Europe: What fate for the beleaguered euro?

In recent months, the crisis in the euro zone has spread rapidly from peripheral members, such as Greece, Portugal and Ireland to some of the biggest economies in the European Union, namely Spain and Italy. This week the contagion continued, as interest rates on Belgian and French 10-year government bonds increased, and Germany only managed to sell €3.6 billion of the €6 billion-worth of 10-year Bunds available at an auction on Wednesday.

The European Commission’s index of consumer confidence fell for the fifth month in a row this November, signalling to a likely return to recession in the euro zone. The growing financial pressure in this area is increasing the likelihood of government defaults which may trigger the break-up of the euro zone.

In the not so distant past, to question the stability and solvency of the European single currency would have been thought sacrilegious. Upon the entry into circulation of euro coins and banknotes on 1 January 2002, the euro was widely regarded as a legitimate trading alternative to the US dollar. Confidence in the success of the euro was so strong that no provision for the exit of member states from the single currency was ever written into EU legislation.

The once unthought-of possibility of euro-zone disintegration is fast becoming a reality. Last week Germany’s conservative Christian Democratic Union party passed a resolution calling for changes to the Lisbon Treaty to allow euro-zone members to voluntarily exit the monetary union without giving up membership to the broader European Union.

Increasing unemployment in the euro zone means lower tax receipts and increases in welfare payments, rendering it more difficult for European governments to reduce their deficits. The foreseeable failure of governments to reach deficit-reduction targets will cause markets to question member states’ solvency to an even greater degree than previously.

The unwillingness of investors to fund sovereigns and banks is also undermining confidence in the euro. During the credit boom, cheap foreign loans were purchased in Greece, Spain, Portugal and Ireland to finance housing booms and trade deficits. Consequently, these countries’ net foreign liabilities are close to 100 per cent of GDP. The majority of this debt is financed in the form of bonds sold to investors in creditor countries. While the latter tend to have low bond yields, debitor countries with large international debts have a high cost of borrowing. This amounts to an internal balance-of-payments crisis, which means the economic discrepancy between euro-zone countries is only likely to widen as debitor countries pay ever-increasing interest rates on their debt.

If a euro-zone member is forced to default, it will likely have to reinvent its currency. This would enable the country to write down the value of its debts, while also cutting its wages to give the country a competitive edge over those still in the euro zone. In addition, this would largely eliminate monetary shortages, because the countries’ national central banks would be free to bail them out, something which the ECB has thus far refused to do for ailing euro-zone members.

This currency reinvention comes at a price. If a member state were to pull out of the euro, it would have grave consequences for other weak economies. Governments would have to limit bank withdrawals and introduce capital controls, as depositors rushed to take out their savings to avoid losing money in a forced conversion to a weaker currency. Furthermore, the lack of investment security would disincentivise investment and lead to a credit shortage. Governments would be forced to find other sources of funding to bridge the gap between tax revenue and public spending.

While it is difficult to pre-empt how a disintegration of the euro-zone might come about, let us speculate. In advance of his resignation some two weeks ago, Mr Papandreou, the former Greek prime minister, proposed a referendum on Greece’s membership to the euro zone. Although the referendum was killed off by threats from the EU to withdraw the latest instalment of bail out money, a similar future fall-out between Greece and its creditors (the EU, the ECB and the IMF) may prompt Greek withdrawal from the single currency. Or perhaps it will be a failed bond auction that tips the applecart and leads to a euro-zone member leaving the monetary union. Italian bonds worth €33 billion and €48 billion will reach maturity in January and February respectively. Given Germany’s recent troubles shifting its sovereign bonds, it is not unlikely that Italy will also struggle to sell its debt off to investors.

If the euro zone does disintegrate, the consequences would be disastrous. The region would be torn apart by government defaults, a drying up of available capital, bank failures, and the imposition of capital controls. More broadly, the demise of the euro zone would endanger the future of the European Union itself.

Nevertheless, the euro zone can still survive, but only with strong policies and swift action. The ECB, hitherto unwavering in its refusal to act as a lender of last resort, should launch a comprehensive programme of bond-buying to avoid the euro zone plunging into a deep recession. However, to attract investors back to government bonds, the euro zone also requires more than just ECB support. Analysts stress the need for a solid debt instrument which would, in some form, share liability for government debts. Germany’s Council of Economic Experts has proposed mutualising all euro-zone debt above 60 per cent of each country’s GDP, and allocating a percentage of tax revenue to paying it off over a 25-year period. The German administration has nevertheless rejected this idea, fearful that it would be their country bearing the burden of weaker states’ economic strife.

One thing is sure: the attitude in member states’ governments needs to change. And fast. Otherwise the euro will certainly die a very painful death. 


By Sonia Jordan

Memos from Member States

Belgium: Political stalemate to end?

Moves were made to put an end to the political stalemate in Belgium this week, with Elio di Rupo as the likely candidate to become the next prime minister after the King asked the French speaking socialist leader to form a new government.

The move comes after the political parties reached a deal on the 2012 budget in which Belgium commits to reduce its deficit to 2.8 per cent of GDP. The agreement symbolises an important step towards to the formation of a new government more than 18 months after elections were held.

Pressure was building on Belgium to act after Standard and Poors downgraded the country’s credit rating stating the government’s inability to respond to economic pressures as one of the principal factors contributing to the downgrade.

