As the economic crisis in Greece becomes a graver and graver problem for the EU, the chances of some sort of bail out, at least in the short term, become greater. There is a huge amount riding on the ability of Greece to avoid defaulting on its sovereign debts, of which, apart from any new borrowing, some 22 billion euros is due to be refinanced as early as April and May this year. As a result, EU leaders have been suggesting that they will stand by Greece but without, at least so far, any specific guarantees being put in place. The reason for this is that there is massive popular opposition, particularly in Germany, to paying for what is seen as Greek profligacy and indiscipline. Why should Germans, who have to retire at age 67, subsidise Greeks with a retirement age of 63? EU policy towards Greece is thus in considerable disarray, and it is hardly surprising that, in these circumstances, the spread in Greek and German bond interest rates is widening, as those from whom the Greek government has to borrow become increasingly concerned about the security of the loans they are being asked to make.
Faced with the dire consequences of a Greek default, nevertheless, it is hardly surprising that there will be huge pressure on a reluctant Germany, whose economy is by far the strongest in Europe, to orchestrate sufficient loans and guarantees to Greece to stave off this happening. It is possible that such a policy may succeed in avoiding a default for a time. It is, however, extremely unlikely that this will provide any long term solution. The reason is simple. The Greek economy is in such bad shape because it has allowed itself to become hopelessly uncompetitive with Germany, Holland and other better disciplined countries within the EU and elsewhere. The yawning Greek balance of payments deficit then causes the domestic economy to deflate, pushing up unemployment and claims on the state budget, while reducing the tax take. This makes it extremely difficult for the Greek government to balance its budget and thus to avoid borrowing to fill the gap. Since all current account deficits have to be matched, as an accounting identity, by capital inflows from abroad - mainly borrowing in Greece's case - the amount of borrowing required is set to increase exponentially. It is already expected to be 125% of GDP by the end of 2010 and 140% by 2012. The only real solution to this problem, short of defaulting, is for the Greek economy to have a lower rate of inflation than countries such as Germany and to go on doing so for year after year. If the cost base in Greece is about 30% higher than Germany's, inflation in Greece would have to be, say, 2% lower than Germany's on average for 15 years consecutively. Does anyone believe that this is remotely possible? If not, and the much more likely scenario of Greek inflation being on average 2% higher per year than in Germany materialises, it can only be a matter of time before anything which the rest of the EU can do to buttress Greek debt gets swept away by the financial markets, as their belief that there is any chance of such policies being successful evaporates.
On the other hand, the consequences of Greece defaulting would be disastrous. A large amount of Greece's government debt is owned by banks, particularly in Britain, France Germany and Ireland. The cost of even an initial bail out for Greece has been estimated at 30 billion euros. If there is a Greek default, all the banks holding Greece's government bonds will incur a very large bad debt as the value of the Greek liabilities is written down by whatever percentage Greece has to devalue. This will further diminish the capital base of all the banks concerned, thus reducing their already constrained capacity to lend and further weakening the already feeble trend towards economic recovery in Europe. It would also be a very major blow to the further economic and political integration of the EU planned by the EU's leadership and most of the European political class. If Greece cannot pay its debts and leaves the Single Currency, a critical component of the European project will lie in ruins. Furthermore, if Greece cannot meet its obligations within the Single Currency framework, what is likely to be the outcome for Spain, Italy, Portugal and Ireland, all of which, to varying degrees, suffer from the same problems as Greece? The likelihood in these circumstances is that the Single Currency area will not disappear completely, but that it will shrink back to being composed only of Germany and those countries with roughly the same competitiveness as the Germans enjoy. A Single Currency area of this sort might not last for ever but it could well stay together for a long time, while the weaker economies one by one are forced out of the euro. Defaults in one form or another for them appear now to be inevitable sooner or later even if the costs of initially fighting them off - estimated by one source to total 320 billion euros - were incurred in the meantime. Germany alone apparently holds well over 500 billion euros in weaker country bonds.
