Since November 2009 there has been a crisis in the Euro zone. It started as a problem specific to Greece after her general election last October was followed by the new Greek socialist administration announcing that her fiscal deficit was in reality double what the previous administration had claimed. Not only was the new level estimated at just over 12 1/2% of Gross Domestic Product concerning in itself, but also the misrepresentation of official Greek statistics went down just about as badly. Markets being what they are they looked for other countries to which the theme of a lack of economic competitiveness and rising fiscal deficits could apply to. So Portugal Ireland and Spain were dragged into the debate, with only Ireland responding quickly to it with an austerity budget which has bought it some relief. However the whole concept of the Euro has been shown to be flawed and damaged.
The essential flaw at the heart of the Euro concept came from its design and concept. Successful currency unions require political and fiscal policy union and this was ignored at the Euro’s creation. Since then Europe’s politicians have been pressing hard for further political union with moves such as the Lisbon Treaty. Unfortunately for them the no vote to the Lisbon Treaty in Ireland was very damaging as Ireland has been treated very favourably by Europe in terms of financial largesse and would ordinarily be expected to be in favour of it . Whilst they got the Lisbon Treaty approved the fact that they required a second vote in Ireland and that the UK’s politicians from all the main parties (apart from the United Kingdom Independence Party or UKIP) turned away from even the suggestion of a referendum meant that the concept of democracy in the Euro zone was weakened. Only time will tell whether Europe’s leaders will be able to continue their drive for political union but just looking at the economics of the Euro it would have been far better to have done this first. With political union would come fiscal union.
In the UK it has been very common for us to only consider our own situation where we have a strong Euro sceptic camp which resides overtly in UKIP but also the Conservatives in particular have a Euro sceptic camp. The Euro is usually expressed as something you are for or against. I would like to introduce another camp those like me who have no conceptual objection to a currency union but feel that the Euro as currently designed was and is flawed. I can see gains in a currency union but always thought that the Euro’s flaws would sooner or later lead to trouble. Staying with the UK you would also need people to accept political union and fiscal union and if you look at our situation as expressed by opinion polls events appear to have taken us further away from this rather than nearer.
However my contention is that we have got so tied up in a domestic argument we have failed to appreciate what has happened in Europe. This crisis has revealed to me something very significant and it is the decision of the German Constitutional Court in 1993 which restricts Germany’s potential involvement in any bail out in the Euro zone. Ottmar Issing who used to be a Bundesbank Council Member and is now the Currency Strategist for the European Central Bank feels that this also precludes Germany from offering a “guarantee” to Greece which could be interpreted as a bail out. As Germany is in effect Europe’s paymaster this is a big problem for the Euro zone in its response to the crisis. It explains some of the dithering that has gone on and if you stop and think for a moment is actually a worse criticism of the Euro zone and its leaders. Up until now I have accused them of dithering, now it is looking possible that they are incompetent and have not considered what they would do in the situation they now find themselves in. Currently constitutional lawyers in Germany must be able to command high fees as a possible solution is sought!
An International Comparison
If we look at the United States it is true to say that some of her states are in a similar position to Greece in terms of fiscal deficits. Perhaps in the case of California it may also be more significant for the world’s economy than Greece. However because the United States has fiscal and political union these problems are not impacting as severely internationally. In this respect America got it right and Europe got it wrong. When the Euro was first conceived I initially thought that the arguments deployed in the UK also applied to us joining the United States and accepting the dollar as our currency and in many respects joining the US dollar would be more logical as a theoretical concept. Now I am not actively arguing for this but consider the concept theoretically, at least we would be joining a currency union that works.
As the crisis has built the foreign exchange markets have shown their opinion with the Euro falling from 1.50 versus the US dollar to 1.35 so a 10% fall. Against the Yen it has fallen from 134 to 121. One side effect of this is that it may help countries such as Greece to export as it helps their competitiveness problem to the extent that they trade outside the Euro zone. I wonder if Greece’s Prime Minister is so anti these “speculators”?
Greece and her Austerity Budget
As I type this Greece has agreed a new austerity budget which is planned to improve her public-sector fiscal position by 4.8 billion Euro’s. This was needed because the previously announced measures were insufficient to achieve the targeted reduction in her fiscal deficit from 12.7% to 8.7% of GDP. The move is split fairly evenly between higher taxes on sales,alcohol and tobacco and planned reductions in government spending mostly comprising a reduction in spending on civil service pay. In a move which may also resonate in the UK Value Added Tax has been raised from 19% to 21% as part of these moves.
The sum total of today’s plan if achieved adds up to 2% of GDP and combined with previous measures should now get Greece within range of her objective for this year. In another form the Greek Government has effectively said, over to you now Europe!
This plan had to a degree been leaked and accordingly had already begun to impact in markets. So Greece’s ten-year government bond yield had fallen to 6.17% as of last nights close and the spread over Germany’s ten-year bund yield had fallen to 3.06%. Initial reaction today has led to a further improvement where the yield is 6.03% and the spread has dipped below 3%. So far so good.
An inherent danger for Greece
As these austerity measures impact they will affect the underlying economy. The danger is that Greece’s economy will be adversely affected by these measures and in truth it is hard to see a scenario where it will no bet. I saw a report today by the French bank BNP that states that Greece may struggle to grow at all over the next 3 years and this is important when you are measuring public sector deficits against economic output. Ideally you need growth but in Greece’s situation I think it is best to merely hope that she will not suffer too much of a recession from this.
On this subject I wish to quote from one of the comments on this site from last week.
It is interesting to note that 2 large firms -OTE (telecoms) and Jumbo (toys) – today posted net results that were significantly affected by one-off levys by the government (of 113m and 10m Euros respectively) aimed at reducing the national deficit, so there seems to be evidence that the government is indeed taking urgent action.
Leaving aside the (important) issue of public reaction to the extra austerity measures, presumably it follows that whilst they may impress the EU, their effect will have a devastating effect on Greece’s GDP.
I hope that the effect is not devastating but only time will tell on this and in the game of poker and realpolitik it is now Europe’s move as it is clear there will be adverse effects for Greece…..