Sunday, November 13, 2011

The ex-editor of the Financial Times, Andrew Gowers, has had the courage to publish this astonishing me culpa this morning in The Times. As I can't just link to it, I've reproduced it in full.

It's a comprehensive recognition that he was wrong to support the introduction of the euro ten years ago and that not all eurosceptics deserved to have their arguments dismissed as lunacy. Of course, like the rest of us, he has no real idea of what should be done now, as Europe's elite struggles with the choice between "the cholera and the plague".

I'm intrigued to see he uses a phrase I've resorted to several times over the decade, viz. that the euro would "collapse under the weight of its own internal contradictions". So I wonder if it was in common use before I adopted it.

The article also reminds me of that old cynical view that every major reform results in the exact opposite of that for which it was designed.

It’s confession time. Exactly 10 years ago, I was cheering as the preparations to launch notes and coins for Europe’s bold new single currency reached their climax. For more than a decade before that, mine was among the voices egging on Europe’s leaders as they agreed to pool control over their money and form an economic and monetary union (Emu). In the years that followed, with the euro establishing itself as an instrument of European power and integration, I was one of those celebrating its success and urging Britain to join the party.

I now believe I was wrong. In recent months, as Europe’s leaders have struggled impotently with debts and deficits, with stricken banks and sluggish economies, with angry voters and helpless political institutions, the awful possibility has taken shape that they will fail.
Last week, as Italy teetered on the brink of the abyss that has already claimed Greece, Portugal and Ireland, a prospect loomed that I and other advocates of the single currency long regarded as unthinkable — that of the euro collapsing under the weight of its own contradictions, causing a financial crash and depression in Europe and sending economic shockwaves around the world.
This is not (yet) a prediction. It is possible that apocalypse will be avoided and that the EU will find a way of muddling through to save the euro in some form. Some argue that failure is inconceivable given what’s at stake.
But even so, for me something fundamental has changed. The travails of the euro have done irrevocable damage to the political assumptions I have carried around for most of my adult life — that the evolving “European project” is, for all its much-discussed faults, by definition a force for good; that economic integration driven by the EU is the essential motor for peace, prosperity and economic development across the continent.
In fact, watching Europe’s leaders floundering and fumbling for the past 18 months and more, it is hard not to conclude that the single currency is achieving the precise opposite of what its progenitors intended.
Where they promised greater economic stability, the euro has exacerbated uncertainty and volatility. Where the single currency was supposed to promote trade and integration, it has instead created new divisions. Where it was portrayed as a vehicle to enhance Europe’s influence in the world, it has reduced the EU to an international laughing stock, or worse. Where it was promoted as a forge for closer political co-operation in Europe, as part of the formula to end the wars and bloodshed of the 20th century, it has fuelled conflict, undermined democratic structures and reawakened age-old national resentments.
As David Marsh, a banker, former journalist and author, whose recently updated book The Euro remains the definitive study of the subject, puts it: “The single currency bloc stands revealed as a zone of semi-permanent economic divergence, political polarisation and built-in financial imbalance. For the broad mass of the European electorate, the notion of ‘Europe’ has become a byword for unpopular and painful economic restructuring. Emu governments have decided to commit colossal sums of taxpayers’ money they cannot afford to heal internal disparities they cannot conceal to shore up an edifice many believe cannot stand — at least in its current form.
What makes this litany all the more humiliating is that we should have seen it coming. The current euro mess is not merely a story of incompetence and political weakness at the highest levels in Athens, Rome, Berlin and Paris — though it is certainly that. It is not based exclusively in a failure of technical execution by policy wonks — though it is that, too.
More than either of those, it is a comprehensive and devastating failure of political leadership and economic understanding — Europe’s worst fiasco since the second world war. Its roots go back to the origins of the project and, to me regrettably, its consequences now threaten the long-term future of the European Union.
In a sense this is Europe’s Lehman Brothers moment, with plenty of blame to go round.
All of those involved — the political leaders who signed the 1992 Maastricht treaty that created Emu, the central bankers, officials and policy experts who designed the common currency and its institutions, the cheerleaders in the worlds of journalism, economics and business — bear a share of it. All of us paid too little attention to the arguments of those who opposed the project in principle and of those who worried about its viability.
