Is a queue forming at the EU’s fiscal soup kitchen?

February 11, 2010

copelandl Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own.

Back in the prehistory of the euro zone, I wrote an article in the Times trying to work out how the game currently being played out in Europe would end.

Re-reading it, I think on balance I stand by my 1997 forecast.

Of course, back then it seemed far more likely that the major default threat would come from Italy or Belgium – Greece wasn’t even a member (and seemed unlikely at that stage to be admitted), but otherwise the endgame still looks the same to me.

The situation is as follows. Greece’s national debt is over 110 percent of its GDP, a figure which is growing by 12 percent or more every year (we cannot be sure, because there is widespread suspicion that the government is understating its deficit).

Given that Latin American countries have been often defaulted with far lower levels of debt, the markets are worried – which is hardly surprising, since Eurozone members are in exactly the same situation as third-world countries borrowing in dollars.

It cannot be emphasised enough that, at least in principle, the euro is nobody’s domestic currency, in the sense that no national government or central bank has the right to print it in order to repay its debts. Printing euros is the sole prerogative of the European Central Bank and its governing council, made up of representatives of all the euro zone member countries.

It follows that, without assistance, Greece will need to generate a substantial surplus in order simply to cover the interest on its debt, let alone to start repaying the principal. In recent weeks, the markets have woken up to the danger that Greece’s problem will be exacerbated when the ECB starts to raise interest rates from their crisis levels towards a more normal range, as it is expected to start doing soon.

Hence, the dilemma facing the European authorities. Should they contribute to paying off Greece’s debts, or should they allow it to default? A bailout was explicitly ruled out in the treaties establishing the European Monetary Union, but until recently the markets either ignored the possibility of default or assumed that the no-bailout clause would be overridden if necessary with little fuss. Their sang froid was reinforced by the banking authorities who insisted that Government debt should be treated the same whichever country issues it, a regulatory requirement which could quite reasonably be interpreted as an implicit guarantee.

Obviously, bailing out Greece would not place an intolerable burden on EU budgets, since it is a small country with debts which are insignificant relative to the European economy. The difficulty is that Italy, the euro zone’s third-largest economic power, has a debt-to-GDP ratio similar to Greece’s, and for Belgium – smaller, but emblematic for the EU in a way Greece will never be – the figure is around 100 percent, so there could be a queue forming at the EU’s fiscal soup kitchen.

Recently, Germany has been talking tough, trying to shake the market’s confidence in a bailout, with considerable success, as can be gauged from the fact that it currently costs over 4 percent to ensure against a default on Greek debt and 1½ percent for Italian debt. But is it really likely that Germany will be able to hold the line in the councils of the EU, against the assault of at least 5 countries which are potentially facing a default meltdown: Portugal, Italy, Greece, Spain (the so-called PIGS), plus Belgium? Add the fact that France will certainly want to take the line of least resistance, whereas Germany can probably count only on the support of the Dutch and Austrians, and the battle looks unwinnable.

What happens next? I suspect that brotherly feelings are no more prevalent inside the EU than anywhere else. As voters in surplus countries realise they face years of paying taxes to support their less responsible euro brethren, I expect them to react in either or both of two ways: with new political movements which may well turn ugly, and with increasing demands on their politicians for more spending. After all, if they can’t beat ‘em, they may as well join ‘em in what I previously called the euro zone’s poverty trap. The medium-term outcome will be a flood of euros as member governments’ debts are monetised, with obvious consequences for the currency.

There is one very important caveat to this conclusion, however. In the last decade, both Britain and the U.S. have followed fiscal policies every bit as irresponsible as Greece, and while neither is likely to default formally, both will ultimately inflate away their debts, so the prospects for the pound and dollar are every bit as grim as for the euro. The real significance of the euro zone debt crisis is that it makes it absolutely clear that, much as we may need a new reserve currency to replace the dollar, the euro is in no position to fill the role. The renminbi is still unconvertible and subject to all sorts of restrictions by the nervous Chinese economic policymakers, but if they could only find the courage to dive into the pool, they would surely scoop the gold.


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Well written article, comparing the Euro dilema with Britain and US. The article would have been complete by giving the percent of the national debt of US and Britain.

Posted by k shen | Report as abusive

I understand the problems of the eurozone, all these countries indebtedness and how to bail them out. Britain is not in a position to plough money into these countries and it should be understood that the 20% contibution to the EU should not be spent on bail outs but on trying to get the eu moving again
Germany and France should if they wish bail out these countries. The unthinkable should be allowed or made to happen, disolve the Euro and go back to a common market giving national countries power to sort out their own economies.

