Now the Euro crisis infects the world


              We few who wrote and spoke strongly against the Euro in the 1990s did so because we thought it could not work. We thought it would make people poorer, destroying jobs and output.

             In the two books I wrote I stressed

1. They wanted countries to join which were nowhere near ready to join on their own sensible criteria. The high borrowing, inflation and devaluation prone countries were not  compatible with Germany.

2. The Euro area authorities  had insufficient political control over spending, tax and borrowing when they needed to stop countries free riding by borrowing too much.

3. They would find out that belonging to a single currency meant they were sharing the bank account with the neighbours. It implied the neighbours would pick up excessive bills. The neighbours would be dragged into paying more tax and sending more transfer payments to the weaker parts of the union.

           So it is proving. Yesterday Mr Barroso helped trigger a world market crisis by saying the contagion from Greece, Portugal, Ireland and Cyprus was now spreading to Italy and Spain. Markets had been warning this could happen.  It was altogether more serious when Mr Barroso himself said it is happening. Mr Trichet at the European Central Bank followed up by saying the Bank is in the business of buying bad bonds from stressed countries. That led people to ask why were the bonds still so weak, and how much buying could the Bank plausibly do?

¬†¬†¬†¬†¬†¬†¬†¬†¬†¬† Why did two such senior Euro figures make such unhelpful statements?¬† In the case of Mr Barroso it may be that he was so concentrating on the audience of the member states that he forgot the impact his words could have on everyone else. Or it is possible that he wanted such an impact, because he is trying to get the member states to do something when they would rather forget the problems between meetings. Mr Barroso wants the EU states to complete the ratification of new rules for the bail out funds, and wants the Euro area to intervene more rapidly and with convincing sums of money behind it. ¬†Mrs Merkel’s people expressed their displeasure at Mr Barroso re-opening this issue.

Mr Trichet may simply have run out of any answers which could reassure investors. He would be damned if he said he was not going to intervene, and damned if he said he would. If he ruled out intervention it was a further sign that Euroland was not yet grown up, that it did  not yet  recognise the need to restore some balance to its troubled debt markets. If he said he would intervene it highlighted the lack of financial firepower of the zone to sort out Italy and Spain on top of the four countries already recognised as debtors of the system.

            So what are the options from here? Each time we review them there is a predictably bigger mess to sort out.

             I still advise the Eurozone to undergo an orderly break up.It is the least bad option. If they had pushed Greece and Portugal out a year ago they  might have been able to contain the pressures. Now it is more difficult  to keep Spain and Italy in.

                They of course will not want to do that. They are more likely to move more rapdily towards a stronger European economic government. That is probably why Mr Barroso said and wrote what he did this week.

                 It is getting a bit late for that. Such a Euro sovereign will need to impose credible limits on how much member states can spend and borrow in the common currency immediately. It will need to work with an active European Central Bank, buying in debt of the weak states, issuing its own Euro debts, and printing more Euros to meet obligations and inflate away some of the liabilities. It will have to follow something  more like the US policy.

                This US  policy itself is not proving to be a huge success, but it is the current Establishment orthodoxy.

                How likely is all this? My guess is Euroland will do too little too late again. The main politicians and Parliaments are all on holiday. Mr Barroso will find it difficult to get them assembled and to persuade them to take action. As the full costs of keeping this system afloat are revealed Germany will find it more difficult to sell it  to the German people. The weak countries have to be made more credit worthy. That means the strong countries have to subsidise them one way or another. That in turn means the strong countries have to become less credit worthy. There may be limits to how far public opinion in the stronger countries  will allow that to happen.


  1. The Remittance Man
    August 5, 2011

    My guess is Euroland will do too little too late again. The main politicians and Parliaments are all on holiday. Mr Barroso will find it difficult to get them assembled and to persuade them to take action.

    In August 1914 Europe fell apart largely because the key decision makers were all on holiday.

    I’m not suggesting we are about to descend into all out warfare, but I can’t help wondering if in August 2011 the continent is not about to experience disasterous economic chaos for many of the same reasons.

  2. Gary
    August 5, 2011

    This is a credit crises. It is not limited to the EU. In fact, the UK is the most indebted country in the developed world. More indebted than Greece. I am not sure why we keep banging on about the EU, but I have my suspicions.