For there were enough voices, both in continental Europe and in Britain, warning of the economic and political risks inherent in the euro’s conception and design as the project gained momentum in the 1980s and 1990s.
They argued variously that there were no examples in history of lasting currency unions being established without the backing of a political union; that the European Central Bank would lack the firepower and authority to underpin the continent’s financial system; that a “one-size-fits-all” interest rate would generate damaging and destabilising imbalances between euro member states; that countries locked into a single currency with no possibilities of exchange rate adjustment could easily develop serious problems of economic competitiveness. Many argued strongly that the project was subject to insufficient democratic consent across Europe, and thus fraught with political risk.
Too often, their arguments were drowned out by the political imperatives driving the project forward and, frankly, by a tendency among euro supporters, including myself, to lump together the critics — the die-hards who had always opposed European integration and who had been mostly wrong, and those who saw the point of Europe but worried about the euro — under the prejudicial label “sceptics”. It was, in that sense, an epic-scale exercise in “group-think”.
Last week I spoke to a number of the British luminaries who were prominent in the pro-euro campaign 10 years ago. They are not a happy bunch. They also, by and large, prefer not to speak for the record (unlike Michael Heseltine, who told fellow Tories last week that Britain should still join the euro “in order to become more like Germany”.) “I don’t want to get involved in polemics right now,” said one leading pro-euro businessman. “If I speak out, I fear I’ll become a target,” a leading economist said. Another very prominent pro-euro figure responded that he had moved on to new areas of study and “I really doubt my views on the euro crisis are of any interest”.
But as they spoke to me, mostly off the record, four key themes emerged. First, most insisted that for reasons of economic structure and competitiveness, the idea of a common currency remains right in principle — with or without Britain. It was needed to underpin the single European market, launched with the strong support of Margaret Thatcher’s government and of British business in the 1990s. It was needed to maintain Europe’s peaceful post-war order.
As a continent of small to medium-sized nation states, Europe badly needs a framework to govern its economy,” said one prominent businessman with new Labour affiliations.
The euro was set up to address a real need which has not gone away, namely to underpin the single market,” said Will Hutton, one of the authors — with Chris Huhne, Adair Turner and others — of the 2002 pamphlet Why Britain Should Join the Euro and one of the few proponents still prepared to carry the banner aloft in public. “I’m not prepared to run up the white flag just yet. There is still a chance that, over time, the euro will have the positive effects on trade, growth and living standards that some of us predicted.
Don’t forget that the shadow of past conflicts hangs heavy over Europe — the shadow of Germany. France was right in its instinct at the outset. Europe needs a system to help it cope with German economic power. That is the benchmark against which all other European economies will continue to be tested: better to do so in an organised framework than with free-floating currencies.”
Second, all agree that the design of the euro as launched 10 years ago was fatally flawed, largely for political reasons involving those former bitter enemies France and Germany.
The politics was present at the moment of the euro’s conception, when France persuaded Germany to give up the deutschmark and embrace the new currency as a quid pro quo for consenting to German reunification. The problem was that the two leaders who struck this grand bargain had fundamentally different ideas on how the new currency should be organised.
France’s François Mitterrand saw it as the precursor to a political arrangement to keep German power in check. Germany’s Helmut Kohl — who as Ken Clarke once said had “no interest in economics” — was more preoccupied with his own people’s political attachment to the D-mark. Mindful of Germans’ memories of the hyperinflation and economic collapse that brought Hitler to power, he wanted a currency moulded in the D-mark’s image. There would be no “economic government” or fiscal transfers from richer countries to struggling ones; no bailouts of governments that got into trouble; no central banking lender of last resort; no possibility of exit from the single currency, or at least not without a country leaving the EU altogether.
Most, if not all, national currencies and economies are underpinned by measures enabling governments to iron out economic imbalances or help regions in trouble. Europe’s leaders decided to do without them. Instead, they agreed on a set of budgetary rules that were supposed to guide euro member states’ taxing and spending decisions, specifically a stipulation that a government’s budget deficit never be allowed to exceed 3% of a country’s gross domestic product.

These were the central elements eventually agreed in the Maastricht treaty, and as many observed at the time, they were a fudge. It was not clear how the budgetary rules would be enforced. Nor was it obvious how the monetary union would cope if any of its members got into financial trouble.

