Possible Options for the Euro

The single currency has arrived at a three-pronged fork in the road

There are three possible ways out of the eurozone crisis: austerity, investment or the route taken by Argentina in the 90s

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• • Larry Elliott
  • guardian.co.uk, Sunday 15 April 2012 18.28 BST 
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Greeks protest outside the headquarters of the Bank of Greece in Athens. Photograph: Simela Pantzartzi/EPA

The next 12 months will decide the fate of the eurozone. The single currency's problems have not gone away and will again dominate this week's meeting of the International Monetary Fund in Washington. Every one of those attending knows that the crisis could erupt again at any moment; last week's selloff in Spanish and Italian bonds was like the puff of smoke billowing out of a volcano getting ready to blow.

Here's a summary of how things stand. The euro was constructed on the false premise that monetary union would lead to a harmonisation of economic performance across member states. Greece would become like Germany; Portugal would be similar to Finland. Instead, the euro has led to a widening gulf between rich and poor, and this has been brutally exposed by the financial crisis and its aftermath.

It became clear that the countries on the periphery of the eurozone had a cocktail of problems. Their economies were much less productive than those at the core, so they were gradually becoming less competitive. They had shaky banking systems. And they had weak public finances. Investors, unsurprisingly, came to believe that holding Greek, Italian or Spanish bonds was risky, and demanded higher interest rates for doing so. This added to the pressure on banks and governments, and by pushing up borrowing costs, affected growth prospects as well.

By late last year the eurozone was on the brink of meltdown. At that point, the European Central Bank stepped in and announced long-term refinancing operations (LTROs). These pumped unlimited ultra-cheap money into the eurozone banking system to satisfy the funding needs of banks for three years.

The idea was to kill two birds with one stone. Banks would have more cash and could use it to buy government bonds in their own countries, thus driving down interest rates and so boosting growth.
This was a high-risk strategy that depended on the crisis-affected countries quickly returning to steady and robust growth. If they didn't, their banks would be loaded up with government bonds and vulnerable to a selloff in the markets.

In the past couple of weeks this possibility has dawned on markets. They have started to mull over a scenario in which a deepening recession in Spain leads to the government missing its deficit-reduction targets, prompting rising bond yields and eventually necessitating an international bailout.
There is much talk in European circles about how Greece was a one-off. Few in the markets believe that.

In the very worst case the euro will break up entirely, leaving the ECB nursing big losses and ruing the day when it embarked on an expansion of the money supply.

As George Soros noted last week, the Bundesbank perceives the risk, which is why it is campaigning hard against any further LTROs. The message from Germany, and from other core countries, is that it is time for Spain, Italy, Greece and Portugal to start delivering on their promised structural reforms.
All that explains why Christine Lagarde, managing director of the IMF, keeps insisting that Europe has bought itself just a little time to sort out its problems. Lagarde is absolutely right about that: the single currency has arrived at a three-pronged fork in the road.

Route number one is Austerity Avenue. The eurozone continues on the same road, the poorer countries on the fringe making themselves more competitive by what is known as internal devaluation. This involves driving down production costs via wage and welfare cuts, and state assets selloffs. Living standards take a big hit for a prolonged period, but eventually countries such as Greece bridge the gap between themselves and Germany.

Economic and political problems beset this route. Austerity is killing growth, making it harder to reduce government borrowing, and it inflames populations unhappy at the prospect of falling living standards year after year. It's a bumpy road; it could also prove a short one.

Next up is the High-Investment Highway. The premise for this route is that the single currency can survive but only if measures are taken to stimulate growth. Soros proposed a plan last week in which all countries could refinance their debts at the same rate – but, as he admitted, this would never get past the Bundesbank.

Another idea, suggested by the former Labour MP Stuart Holland, is bond-financed investment programmes modelled on Roosevelt's New Deal. This would have two components: Union bonds, under which a country could convert up to 60% of its national debt into non-traded Union bonds; and Eurobonds, which would be traded and actively marketed to fast-growing countries of the emerging world wanting an alternative to dollar reserves.

The idea, which caught the interest of France's socialist presidential candidate, François Hollande, would be to use Union bonds to stabilise debt and Eurobonds to finance investment.

As with the Soros plan, this would no doubt run into stiff opposition from Germany. It would also involve a much higher degree of fiscal integration. But if Austerity Avenue is a dead end and High-Investment Highway a road to nowhere, that really leaves only one other exit: Buenos Aires Boulevard.

A paper published last week by Capital Economics described the similarities between the struggling eurozone countries today and Argentina in the late 1990s. Argentina had fixed the peso against the dollar irrevocably at the start of the 90s but, after a few good years of strong growth and low inflation, by the end of the decade was under severe strain.

The solutions tried now in Greece – austerity, debt rescheduling, IMF programmes – were tried in Argentina to no avail. Indeed, output crashed, making the country's debt position even worse. Eventually the pressure was too much and Argentina devalued and defaulted.

But far from the sky falling in, which was what the IMF and the other proponents of orthodoxy predicted, Argentina's growth averaged 9% a year from 2003 to 2007.

As Andrew Kenningham, of Capital Economics, accepts, Greece would not be expected to do nearly as well as post-crisis Argentina, which benefited from rising commodity prices and did not have to cope with the inevitable contagion effects arising from a country leaving a single currency. But, he says, Argentina's example offers a "painful but viable" exit from the crisis that the current deflationary policies do not. And unless policymakers in Europe can offer their citizens somethingmore enticing than endless austerity, a stroll down Buenos Aires Boulevard will look increasingly enticing.

My Weltanschhaung - 11/2/2012

I am glad that atleast now a few Greek politicos have called the bail out terms extortionate. I think Greeks should default on their loans. Else, where is the risk for the lender who seems to get his money back in all circumstances and even by hurting innocent victims in a society.

