Sunday, December 11, 2011
Eurozone rescue rests on shaky foundations
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

I am not going to add much to the thousands of words on David Cameron’s tactics in Brussels. But, if John Major could claim “game, set and match for Britain” (not necessarily accurately) 20 years ago at the Maastricht negotations, this was more: “It’s my ball and I’m taking it home.”

It is not obvious the prime minister’s veto will be of benefit to the City of London, whose interests he was keen to protect. A grouping of 10 euro “outs” with Britain as its leader might have been viable. One lonely objector out of 27 is different.

It points towards a looser relationship between Britain and the rest of the EU, a free trade relationship, though achieving it will be easier said than done.

Establishing the regulatory paraphernalia that goes with the single market is easier than dismantling it. Can Britain stay in the EU? Yes, but as the equivalent of a social member at sports clubs, not allowed to participate in most events.

Many in Europe, of course, see Britain as part of an Anglo-Saxon conspiracy seeking to derail their project. So the occasionally harsh judgments of the City on euro rescue efforts are of a piece with last week’s threatened downgrade of most EU economies by Standard & Poor’s, the ratings agency.

The fact some of us have a pretty low opinion of S&P, which seems to think its pronouncements are great publicity coups, is neither here nor there.

What of the deal struck by EU leaders in Brussels on bolstering the euro? It was probably as much as could have been expected. Angela Merkel has acceded to the idea of fiscal union, though she means enhanced discipline over euro members rather than a genuine pooling of debts and deficits.

The deal, limiting “structural” budget deficits of eurozone members to 0.5% of gross domestic product, imposing fines on those whose deficits exceed 3%, accelerating the permanent European Stability Mechanism and making available an extra 200 billion euros in firepower, makes sense as a resting place for the eurozone.

We have to get from here - big budget deficits and tough austerity programmes - to there. Comments by Mario Draghi, the president of the European Central Bank, left open the question of how much the ECB will be smoothing that journey.

We will see what happens in the coming weeks. My sense is that markets are suffering from crisis fatigue and will give the deal the benefit of the doubt for now. But nobody can pretend the crisis ends here.

What is the underlying problem? In introducing the Bank of England’s financial stability report a few days ago Sir Mervyn King rehearsed a familiar line.

The eurozone crisis, he said, was all about imbalances. Some members have big payments surpluses, others have deficits.

As he put it: “Governments will have to confront the underlying causes. A loss of external competitiveness in some euro-area countries has led to current account imbalances and large build-ups of private and public debt, much of it external. The problems in the euro area are part of the wider imbalances in the world economy.”

Hearing that I thought it was a brilliant summation of the problem. Then I thought there must be more to it. Imbalances are like the hunchback of Notre Dame’s “the bells”. They ring so loud they can make you deaf to everything else.

Emphasising global imbalances, whether for China, America or Europe, sounds like a counsel of despair. They have been around for decades. In an ideal world, they would not exist. In the real world they do. No system can deliver perfect balance.

I am not attacking King for being unduly gloomy. It would be alarming if he were suddenly cheerful. It is known in the Bank there are three distinct views: the optimistic, the gloomy and the governor in the corner with a dark cloud over his head.

The point is that the imbalances story does not fit the eurozone that well. True, countries like Germany, the Netherlands and Austria have big surpluses, while Spain, Portugal and Greece have deficits.

True, some countries went into the crisis with a lethal combination of big budget and current account deficits. That applied particularly to Spain, Portugal and Greece. Things, however, have moved on.

Ireland is already back in current account surplus, which did not prevent another tough austerity package last week. Every other eurozone country is correcting its external balance, says the OECD.

Greece, having had a 15% current account deficit in 2008, will be down to just over 5% in 2013. Portugal goes from 13% of GDP to less than 2% and Spain from 10% to 2%. France has a small current account deficit of just over 2% of GDP. Italy’s is 3.6% this year but falling to less than 2% in 2013.

As an aside, my long-time forecast of Britain returning to current account surplus is backed by the OECD, which sees surpluses for 2012 and 2013. Trade figures on Friday showed a sharp improvement.

The issue for the euro is not imbalances but what lies behind them. Nobody would claim Britain’s return to surplus, should it occur, is the sign of a healthy economy. It is happening because of depressed activity.

What is true for Britain is also true for the eurozone. Imbalances are narrowing because of extremely depressed conditions. Weak demand as the eurozone slides into recession is shrinking the imbalances.

The big long-term question, and this takes us back closer to King’s point, is whether eurozone members can claw back the huge loss of competitiveness they have endured since the euro came into being.

Since 2000, German unit labour costs have risen less than 5%. France’s, in contrast, are up 25%, Spain’s more than 30% and Italy almost 40%. Greece and Ireland have clawed back some lost competitiveness (but with a huge gap to close). Most countries will not begin to close the gap in the next two years, according to the OECD.

That, beyond the short-term rescue, is the long-term issue. Is there a mechanism for countries to grow their way out of trouble — and prevent debt from rising inexorably — while remaining in the euro?

I am not sure there is, or that it is in the gift of politicians to bring it about. The agenda in Brussels was about keeping the euro together, with or without Britain’s help. Call me Anglo-Saxon, but there will surely be future summits where talk turns to how to manage the exit of some eurozone members.