I do not regret paying my access fee to the FT website. This morning there are two excellent articles on the Euro crisis from the two regular Wednesday morning columnists: Martin Wolf and John Kay. It has helped clarify the way ahead for me.
Mr Kay comes in at high level to give an overview of the crisis. It is not comfortable reading for supporters of the Euro project like me, but, as usual for this author, pretty much spot on. The main problem is not that the currency area lacks appropriate institutions at the centre, but that local institutions in many member countries are not strong enough to cope with the pressures of being in the single currency.
The eurozone’s difficulties result not from the absence of strong central institutions but the absence of strong local institutions. A miscellany of domestic problems – rampant property speculation in Ireland and Spain, hopeless governance in Italy, lack of economic development in Portugal, Greece’s bloated public sector – have become problems for the EU as a whole. The solutions to these problems in every case can only be found locally.
So the answer will not come from strengthening the EU’s central institutions. This goes back to the original design of the Euro: the whole idea was to put pressure on governments to reform themselves, by denying them the easy escape route of devaluation. Unfortunately the EU’s politicians forgot this in the first decade of the Euro, so no real pressure was brought to bear, making the crisis infinitely worse once it hit.
This article does not say much about how to go forward from here, beyond suggesting that grandstanding at summits like today’s may be part of the problem rather than the solution. Mr Wolf’s looks at one aspect of how to manage the crisis itself. This in turn in is based on a paper by Paul de Grauwe of Leuven university, who literally wrote the textbook on the Euro (I know, since I read it as part of my degree course).
Professor de Grauwe points out an interesting fact: the bond markets are much harder on the Euro zone fringe economies of Italy and Spain than they are on the UK, even though the underlying positions of the countries is not all that different. The difference is that the UK markets are stabilised by having the Bank of England as a lender of last resort which is able to deal with liquidity crises (i.e. an inability to raise cash for temporary reasons rather than underlying insolvency). The European Central Bank does not do this, or not enough, for the Eurozone economies. Mr Wolf, who structures his article as an open letter to the new ECB president Mario Draghi, argues passionately that it should. This would stop the contagion spreading from the insolvent economies of Greece and maybe Ireland to solvent but challenged economies like Italy, Spain and indeed France.
This must be right. The Germans, who are the main sceptics, must be persuaded – and convinced that such interventions would only apply to liquidity crises and not solvency problems, and that the ECB has the integrity and independence to tell the difference, in the way that politicians never do.
Giving the ECB a wider and stronger remit will be a big help. This should extend to supervision of the European financial system (preferably for the whole EU and not just the Eurozone). This will help deal with one of the biggest problems for modern central banking – that of coping with spillover effects, as described in this thought-provoking paper from Claudio Bono of the BIS (warning: contains mild economic jargon, such as “partial-equilibrium”).
So a reconfigured ECB will help the Euro through the crisis and prevent self-fulfilling prophesies of doom in financial markets having to be solved in grandstand summits. That still leaves the longer term problem of how the less competitive Southern European economies can have a long term future in the zone. But then again, I think they would have just as challenging a future outside the zone – even if it were possible to devise an orderly exit mechanism for them.