Despite its flaws the euro is still worth saving
I have always had a gut instinct that when push would come to shove, the EU political firmament would do the right thing and save the euro despite its many fundamental flaws. Perhaps I have been too generous to that political elite.
European history does show us that when push comes to shove, European politicians do not always do the right thing. Witness two European wars, and the fiasco that developed in the former Yugoslavia. It would take a brave soul to bet on the current political leadership doing the right thing.
What emerged from last weekend’s summit was nothing short of another vague and monumental fudge. The notion of creating a “fiscal compact” does in theory make sense, as this should have been built into the original EMU architecture. However, there is a major level of vagueness surrounding the proposed pact — how will it be implemented? How will it be policed? What if countries decide to ignore it just as many ignored the Stability and Growth Pact that was negotiated by Ruairi Quinn all those years ago in Dublin Castle? It is not at all clear what the answers to any of these questions are, but we are assured that all will be revealed by the end of March.
This timeline says it all about the level of incompetence that currently characterises the European political leadership. After all they have had two years to prepare a response to the crisis, but it is clear that they either have not been preparing, or indeed they may have decided not to prepare due to a lack of understanding of the real issues involved, or some may have given up the ghost on this fundamentally flawed construct, which was after all a monumental victory for politics over economics. The economics has now bitten back and the architecture is incapable of reacting to the crisis.
What needs to be done to save the system is still reasonably clear. Despite all of its flaws it is still probably worth saving, because the dismantling of the world’s second largest currency would be a potentially chaotic and catastrophic event. The costs involved in its disintegration would most likely dwarf any costs involved in saving it. The EFSF needs to be ramped up to at least €3 trillion to create the firepower to convince the justifiably sceptical markets of the strong political will that still exists to do whatever is required to save the currency. Of course it is possible that this political will does not really exist, but we should probably assume it does. This funding would be provided by quantitative easing of money supply by the ECB.
Once all of this is done, the so-called fiscal compact should then be put in place to try to cement fiscal prudence into the system. This would not be easy to achieve, but a much more centralised fiscal policy entity with massive political powers would have to be created.
These suggestions are all well and good, but it is not at all obvious that the political will exists to do all of these things. If not, then it is fairly clear that once we come into 2012, all hell could break loose on the markets and the system could fall apart within months. It is impossible to understand the near-term impact of such an eventuality. However, from a political and economic perspective it would most likely be a totally chaotic disintegration and European growth could be wiped out for a period.
Eventually things would settle down and a new equilibrium would be re- achieved, but by then irreparable damage could have been done to the whole EU construct. The currencies of the peripheral currencies would be considerably weaker and an export boom of sorts could ensue.
However, the national authorities of those countries, which would include Ireland, would have to ensure that austere and prudent policies are pursued, to ensure that the benefits of the more competitive currency would not be wiped away through rampant inflation. There are no easy options.
