The euro area is unlikely to break up, but it is not immune either

By: Wolfgang Münchau

Anglo-Saxon investors no longer ask whether the euro area will break down. They only ask when.

 

To them, it is clear that Greece and Portugal will soon quit because the economic pressures have become too large. Our Anglo-Saxon friends often do not know the details of European law and European history. They believe you can easily get it or out, as you do with a bus. They regard the euro as an extravagant adventure. Even famous economists like the Martin Feldstein argue on those lines. To mark the euro's tenth birthday celebration he repeated his forecast from the 1990s that this fair-weather construction of a currency union would break down under the first storm.

 

I myself have dismissed these reports and forecasts as nonsense because they misjudge the political and economic dynamics of the European Union. Feldstein believes, Greece can simply leave the euro unilaterally. It is not clear at all whether this is possible. There is no exit clause in the European Treaties. In the new Lisbon Treaty there is only an exit clause from the EU itself. One can perhaps interpret this in such a way that somebody who wants to leave the euro area must also quit the EU, because otherwise the Treaty would have contained an explicit clause. That would be my interpretation, but who knows?

 

Recent European history taught us that one should not rely too much on the legal interpretations of the Treaty if economic necessity dictates otherwise. The stability pact failed on economic grounds, and it was subsequently renegotiated. Should the Europeans ever want to abolish the euro, they will find a legal way to do it.

 

But it is not that easy to construct a scenario in which a single member state would actually want to get out. Greece is not likely to quit for a host of reasons. The threat of departure would make every Greek citizen send their euros to a Luxembourg bank to avoid a compulsory conversion into new drachmas. The next thing would be a banking crisis and presumably also a currency crisis. The interest rate would shoot up, and the economy would fall into a deep black hole. The crisis would turn into a disaster.

 

But that does not mean that a breakdown of the euro area is inconceivable under all scenarios. Let us start with the hypothetical scenario of a Greek payment default. If the German finance minister, as I would expect, were to insist pedantically to apply the no-bail out clause, the crisis could, within hours, spill over to Portugal, Ireland, Spain and Italy, where bond spreads would be shooting up. Hedge funds will suddenly have discovered a good opportunity to make up for previous losses. Finance instruments such as Credit Default Swaps (CDS) are imminently suited to this type of speculation: If you stock up with Portuguese or Italian CDS during one of the panic runs, you stand to make very large profits. This in turn accelerates the domino effect of the crisis, and market interest rates will go up to double-digit rates all over southern Europe. The EU will hold an emergency summit at which it becomes clear that it is too late for a general bailout. This would have worked in the case of Greece or Ireland. But Italy and Spain are simply too big.

 

The summit would summon experts who tell the prime ministers that there are only two alternatives. Either the euro-area is dissolved with immediate effect. Or, one creates an imminent fiscal union, starting with single the European issuance of all future debt, and the transformation of all existing debt into a single European bond. The member countries would lose the sovereignty over budgetary politics. The finance ministers would receive their daily marching orders from Brussels. This would, of course, require a whole new EU Treaty, which the prime minister would have to agree on almost in real time.

 

I am not sure how Germany’s political leadership would jump when confronted with such a stark choice. Jean Quatremer, the Brussels correspondent of the French newspaper "Libération", asked on his blog on Tuesday whether Germany is still a European country? The political instincts of Angela Merkel and Peer Steinbrück have been clearly anti-European during this entire crisis. They have prevented any real economic coordination with persistent reference to the national interest.

 

This attitude is a problem because the euro area is not complete. When the euro was launched, several governance questions were left unanswered, for example the question of who is responsible for an exchange rate policy, or how to organise the euro area’s international representation, or what to do when a member state defaults? To solve any of these problems, and many more, it requires a degree of political cooperation and co-ordination.

 

It is impossible to come up with a percentage probability for a collapse of the euro. But if the job to the save the euro falls to Merkel or Steinbrück, then that likelihood of a collapse must clearly be greater than zero. The markets also seem to believe this. And this means that the persistent failure to coordinate already carries a significant economic cost.

 

 

 

The original German version was published in the Financial Times Deutschland on February 4.

 

 

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