( SIX MINUTE READ)
While we are all distracted by Brexit which has several possible outcomes in March 2019, all given a certain probability by market analysts:
– No-deal
– Canada-style trade deal
– Chequers plan
– EFTA/Norway agreement.
– Suspension of Article 50
– Reversal of Article 50.
Each is given a probability in terms of its likelihood but I would pay little attention to those probabilities as market analysts are not political insiders and in general, a lot of experts have misjudged the EU, as its rule-based way of operating has caught many out, not least the British negotiation team.
No matter how you look at the European Union it is a market run by rules which Independent Countries join to trade in a currency called Euros.
Although the creation of the euro, in particular, was deemed to be a key component helping to move the EU to an “ever closer union,” riding the continent of centuries of historic enmities, in reality, it has and is doing the opposite.
The monetary union and the austerity-linked conditions governing membership in the eurozone continue to create conditions ripe for extreme nationalist movements in Italy, France, Hungary, Poland and elsewhere.
The two principal goals of prosperity and political integration … are now more distant than they were before the creation of the eurozone.
The euro crisis was always likely to have a second act, and the stage was always likely to be Italy. (The only member yet to come to terms with the single currency. To do that, Italian democracy must be allowed to rise to the challenge.)
Were a further divorce to happen within the Union it would create a tremendous financial fallout for the rest of us, and likely mean the end of the euro itself.
The Euro to date has been both the glue and dissolvent of the European market.
Since the financial crisis of 2007-09, after dealing with Greece and the potential for defaults that led to a bailout of the EU member just a few short years ago, Italy is now on the list.
As such, these “states” are or were subject to solvency risk, because they themselves cannot create the euros to fund their debt.
With Brexit, it will become clear that we shouldn’t wait for the next crisis.
The next one could be very harmful, if not destroy the euro altogether.
A construction like the eurozone only partly rests on rules, technical procedures, institutions, etc. It relies on the fact that governments can trust each other at a minimum level. Take that away, and the whole edifice suddenly becomes much more fragile and the willingness to reform shrinks.
In these terms, a sustainable European currency requires either the export of the foundations of German economic strength to the periphery or Germany’s willingness to relinquish its obsession with ordo-liberalism and achieving a large current account trade surplus.
To date, its willingness to act to save the euro has not in fact been put to the test.
Far from involving domestic sacrifices imposed to save the euro, Germany’s handling of the eurozone crisis thus far has been, first and foremost, an opportunity for Germany to ‘Europeanise’ the burdens of its banks.
Germany may, therefore, end up with total dominance over something that doesn’t work, and holding the creditor bag on a currency that eventually may not exist.
Barring a wholesale shift in ideology, any short-term stitch-up will just set the stage for a bigger problem down the road, likely provoking more nationalist backlashes against the EU, which continues to play with fire, backed by Berlin.
So can the euro survive an Italian Bank/Country collapse?
Italy’s GDP has shrunk by a massive 10%, regressing to levels last seen over a decade ago. In terms of per capita GDP, the situation is even more shocking: According to this measure, Italy has regressed back to levels of 20 years ago, before the country became a founding member of the single currency.
As a result, around 20% of Italy’s industrial capacity has been destroyed, and 30% of the country’s firms have defaulted.
Its competitiveness can only be restored, therefore, via an “internal devaluation,” which in essence means crushing the living standards of the Italian people, so that they can compete in the global export market, rather than using fiscal policy to enhance the country’s domestic economy.
Understandably, the current coalition government in Rome doesn’t want to play along.
Its component parties were elected to defend the interests of the Italian people and deliver a different sort of economic program, which doesn’t consign the electorate to another decade of declining living standards. And Italy’s voters remain supportive if the most recent polls are anything to go by.
Hence the coalition’s resistance to Brussels/Berlin–imposed spending limits.
Europe’s central bank was (and is) the only institution that could credibly backstop the debt without limit because it is the sole issuer of the euro. However, the ECG has recently decided to put a stop to Quantitive Easing.
(Quantitative easing is a modern version of the printing press. It consists of the central bank creating money to buy government or private bonds held by investors on the market. The goal is for the latter to reinject the cash they get back into the economy by lending to households and businesses, which in turn must stimulate growth and inflation.)
