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March 24, 2013 6:29 pm
In the past eight months before Cyprus erupted people have frequently reminded me, often with a smirk, of a forecast I made in late November 2011. On these pages, I declared that eurozone leaders had 10 days to save the euro. I made an ultimately similar, though less dramatic, prediction in 2006 when I wrote that Romano Prodi’s administration offered Italy’s last chance to achieve a sustainable position in the eurozone.
Mr Prodi’s administration did not deliver. The 10 days in 2011 passed without action. It is 2013, the euro is still there, Italy is still in it – and I am still making forecasts. Undeterred, I will double down today. A eurozone that compromises countries as diverse as Germany and Cyprus is not sustainable, even if the EU and Cyprus manage to find a last-minute compromise. An operational banking union that comprises supervision, resolution and deposit insurance would have been a minimally sufficient condition to make a divergent monetary system work against the odds. It would have solved the problems of the Cypriot banks for sure. But the eurozone does not have such a banking union. It will not have such a banking union in five years. Germany rejects it flat out on the grounds that it is too expensive for the German taxpayer. Ironically, Cyprus would also reject it as it would kill the country’s business model as an offshore centre for foreign deposits. Whatever banking union will ultimately emerge in the long run will be irrelevant to this crisis.
What happened in Cyprus last week is not a deep cause of anything. But it is a perfect illustration of the eurozone’s collective action problem. This latest escalation began with the dangerous agreement to bail-in insured depositors. Eurozone officials are as legally literate as they are economically illiterate. Their ever so brilliant idea was not to haircut insured deposits of under €100,000, but simply to tax them. They did not realise that if they take away the promise inherent in deposit insurance, they are in default, and in danger of starting a bank run.
The Cypriot parliament was right to reject this mad deal. But the Cypriot government then committed three subsequent blunders. The first was the decision by President Nicos Anastasiades to seek help from Russia. Instead of working with the eurozone, he worked against it. The Germans, in particular, saw this as an openly hostile move. It was also ill-judged because the Russians rejected the offer. The second was the decision not to communicate with the European finance ministers and the euro working group for three critical days last week. The third was the Cypriot government’s proposal on Thursday to create a sovereign wealth fund backed by a raid on the pension fund and other state assets. On Friday Angela Merkel swiftly dismissed it.
What happened last week is a fitting example of European political leaders, in a most unprofessional pursuit of narrow national interests, failing to defend the common good.
The main risk I want to emphasise is, however, not a big accident. It might happen, of course. But I suspect the single biggest risk ultimately stems from the eurozone’s repeated policy errors. Their effect is slow but cumulative.
Of those, the most damaging has been the policy of asymmetric adjustment through austerity. Banks in Cyprus are falling now because the Greek state and Greek banks fell earlier, and because the eurozone forced a private-sector involvement. In Italy, it was also austerity that turned a recession into a depression. That, in turn, transformed an anti-euro, anti-establishment protest movement into the single largest political party in the Italian parliament at the last elections. There is a good chance that its leader, Beppe Grillo, could end up with an absolute majority if Italy were to hold another round of elections later this year.
If austerity in the south had at least been compensated by fiscal expansion in the north, the overall fiscal stance of the eurozone would have been macroeconomically neutral. But since the north joined the austerity, the eurozone ended up with a primary fiscal surplus in a recession. In such an environment, economic adjustment simply does not take place. Without that, there can be no solution to the crisis.
I have believed for some time that it is impossible for Germany, Finland and the Netherlands to be in a monetary union with Cyprus, Greece and Portugal. Either the two sides agree to adjust more symmetrically, politically and economically, or this experiment should end.
The prediction I made in November 2011, and which I am repeating today, is that it will probably end one day, though that day may still be a long way off. I cannot exclude the possibility that the various governments will do the right thing, but three years of crisis management suggest otherwise.
With the current policy, they will need force to keep it going against the interests of the people. You do not need to be a eurosceptic to conclude that such a monetary union is also deeply immoral.
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