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Surviving the euro

We need an orderly end to the EU’s disastrous economic experiment

19 November 2011

2:00 PM

19 November 2011

2:00 PM

We need an orderly end to the EU’s disastrous economic experiment

The eurozone crisis threatens the world’s economic stability, but not for the reasons people think. The crisis was predictable and predicted, but schadenfreude is neither appropriate nor affordable. The task now is to extricate ourselves from this mess, and to learn its lessons. This means identifying the factors behind the debt crisis, and deciding how best to bring the calamitous eurozone experiment to an end.

The economic threat comes from a further weakening of an already enfeebled western banking system, as a result of unwise lending and borrowing on a massive scale. Why did the West borrow so much? It has become fashionable to blame China’s huge surplus. The West’s debt problem, it is argued, stems from China’s excessive savings, which let the West borrow cheaply on a vast scale; until the Chinese start to spend more, there is little the West can do. The most recent expression of this theory was in a speech given by the Governor of the Bank of England, Sir Mervyn King, in Liverpool a fortnight or so ago.

I have the highest regard for Sir Mervyn, whom I have known well for many years, and who has proved an excellent governor during the most testing time within living memory. But on this issue I believe him to be mistaken. As he put it: ‘What were the causes of the unsustainable build-up of debt in Europe and elsewhere? They lay in the continuing imbalance between those economies running large current account surpluses and those running large current account deficits… Surplus countries, a group which includes three of the world’s largest four economies [Japan, Germany and China], share a responsibility to respond to our present dilemma by expanding domestic demand.’

This preoccupation with current account imbalances is hardly new. I remember similar fears about Japan during my time as Chancellor in the 1980s. But is this really an economic defect? For these imbalances to be eliminated, capital inflows and capital outflows would need to be precisely the same — an implausible scenario. We are living now in what might be termed the second coming of globalisation, the creation to a considerable extent of a single world economy, the first coming having been the remarkably successful half-century between the end of the American Civil War and the outbreak of the first world war, a period justly dubbed la belle époque.

Nobody then lost any sleep over the current account of the balance of payments. Not least because the figures did not exist. But it is clear from the huge amount of overseas investment that occurred, notably from the UK and other European countries into both North and South America, that the imbalances must have been substantial and persistent. There is nothing perverse about it.

Perhaps a domestic example might help. In the old days when house purchase in the UK was financed by building societies, far and away the largest building society in the country was based not in London but in Halifax — now alas simply the ‘H’ in the failed Lloyds HBOS banking group. This was not because the people of Yorkshire were richer than the people of London and the south: quite the reverse. But Yorkshire people saved, while southerners spent. So the Halifax Building Society came to dominate the UK housing finance market by channelling savings from the poorer north to the richer south.

The Chinese savings surplus has clearly been exacerbated by what we would consider an inadequate social safety net. This obliges the Chinese people to save for their own protection: they will have no welfare state to fund their retirement or help them if they fall sick. This will change in time, if only because the Chinese authorities are increasingly fearful of social unrest. But it would be surprising if substantial imbalances did not persist. There is no use wishing them away, or blaming the Chinese for saving so much. The ready availability of cheap money is no excuse for unwise borrowing or foolish lending decisions. And this is the heart of the problem.

The banks were ineptly regulated, to be sure. Greed and folly of bankers can have greater consequences than greed and folly among the rest of us. But nowhere has the folly of government, bankers and politicians been greater than over the eurozone disaster. It was of course folly on the part of the banks to take European monetary union at face value — to accept the politicians’ prospectus, and to load their balance sheet with dodgy sovereign debt on the basis that there was no longer any significant difference in risk between Germany and Greece.

But the architects of the eurozone disaster were undoubtedly the political leaders responsible for this misbegotten adventure. It was clear from the start that the project would end in tears unless it was accompanied by full fiscal union, which in a democracy requires full political union. I spelled this out publicly when I was still Chancellor, in January 1989 — the first prominent politician to do so, as it happens — and I repeated it on a number of occasions, in which I also argued that a full political union was neither desirable nor attainable. The eurozone project was doomed from the start.

How, then, did it come to be embarked upon? Those responsible for European monetary union can be placed into three broad categories. The first are ideologues, who held as an article of faith that any transfer of responsibility from the national to the European level was desirable. They never cared much for the economics. The bigger the transfer the better — regardless of the practical consequences. Then there were those who saw the danger that some countries would over-spend and over-borrow, but believed in the no-bailout clause in the EU’s architecture, and thought that fiscal discipline would be enforced by the financial markets. As I and many others pointed out at the time, the ‘no bailout’ rule lacked either political or financial market credibility. And so it has proved.

The third group of Europhiles had a different agenda all along. They fully understood the dangers, yet promoted EMU precisely because a crisis could be overcome only by full fiscal and political union. For them, this was the objective. But such union is only practicable if it is the clearly expressed wish of the majority of the peoples of Europe; and that is manifestly not the case. Contempt for democracy has always been one of the most striking and least attractive characteristics of the European movement. It lies at the heart of the present crisis.

So where do we go from here? The ultimate outcome needs to be an orderly abandonment of the whole notion of European monetary union. The longer it endures, the greater the cost to the economies of the member countries and to the world as a whole. There are also political costs in seeking to preserve it, from the sort of thing we see today on the streets of Athens to growing resentment among the taxpayers of Germany — so far only partially reflected in the stance of their leaders — at being the paymasters of Europe. Not to mention the increasing divisions between those EU members that are part of the eurozone and those, like the UK, which very sensibly are not.

But there is a compelling case for buying time. This is needed for an orderly dissolution of the eurozone, and for European banks to strengthen their balance sheets to cope with the inevitable sovereign debt write-downs and defaults. Many banks have Greek and Italian debt that is never going to be repaid in full. They will need time to adjust to that.

Meanwhile, the longer-term lessons need to be learned. The European Union needs explicitly to abandon the failed notion of ever-closer union, and to agree a constitution which sets out the inalienable competences and responsibilities of the individual member states. For Britain, we have a specific requirement. It is clearly unacceptable that the City of London, wh
ich as a financial centre is more important than all other EU financial centres put together, should have to submit to EU regulation — where Britain can be outvoted.

I very much hope that the European Union will reform itself along these lines. Should it refuse to do so, then a changed relationship between this country and the EU would have to be the fall-back. But I hope that this will not prove necessary.

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