The much-heralded solution to the European debt crisis has been replaced -- quickly -- by a new impetus to dissolution. Less than two months ago, European officials were all abuzz with excitement about the July 21 EU pact, through which Greece would get its second bailout. The private sector (i.e., the banks) would take some losses on Greek bonds, but not in a way that would activate credit-default swap payments. The EFSF, the European Financial Stability Fund, would be allowed to buy bonds of troubled Eurozone countries in the secondary market so that the European Central Bank would no longer have to.
The Germans were happy enough. The banks -- and the Central Bank -- were happy enough. The Greeks were just plain happy. Little did they know.
These days, with the European economy slowing down, with bond markets staring askance at Spain and especially Italy, with private-sector involvement struggling to reach the desired levels, and with the Greek government facing economic collapse and social turmoil as it tries to meet deficit-cutting targets for 2011, voices calling for the break-up of the Eurozone are popping up all over the place, like cyclamens in early autumn. Greece, as the most hopeless case, is the candidate on everyone's mind (and some people's lips). At the same time, the ever-worsening crisis is emboldening those who believe in a much closer union -- who argue, with good cause, that without far-reaching fiscal integration, the euro cannot survive.
These contradictory pursuits are responses to the same realization: The euro, as initially designed, was badly flawed. There was monetary union, meaning that a common central bank would set monetary policy for the whole bloc. But each country was allowed to retain independence in fiscal policy. This minefield of a set-up was papered over by the Stability & Growth pact, which ruled among other things that Eurozone members' budget deficits should not exceed 3 percent of gross domestic product and that their public debt should remain under 60 percent of GDP. The wishful idea was that this would lead to convergence between the very different economies and allow the Eurozone to become an optimal currency area.
It did not work out that way. The Stability & Growth pact was widely disregarded -- and not just by the Greeks, though they violated it most spectacularly. Countries with deficits were able to borrow at low rates and kept doing so, becoming ever more uncompetitive. Conversely, the competitive advantage of surplus countries increased. The global crisis brought this growing divergence into stark relief, initiating the ebb of confidence in the solvency of the weaker countries.
The euro cannot go on as before. The Eurozone must either change its structure or change its membership, as a recent report on the possible consequences of a break-up of the common currency by Swiss bank UBS put it. Those who support changing membership argue that the differences between economies like Germany and economies like Greece are simply too great. This makes participation in a common currency area a constant source of tension and conflict.
Hans-Olaf Henkel, a former chair of the German Federation of Industry (BDI), argued recently in the Financial Times that secession of its fiscally strongest members -- Germany, Finland, Austria, and the Netherlands -- would increase competitiveness in the Eurozone, since the euro would be devalued against the new currency. The Northerners, for their part, would gain a guarantee of lower inflation and would no longer need to bail out fiscal laggards.
Suggestions that Greece and other countries on the periphery should help themselves to the exit -- ejection is not currently an option, according to European treaties -- also stem from the same point of view: that the design flaws of the euro can be fixed by limiting it to homogeneous economies, with coordinated business cycles and similar monetary policy needs.
The structuralists, on the other hand, are a lot less sanguine about what may follow one country's exit from the Eurozone -- to the point where they fear for the survival of the single market and even the EU itself. For them, the design flaw must be fixed by creating the fiscal counterpart of ECB, that is to say, by granting EU authorities powers to tax and to issue debt in the name of the entire Eurozone. This would solve the problem of the lack of homogeneity by creating the necessary flexibility, through automatic fiscal stabilizers -- creating, in other words, a kind of United States of Europe.
This is, of course, an extremely ambitious proposal. In Northern European countries, public opinion runs against bailing out the South. In the South, people don't want to be put in a fiscal straitjacket. There are also many institutional barriers. But the structuralists are right to be terrified of what may follow a country's exit from the Eurozone. The UBS study put the cost, for the seccesion, at 40 percent to 50 percent of GDP in the first year alone for "weak" countries and 20 percent to 25 percent of GDP for "strong" ones. In the end, this fear, which certainly seems to be shared by cautious politicians like chancellor Merkel, is likely to keep the Europeans dragging themselves, laboriously and with much hesitation, toward a form of fiscal union. But it would be blithely optimistic to rule out the possibility of major accidents along the way.
