Will the euro survive?
Martin Wolf, Associate Editor & Chief
Economics Commentator, Financial Times
Nottingham University
14th February 2013
Will the euro survive?
“The effort to bind states together may lead,
instead, to a huge increase in frictions among
them. If so, the event would meet the
classical definition of tragedy:
hubris (arrogance); até (folly); nemesis
(destruction).”
Martin Wolf, FT, December 1991.
Will the euro survive?
Will the euro survive?
• Why did the crisis happen?
• What are the results of the crisis?
• Is the crisis being solved?
• What does this mean for the UK?
4
1. Why did the crisis happen?
• The crisis is not, in its origin, a fiscal crisis, as many
think, but a balance of payments crisis:
– In the run up to the crisis, there were huge internal capital
flows. These opened up current account imbalances and
generated huge divergences in competitiveness.
– After 2008, cross-border private financial flows suffered a
series of “sudden stops”. These caused, or aggravated,
fiscal crises.
• The view that this is a fiscal crisis lets creditors blame
debtors.
• The correct view that this is a financial crisis puts
blame on creditors, debtors and the system.
5
1. Why did the crisis happen?
NOT THE ROAD TO THE EUROZONE CRISES
NET PUBLIC DEBT OVER GDP 2007 (per cent)
120
100
80
60
40
20
0
-20
-40
-60
-80
-100
6
107
87
41
11
-73
22
27
51
60
64
73
1. Why did the crisis happen?
CONSEQUENCES OF THE CRISIS
NET PUBLIC DEBT (over GDP)
(Source: IMF)
200
180
160
140
120
100
80
60
40
20
0
Ireland
Spain
Portugal
2007
7
2010
Italy
2013
Greece
1. Why did the crisis happen?
ROAD TO THE EUROZONE CRISES
AVERAGE CURRENT ACCOUNT BALANCE
(1997-2007, as shares of GDP)
8.0
5.2
6.0
3.9
4.0
2.1
2.0
0.1
0.7
0.0
-0.9
-2.0
-4.0
-4.6
-6.0
-8.0
-10.0
-7.5
-8.8
Average 1997-2007
8
1.1
5.8
1. Why did the crisis happen?
LOST COMPETITIVENESS
UNIT LABOUR COSTS IN MANUFACTURING
(Germany = 100)
200
180
160
140
120
100
80
60
99 99 00 00 01 01 02 02 03 03 04 04 05 05 06 06 07 07 08 08 09 09 10 10 11
-19 3-19 1-20 3-20 1-20 3-20 1-20 3-20 1-20 3-20 1-20 3-20 1-20 3-20 1-20 3-20 1-20 3-20 1-20 3-20 1-20 3-20 1-20 3-20 1-20
1
Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q
Portugal
9
Italy
Ireland
Greece
Spain
1. Why did the crisis happen?
• Why were proponents of the eurozone unaware of
the danger of cross-border financial flows and current
account imbalances?
– They thought these flows were the purpose of the exercise;
– They thought currency risk was the only danger; and
– They thought they had eliminated currency risk.
• They were wrong:
– Currency risk cannot be eliminated; and
– It will re-emerge as credit risk.
10
1. Why did the crisis happen?
• Even regions within countries can suffer the
consequences of current account imbalances:
• But mechanisms for handling the worst
consequences of regional “busts” exist:
– Support for the financial system;
– Fiscal transfers; and
– Labour mobility.
• Eurozone member countries are in a gold-standard
type of mechanism: adjustment goes via depression.
11
1. Why did the crisis happen?
• They did have a central bank, which has helped
through a range of programmes, including recently
the Long-term Refinancing Operations for banks and
Outright Monetary Transactions, for sovereigns
• But, as Spain has discovered, support from the
European Central Bank is not the same as having
one’s own central bank and a floating exchange
rate.
• Spain and UK have similar fiscal situations, but very
different interest rates on public debt.
• This reveals liquidity, credit and break-up risk.
12
1. Why did the crisis happen?
WHO’S THE MORE INDEBTED?
NET PUBLIC DEBT IN SPAIN AND THE UK
(as per cent of GDP)
90
80
70
60
50
40
30
20
10
0
1999
2000
2001
2002
2003
2004
Spain
13
2005
2006
2007
United Kingdom
2008
2009
2010
2011
2012
1. Why did the crisis happen?
WHO’S THE MORE INDEBTED?