Posted by T Watson | Report as abusive

Very good article. It looks as if bailing out Greece as well as not bailing out Greece will weaken the Euro albeit in different ways. Perhaps allowing Greece to default is the only way long term behaviour can be expected to change.

Posted by G.Stokholm | Report as abusive

Should Germany buy out Greece’s debt, surely it would be conditional on their putting into place a management consortium, to make efficiency savings and thus earn a healthy return on their investment. The new management would be under no obligation to the Greek people, only their shareholders,so could make the tough decisions necessary to turn the country around.
Having no powers of authority, the Greek government would be a puppet government which they would need to maintain as a matter of form. Let us call it the Vichy Government as the precedent has been set in other countries.
Did you say Belgium next? And how is Poland getting on?

Posted by M Aspden | Report as abusive

when is the question about who is recieving the vast interest revenue going to be addressed?
Who is the money maker holding the world to ransom. The european countries and international countries are falling to this greedy monster almost weekly now, and still the interest is what is crippling every nation. how long before Britain going to fall to this monster?? Who amongst our leaders has not indulged in vice and therefore cannot be blackmailed into silence? Who amongst our leaders has the gumption to rid our civilisation from these monstrous leeches who have only power and utter domination in thier hearts. Who amongst our leaders arenot afraid to rid us of the few destroying our world, if it is five or six big families then surely there is a mass of men and women in positions to challenge and rid us of thier insatiable greed and abhorrent lack of compassion for fellow man.

Posted by mrs mcmetal | Report as abusive

We should Not Bail out any EU country they should abandon the Euro in the same way that we dropped out of the IMF under John Major and pay the price as we did.

Posted by J Russell | Report as abusive

It is refreshing to read at last some sound ideas that summarise the nonsense of the gradual EU marriage . European governments have bloated their respective state sectors with scant regard for economic cycles , epitomised by the Blair/Brown mantra of “the end of boom/bust .

This championed the concept that a well managed state could counter any cyclical effect that was thrown at them. Productivity became confused with asset inflation
until the ridiculous scenario of 27 states being shoe- horned into economic equality whilst being stripped of any fiscal tools to dig themselves out of the swamp.
Interest rate hikes ,quantitative easing ,or devaluation are not available to the PIGS economies leaving them saddled with all the social chapter costs of the EU and no way out. A German- Franco bailout creates a moral hazard , why cut back when the big economies will bail you out.?

How can you have a uniform fiscal policy when economies such as say Italy and Germany have such a diverse attitude to paying taxes, Italy sees avoiding paying as a Sport, Germans see it as a social necessity. Any fiscal measure will have the same disproportionate diverse effect. Meanwhile the avaricious public sector steals a bigger slice of the pie and steadily grows with each wave of politicians inventing more creature comforts for an increasingly unproductive Europe. Any idea of the neo- classical economic theory of production has become regarded as old thinking .

I share the view expressed that the ASEAN economies armed now with their free trade agreements and pegged currencies are not going to make the mistakes of the EU and are poised for a period of outstanding growth . America has a better chance than europe since it is a leaner machine and reacts to stimulus.

The solution for Europe (and it will not happen) is to retrace the steps of this perilous meander and return states to their own currencies by their choice , free to remove social measures forced upon them yet retaining the free trade criteria. Free to keep the comparative advantage of trade which was the reason for the union in the first place .Bailing out the PIGS is the job of the IMF formed as a global institution of salvation since it has always imposed uniform controls in return for funding and does not cause the alarms that may be felt in the villages of the Rhone and Rhine valleys when the poor men of Europe come knocking at the door.

Posted by Geoff Howard | Report as abusive

You see, if it wsere but a queu with everyone holding a small food pail. But these are heavyweights who each want a truckload of banknotes. They soon won’t find anyone to buy these bonds but will have to “monetise” the scrap, leading ever faster to sovereign default.

Posted by CrisisMaven | Report as abusive

Good article that speaks volume of the level of incompentent politicians at the head of States. Most individuals would be a better job than most of the EU, UK and US finance ministers :-)

Posted by Christophe | Report as abusive

Good point on domestic currencies.

All the countries report their debt as being in ‘domestic’ currency – but in fact, for practical purposes all EMU debt should be seen as external, there is no easy option to print a way out of this mess.

Will Germany ever sanction a printing press speed-up? Perhaps, inflation is the least bad way of sharing the pain out.

Posted by Chris A | Report as abusive