A more disturbing news is that Chinese imports (of raw materials, I presume) fell in January. This will worry all export led growth oriented countries, unless they are beating China at their own game. Unlikely though since Chinese firms enjoy state subsidised capitalism.

Harry Redknapp seems to be inching towards the England managership. I suppose every man rises to a level of failure, but it won't be Harry's fault as there appears to be a shortage of talent in England.

Argentina accuses the UK of storing nuclear weapons near the Falklands. At the same time the UK tries to prevent Iran and others from getting nuclear weapons.

The global outlook for oil appears gloomy, so will the energy suppliers lower retail prices?

My Weltanschhaung - 8/2/2012

I watched Prime Minister's questions and noticed that everytime David Cameron felt uncomfortable, he used David Miliband to beat Ed Miliband with. I wondered what that had to do with Ed's questions on the NHS.

I have come to the conclusion that reform or not the NHS will get progressively worse year upon year.

I was surprised at the all party unity in the UK on invading Syria and the hatred towards the Russian and Chinese veto at the UN. Who said imperialism was dead?

I look forward to Argentina raising the Falklands issue at the UN. Will the UK use its veto then?

On of my students opined that a small shareholder could influence decision making in a big corporation, and hence he was a believer in corporate democracy as against political democracy.


I watched two BBC programmes on the ancient African kingdoms of Ashante and Zulu. Very Good.

It's time to cancel unpayable old debts

By Aditya Chakrabortty in The Guardian

In the week between Christmas and New Year, those bleary few days when the world has better things to do than catch up on news or check its Twitter account, The Guardian carried a story that bears repeating. It was about Dimitris and Christina Gasparinatos and their kids in the Greek port of Patras. For ever hard up, the parents had been pushed by the economic crisis into outright poverty; and just before Christmas Dimitris and Christina put four of their children into care.

Nor is the Gasparinatos' case an isolated one. Greece must be the most family-centric society in western Europe, yet its media is full of reports of newborns dumped outside clinics, or infants shunted into foster homes.

Such stories almost never come up when politicians and economists debate Europe's meltdown; implicitly, they are categorised as fall-out, for journalists and campaigners to highlight. Yet the abandoned children of Greece are not merely coincidental to those discussions about how to tackle the debt; they are integral to it.

Strip away the technicalities and you are left with two ways to think about the debt crisis. One is as a battle between the past and the future. The vast majority of Greece's debts are historic commitments made to creditors by previous governments, sometimes in very dubious circumstances. Yet Athens has been forced to prioritise repaying these old loans over generating economic growth, or future income. One result of that policy has been to snatch away whatever chance the Gasparinatos kids might have had of decent lives.

Something similar is happening in Britain. David Cameron came to office with the primary goal of paying down debt. Less than two years later, his ministers are now obliged to go on the BBC at regular intervals to explain why more than a million young people are out of work. Study after study shows that a young adult unemployed at the outset of his or her career suffers permanent damage to their prospects, yet this government's economic policy favours the past even though it means ruining the future.

Why? This brings us to the second way to think about any argument over debt: as a fight between creditors and borrowers, or the haves and the have-nots. The creditors have the money and therefore the whip-hand over the borrowers. They also have the political influence: the boss of Deutsche Bank would, one suspects, get more face time with Greece's prime minister or any other eurozone leader than the Gasparinatos family and a whole coachload of their neighbours. His demands are also more likely to get preferential treatment, which is a major reason why Angela Merkel and Nicolas Sarkozy has gone through such contortions over Athens' loans.

Before last summer, eurozone policy-makers swore blind that they would never countenance Greece failing to pay all of its debts in full. After finally accepting that that was impossible, they then asked if bankers would be good enough to knock 21% off the country's loans, rising over time to 40% and then 50%, or even a little more. Meanwhile, economists at the IMF estimate that Greece should actually have 75% wiped off its debt burden – and market prices indicate that figure should really be over 90%. But economic reality has been no match for the stranglehold bankers have on European politicians – who, by the way, swore last month that no other country would fail to pay its loans in full.

And yet economic history is full of examples of successful debt default. When American Airlines declared recently that it was bankrupt and couldn't carry on repaying its loans, it was applauded by Wall Street analysts as "very smart". The whole point of company insolvencies is to work out the value and viability of the underlying enterprise; if it can carry on, banks and other creditors get squared off at vastly reduced sums and the productive part of the firm is back in business.

The same goes for countries. Regimes sunk by revolutions don't repay their debts; nor do countries that lose wars. (When they are made to, as with Germany after the first world war, terrible things can result.) Over the past couple of decades, campaigners have successfully won debt relief for poor countries in Africa and Asia. Other nations, such as Ecuador or Argentina or Iceland, have simply declared they cannot repay all that they owe.

Ultimately, a loan is a social arrangement and, like any other contract, it can be renegotiated. A few decades ago, archaeologists discovered the first ever legal contract in Lagash in modern-day Iraq. Dated back 4,400 years and carved into the bricks of a Mesopotamian temple, it was for the cancellation of debt. It's claimed that countries that don't repay their loans will be frozen out by lenders. Yet, as I wrote here last year, IMF economists have recently argued that "the economic costs are generally significant but short-lived . . . we almost never can detect effects beyond one or two years."

In his recent, brilliant history Debt: the First 5,000 Years, the anthropologist David Graeber calls for a modern-day debt jubilee, a cancellation of all debts, just as they had in Mesopotamia. His suggestion is provocative, but it should be taken seriously. Because the longer we keep protecting the haves over the have-nots and honouring the past while destroying the future, the worse this debt crisis will get.