The problem faced by the weaker members of the eurozone is generally viewed as being one whose principle component is their governments running out of liquidity. The solution is then perceived to be to provide them with sufficient loans to tide them over until enough cuts in expenditure and earnings can be pushed through to get their finances back in balance. This analysis is, however, grossly flawed. The fundamental problem which the struggling members of the eurozone face is not primarily one of liquidity or solvency. It is that they are hopelessly uncompetitive. They have allowed their cost bases - the amount they charge the rest of the world for all their exports of goods and services - to rise far above the levels available from much stronger economies such as Germany and Holland. The financial difficulties which the governments of countries such as Greece, Ireland and Portugal are facing are merely symptoms of their underlying lack of ability to compete in either EU or world markets. It is their lack of competitiveness which is the cause of their falling tax revenues and rising borrowing and social security costs. Their economies can no longer pay their way in the world.
The policies pursued by the EU - engineering one round of funding after another to prop up the governments and banks of the failing members of the eurozone - is never going to work in the long term because it offers no solution to the competitiveness problem. One loan after another may stave off immediate crises but only at the expense racking up more and more debts which are less and less likely ever to be repaid. It may well be the case that the cost bases of the weaker economies could be made much more competitive if there was heavy enough investment in both new industry and radical changes in working practices, but these conditions are difficult enough to fulfil in the most favourable of circumstances. Against a background of weak or non-existent growth in demand, rising taxes and increasing unemployment, they have no chance of success. To achieve stability, countries like Greece, Ireland and Portugal would have to reduce their costs by perhaps 30% compared to the international competition they face, even assuming that there was no continuing improvement in the export competitiveness of countries such as Germany, which there almost certainly will be. Does anyone seriously believe that these weak economies will have, say, 2% lower inflation rates on average than Germany for 15 years without a break - or that the electorates in the weaker economies are going to put up with the savage deflation which would be required for the whole of this period - especially if all this privation is in fact unnecessary and therefore ultimately pointless?
The policies currently being pursued by Brussels are, nevertheless, wholly focused on providing financial aid rather than allowing any major restructuring to take place. This is because the EU political elite are desperate not to see the eurozone imploding, because of the huge damage that this would do to their vision of Europe. How long will this approach hold out before the dam breaks? As always, when dealing with these sorts of questions, it is hard to say. What is clear, however, is that there are inevitably going to be increasing risks that the current EU policy will become unsustainable as four factors become more and more to the fore. The first is whether the electorates in the weaker economies are going to be willing to put up indefinitely with never improving economic conditions. The second is whether the bond markets will be willing to support the ailing economies by continuing to lend more money to them on anything like viable terms. The third is whether, especially if the political situation deteriorates and the bond markets get more and more nervous, the European Central Bank is going to be able and willing to continue to act as the lender of last resort. The fourth is whether the stronger eurozone economies are going to be willing to go on supporting the weaker ones. It is clear, therefore, that there are thus massive risks that the EU's current policy is not going to work for an unlimited period of time. As increasing numbers of people come to realise that this is the case, the costs and problems of sustaining the eurozone as it is at present are likely to become - perhaps suddenly - increasingly apparent.
If, sooner or later, radical eurozone restructuring is going to become inevitable, as seems almost certainly to be the case, there are overwhelmingly strong arguments for it to be done sooner rather than later - indeed as early as possible. This is because every month which goes by entails the weaker economies becoming less able to compete as a result of falling investment and rising costs, while at the same time the cumulative amount of money they are having to borrow to pay for their governments' otherwise unfundable expenditure goes up. "Restructuring" does not, therefore, mean just extending credit terms or reducing interest rates. It means allowing the weaker economies to devalue so that they can start paying their way again. If this is not done, as the total sum at risk gets larger and larger, the potential strain on Europe's banking system will become greater and greater - not least on the European Central Bank which is reported already to have committed as much as two hundred billion pounds to fund sovereign bond purchases and to take on other liabilities to support the existing eurozone. The danger, if there is a long further period of delay, is that - when devaluations eventually take place - the total losses which the banking system will sustain will be so large that there will simply not be enough financial strength, funding capacity and political will among either the EU's sovereign states or the IMF to avoid bank insolvencies. If banks start to fail across the EU because there is insufficient sovereign creditworthiness to take over all their liabilities, the European economy really will be in deep trouble.