The tragedy about the events now unfolding in the Single Currency is that it was so easily predictable that they would happen. No single currency area can survive for any length of time unless it is a single state, with all the homogeneity and shared taxable capacity that then becomes possible. History is littered with attempts to weld currencies together without political union and the results have been uniformly unsuccessful. Everyone knew, before they joined the Single Currency, that the economies particularly of Greece, Italy and Portugal were in no position to compete on a long term basis with Germany and Holland, exactly as they had failed to do in the Snake and the Exchange Rate Mechanism. It was wishful thinking of an extreme order that the discipline of the Stability and Growth Pact would hold them in line, especially as France and Germany both ignored the constraints which the Pact imposed as soon as it suited them to do so. By driving ahead with monetary union, entirely for political reasons, without paying any attention to the underlying economic realities, the EU leaders who committed the EU to such a reckless gamble have done the whole of Europe a huge disservice.
True to form, the response from within the EU Commission and among EU leaders has been to use the disarray in which the eurozone now finds itself to propose that the solution is more economic integration and more control from Brussels as to how the EU economies are to be run. There are, however, a number of reasons why it is very unlikely that such moves will be successful in holding the Single Currency together for very long. In the first place, the total EU budget is still small - at about 2% of total EU national income - which is much too little to provide the tax and spend redistribution required. Second, language, legal and cultural barriers in Europe make it difficult for population movements to even out disparities in opportunities between different countries. Neither of the two main conditions which allow single currency areas which are also sovereign states to work successfully are thus present. Perhaps most important of all, however, the EU simply does not have the credibility and thus the support of its electorate for it to move towards having much greater centralised responsibility for economic management across the whole of the EU. This could only be done if taxation was organised on a Europe wide basis, with major spending programmes such as social security, health, education and defence run by Brussels. There is no chance of this happening within the timescales set by the increasing instability of the Single Currency.
Without a huge increase in economic integration in Europe, however, it is now difficult to see how the Single Currency can survive in the long term. Although their problems are not all the same, not only Greece but also at least four other eurozone countries - Italy, Spain, Portugal and Ireland - are clearly already very uncompetitive particularly with Germany. None of these five weaker economies, with the possible exception of Ireland, look as though they have any likelihood of being able to muster the political and social cohesion to enable them to implement the savage deflationary policies required to get their cost bases anywhere close to Germany's. Nor does it make any rational sense for them to try to do so. Why should they submit their countries' economies to the very high levels of unemployment, cuts in public expenditure, social disruption, stagnant or falling living standards and economic hardship, especially for poorer and more disadvantaged people, which such policies entail, if defaulting is a much less painful and ultimately inevitable option? In these circumstances, where political opposition to unending austerity is likely to become an increasingly potent factor, are the financial markets really likely to go on lending to countries which, far from gradually becoming less uncompetitive, are very likely to be clearly trending to being more so?
Although Britain of course never joined the euro, it would be a big mistake to think that we would be left unscathed if the Single Currency began to break up. We would certainly be left with the vitally important advantage of having our own currency to cushion whatever happened elsewhere, by allowing our currency to appreciate or depreciate, according to circumstances. The gradual processes involved in having a floating currency, as we do, allow major adjustments to be made without default becoming a threat. If Britain's credit rating ever became under pressure, the solution would have to be for us to devalue, thus using increased competitiveness to allow us to pay our debts - exactly as the weaker eurozone economies need to do. If, however, the euro-zone broke up as a result of a series of defaults - a very different proposition from the gradual depreciation which a floating exchange rate like we have allows - Britain would undoubtedly be caught up in the ensuing crisis. British banks hold a substantial amount of the debt of the countries likely to default, and they would have to take the losses involved with all the negative consequences on their subsequent capacity to support the UK economy by lending. Single Currency defaults would also be bound to have a major depressing effect on the eurozone, with implications for our exports to them. There may well, in the meantime, be calls for Britain to contribute to bail out operations, with poor prospects of our ever getting the money back. The wider lesson, however, is surely that the current problems with the Single Currency reinforce the view that European Union is a heavily flawed concept, foisting a future on the peoples of Europe which is fragile, poorly conceived, not supported by large sections of the electorates, including significant majorities, particularly in the UK. Almost everyone in Britain wants as much co-operation and friendship as possible with our European neighbours. This is, however, a very different matter from using inappropriate, damaging and ineffective systems such as the Single Currency as part of a master plan to impose a United States of Europe on increasingly disaffected and distrustful electorates.