Unlike previous summits where the German and French leaders met in advance to hammer out a common stance, there was little sign of unity in Brussels overnight. Investors now worry that the relationship between new French president François Hollande and German Chancellor Angela Merkel … is turning out to be fractious and unproductive.
Karen Maley, Business Spectator
It was perhaps to be expected. On the campaign trail, new French president François Hollande pledged to take a different tack on European economic policy from his rival, Nicolas Sarkozy. Whereas Sarkozy was largely content to accept the platform ‘austerity’ championed by his German counterpart, Angela Merkel, Hollande has declared his intent to promote an agenda of ‘growth’. And now, after the first European leaders’ summit since Hollande came to power, the divisions remain as stark as ever. Unfortunately, this is precisely the time when Europe needs its two key leaders to find common ground.
As Karen Maley reports, France wants jointly-backed Eurobonds to backstop national debts. Italy wants a guarantee on all Eurozone bank deposits to short-circuit any bank runs that might follow a Greek withdrawal from the Eurozone. Spain is also worried about financial institutions, having recently nationalised one major lender, and wants Europe’s bailout fund to be able to lend directly to banks. (Currently, it is only able to fund governments — and Spain wants to avoid being the latest economy to go cap in hand to its neighbours for a handout.)
Germany isn’t having a bar of any of it, and is supported by Finland and the Netherlands among others. In other words, Europe is fracturing: those firmly in crisis mode (along with their new champion, France) versus those who are footing the bill for the various bailout measures. The European Central Bank will likely be forced to intervene while the politicians bicker. But any of the options available to it are measures they’ve tried before, and have proven to be little more than stop-gaps. The Franco-German alliance is bust — and the Eurozone will be too, unless Merkel and Hollande can somehow forge a new consensus.
Can the Eurozone survive without political union?
Many commentators have argued that the Eurozone can only work if monetary union is matched by fiscal, financial and political union. For countries to share a currency, a full range of policy settings must be harmonised. And this has been sadly lacking in Europe. You need look no further than the stark differences between Germany and Greece — not just today, but well before the current debt crisis exploded.
In contrast to this conventional wisdom, Reuters’ Hugo Dixon — a long-time business journalist — argues that the euro can survive while still preserving a degree of national sovereignty. Indeed, he contends that respecting the interests of different states is a necessary condition for saving the single currency. The euro has, since its establishment, been unpopular in some quarters. The political appeal of such views has only grown in recent years, as the success of the isolationist National Front in France (to take only one example) in the first round of that country’s presidential election in April demonstrates. Forcing through greater integration will only anger large blocks of voters across the region.
As Dixon acknowledges though, there are some steps that must be taken to put the euro on a surer footing. First, insolvent governments and banks need to have their debts restructured. The refusal of European leaders to accept years ago that Greece was bankrupt has directly led to the present calamity — it could have been averted (or at least ameliorated) by acting earlier. Second, Europe require a region-wide ‘liquidity backstop’: that is, ensuring that there is sufficient capital for solvent banks and governments to operate during times of stress. The various ad hoc measures and compromises that Europe has used to date in muddling through the debt crisis have not promoted long-term confidence — quite the opposite. A lasting commitment is needed to keep Europe ticking over.
While items one and two on Dixon’s wish list have been frustrated by Germany (among others, who are worried about having to ultimately foot the bill), the third condition has been championed by Berlin, but opposed by many embattled governments. Dixon argues that domestic economic policies must favour greater flexibility — particularly in the labour market. Onerous regulations, such as those that establish generous employer-paid entitlements and make ‘permanent’ workers virtually unsackable, have been central in driving up youth unemployment and driving down labour productivity. Without greater scope for businesses to manage their labour costs, there is little prospect of them being able to compete within Europe — let alone on the world stage. Limited, piecemeal reforms will only ensure low growth for years to come — certainly not enough to catapult Europe out of its current malaise.
A Greek exit from the euro area would inflict heavy damage in Greece and throughout Europe. It could also be one of the best things that ever happened to the currency union.
Jacob Kirkegaard, Peterson Institute for International Economics
A quick check of share markets around the world would tell you that investors are clearly nervous about events in Greece and the fate of the Eurozone. And it’s true that if next month’s second attempt at parliamentary elections in Greece return a clear majority for anti-austerity parties (presumably led by the radical-left Syriza, which may end up being the largest party), the likely consequences will be the termination of the Greek bailout package, full-scale default, and a return to the drachma. The immediate effects would be catastrophic, plunging Greece into an even more traumatic recession, and raising the spectre across Europe of other countries abandoning the single currency.
