Everybody is saying it: Greece will go under and probably the euro with it. Indeed, not just on the Eurosceptic right but on the left too it has become oddly fashionable to welcome Greece’s exit from the euro. This is dangerous nonsense.
If Greece leaves, the euro is almost certainly doomed. Nobody can be certain how quickly or how far contagion will spread, but as economists as diverse as Nouriel Roubini, Mervin King and Will Hutton have argued, we are courting disaster. If Greece leaves, who will want to hold Portuguese, Spanish or even Italian sovereign euro-bonds?
Financial markets are notoriously prone to the herd instinct—once the bears start moving south, everybody heads in the same direction. The result of skyrocketing sovereign yields in Europe (including the semi-detached UK) would be massive bank insolvency, bank runs and quite probably financial collapse on a scale which would make the 1930s look like a tea party. We are not talking billions of euros but trillions!! Europe is already stagnating or in recession—such a meltdown would lead to several decades of deep gloom.
Some on the left in Britain argue that the euro was always a bad idea; that losing the ability to devalue was suicidal since any ‘loss of competitiveness’ could only be offset by internal devaluations. This argument, although partly correct, ignores the fact that in the 1930s European countries exported unemployment by means of competitive devaluation. Today we have beggar-thy-neighbour wage cuts instead.
Certainly, the design of EMU and the euro which emerged from Maastricht was deeply flawed, as eminent economists such as Paul de Grauwe argued years before the credit crunch. Indeed, as argued in my 2007 book, creating a central bank without a federal fiscal system—or more generally a politically unified Europe—led to making the Eurozone a ‘monetary giant but a fiscal dwarf’.
Equally foolish was German insistence at the time of Maastricht that each member-state should finance any deficit through sovereign euro-bonds as opposed to the some form of common Eurobond as proposed recently by the Breugel Institute. Just imagine what the plight of the US state of Louisiana would be if it had to rely on the international financial market to purchase Louisiana dollar-bonds—while Ohio refused to lend ‘feckless southerners’ money from its own hard-working taxpayers?
In truth, however, there is not enough time to create a federal Europe, or to rebalance German trade surpluses as Keynes would have advised, or even to substitute jointly backed blue bonds for much or all of the sovereigns. Nor does the new European Stability Mechanism (ESM) have the firepower to prevent contagion, even assuming its restrictive conditionality (the Fiscal Compact and EU six-pack) were fit for purpose.
The only remaining answer is for the ECB to announce that it will buy as many sovereigns as necessary to keep yields below, say, 4 per cent. This might cost the ECB 2-3 trillion euros, but that is a paltry sum compared to what bailing out the entire European banking system would cost!
The Germans, Dutch and some conservative Nordic states will oppose such a move on the grounds that turning the ECB into lender of the last resort and capping bond yields involves an unacceptably high degree of moral hazard; ie, that it encourages member-states to be profligate since the ECB will bail them out.
This is the main reason Mario Draghi made it clear that the long-term refinancing operation (LTRO) undertaken by the ECB this year would be temporary. But though the LTRO has arguably staved off disaster by preventing the private banking system from freezing up, it has not cured the underlying problem.
Britain’s role in the euro has been entirely negative: it sits gleefully on the side-lines exhibiting schadenfreude while remaining haughtily impervious to looming financial disaster. Yet it is now nearly certain the Greek voters will reject further austerity on June 17th, and that the response of the troika (the IMF, EU and ECB) will be to cut off further lending.
Nobody can forecast with certainty what will happen after that, but one thing is sure: we will not return to the comfortable Europe (including the UK) we once knew. Europe’s callow and ill-informed politicians have killed that hope forever.