    1. Robert
      August 5, 2011

      What you say about the UK is fairly accurate – but apart from several EU members the EU is in a mess. By the end of 2010 the global banking system had lent $2.2 trillion to Portugal, Ireland, Greece and Spain (PIGS). $1.7 trillion (81% of the total) was from European banks. This equates to 59% of European bank capital, with Germany having the greatest exposure at 87% of bank equity. This is compounded by the high gearing of European banks, with an asset-to-equity ratio of 21x versus a more sensible 8.8x for US banks.The negative implications for bank equity and the availability of credit are considerable. If banks are forced to write off just 30% of their exposure ‚Äď a reasonable assumption given current PIGS‚Äô government bonds often trade at much greater discounts – then we estimate that European banks will have to write-off $515bn of equity (18% of capital). US banks will have to write off $112bn (8%). Based on the gearing ratios for European and US banks, the $627bn capital loss would translate into $11.8 trillion ($10.8 trillion for European banks and $1.0 trillion for US banks) of credit at risk; a massive 74% and 7% of European and US GDP respectively. This direct risk is compounded by the systemic risk created through the highly interconnected financial system. Credit will thus become increasingly scarce and expensive. The conclusions for investors are that despite their weak stock prices, banks and financials should still be avoided as well as highly geared companies with short term funding needs, for they face a sharp jump in financing costs.Weak credit means weak economic growth.I have since early 2009 highlighted that the unsustainable debt levels of many industrialised countries would result in sub-par economic growth and continued bouts of market stress. In particular heightened sovereign default risk was a natural consequence along with continued ‚Äėhits‚Äô to bank capital. The banking sector is only as strong as its sovereign, need I say more?

    2. James Matthews
      August 5, 2011

      Umm, because whilst the UK is heavily indebted it can still (for the time being) borrow what it needs at sustainable rates, unlike Portugal, Ireland, Greece and perhaps Italy and Spain. Consequently the euro is under immediate threat as a currency whilst the pound, as yet, is not.

  3. Amanda
    August 5, 2011

    In terms of what the different countries of the Eurozone will and will not allow – hasn’t a German court ruled that the EU has broken it’s own rules, and that no more integration can be allowed without a national vote in each country?

    I also see Mme Largarde was appointed head of the IMP with the threat of a court case for financial irregularity hanging over her as French Finance Minister. So, why was she appointed? Was she so brilliant that even with a potential court case, only she could do the job? Or, is this yet more conniving and corruption from European politicians.

    Why or why are we still tied up to this sinking ship, we may not be very sea worthy ourselves, but on our own and with honest and strong leadership, we can mend our country and make it sea worthy again – and we can start by spending more money on our navy to patrol our waters.

    1. Amanda
      August 5, 2011

      That is, or course, IMF not IMP

  4. alan jutson
    August 5, 2011

    I wonder what the result of all this chaos will be ?

    Will the feckless eventually win, and all their debts be scrapped as we start a new order.

    Will the thrifty be screwed, as their life savings prove to be worthless in value, or will they rise to the top proving prudence was right.

    Cash for many years was king, now it seems it depends perhaps on what type of cash/currency you hold, and where you hold it.

    Politicians have a lot to answer for.

  5. Brian Tomkinson
    August 5, 2011

    I’m not sure which is worse – all the main politicians being away on holiday or having them all waffling on about what they are going to do when it seems plain that most if not all of them simply have no idea. Certainly, every time a Eurocrat or EU leader speaks the markets react badly. Politicians are addicted to politics and power; what do they know about world economies?

  6. oldtimer
    August 5, 2011

    What worries me is the possibilitiy that there will be another rushed, botched stitch up which the UK again meekly agrees to without securing the changes in its EU relationships that the UK needs. If this possibility were to materialise, what chance is there of a recall of Parliament and the Coalition government being held to account?

  7. Javelin
    August 5, 2011

    I think you are spot on when you point out that as well as the politics, timing and planning are the key issues amplifying the crisis – especially because Europe needs to move towards integration or disintegration because it cannot stay where it is right now.

    Moving toward tighter integration is a timing problem. The EU would need a referendum from countries if they are to issue Eurobonds and getting that set up and running the campaign will not move as fast as the debts and interest rates are rising. Defaults will outrun the politicians. The markets are not hares they cannot be persuaded to stop to let the tortoise catch up – they are relentless and demand payment for their loans.

    On the other hand the disintegration of the Euro is a planning problem. It was never planned for. A disorderly exit would be very problematic. You made an excellent post recently explaining a half orderly exit for Greece – preventing a run on the currency. I actually think this would be the least worst option for Greece and Portugal – and possibly Italy until they sort their tax collection out.

    The UKs place in this is interesting because whilst the ECB would issue the bonds I think the UK would be held liable without a further exemption. A treaty would be needed at this point and ratification would be perilous by the Northern European nations. I think this is the point that the UK has maximum power and must wield it’s power ruthlessly and without any pity for the other EU economies. It must not only ensure a fantastic deal it must ensure such a fantastic deal that the EU cannot come back and be revengeful to us in future.

    For example we must be able to opt out of any Euro nation liability. We must not be subject to taxation, control or regulations. We must ensure not only is there no back door for Europe to pull our economy into we must ensure there is no wall to build a back door into.