But as Jacob Kirkegaard argues in a piece for Bloomberg View, crisis is often necessary to prompt Europe to act. Just as austerity has been forced on governments with no other choices, if a full-scale Eurozone meltdown is in prospect, Europe’s leaders may finally see fit to pursue the needed fiscal and political integration to make the single currency work.
For example, Kirkegaard notes the increased risk of bank runs across Europe if Greece dumps the euro. After all, if Greece can leave what was meant to be an ‘irrevocable’ currency union, citizens in Spain, Italy and elsewhere might well fear the devaluation of their own life savings if — in an instant — their own governments decided on a return to the peseta, the lira, or whatever else they once traded in. Bank runs are toxic to economies, and would rip the Eurozone apart. This fear might prompt Europe’s leaders to agree on supra-national financial protections, such as Europe-wide deposit-guarantee programs. Banking would become a European industry, not a patchwork of national industries.
Perhaps most potent in forging consensus on previous no-go zones is the demonstration effect that Greece would provide as it slides into a post-euro abyss. Whatever miseries austerity might inflict, no one would want to replicate Greece’s experiences. That’s of no comfort to ordinary Greeks, of course. Perhaps that’s something for them to reflect on as they cast their ballot papers in June?
[Since] it gained its independence from the Ottomans in 1832, Greece has been in default or restructuring for half this period. [But] this time, Germany is willing to bail it out.
Fareed Zakaria, Time
German chancellor Angela Merkel has become the arch-villain to many voters in debt-ridden European economies. She continues to insist that the countries her government bails out must meet stringent conditions. The resentment — indeed, anger — this has fostered is most evident in Greece. But it can be witnessed even in the likes of more powerful (and relatively more stable) countries like France.
However, as Time magazine’s Fareed Zakaria writes, Europe has much to thank Germany for. Through the European Union’s transfer mechanisms, bucket fulls of money have been channelled from the thrifty Germans to the profligate ‘periphery’. For instance, unit labour costs increased a mere 2 per cent in Germany between 2000 and 2010. By contrast, they surged 35 per cent in Greece.
While politicians and voters decry ‘austerity’, Germany is primarily pushing for unpopular structural reforms that offer a long-term path to growth in otherwise stagnant economies. Liberalisation of labour markets will offer new opportunities for employment. Reducing barriers to entry in different professions will foster competition and spur innovation. And in exchange for this, Germany has shown remarkable willingness to prop up governments whose debts have grown so great that private markets are no longer willing to lend to them — at least not without attracting interest rates those same governments regard as punitive.
The message from all of this is that Germany wants Europe to succeed. But it requires other leaders who are willing to make the tough decisions necessarily to ensure that success can be sustained over the long term.
From marathon to sprint
With doubts openly swirling about Greece’s future within the Eurozone, it’s hardly surprising that ordinary Greeks are starting to worry about the fate of their country — and their money. There is mounting evidence that Greeks are withdrawing funds from their local banks, and depositing them in other Eurozone member states (Cyprus in particular, given historical ties). The advantage of this approach is that, if (when) Greece is forced to return to a heavily devalued drachma, their savings will still be stored in (relatively more valuable) euros. The downside is that it hastens Greece’s eventual demise: these are the first steps in a bank run that could fatally undermine Greece’s banking system.
Once a bank run takes hold, it is hard to stop. Realistically, the government would be forced to introduce harsh controls that would limit withdrawals — effectively depriving people of access to their money, and forcing them to take a massive haircut on their life savings. At some point, banks would either have to be recapitalised by the government (which Greece can’t afford), or could simply topple — probably taking any government down with it, such would be the public outrage.
From Europe’s perspective, a Greek banking crisis would not of itself be a threat — Greek deposits are a small percentage of Europe’s banking sector, and most other European financial institutions have spent recent months divesting themselves of their exposure to Greek banks. But as we have seen throughout this debt crisis, what starts in Greece can spread like wildfire through the region. There are already concerns about Spanish banks, with one major lender — Bankia — having to be nationalised by Madrid. Italians too can hardly consider their financial sector entirely robust.
As Karen Maley notes at Business Spectator, the wealthy have for several months been shifting their money out of Greece, Spain and Italy into the safer havens of Germany, Switzerland and the United Kingdom. If the average Greek citizen is now joining in the rush, how long before ordinary Spaniards and Italians start pulling their cash out? And how willing will the rest of Europe be to use the European Central Bank to prop up wobbly financial institutions — especially at a time when the ECB’s balance sheet is already overloaded with the government debt of embattled economies.
