The euro crisis is following a predictable path. The bills have increased greatly, and are being passed around in the hope the problems will go away.
Unfortunately the countries in trouble are spending too much and earning too little. That has to be tackled, as there will be limits to the patience and the amount of money the EU and the IMF can throw at this problem.
The origins of the crisis stem from the establishment of the single currency. Its architects knew to have a sound currency they needed to recruit countries that controlled their debts and deficits, kept their inflation under control and managed their currencies to demonstrate stability against the others in the system.
If they had stuck to these requirements, the single currency could have worked. Instead, when it came to decision time, they allowed in countries that were nowhere near hitting the targets for these important matters.
They comforted themselves by saying in future countries had to stick to the targets to get their deficits down to no more than 3% of National Income, and to cut their stock of debt to 60% of the same figure. They assumed inflation would level out around the euro area.
In countries like Spain and Ireland, lower interest rates helped fuel a private sector credit bubble and property boom. Germany worked away at making itself more competitive, cutting costs and curbing inflation. Other countries allowed themselves to become less and less competitive with Germany within the zone. As a result, they experienced falling competitiveness outside the zone as well, at the common currency exchange rates with the leading world trading partners.
Like the US, the EU then plunged into a credit crunch. Europeans preferred to think it was just an American problem which infected them a bit. Analysis of the figures shows that the EU built its own banking crisis. It often made the same mistakes as the US in monetary policy and banking regulation, but there was an EU dimension to the crisis as well as a US one. The resulting bank problems, bailouts and recession did untold damage to the financial position of the weakened countries that had not exerted proper discipline over the first ten years of the euro’s life.
So what has to be done to rescue Greece, Portugal, Ireland and the others who could still get into more public difficulty? They need to go back to the tough but sensible disciplines of the original scheme. Countries at risk have to cut their costs by raising productivity or lowering wages.
State deficits have to be brought down quickly so borrowing is under control. Weak banks have to be sorted out by selling assets, writing off losses and finding new owners where needed with the capital to sustain them.
Germany is reluctant to allow the cuts in real incomes to occur by devaluation. The US and UK decided to print more money and to cut living standards by allowing a weaker dollar and pound.
All the time euroland wants a strong euro, the cost reduction has to be undertaken by cost controls. There is a battle going on between those who want the European Central Bank to buy in more weak state bonds and print the extra money, and those who still want the eurozone to be an area of strong currency and low inflation. While they battle it out, expect investors to avoid assets in the countries at risk.
John Redwood is a former Conservative cabinet minister and now chairman of the investment committee for passive investment house Evercore Pan-Asset Capital Management
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