DIRECTOR OF CURRENCY RESEARCH, GFT
LAST week, my parents, who never trade the currency market, and who are generally bewildered by the volatility of finance, offered the best insight into the what’s really wrong with euro. As we sat down to dinner on a beautiful Boston night, my mother said: “You see, Germans will naturally follow the law. If a light is a red, but there are no cars in sight they will nevertheless wait as long as it takes until the light turns green before they cross the street.”
“Italians on the other hand,” my Dad chimed in, ”will do just the opposite. They will try to avoid obeying the law as much as possible. Therein lies the problem in Europe.”
Therein lies the problem indeed. What my parents so disarmingly pointed out is that there is a vast cultural difference between northern and southern European economies and it is killing the euro. The problems of the Eurozone credit crisis are not simply a matter of economics but of politics as well.
I have long argued that the fiasco in Greece has now moved well past the bailout stage. Any serious financial analyst will tell you that saddling the country with even more debt will only exacerbate its problems and hasten its default. What Greece needs is debt forgiveness, rather than any further financial engineering that extends the terms repayment in perpetuity. Furthermore, having watched the bailout disaster unfold in Greece, Portugal and Ireland, there is no way that citizens of Italy or Spain will ever accept the same bailout terms when their turn comes.
And their turn is coming. As credit conditions and economic growth in southern Europe continues to deteriorate, the two largest Club Med economies are teetering on the edge of a full-blown crisis, I very much doubt that the Troika could force the same deal on Spain and Italy as it did on Greece.
It is much more likely that if Italy and Spain reach a breaking point, the European Central Bank will have to monetise their debt directly, creating a much larger quantitative easing program than Berlin had ever imagined. However, the Germans and other northern Europeans will never agree to such open-ended monetary policy without some concessions from the south. And rightly so. Germans are tired of paying for the profligacy in the south while seeing no improvement in the region’s fiscal conditions.
For the euro to work, the members of the union must clarify their common interests and create a much stronger system of mutual benefits. Northern European economies must provide direct transfer payments to the south that would eliminate, rather than extend the massive debt burden of the region. Which in turn would help revive growth and improve their fiscal position. Southern European economies on the other hand must acquiesce to a trans-European tax authority agency that would standardise revenue collection across the continent, eliminating much of the fraud and non-compliance that has resulted in such a fiscal mess in Club Med economies.
Whether such a social compromise could take place remains to be seen. Ultimately, however, this is the only way that the euro can remain a viable currency. Given the enormous political and economic importance of the euro project, I believe that authorities in the region will make the necessary policy choices to keep the currency alive, but in the meantime the pair may see further volatility until the point of pain becomes too much for everyone to bear.
6 June 2012 2:38am
DIRECTOR OF CURRENCY RESEARCH, GFT