To make matters worse, a queue of European countries rapidly formed at the door, begging to be let into the euro, including countries with mountainous debts and questionable governance such as Italy and Greece. Reservations expressed by the Bundesbank and other guardians of economic stability were overruled. The political need to build an inclusive club overrode the imperative to build one that was sustainable.
Here is the verdict of elder statesman Helmut Schmidt, a man with a lifetime’s experience and more understanding of economics than all of his successors as German chancellor put together: “They invented the euro and invited everybody to become a member of the euro area. And this was done without changing the rules or clarifying the rules beforehand. This was when the great mistakes were made. What we are suffering now is the consequence of that failure.”
A leading British pro-euro businessman agrees. “It was a fundamental flaw that there was no exit clause. A great many of the problems we have today would not exist if a country in trouble such as Greece had been able to leave the euro.
Greece should never have been admitted to the club in the first place. People knew it was coming in under false pretences and with fiddled figures. Finally, a single currency has to have a single fiscal authority. The absence of such an authority was a serious birth defect.”
Of course the design of the euro was flawed,” Hutton agrees. “Of course it should have been confined to an inner core of EU member states to begin with and should not have admitted Italy or Greece.”
Third, even the project’s staunchest supporters concede that since the launch, member states’ management of the euro has been somewhere between miserable and catastrophic. One obvious sign of trouble came a few years in when France and Germany, having agreed to cap government deficits at 3% of GDP, agreed to throw the rule overboard when they found keeping a lid on spending too hard.
Was it naive to expect that France and Germany would stick to rules which the latter had been most insistent on imposing in the first place?” one pro-euro economist said. “Possibly. But the fact that they disregarded it was a serious blow to any hope that the euro would bring with it prudent management of the public finances.”
In the growth years that followed the euro’s introduction, many of its members went on a public and private-sector borrowing spree. The financial markets obliged them by shrinking the differentials between interest rates charged to government and private borrowers in the weakest economies and those in the strongest to almost zero. In other words, investors were behaving as if they believed that there was exactly the same — minimal — risk of a default by Italy, Spain or Greece as by Germany.
And all the while, the peripheral members — the countries that came to be known collectively as “Pigs” (for Portugal, Ireland, Greece and Spain) — were steadily losing competitiveness, thanks to the fixed exchange rate and inflexible economies. Mountainous debt, sluggish growth, poor productivity — it is the combination that led directly to the crisis Europe faces today; and it is a treadmill from which these economies have no chance of emerging for a decade or more if they stay in the euro.
Other countries, of course, have had a boom-and-bust problem in recent years — notably our own. The difference, though, is that having made a mess, we are clearing it up under a government that can claim a popular mandate — and being given the credit, in the form of ultra-low borrowing costs. For euro members, given the warped system by which the currency is governed, the task of resolving the crisis is infinitely more complicated and contentious.
Miserable is also the word for the eurozone’s crisis management. In attempting to mop up the mess, Europe’s leaders have been constantly behind the curve, coming up with half-measures that buy them a moment’s calm before a fresh and even more vehement burst of market fury.
If it appears as if they have been acting with one hand tied behind their back, that is because they have — thanks to the flaws built into the Maastricht treaty, and the political difficulties caused by exposure of those defects.
The “no bailout” clause was a fiction that was brutally exposed with the first, failed Greek rescue in May of last year.
The “independent” central bank is struggling to maintain its independent status, as it faces mounting pressure — against vehement opposition from Germany — to act as lender of last resort and buy up the troubled economies’ debt.
Willem Buiter, another of the economists behind the original Why Britain Should Join the Euro pamphlet, is now chief economist at the global banking giant Citigroup. He wrote in a recent note to investors: “Europe was utterly unprepared, institutionally, politically, ideologically and culturally, to handle such fundamental financial and economic crises and the distributional conflicts that they entail. The result has been a succession of panic- driven policy measures and provisional, tentative institutional innovations that often were revised as soon as they had been announced.”
Yet the fourth point our pro-euro businessmen and economists make is that having set out down the road, Europe is doomed to carry on. There can be no turning back. It may be messy, but the consequences of failure and the collapse of the single currency would be much worse.