Latvia: Latvijas Krajbanka goes bust

The Latvian financial watchdog Finansu un Kapitala Tirgus Komisija (FKTK) announced this week that the troubled Latvian bank Latvijas Krajbanka had no further deposit availability, meaning that the bank is no longer able to function.

The Latvian government has announced that there will be no state bail out for Latvijas Krajbanka, of which the Lithuanian government is the majority shareholder. The Latvian government has instead urged Lithuania to bail out the bank.

Krajbanka's clients will receive their state-guaranteed compensations for their deposits up to the sum of LVL 70,000 (EUR 100,000) within 20 days. Deposits beyond that sum will be lost if no takers are found to bail out the bank. Several Latvian state institutions have much larger deposits in Krajbanka.

While the majority of deposits in Latvijas Krajbanka – LVL 343 million altogether – is private individuals' money, small and medium-sized enterprises, corporate entities, and state-owned companies are also entitled to receive the state-guaranteed compensation. Despite the much larger size of their deposits however, these companies and intuitions will only receive a maximum of LVL 70,000 each, the same sum as individual investors.

Germany: Neo-nazi activities to be investigated

The east-German authorities faced scrutiny this week over whether official protection was afforded to a trio of neo-Nazis who murdered members of minority groups – mostly Turkish store owners but also one German police officer – between 2000 and 2007.

Two male members of the far-right group called the ‘National Socialist Underground’ were found dead this month, in suspected suicide cases.

Investigations are currently being undertaken to ascertain whether the killers benefited from sympathy from the German information services. All unsolved cases with a possible racist motive since 1998 were reopened this week.

By Sonia Jordan

Memos from Member States

Spain: Centre-right predicted to win general elections

Voters in Spain headed to the polls on Sunday in an election expected to bring an end to over 7 years of socialist party rule. Opinion polls conducted in November predict that the centre-right Partido Popular, led by Mariano Rajoy Brey, will win more than 45 per cent of the vote, some 15 per cent ahead of the Socialists.

The election was called by current prime minister, Jose Luis Rodriguez Zapatero, amid concerns over the economy. With slow growth, the highest unemployment rates in Europe, and borrowing rates that passed 6 per cent this week, the economy has been at the centre of the election campaign.

The Partido Popular has gained support due to its proposed policies to fix the country's economic problems and reduce unemployment. The Partido Socialista Obrero Español has been critical of these policies however, accusing Mr Rajoy of planning to make severe cuts to health and education.

The voting boxes opened at 9am Sunday morning, and as this article went live, votes were still being counted.

Europe: Technocracy or democracy?

George Papandreou, the Greek prime minister and Silvio Berlusconi, his Italian counterpart, have been in a political fiddle for some time now. Mr Berlusconi has been heavily criticised for his monopoly over the Italian media and his premiership has been plagued by sex scandals. Mr Papandreou’s austerity programme led to a wave of nationwide strikes and created divisions in even the upper-most echelons of government.

Nevertheless, their recent resignations were no doubt triggered by the ultimatum put to them by euro-zone leaders at the G20 summit in Cannes: either reform your economies or clear your desks. Mr Papandreou was told to approve the latest European bail-out deal or lose his loans, while Mr Berlusconi was instructed to allow IMF supervision of his reforms.

Although the European Union (EU) has long influenced domestic policy, the intrusion of euro leaders into the internal politics of Italy and Greece is unprecedented in terms of the scale and urgency of demands. The age-old debate over whether the EU is an intergovernmental or supranational organisation has resurfaced.

As decisions are increasingly migrated to Brussels, many voters feel distanced from, and powerless before, those drafting legislation to which, as citizens, they must abide. But, if the increased powers afforded to Brussels under the Lisbon treaty weren’t enough, the very fabric with which Western nations have sewn their political structures, namely democracy, is under siege.  

Europe: Apocalypse now?

Concerns over Europe's ability to manage its sovereign debt crisis intensified this week, as political turmoil in Rome and Athens, and the stark possibility of a double dip recession, provoked panic on world markets.

The announcement that Silvio Berlusconi would step down as Italy’s prime minister once austerity measures were pushed through parliament, did not prevent a collapse of investor confidence. Rather, Italian 10-year bond yields passed the 7 per cent mark on Wednesday; a level that previously drove Portugal, Greece and Ireland to seek European bailouts. The European Central Bank (ECB) was forced to intervene and bought limited quantities of the country’s debt, which enabled bonds to rebound from previous lows.

Political chaos also characterised Athens this week, as talks to appoint a prime minister to succeed George Papandreou temporarily stalled. Greek party leaders ultimately agreed to name Lucas Papademos, a former ECB vice-president, as prime minister of a new interim government until early elections determine a permanent replacement in the first quarter of next year.

Memos from Member States...

The United Kingdom: Support grows for Occupy London protest
War veterans are the latest in a long line of recruits joining the Occupy protests outside St Paul’s Cathedral in London. Such is the scale of the protest that, in a break with tradition lasting more than 800 years, the new Lord Mayor of the City of London was this week anointed at the cathedral’s south entrance rather than the building’s front steps.

The peaceful protest against economic inequality, social injustice and corporate greed began on 15 October 2011 in solidarity with the Occupy Wall Street protests in New York. The protestors occupy two encampments in central London in St Paul's Cathedral and Finsbury Square.

As protestors attended Remembrance Day services at St Paul's Cathedral, they were joined by former service personnel with their own list of grievances against the government. At least 15 military veterans have joined the camp in protest over their post-conflict treatment.