The eurozone, to me, is still the biggest single threat to global recovery. There are plenty of hurdles to negotiate before the eurozone can be considered to be even moderately secure. The German constitutional court will rule on September 7 on the legality of the Greek and other eurozone bailouts.
Finland has put the cat amongst the pigeons on the second Greek bailout by demanding collateral in return for participation, helping push the yield on two-year Greek government debt to more than 40%.
When they met a couple of weeks ago Angela Merkel, the German chancellor, and Nicolas Sarkozy, the French president, went seriously off piste in backing an EU-wide financial transactions tax, which would have the effect of damaging London without helping the eurozone one bit.
They also said they favoured more eurozone government, which appears to involve more frequent meetings, Merkel rejecting the idea of issuing eurobonds, as an alternative to the national bonds of individual eurozone members.
In Britain, fortunately, we can only be spectators as this drama, some would say tragedy, plays itself out. It is painful to watch, however, both because it was predictable and because it can be solved.
It is bad manners to mention one’s books but that has never stopped me. In 1999, I wrote a book called Will Europe Work? It predicted, using Robert Mundell’s famous optimal currency area approach, a European monetary union without a fiscal union would soon run into problems.
It did not happen straight away. I remember the then head of the National Institute of Economic and Social Research telling me that the book was based on old economics and that things had changed. I also remember Adair Turner suggesting I had been wrong to say the peripheral economies would be the euro’s Achilles’ heel.
At the time, in the early 2000s, countries like Germany and France were struggling in the euro, while Ireland, Spain, Portugal and eventually Greece, were making hay. Europe had adopted a stability and growth pact, intended to restrict budget deficits to under 3% of gross domestic product. But it was France and Germany which broke the pact rules and effectively killed it off.
In the end, however, the predictable exerted itself. The less-competitive peripheral economies got into trouble, exacerbated by the global financial crisis, their public finances were shot to pieces, and the eurozone sovereign debt crisis was solved.
But it is not too late. And the crisis is, as I say, entirely capable of being solved. This is because the eurozone’s overall fiscal position is quite healthy, and certainly much healthier than Britain or America.
Though France has just unveiled an austerity package, including a 3% tax levy on high earners, and Germany’s Ifo index points to weaker growth ahead, the eurozone does not have a big deficit problem.
OECD figures show that the eurozone’s overall budget deficit last year, 6% of gross domestic product, was significantly smaller than that of Britain, 10.3%, and America, 10.6%. By next year, according to the OECD, the eurozone deficit will be down to 3% of GDP, compared with 7.1% for Britain and 9.1% for America.
The eurozone picture is even better when its underlying fiscal position, adjusted for the cycle and excluding debt interest, is taken into account.
While Britain had a deficit of 5.7% of GDP last year on this basis and America 7%, the eurozone’s was just 1.1%. By next year, according to the OECD, the eurozone will have an underlying budget surplus of 0.9% of GDP, compared with deficits of 3% for Britain and 5.8% for America.
Stephen King, HSBC’s chief economist, points out that Italy’s underlying deficit position is one of the healthiest in the advanced world. It may have a peculiar prime minister but its budgetary position is a lot healthier than markets think.
The task for the eurozone is to harness the overall health of its public finances. If it could do so, the eurozone sovereign debt crisis could be solved. This is why fiscal union has gained some unlikely supporters, including George Osborne.
Ruth Lea, former director of the Eurosceptic Global Vision pressure group, now economist for Arbuthnot, says “fully-fledged fiscal union” is the only long-term alternative to some kind of euro break-up.
The trouble is that the political hurdles to fiscal union are huge. There are plenty of integrationists in Europe who adopt the Rahm Emanuel doctrine that a good crisis should not go to waste but even they draw the line at having far-reaching reforms forced upon them by volatile markets.
Fiscal union is resisted by those who would pay for it, particularly German taxpayers, and by those who would benefit from it, notably the Greeks. Merkel may be the most powerful woman in the world, according to Forbes magazine, but even she could not, at present, persuade the German people to accept fiscal union.
The question, then, is what can be done to hold the euro together while the politics catches up with economic necessity of some kind of fiscal union. The urgent need will be to get away from 11th-hour, piecemeal rescues, which are always subject to being pulled apart, as with the latest Greek rescue, to something more permanent.
This could be a much larger eurozone rescue fund, boosting the size of the existing EFSF (the European Financial Stability Facility), so that bailouts would become less politically charged.
It could involve, as a staging post to the issue of eurobonds, a new Euro Area Borrowing Authority, as suggested by Barclays Capital, to guarantee new bond issues of eurozone members subject to them meeting debt and deficit conditions. It could be the agency for the policy co-ordination favoured by Merkel and Sarkozy.
In the long run, there will have to be fiscal union for the euro to survive. It would not mean individual countries lose control over their tax rates. It would mean they would lose control of their ability to run their public finances irresponsibly. Whether Europe’s leaders can rise to the challenge is the big question.
My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
This post originally appeared at David Smith’s EconomicsUK and is reproduced with permission.