10-YEAR SOVEREIGN BOND YIELDS
8
7
6
5
4
3
2
1
0
1/1/07
1/1/08
1/1/09
1/1/10
Spain
14
1/1/11
UK
1/1/12
1/1/13
1. Why did the crisis happen?
• High-income countries embedded inside a currency union are
more vulnerable to balance of payments cum financial crises
than countries with floating exchange rates and their own
central banks.
• They are like emerging countries with exceptionally hard
exchange-rate pegs, though they do enjoy semi-automatic
monetary financing from the ECB.
• Thus the currency union has replaced the brief currency crises
of the exchange-rate mechanism with long-running solvency,
employment and political crises.
15
2. What are the results of the crisis?
• The results of the crisis have included:
– Exorbitant bond yields in deficit countries;
– Dwindling cross-border finance, capital flight, bank runs;
– Tighter links between domestic banks and their sovereigns;
– Private retrenchment, collapsing GDP and soaring
unemployment; and
– Rising political friction.
16
2. What are the results of the crisis?
FLIGHT FROM VULNERABLE COUNTRIES’ BONDS
SPREADS OVER BUNDS
50
40
30
20
10
0
1/1/07
1/1/08
1/1/09
1/1/10
1/1/11
-10
Portugal
17
Ireland
Greece
1/1/12
1/1/13
2. What are the results of the crisis?
THE EROSION OF FINANCIAL INTEGRATION
OWNERSHIP OF SPANISH SOVEREIGN BONDS
(Source: Merler, Bruegel)
80%
70%
60%
50%
40%
30%
20%
Resident banks
18
Non-residents
2012_2
2011_4
2011_2
2010_4
2010_2
2009_4
2009_2
2008_4
2008_2
2007_4
2007_2
2006_4
2006_2
2005_4
2005_2
2004_4
2004_2
2003_4
2003_2
2002_4
2002_2
2001_4
2001_2
2000_4
2000_2
1999_4
1999_2
1998_4
1998_2
0%
1997_4
10%
2. What are the results of the crisis?
THE EROSION OF FINANCIAL INTEGRATION
OWNERSHIP OF ITALIAN SOVEREIGN BONDS
(Source: Merler, Bruegel)