It is absolute and total nonsense to pretend, as some in Britain appear to, that there is some kind of low-pain escape,” says a company chairman. “If anyone in the UK — europhile or eurosceptic — thinks we can just sit by while the euro implodes without incurring serious damage, they’re mad.”
Failure is unthinkable,” says another businessman. “Germany won’t let it happen.”
A Greek exit from the euro would be a disaster,” Hutton adds. “There would be massive capital flight from other peripheral countries and the resulting tensions could scupper the entire European Union.”
John Llewellyn, an independent economist who has written extensively on the euro, says Germany’s chancellor, Angela Merkel, may have been criticised for weak and dithering leadership during the crisis, but we should not underestimate her determination to keep the show on the road. “Would [Nicolas] Sarkozy [the French president] and Merkel build the euro if they were starting today? I doubt it. But they may well ultimately conclude that it’s better — and cheaper — to fix it than to let it collapse.”
The big question is: on the road to what? For every imagined solution to the crisis put forward in recent months has been countered with a formidable array of objections or obstacles.
A financial “big bazooka”, in David Cameron’s phrase, to intervene in the market and show the world that the eurozone is serious about supporting its weaker members? Too difficult, according to participants in the last round of summits. Germany won’t sanction the funds; France is deep in debt itself; and China — the target of a humiliating begging mission from Brussels two weeks ago — won’t help either.
A fiscal union — involving the pooling of national budgets and/or the issuing of joint euro-bonds by eurozone governments? Desirable but unfeasible, Buiter says. “Whatever the pros and cons of fiscal federalism as a means of imposing fiscal discipline on EU or euro area member states, it is, for the foreseeable future, a political non-starter,” he says.
Secession from the euro by one or more member states? It was not a possibility the currency’s founders were prepared to contemplate. But after George Papandreou, the Greek prime minister, had the temerity last month to propose holding a referendum on the latest bailout, Greece’s forced departure was openly discussed by Merkel and Sarkozy.
An “inner euro” comprising Germany and other countries who understand budgetary discipline? Sounds attractive. But getting there would make unscrambling an omelette seem like child’s play. And who would be in? Without France it would make no sense at all, and France with its own considerable debt burden is widely seen as the next domino in line after Italy.
That exposes the real problem for all to see: not just debt and deficits or banks and finance but politics with a capital P. That is why I wonder whether the euro will in the end be saved and why I fear for the future of the European Union.
Euro-politics has already felled five governments out of the eurozone 17: Ireland, Portugal, Slovakia, Greece and Italy. The demise of a sixth in Spain’s forthcoming election seems a foregone conclusion. And no one has the faintest idea if new governments being formed in Greece or Italy have a chance of getting to grips with their problems. Hence the alarming upward trajectory of interest rates on Italy’s debt at the end of last week. The crisis had simply moved beyond anyone’s control.
The point that looks so obvious in hindsight is that countries such as Greece and Italy do not respond in predictable ways to rational Teutonic calls for discipline and hard work. Their politics are chaotic and corrupt. Handed an easy option — such as a hard currency and guaranteed low borrowing costs with no real pressure to reform — they took it. Now that the emergency is forcing governments to act, it is understandable that the voters protest — and blame Europe as well as their own politicians. In some of the problem countries, violent protests are on the rise, sometimes featuring anti-German slurs of a historically uncomfortable variety.
But everywhere you look in the eurozone, governments are in trouble. Sarkozy’s poll ratings are in the tank — lower than any other president in the history of France’s Fifth Republic. Merkel is under severe pressure at home for presiding over what Germans, in one of those phrases that can become electoral poison, call a “transfer union”. In the words of Sir Richard Lambert, my predecessor at the Financial Times and subsequent CBI boss, “the big political problem is that nobody voted for this”.
That is why I now conclude that the rush to create the euro in the past 20 years has been a historic mistake with risks far outweighing the likely rewards. Europe’s leaders should never have launched a currency based on such flimsy economic and political foundations. But they did and the current mess is the direct result. To resolve it, Merkel in particular has to choose between cholera and the plague.
Either she uses the European Central Bank to throw hundreds of billions more into supporting Italy, Greece and the other delinquents, thus saving the euro but enraging her electorate, or she starts urgent talks to reshape the euro with fewer members and tighter rules.
The latter course is fraught with danger. It could easily collapse in acrimony and turn current market tremors into a meltdown and a deep global recession. So in the circumstances, and for the sake of avoiding that fate, there is nothing for it but to overlook the history of this misshapen creation and throw money at it. The political consequences, though, hardly bear thinking about.

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