The EU officials who are planning how to save the Euro are following a kind of economic sado-masochism as their strategy. They can enjoy watching member states struggle as they pile on the controls and requirements for them to cut spending and raise taxes. They themselves put up their own budgets and salaries and send the bill to the Union members. The states in difficulty have to enjoy the results of the strategy, saying thank you for the bail outs and cuts which represent the policy.
There are four elements to the approach. The first is to offer loans on quite expensive terms to any state that needs financing. Greece and Ireland have been through the process. The Union is able to use the loan negotiations as a means to exerting more control over the budget of the state concerned. There might be more such bail outs. The cost of Portuguese, Spanish and Italian borrowing is rising despite the Irish bail out “to stop contagion.”
The second is to tighten discipline over the budgets of all member states. The weaker ones are meant to take heed of what is happening to the states going through bail out, and cut enough off spending or put taxes up sufficiently to avoid a similar fate.
The third is to take new powers for the Union to control budgets more strictly in future, limiting the amount any state can borrow in the common currency. States will be fined or made to lodge special deposits with the centre if they are errant. This way the Union hopes to avoid a repeat of the current debt crisis.
The fourth is to impose new rules on how states borrow after 2013. They will require states to put a clause in any loan agreement to say that if the state gets into difficulties it may reduce the amount of interest or the amount of capital it repays. This would replace the current de facto decision of the Union to bail out member states so they can repay existing borrowings.
This is a compromise policy which is unlikely to work. If they succeed in controlling budget deficits after 2013 the warning to the bond markets is needless. In the meantime it is spooking markets and making it more difficult for states to raise money. Preventing a future problem does not solve the current one.
Markets are unimpressed by the bail outs, because they fail to address the underlying problem, the lack of growth in the struggling states. Wiithout growth,cutting the deficits and paying the interest is going to be very difficult if not impossible. The EU’s policy has led it to forecast no growth for Greece and Portugal next year.
Later this week I will set out some of the other options the EU has to save the Euro which would work better.