80%
70%
60%
50%
40%
30%
20%
10%
1997_4
1998_2
1998_4
1999_2
1999_4
2000_2
2000_4
2001_2
2001_4
2002_2
2002_4
2003_2
2003_4
2004_2
2004_4
2005_2
2005_4
2006_2
2006_4
2007_2
2007_4
2008_2
2008_4
2009_2
2009_4
2010_2
2010_4
2011_2
2011_4
2012_2
0%
Resident banks
19
Non-residents
20
Italy
Spain
1/1/13
11/1/12
9/1/12
7/1/12
5/1/12
3/1/12
1/1/12
11/1/11
9/1/11
7/1/11
5/1/11
3/1/11
1/1/11
11/1/10
9/1/10
7/1/10
5/1/10
3/1/10
1/1/10
11/1/09
9/1/09
7/1/09
5/1/09
3/1/09
1/1/09
11/1/08
9/1/08
7/1/08
5/1/08
3/1/08
1/1/08
11/1/07
9/1/07
7/1/07
5/1/07
3/1/07
1/1/07
2. What are the results of the crisis?
ECB INTERVENTION
SPREADS OVER BUNDS
7
6
5
4
3
2
1
0
2. What are the results of the crisis?
ECB INTERVENTION
10-YEAR SOVEREIGN BOND YIELDS
8
7
6
5
4
3
2
1
0
1/1/07
7/1/07
1/1/08
7/1/08
1/1/09
7/1/09
1/1/10
Italy
21
7/1/10
Spain
1/1/11
7/1/11
1/1/12
7/1/12
1/1/13
0
22
Santander
BBVA
Unicredit
Intesa Sanpaolo
01/12/2012
01/10/2012
01/08/2012
01/06/2012
01/04/2012
01/02/2012
01/12/2011
01/10/2011
01/08/2011
01/06/2011
01/04/2011
01/02/2011
01/12/2010
01/10/2010
01/08/2010
01/06/2010
01/04/2010
01/02/2010
01/12/2009
01/10/2009
01/08/2009
01/06/2009
01/04/2009
01/02/2009
01/12/2008
01/10/2008
01/08/2008
2. What are the results of the crisis?
ECB INTERVENTION
FIVE-YEAR BANK CDS
800
700
600
500
400
300
200
100
2. What are the results of the crisis?
THE PATH TO SLUMP
REAL GDP IN THE CRISIS
104
102
100
98
96
94
92
90
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
Q4
Q1
Q2
Q3
2008 2008 2008 2008 2009 2009 2009 2009 2010 2010 2010 2010 2011 2011 2011 2011 2012 2012 2012
Germany
23
Italy
Spain
Portugal
Ireland
Greece
2. What are the results of the crisis?
THE PATH TO SLUMP
CURRENT ACCOUNT BALANCE
(Euro millions, four quarters)
20,000 €
0€
-20,000 €
-40,000 €
-60,000 €
-80,000 €
-100,000 €
-120,000 €
-140,000 €
Portugal
24
Italy
Ireland
Greece
Spain
2. What are the results of the crisis?
THE PATH TO STAGNATION
25
3. Is the crisis being solved?
• The euro will probably survive. But the crisis is
definitely not over.
• I see three scenarios – good marriage, bad marriage
or (full or partial) divorce:
– Divorce would be costly and hard to manage;
– Bad marriage is very painful;
– The aim is to reach good marriage.
• But reaching that destination will take a lot of reform,
both economic and political, and will take up to a
decade.
26
3. Is the crisis being solved?
• Here are the challenges to be met:
1. Debt write-offs: to clear up the legacy costs of the poorly
structured and managed currency union, Mark I.
2. Financing: to prevent collapses. By “financing”, I mean
maintaining a working financial system and manageable
costs of government funding. The ECB is now doing much
of this. That is risky, but necessary.
3. Adjustment: structural reforms and divergent inflation across
the eurozone, with higher inflation and stronger final
demand in core countries. This will take at least 5-10 years.
4. Long-term reform: creating a workable union that is not a
full federation
27
3. Is the crisis being solved?
• Debt write-offs:
• There has been a debt write-off for Greece. But the
likelihood is that further large write-offs will be needed,
particularly because the adjustment mechanism creates
debt deflation, via falling nominal GDP. These write-offs may
include big countries.
• Financing:
• There is a trade-off between financing and adjustment. The
ECB’s interventions, plus the creation of the European
Stability Mechanism has created adequate financing, in the
short run. But political and economic developments may
force activation of the OMT. Its internal contradictions –
“unlimited, but conditional” – may then blow it apart. It may
have worked because it has not been tested.
28
3. Is the crisis being solved?
• Adjustment:
• Adjustment means a current account financed sustainably
by private funds, with the economy at close to full potential.
• There have been external adjustments, much due to deep
recessions. Competitiveness needs to be restored and new
industries created.
• Meanwhile, fiscal adjustment in countries with large deficits
inevitably leads to recession when the private sector is also
retrenching.
• If external adjustment is unsuccessful, external balance may
mean internal imbalances – i.e. long-term slumps, with high
unemployment and emigration of qualified people.
• Adjustment is made more difficult by structural surpluses in
core countries, particularly Germany.
29
3. Is the crisis being solved?
• Long-term reform:
• The aim is to create what I think of as a minimum federation
• This should include:
•
A banking union: this would be possible, without fiscal backup,
if (and only if) banks could be resolved without budgetary
support.
•
An adequate safety net: Eurobonds are one way to do this;
and an even bigger European Stability Mechanism, plus
European Central Bank support, is another.
– Permanent transfers would be dangerous.
• But it has to be an adjustment union more than a
fiscal union.
30
3. Is the crisis being solved?
• Willingness to act proved substantial, once it became
obvious that the original design had failed. But
willingness to act has also been insufficient.
• The force for action is the lack of an alternative.
• The obstacles are of three kinds:
– Economic: it is hard to make this work;
– Ideological: the difference in economic perspectives are
large; and
– Political: the countries and peoples neither like one another
nor identify with one another. Reforms also raise huge
questions about political legitimacy.
31
4. What does this mean for the UK?
• What does this mean for Britain?
• It means fundamental change in relations with the
rest of the EU, for sure.
• But the nature of the fundamental change depends
on the outcome for the eurozone over which Britain
has little, if any, influence.
• The way I analyse this question is as follows:
– The status quo in the eurozone is untenable;
– Thus, the eurozone will either fragment or it will become
much more integrated.
32
4. What does this mean for the UK?
• If the Eurozone integrates, the UK may find itself at
its mercy of the Eurozone decision-making process.
• This might tip the UK’s political balance towards exit.
• The future of the EU, and so of the UK in the EU, has
become extremely unpredictable.
• The likely need for a treaty ratification may trigger the
upheaval.
33