The Eurozone crisis has now become the biggest single threat to global stability and prosperity. Months of indecision have allowed the markets to become ever more uncertain about what the future holds. A major fault line lies between Germany and France. There is huge pressure to use Germany's creditworthiness to underwrite bonds to support the whole of the Eurozone, which Germany is resisting because, if and when it all went wrong, they would have to pay. The only basis on which Germany might be willing to agree to take on this risk is if the Germans, with the financial support of the European Central Bank, were given a far greater degree of oversight and control of other Eurozone Member States' economic affairs than they would be content to tolerate. France, in the meantime, while desperate not to lose its AAA credit rating by losing Germany's support, is equally determined not to find its position in the Eurozone eclipsed by German economic power. While tortured negotiations led by Germany and France continue, all the Eurozone countries have, with varying degrees of reluctance, signed up to rescue proposals involving recapitalising European banks, shoring up the European Financial Stability Facility and arranging to write off 50% of Greek privately held debt. This looks like being, again, too little too late, and nowhere near providing a long term viable solution to the fundamental contradictions and weaknesses in the Eurozone. It is also far from clear whether more unending austerity is going to be acceptable to the Greeks and others similarly affected.
The fundamental reason why the Eurozone's problems have dragged on for so long and why they look so difficult to resolve is that the measures currently being canvassed do not really begin to resolve the root cause of the malaise which the existence of the euro has generated. All the main focus of attention at the moment is on mustering sufficient financial fire power to stop any of the existing Single Currency members dropping out of the Eurozone altogether and ceasing to use the euro as their currency. The current talk of default by countries such as Greece does not entail them leaving the euro. It means that some of their debts would be written off but they would still remain as Eurozone members, without being allowed to devalue. There are two main reasons why Europe's political leaders are so keen not to see any Eurozone members leaving the club. One is that this would be a hugely disruptive and damaging event, causing endless financial and legal problems and massive losses to the banks and other lenders exposed to debt defaults. The other is that the euro is, of course, a flagship EU policy and, if it were to collapse, this would deal a very heavy blow to the future of the EU and the vision of a United States of Europe which led to the Single Currency being established in the first place.
There are, however, very heavy risks with the current approach within the EU to resolving the Eurozone crisis. These stem from all the reasons why the Single Currency should never have been set up in the first place. The root problem with the Eurozone is not that its weaker members - Greece, Ireland, Portugal, Spain and Italy - are all facing liquidity and solvency problems, which may well soon be shared by Belgium and France. It is the lack of competitiveness among all these countries which is the fundamental problem. As a result of their relatively high rates of inflation since the euro currencies were locked together in 1998, they are now hopelessly uncompetitive with Germany and other northern tier members of the Eurozone. The result is that all the weaker Eurozone members are importing much more than they are exporting, generating deficits which require huge amounts of financing. As all these countries are then under great pressure to cut back on expenditure to try to reduce their deficits, their growth rate goes down, making them less and less likely ever to be able to pay back the ever increasing loans they need to keep going. The markets are only too aware of the fact that if any economy has to borrow more and more money every year but there is no growth, sooner or later it will get to a point where it cannot service its debts and it will have to default. This is why Greece is only the first in a queue of Eurozone countries which are going before long to suffer from the same problem.
The current Eurozone objective of raising enough financial fire power to reassure the markets that no country now within the Single Currency will cease to be in the Eurozone therefore unfortunately does nothing to deal with the underlying reason why the Single Currency is in it present crisis. The only long term solution is to get back to a situation where all the Eurozone member countries can compete with each other, with their foreign payments roughly in balance. Before the establishment of the Single Currency, this used to happen as a result of currency realignments, with the weaker economies, suffering from higher inflation, devaluing from time to time against the stronger ones such as Germany. Now that, within the Single Currency framework, devaluation is not an option, the only way that competitiveness can "at least in theory" be re-established is by drastic reductions in costs, particularly in wages. In practice, however, wage cuts on the scale required "somewhere in excess of 30% in many cases" are from every point of view "economic, social and political"simply impossible to achieve, particularly against the constantly improving efficiency of Germany. The likelihood, therefore of the weaker economies regaining sufficient competitiveness, as long as they stay in the Single Currency is therefore vanishingly small both in the short and longer term.
If the weaker economies are unable to regain the competitiveness they need, then all that will be achieved by the huge loans and guarantees currently being arranged is putting off the day when devaluations take place. This is likely to happen as soon as a sufficient number of people realise that the size and scope of the financial support which the banks and sovereign states are being required to provide, especially in the case of large economies such as Italy and Spain, is beyond their capacity to manage. It is possible that the current bail out funds may be sufficient to stave off the Eurozone being restructured for a year or two "although this may well turn out to be much too optimistic an assessment - but it is very unlikely that the current situation will last indefinitely. There are two main reasons for this, one political and one financial.
The main political reason why propping up the Eurozone with bigger and bigger loans and guarantees may come to an end is because there is less and less support for doing this, particularly among the electorate in Germany, which is the only economy with the strength and creditworthiness to take most of the load. The Single Currency has never had much democratic legitimacy and the steps now being taken to bail it out have even less, as the recent events surrounding the proposed referendum in Greece have shown. German polls show large majorities against pouring more German funds into bailing out what most Germans regard as the undeserving weaker members of the Single Currency. While the Commission in Brussels does not have to bother about winning elections, the politicians at national level, who are now the main actors in the Eurozone crisis, certainly do have to do so. As opposition among their electorates to supporting the Eurozone gathers in strength in the countries which are being called on to underpin it, so the capacity of the existing European leaders to deliver the support required is being eroded.
On the financial front, however, it may be that the markets will derail the Single Currency before the political will to keep it going withers to a point where it becomes unsustainable. This will happen as the markets realise that growth in Europe is grinding to a halt, but the borrowing needs of the weaker Eurozone countries are continuing to rise. Their capacity to repay their debts, or even to service them in the meantime, will then have sunk to a point where the risk attached to further lending become completely unacceptable. Initially, as the lending risks get greater, they may be absorbed by higher interest rates. Before long, however, the danger of default will get so high that no feasible rates of interest for the sovereign borrowing required will offset the risks. Led by more downgrading from the credit rating agencies, further borrowing from external and private sources will become impossible. This will then leave only the stronger EU sovereign states and the European Central Bank as lenders, but their financial strength is not inexhaustible either. Once they get sufficiently over-stretched and their credit worthiness gets exhausted too, a really major financial crisis beckons.
We can only be thankful that we never joined the euro, but there are still huge dangers to Britain from a financial melt down in Europe. Any such event is bound to hit our exports to the Eurozone countries and to make any economic recovery in the UK more difficult to achieve. It is also likely to present the government with very difficult choices as to how to react to Eurozone efforts to construct much tighter controls over the budgets and economic policies of Eurozone Member States. There is talk of repatriating policy making powers in return for agreeing to treaty changes in the EU, but the difficulties involved in doing this are huge mainly because they will require the consent of all the other 26 countries in the EU. If this kind of renegotiation is unsuccessful, it is all too likely that the outcome will be a two speed Europe with Britain in a relatively ineffective minority with insufficient allies to avoid being outvoted on issues of major concern. With neither political nor economic benefits stemming from our EU membership, discontent with the EU, which is already high in the UK, is bound steadily to increase. Calls from within the UK for an "in-out" referendum may then coalesce with requirements from other countries for a referendum for treaty changes. It seems increasingly unlikely that our continued membership of the EU can be assured.