As it concerns nineteen countries using the same currency, the ECB’s purchasing program is more framed than that of the US Federal Reserve, the Bank of England or the Bank of Japan.
It may have taken Trump, Brexit and the threat of a global trade war, but the markets in Europe are finally waking up to what the end of QE will look like.
The markets are finally facing up to a reality where fundamentals actually matter and are no longer being swept away by ‘QE infinity’.
That should be a relief, given the huge distortions that QE has created in the global economy, most notably in asset price inflation and a consequent widening of inequality throughout the developed world.
The political implications are obvious and are still continuing. But how quickly and safely central banks can be weaned off this great monetary experiment remains to be seen.
If QE is no longer an active policy instrument what will replace it?
Quantitative easing is – and always has been – a dangerous monetary experiment and these are not the times to experiment. Especially not in Europe, where the political gap between north and south has widened in a disturbing way and interdependencies grow bigger and bigger.
What if Germany, France and the Netherlands continue to grow, and Italy, Greece and Portugal don’t?
Then the gap between the higher income rates they have to pay and their lack of growth becomes even bigger.
The political and economic instability of the southern European democracies is eroding the political basis of the euro – and therefore its stability. Because of this everyone suffers.
THE QUESTION IS WILL ITALY BE ALLOWED TO GO THE WAY OF GREECE?
That could prove economically calamitous, exposing the country’s international creditors (including other eurozone nations, such as Germany and France) to literally trillions in liabilities. To be repaid in what? Euros?
A reconstituted, and possibly heavily devalued, lira?
What happens to the pension funds? What about capital flight? Runs on the banks?
The point is that Italy does have leverage, but deploying the leverage will be costly for all concerned.
Considering the political turbulence in Italy which wants to raise its budget deficit by 2.4% in 2019, ( Its current debt is more than 2billion euros 131% of its GDP.)
Driving Italy out of the euro makes no sense at all. Italy is facing not just a financial but a democratic reckoning.
The euro debacle has tested the democratic integrity of the weakest eurozone member states to a breaking point. In Ireland, Spain and Portugal – the other countries affected by the single currency’s woes – democracy not only survived the test but flourished after it.
In 2019 we are going to see Italy’s political class discredited, its economy exposed as a sham, and it can only be rescued with other people’s money on other people’s terms.
It has now brought Italy to the brink of another failure of state as dangerous as the one that occurred during the confrontation with the Mafia in the early 1990s.
One of the major challenges for members of the euro area has always been not simply to rectify external imbalances, but to do so at reasonably high levels of employment. The fact that failures to meet this challenge are encountering political difficulties in Italy and elsewhere is hardly surprising.
So to stabilize the euro area and foster the financial integration across countries, we need to end the vicious circle of youth unemployment in the Southern countries of Europe and not penalise breached of budgetary Rules.
The euro is neither the problem nor the solution.
Italy’s profound problems lie at home — especially in central and southern Italy — and need to be addressed at home.
Both Europes and Italy’s problems arise out of acute regional imbalance.
You can not look at Italy as one economy, but two or perhaps three: North, Centre, South which is reflected in the whole of Europe’s problem.
Take the hyper-competitiveness of Germany.
Its massive current account surplus (8% of GDP) combined with its virtually full employment implies unambiguously that for Germany the euro is significantly undervalued, just as for Italy the evidence suggests that it is overvalued.
So we have an interesting, but risky, game of chicken developing.
Even though virtually every country within the eurozone, including fiscally virtuous Germany, has routinely breached budget limits, these rules do matter because, under Maastricht Treaty terms, countries can be punished by European institutions and also by markets, as has happened to Greece and now is increasingly happening to Italy.
Its debt load is the third-largest in the world and will eventually become unsustainable if the country is unable to revive economic growth.
What can Europe do – that is not already being done – to get its millions of jobless young people into work?
Things cannot be implemented overnight and will never be unless there is a willingness to move on with euro area reforms.
On top of all our problems is the Automation of the job market.
WILL THE EURO SURVIVE?
YES.
Boosting productivity is essential to resolve both problems.
So here is a suggestion.
Why not make the two most Southern Countries of Europe where the sun does shine – Italy Spain – the new green energy hobs of Europe – implementing a huge investment into solar power to supplement the energy requirements of the Northern member states.
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