The crises of the euro

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This article is a guest contribution by Dr Stefan de Vylder*, well-known Swedish economist.

The 85 billion euros that were recently mobilised by the IMF, the European Union and various bilateral lenders to save Ireland – or, rather, to save banks and other private investors who have invested in Irish assets – confirms my view of the European Monetary Union (EMU) as a club with the wrong membership and a weak management.

Early in 2010, Greece was the ideal scapegoat. A huge fiscal deficit which previous governments had tried to cover up with the help of creative bookkeeping and outright cheating provided a reason for the vilification of Greece. But it was membership in the currency union that had made it possible for Greece – and, indeed, for all members of the union – to benefit temporarily from a rising euro and easy access to cheap credit. Neither the financial markets, nor the European Central Bank (ECB) or other EU authorities, were vigilant enough to warn of the danger of the growing bubbles and deficits that came to characterise a large number of the euro zone countries.

Yesterday Greece, today Ireland, tomorrow Portugal and Spain, the day after tomorrow perhaps Italy and France. A large part of the EU is in severe financial trouble and the recipient of punitive loans with adverse policy conditions attached. These are the prospects for an association that was formed with supposedly binding rules for responsible behaviour.

The cornerstone of the EMU was the so-called Growth and Stability pact, which stated that no member of the club was allowed to run a fiscal deficit exceeding three per cent of GDP. When Germany and France soon after the formation of the EMU broke this golden rule the stability pact was de facto buried. At present, the average size of the euro zone’s fiscal deficit is 6,5 per cent of GDP.

The next rule that was violated, and proved to be fiction last spring, was the “no bailout” clause in the Lisbon Treaty, which explicitly forbids the EU to rescue countries in crisis. Furthermore, the 110 billion package to Greece was, as was the case in the recent deal with Ireland, tied to the implementation of austerity policies that were so severe that even the IMF expressed its concern.

The loan conditions to Greece and Ireland are very tough. But the EU and IMF message could also be interpreted in the following way by countries in crisis: if you promise to reduce your deficits you may borrow enough euros to be spared. For the time being.

The third pillar of responsible behaviour was the European Central Bank, which was forbidden to bail out member countries in crisis by buying their government bonds. Today ECB is the largest – and soon, perhaps the only – together with China – single buyer of Greek and Irish bonds. The sellers are those private investors who with a sigh of relief are happy to find someone willing to buy their high-risk assets.

These rescue operations suffer from one major weakness: they fail to solve the main problems of the euro zone, which are rather likely to be aggravated.

Insolvency, not Illiquidity
If illiquidity, i.e. a temporary lack of liquid funds, is the problem, borrowing in order to bridge a brief financial gap is an excellent solution. But when a country – or an individual – is unlikely to be able to service its debt in a longer-term perspective, we are talking about insolvency. However, the crisis affecting a number of euro-zone countries is not a short-term liquidity crisis. If that had been the case, the rescue packages would have made sense. But we are dealing with a crisis of insolvency, not illiquidity.

The EU leaders are amazingly silent on the grave predicament the EMU is now in. Simply put, those EU countries unable to service their debts will not be helped by taking up new loans, especially not if these loans are given at exorbitantly high interest rates.

Click here for the full article.

Source: Dr Stefan de Vylder, December 29, 2010.

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1 comment to The crises of the euro

  • Bill

    I found this to be an excellent article, clearly written. I
    have seldom seen such a concise explanation of the dilemma

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