A version of this aritcle appeared in the Sunday Telegraph:
Eurozone leaders took some decisive action this week to save their currency. But while the deal agreed at an EU summit on Thursday looks decent on paper, it rests on some heroic assumptions. Moreover, with the confusion over figures and formulas that arose in its wake, Europe has again been left with a worrying feeling that its politicians do not quite understand exactly what they have signed up to.
The deal contained three main elements: reduced interest rates on the bailout loans to Greece, Ireland and Portugal, some losses for private investors to reduce Greece’s debt and a transformation of the eurozone’s temporary bailout fund, the EFSF, into a cash-point for banks and possibly Spain and Italy to tap (but so far without the sufficient funds). In addition, eurozone leaders finally came back to reality by accepting that Greece will enter some form of default given its huge debt mountain. For now, these seemingly radical results have appeased financial markets. To be fair, in that sense, the package on the table does go some way to stemming the risk of contagion to other eurozone economies. But scratch the surface, and the eurozone crisis is far from over.
For starters, the deal is a huge political gamble on the willingness of taxpayers throughout the eurozone, to continue to underwrite other countries’ debts. By expanding the scope of the EFSF the agreement is providing greater avenues through which risk can be transferred from private sector bondholders to taxpayer-backed institutions. In fact, the deal hints at nothing short of unlimited bailouts, which means that the EFSF has to be radically increased in size to serve as a credible backstop. This may sit well with investors who will continue to see their losses socialised, but convincing Dutch, Finnish, German, Slovakian or even French taxpayers (under the agreement, the latter’s government could face higher borrowing costs than those it is bailing out) to provide not billions, but trillions (think Italy’s €1.8 trillion bond market), in loan guarantees to struggling banks and governments around Europe will be a mighty task indeed.
This amounts to another step down the slippery slope towards debt union in Europe. If the EU Treaties’ infamous no bailout clause, once seen as a pillar for a monetary union based on fiscal prudence, was stretched before, it has now been broken beyond repair.
The hotly disputed topic of private sector involvement also seems to have provided more questions than answers. In the days following the summit, politicians throughout the eurozone have struggled to get to grips with the deal which they supposedly masterminded. The confusion was illustrated by a bizarre moment on Friday when the Commission and the Dutch government gave two completely different figures for the actual size of the bailout. €109 billion said the Dutch, €159 billion said the Commission (leaving the Dutch Parliament, that had already preliminarily approved the deal, utterly perplexed).
But beneath the complexity, the level of debt reduction achieved by involving the private sector falls far short of what is needed. To return Greece to solvency, at least a 40% haircut to the country’s debt is needed, while this deal achieves a mere 7.5% debt reduction according to most estimates. Where the rest is supposed to come from remains anyone’s guess.
The proposal also glosses over a couple of key problems which have remained since the first bailout: will the Greek population put up with continued austerity measures given the resistance already brewing in the country, and what happens if the austerity targets are not met? Even more fundamentally, will Greece ever be able to become competitive within the confines of the eurozone? The deal contains a commitment to economic growth and competitiveness. But it is still just as unclear as ever how to achieve this in a country stuck with a hopelessly overvalued currency, an ingrained entitlement culture, an inflexible labour market and a bloated public sector.
So where does all of this leave Britain?
Economically, since the agreement fails to cut to the core of the crisis, Britain remains exposed to future problems in the eurozone, not least via its banking system. Additionally, cutting too fast and too hard in the eurozone’s vulnerable economies under the new deal – while necessary in the long-term – could trigger a pretty nasty economic downturn in the eurozone in the short-term. Given the trading volume between the UK and the eurozone, this could have a hugely negative impacts on the UK, at a time when it least can afford it.
UK Chancellor George Osborne has said that further “eurozone integration” is in the UK’s interest, that is, if it means a functioning Single Currency. The problem is that few – if any - of the proposals on the table fit the bill. To make fiscal union economically viable, it is all or nothing. Either fiscal transfers (i.e. gifts) from the strong to the weak to compensate for huge economic divergences – which is not even remotely politically acceptable to most, if not all, eurozone electorates – or a scaled down eurozone consisting of a limited number of similar economies. Somewhere in the middle will ultimately be just as unsustainable as the current situation. At the very least, if the UK is going to encourage further integration, it must develop a clear and unwavering vision about its own relationship with this evolving EU. This should include a defined list of measures to push through in Europe, including powers that it wants returned from Brussels to Westminster. Far from derailing the efforts to save the euro, such a list, if it leads to a more competitive, economically vibrant and accountable Europe would do far more to save the euro – in whatever from it exists in future – than any of the proposals that were agreed this week.
The failure to address the fundamental causes of this crisis and a suspicion that the eurozone’s political leaders fail to understand what their new deal actually means, suggests that, sadly, we may well all be back here again before too long.