    1. sjb
      August 5, 2011

      Javelin wrote: “[The UK] must ensure such a fantastic deal that the EU cannot come back and be revengeful to us in future. ”

      Let us sign the treaty at Versailles.

    2. Denis Cooper
      August 5, 2011

      I muts admit that I’m bemused by talk of the EU needing to issue collective EU bonds, and possibly facing problems with getting a treaty change to permit that, when –

      1. The eurozone states are already issuing collective eurozone bonds through the EFSF – three tranches so far – and

      2. They have been effectively albeit unlawfully released from the constraints of the EU treaties, while continuing to maintain links with, and use the services of, the EU institutions, and

      3. All that is needed is a treaty change to provide the missing legal base for them to have the EFSF or something similar, as they see fit, and to legitimise present and future breaches of the existing EU treaties, and

      4. Just such a treaty amendment was agreed on March 25th, and it only awaits national approval and final ratification before it can come into force – it’s here in the Official Journal of EU:

      5. The UK government has already said that national approval will be through an Act of Parliament without a referendum.

      Indeed even the Irish will not be allowed a referendum on this treaty change, Written Answer to Question 65 here:

      “T√°naiste and Minister for Foreign Affairs and Trade (Deputy Eamon Gilmore): The 24-25 March European Council adopted the Decision amending Article 136 of the Treaty on the Functioning of the European Union in connection with the proposed new European Stability Mechanism. This Decision shall enter into force on 1 January 2013 provided that all Member States have notified the completion of the procedures for the approval of the Decision in accordance with their respective constitutional requirements. Having considered the matter carefully, including the legal advice of the Attorney General, the Government is satisfied that the amendment to the Treaty is compatible with the Constitution. As no amendment of the Constitution arises, a referendum will not be required in order for Ireland to approve the amendment to Article 136 of the Treaty on the Functioning of the European Union.”

  8. Bean Counter
    August 5, 2011

    It was always obvious to anyone who is realistic, honest and possesses a basic knowledge of history that a single currency would fail in the absence of political union. This leads me to believe that political union was the goal all along. All credit to JR for his warnings and I would like an apology from the politicians who were so keen for us abandon sterling and join the Euro. I won’t hold my breath.

  9. GJ Wyatt
    August 5, 2011

    Germany can now see how it bought Piigs in a Poke with gallic blandishments.

    As you say, all parties would be now better off if Greece, Ireland and Portugal had been set free of their euro chains. We should not be encouraging the “ever closer union” which Brussels twists each crisis into. It is actually a bear hug.

  10. Acorn
    August 5, 2011

    “I still advise the Eurozone to undergo an orderly break up.It is the least bad option” [JR]. Too true, continuing on this current path is madness. Shutdown the EU and bring back EFTA.

    Remember a while back, we were talking about the serial numbers on Euro notes; start checking if you have some. You want the ones with an X on; avoid M; T;Y; S and V. The German “X” versions will rocket in exchange value when the Euro-zone breaks up. Not good for German exports but, you can’t win them all. ūüôĀ . Best to buy that new Merc or BMW now. If you have a Euro designated mortgage on that Greek or Spanish villa, make sure you know which Euro you will be buying to pay it back.

  11. sm
    August 5, 2011

    They could always print Euros at least for a while. This will lead to devaluation and inflation- whilst they move to full union or split. China could continue to recycle its surplus in Euro debt for a while but look at the US debt situation.

    The trade/currency imbalances will even out sometime, somehow. The defences against inundation only tend to last so long . The water comes in over the top and from below.

    1. zorro
      August 5, 2011

      This is what they will say that they have been forced to do…..


  12. outsider
    August 5, 2011

    The Major government, of which I believe you were then a non-Cabinet member, did our fellow-Europeans an awful disservice by failing to veto the Maastricht Treaty, as some of us argued at the time. The opt-out was an anti-European cowards way out, though it may have seemed a comradely compromise at the time.

    Without Maastricht, the euro would have been a separate project, starting with France, Germany and Benelux, who knew what they were getting themselves into, and could have grown organically. Because it was a political project, the essential Maastricht rules were bent from day one and everyone knew they did not have to comply.

    For that same reason, however,”an orderly breakup” is scarcely feasible now. What happens to Slovakia, the Czech Republic, Slovenia, Malta and the rest? As you rightly say, it would have been possible for Greece to be thrown out for its own good and for Ireland to stay in but default; then tighten up “governance” for the rest on strict Maastricht lines.

    That may still be possible. OK, Italy and Spain must pay 6 per cent on bonds but that is not a particularly high real interest rate and if they borrow short they might be able to keep going after the August crisis while they make structural changes (eg along German social security lines).

    Otherwise, creation of a euroland federal state seems inevitable as you foresaw. One of conditions the UK, as a good European, should now insist on is that Poland and other states joining the EU should be freed of their obligation to join the euro.

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