It is sometimes argued that restructuring the eurozone would be so difficult as to be virtually impossible and there is no doubt that it would be extremely disruptive. The problem is that the longer the status quo is allowed to exist, the worse the eventual disruption will be. This is why the action which needs to be taken should be got under way as soon as possible. Essentially, the process would be as follows: All those countries in the eurozone which are no longer able to compete with Germany would have to pass legislation making all euro currency and external obligations arising within their borders no longer equal in value to German bloc euros. Countries such as Greece, Ireland and Portugal would have to devalue their domestic euros by possibly around 40% - other countries very probably by less. No euro notes from the devaluing countries would be allowed to be taken abroad, while replacement currencies were prepared and introduced. All external obligations, including sovereign debt, bank and bond liabilities, and commercial and personal debts, would have to be written down by whatever percentage devaluation was selected. Inevitably, there would be hard cases where it was not clear whether assets and liabilities were denominated in strong or weak euro currencies, but these should be kept to the minimum by making the break with the previous Single Currency environment as clear cut, decisive and simple as possible.
There is a simple reason why allowing those countries which cannot pay their way in the EU to devalue, although this will involve them defaulting heavily on their euro obligations, is still the best way ahead. This is the only realistic way in which they are going to be able to get their economies growing again. Only by getting what they can charge for all the goods and services they export at a competitive level again will they be able to avoid unending balance of payments problems and continuing government bail outs and banking crises. Only then will they be able to stop tearing the social fabric apart with further relentless cuts in public expenditure and to start reducing unemployment to tolerable levels.
One of the most acute tragedies of the current situation in Europe is the inability of nearly all the leaders of the mainstream centre left parties to face up to the damage which supporting the existing conditions in the eurozone is doing to everything for which social democracy stands. As a result of these leaders seeing only the need to protect the status quo, they are being forced to abandon the interests of large numbers of their previous supporters. No wonder that, in these circumstances, backing for centre left parties is haemorrhaging right across Europe, as their erstwhile supporters see the parties for which they used to vote abandoning public services, cutting public expenditure and favouring bond holders over working people. Nor is it only centre left party leaders who are being beached by the way events are unfolding. The whole of the EU's political class is losing more and more credibility and the support of its electorate as it pursues policies - untrammelled in large measure by democratic constraints - which are less and less in the interests of the people right across Europe who are suffering from their misjudgements. It is hardly surprising, in these circumstances, to see voters moving their support to extremist and fringe parties and away from the mainstream.
The UK is not, of course, a member of the eurozone and for this we should indeed by thankful. If we had gone into the Single Currency with an exchange rate of 1.45 euros to the pound, as many of our own political establishment figures would have supported when this would have been possible, we would no doubt now be in much the same situation as Greece, Ireland and Portugal. Nevertheless, the fact that we still have our own currency does not by any means fully isolate us from the unfolding eurozone crisis. If and when defaults take place, both our government and our banks are going to be exposed to very heavy losses. This will happen as a result of EU and IMF obligations, to which both Labour and the Coalition governments have committed us, and many highly unwise commercial bank loans from British banks to eurozone countries, which are likely to go sour. Large as these losses are likely to be, however, they will pale into the shadows if the eurozone is kept intact long enough for the debt crisis, when it eventually leads to defaults, to pull down major European banks. If this happens, economies right across Europe will be dragged into a major recession. As about half our external trade is with continental Europe, this would be bound to have a further major negative impact on the UK economy and indeed on the world's prospects generally. For all these reasons, the policy to be pursued by the UK within the EU should surely be to urge eurozone restructuring, with all its short term painful consequences, as early as possible. Establishment of the Single Currency was a huge misjudgement - with the decision to go ahead with it taken entirely for political rather than economic reasons. Now that it is increasingly clear how unwise the establishment of the eurozone was, the sooner it is unravelled the better. The consequences of hanging on until it implodes too late to save the economy of Europe as a whole from a major recession - especially with so many economies, including our own in the fragile condition they are - do not bear thinking about.