not enough money in Europe to subsidise Eurozone membership of countries unable to live with the Euro. If we want a strong euro, Greece, Portugal, Spain, Ireland, Italy, Belgium, even France must leave it. There are a few core countries in Germany's coat tails that could survive in the new Euro, perhaps. The longer these countries take to leave the Euro, the greater will be the cost.

Anonymous said...

It would perhaps make more sense for Germany to get out of the Eurozone - and allow the Euro to plummet to a more appropriate level for the PIIGS.

Rollo said...

Anonymous is right. Certainly Germany leaving would be the best option; the Deutchmark would rise to the correct level, and the Euro would sink to its correct level.
One or two othe northern european countries could take up the Dm, if they could bring themselves to do it.

Charles said...

Mats, in your piece you ask the question, where does this agreement leave the UK. One of the answers, which you could investigate, is without a voice when decisions that affect the UK are being made.

Slipped into the agreement was a reduction in the interest rate paid by Ireland to the Eurozone on its rescue funds. Low and behold a few days later, the UK makes the same cut. So we do not have a seat at the table when a decision was made that we have to go along with.

Open Europe blog team said...

Thanks Charles. You're making a fair point in terms of a potential area of concern though we're not sure your example is that relevant. We very much doubt that the UK wasn't consulted before the rates were cut and, in any case, Britain's decision to follow suit was voluntary so it didn't "have to" go along with the rate cuts (since they were bilateral loans). But in fact, Osborne seems to have been a proponent of cutting the rates long before that meeting so the cuts in rates could just as well be seen as an example of how the UK can achieve policy outcomes that it sees as being in its interest, even when not having 'a seat at the table' (by accident or by design).

Nick H said...

My feelings are that it must surely be time we left this corrupt old boys club calling itself the EU. They,are unelected and have not had their books audited for many years. It really beggars belief that we still belong, and it would not hurt to leave as many commentators say. So come on Cameron honour your promise to hold a referendum on remaining. Or are you too frightened?

Gosporttory said...

Agree with most of the above especially for Germany to leave the euro and thus let it sink to accoomodate the Med peasant countries. Just wish the whole EU Gravytrain would collapse soonest and also our own coalition government so as we can get shot of those liberal socialists. I am sure they will get slaughtered at the next election and with Red Ed in charge of the official socialists, we should be home and dry with a working majority. Better still if we could replace Cameron with a Tory leader and PM that will give the people the Gravytrain referendum we all crave!

Anonymous said...

Had we the people not been misled from day one the EU or the euro would never had got of the ground.Germany/France's absolute agenda was to get Britain on board at all costs,without Britain it would have failed.The EU was founded on lies and deceit,it grows on the same ideals,for the worlds sake it has to fail.

Anonymous said...

Cameron will not be able to duck the UK Referendum membership issue for much longer.

Chris said...

Oil and water just don't mix. A Coalition of Conservatives and Lib Dems really is a deceitful fudge. The question of a UK Referendum will give Cameron the choice of this country leaving the EU or be destroyed by his own backbenchers.

Anonymous said...

The Lim_Dems have had their referendum. If they try to obstruct the clear wishes of the majority of the population, and I suspect the majority of Conservative MPs, he can break the Coalition and go to country on a platform of increased EU integration.

Roger P. said...

All those who have given reasons to leave the EU are absolutely right. I agree with them. The EU is corrupt,it is undemocratic, we never voted for what we got, we would be far better off in all ways without Europe and would still trade with the EU, it is fast becoming dictatorial (fascist?). The vast majority of the people in this country want a referendum. The government owes this to us. We should leave as soon as the moment is appropriate.
Roger P.

Anonymous said...

Oh dear, Clegg is just a total plonker; these LibDems, who clearly never expected to be in a coalition government, really should just SHUT UP, GROW UP,and join the real world of serious politics.
If not the LibDems will be finished for decades.

John Henry said...

Now Huhne is facing DPP, can we find something to fix Clegg with and a big cork to shut up Cable?

I too do not want an EUSSR but could accept a new Hanseatic trading league.

After 10 years of prosperity, we will own so much of France that we will have achieved a Norman reconquest, perhaps.

L. Y. Davis said...

Nick Clegg should decide - and let us know - where his priorities lie. Was he elected to look out for Britain's interests, or to further the EU's ambitions?
What the UK needs is a government like France has, that ALWAYS puts their own coutry's interest first!

Ancient Mariner said...

Cameron should bite the bullet and end this farce coalition.
Call a general election now and if the Tories do not get a massive majority, so be-it!
A majority would give us a referendum on Europe then we could get back to saving the country.
Incidentally I don't think Cameron is the man for the top job, too obsessed with what someone might think instead of for the good of this country.

G Heath said...

There is only one issue that matters, and it shows how untrustworthy both Dave and Nick are for not putting their own issues aside and actually asking the people whom (they have forgotten) they serve. Us.

Do we want to be in the EU at all?

It's quite easy to arrange a referendum, though we'd need to get the BBC reorganised first into a less bias organisation (just look at their on going view on climate change hoax to see that a serious overhaul is long overdue).

All these things are possible, the fact that they are not happening just shows the quality of people in politics (and in the BBC).

Anonymous said...

I believe that Greece will fail and probably bring other countries down with it. I would like to see Britain withdraw from the EU and govern ourselves and not have to obey the dictats that come out of Brussels

Anonymous said...

The Liberal Democrats, whether through naievete or design, are the most dangerous party in British politics. This is because they oppose democracy by wholeheartedly supporting the EU.

Why all the mainstream parties are so pro EU amazes me. It has the whiff of conspiracy but may well be just ignorance.

Ian Harris said...

It has seemed to me for a long time that our best option is to leave the EU, and return to, or revive, EFTA. doomsayers who point out how much business we get selling to the EU fail to mention the larger amount we buy from it - so they can't afford to cut us out. All the bureaucratic nonsense, health n' safety, employment could be simplified back to where we where, and our civil servants employed in administrating this nonsense could look for jobs elsewhere. I've never understood why all our major political parties favour staying in the EU - they can't all hope to get EU jobs when they're kicked out? The other point is that the financing nations are in a voting minority to the financed nations, so it's obvious which way the money votes will go.

SussexEurosceptic said...

Completely agree with all the above and I believe that most people in this country do too.
We should have pulled back from Europe long before now for all the reasons stated. It is distressing to read how much British taxpayers' money is being poured into helping 'failed nations' like Greece even though we are not in the Euro. I would like a referendum tomorrow on withdrawing from EU involvement and it is disappointing that there is none in sight.