What price are we willing to pay?

So another EU summit ends inconclusively, with the poor old can again booted down the road.

While inconclusive in terms of its outcomes, there was a clear sense that the ground has shifted, away from the coordinated austerity-for-all pushed by Germany for the last two years, towards a more balanced approach.

Perhaps we should recall and amend the words of Churchill, substituting European for American and noting that Europeans will do the right thing only when all other alternatives are exhausted.

Eurobonds, where a central or pooled treasury issues bonds and then doles out the cash to members of the pool, are at least back on the table, there is a recognition that growth needs to be at least as much a focus as fiscal discipline and there is an acceptance that bank recapitalisation costs cannot fall only on the taxpayer.

However there is still a massive problem. Europe is mired in recession. Recent PMI indices are all pointing to a deep slowdown. Spanish banks are treading the same dreary path as did Irish banks, with each deep look at the depth of the damage caused by its property boom revealing deeper and deeper holes, and the state adopting sequentially more and more drastic action to stem these holes. At least so far they have avoided a Nama or bank guarantee fiasco.

Meanwhile, Greece continues to fester and the dreadfully dangerous precedent of an exit from the monetary union inches closer.

There can be no doubt looking at the economic history of the last decade that the biggest winner from the adoption of the euro was and is Germany. It has achieved massive relative competitive advantages over the other nations, mainly it must be admitted, by the less than optimal actions of these countries, but also by reducing the labour share of the German cake. From close to 70% in the 2000 period, employees’ compensation as a percentage of GDP is now closer to 60%, and German net exports to the eurozone rose nearly fourfold in the 10 years to 2006. A very crude characterisation of the euro might be that the core lent money to the periphery that bought core goods and now the bills have come due. The reality is that the core and the periphery (which now seems to be everybody bar Germany and Finland…) are locked in a symbiosis.

Coordinated austerity is not going to allow the peripheral nations to grow and in not growing they will not consume core goods nor repay core credits advanced to stem the losses from the credit bubbles.

The sad reality for Europe is that we have a weak German leader in a strong German economy who for too long was propped up by an even weaker French leader in a weakened France. The European experiment, of which the euro is the latest embellishment, is predicated on France and Germany being strong and democratic and working together to keep each other in check and at peace.

In that it has succeeded, but the reality now is that to get Europe out of the mess Germany is the only feasible paymaster. It will have to pay, in one or more of four ways. First, there is a debate on an arcane interbank settlement system called Target 2. In essence there is nothing to be worried about absent a break in the euro, but were that to happen then Germany would be left with a large hole in the bundesbank. While that might appear problematic it can equally be argued the net cost would be minor.

But that would in any case be unthinkable to the money hawks in the German economic apparatus.

A break of the euro would entail the return to the Deutsche Mark, which would result in a massive appreciation, resulting in lower German exports and lower German economic growth. While Germany has shown it can survive and even thrive with a hard currency, the dislocation would be large.

Again, a break in the euro would also result in massive losses to German financial institutions, running potentially into hundreds of billions of euro, which would have to be recapitalised by the German taxpayer.

The alternative to these is some form of Eurobond resulting in a rise in German borrowing costs, or a fiscal union including transfers from Germany and eventually France. The latter in particular would insist on tax harmonization in some guise as a condition of entry.

Thus, we face more weeks of high political economy drama. Germany, and to a lesser extent, France need to accept that the costs of saving the eurozone are going to be high, and weigh these against the incalculable disruption and losses of it collapsing.

A Greek exit would in my view cause irreparable damage, as it would show that the eurozone is not a monetary union.

For Ireland the question will arise sooner than later: what are we willing to give up to remain in the enhanced European system?

* Brian Lucey is professor of finance at Trinity College


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