The current debt problems in Greece, and uncertainties about whether the same situation will be repeated in larger countries such as Spain and Italy, have cast a spotlight on the European Union’s need for a new supervisory model with more forceful economic measures. Along the way, the euro has lost strength versus the dollar, the differentials between the various debt levels in Europe have increased significantly, and some experts are saying that the worst problems have yet to occur.
In fact, George Soros, one of the most influential investors in the world and the twenty-ninth richest man in the world, believes that the future of the euro is at risk. The owner of Soros Fund Management argued recently in an article in the Financial Times that Europe needs “a more active process of supervision as well as institutional mechanisms for conditional support.” According to Soros, “A well-organized market of euro bonds would be desirable; the question is if the political will can be created to adopt such measures.”
For Soros, “the survival of Greece” does not resolve the debate over the future of the euro, since the true battlefields are Europe’s other weakest economies — including Portugal, Italy, Ireland and Spain.
In an article in the Wall Street Journal, Nobel Prize-winning economist Paul Krugman wrote that the problems these countries are facing stem from “the arrogance of elites; specifically, the political elites who urged Europe to adopt a single currency long before the continent was ready for an experiment of this sort.”
One the most widespread currents of thought attributes these problems to the fiscal independence of each member state of the EU. “The [16-nation] eurozone cannot have one monetary union with 27 different fiscal policies [‘the EU 27’],” notes Robert Tornabell, professor of finance at the Esade business school in Spain and author of a recent book titled, The Day after the Crisis. The United States “has a single currency, with a single monetary policy and, of course, an identical fiscal policy for all of the states of the Union — including Alaska, Hawaii, etc.”
Supporters of this approach argue that the European Union needs much stricter monitoring and supervision. They characterize the Stability and Growth Pact of 1997, aimed at facilitating and maintaining economic and monetary union, as weak. This pact currently sets 3% of the GDP and 60% of the public debt as the deficit limits for any country. But the European Commission set a bad precedent in 2004 when it pardoned Germany and France for exceeding those thresholds. According to Soros, the situation now calls for “more intrusive monitoring.”
Another sort of debate has been attracting greater attention in recent months: Some countries may be thinking about getting out of the eurozone. Those countries that are suffering the most from the crisis could be motivated by the temptation to return to the days when each country had its own currency and could therefore devalue its currency when it wanted to, lower interest rates on its own, and/or issue more currency to promote domestic consumption. However, Rafael Pampillón, director of the economics department at the IE Business School, discounts the possibility that countries will abandon the euro. “Nobody wants to get out of the euro,” he says. “But if a country has excessive debt and cannot repay its loans now, it can declare a competition among its creditors.”
Beyond that, it would not be a simple process to abandon the euro because, as credit agency Standard & Poor’s warned recently, if a country moves out of the eurozone, that would mean an enormous devaluation of its new currency, and higher costs for financing. “Although it is possible to negotiate leaving the euro, a unilateral withdrawal would be controversial from a political point of view,” the agency said in a statement.
According to Juan Mascareñas, professor of financial economics at the Complutense University of Madrid (UCM), “The image of the euro would be weakened if any member [of the eurozone] abandoned it. In addition, in the case of Spain and, I believe, any other country as well, the psychological impact on the population would be great. Something similar would happen to us as what happened to Spain’s ‘Generation of ‘98,’ after Spain lost Cuba and the rest of the [Spanish] Empire. It would signify that we were not capable of keeping ourselves in a club that is serious about economics.” The Generation of ‘98 was a group of Spanish writers who were deeply affected by the moral, political, and social crisis that was set off in Spain by the country’s military defeat in Cuba at the hands of the U.S.
Another factor contributing to the eurozone’s woes is that its institutions do not have strong enough mechanisms for sustaining member countries during times of trouble. One possible way to deal with this would be to establish conditional assistance, proposes Soros. “The most efficient solution would consist in issuing euro bonds that are guaranteed in a collective and particular way to refinance, for example, the 75% of the Greek debt that is in the process of expiring, under the condition that Greece fulfills its goals; while leaving the remaining 25% for Greece to finance as it can.”
However, current EU regulations do not take into account any option to undertake rescue operations for its member countries, and the European Central Bank literally rejects such ideas. The only possibility at the moment would be if some countries were to rescue other countries, or if the International Monetary Fund provided help.
“It must be the IMF that rescues Greece, and which imposes the adjustment measures that are necessary in order to be able to receive the loan, because all of us countries already pay our dues to the Fund, and that money is there also for cases like this one,” says Pampillón. In addition, he believes that it would be an ugly precedent if Europe came to the economic rescue of Greece because then the rest of the member states would be tempted to take on excessive debt. “Let those who have bought Greek debt pay for their bad investment,” said Pampillón. “Why must we, the rest of the members of the Union, pay it?”
Yet that seems about to happen. Leaders of the eurozone, especially Germany and France, have committed themselves to helping Greece deal with its debt crisis, although they have not specified exactly how. “Chancellor Angela Merkel and [French] President [Nicolas] Sarkozy have said in public that they are going to guarantee the solvency of Greece. Germany and France cannot permit their own banks, in trying to make billions by buying Greek public debt, to suffer serious losses,” Tornabell notes.
Mascareñas suggests that those states that have problems should resolve them at whatever cost it takes, but they should not be allowed to involve themselves with those who have figured out how to do a better job of managing their own growth — thus sending a message of responsibility. “German people must be tired of using their own savings to pay for other people’s fiestas. Countries that are rescued in order to stay within the euro club must pay a cost” for their rescue, he adds.
The Cost of Rescue
Experts say that the option of various member-states rescuing one another would be acceptable in the case of Greece, but not acceptable if they had to rescue countries that are as big as Spain. According to a report in The Wall Street Journal,BNP Paribas bank calculated that a plan to return confidence to Spain could cost US$270 billion, compared with US$68 billion for a similar plan for Greece; US$47 billion for Ireland, and $41 billion for Portugal. The newspaper wrote that Spain has become “the next battlefield for the euro,” and that it could determine whether the currency of the 16-nation zone manages to get by or falls.
Mascareñas notes that “Italy and Spain are the countries that have the greatest weight in the GDP of the eurozone — a combined 28%. It would be a serious problem for the euro because you have to realize that a significant portion of the creditors of both countries are the other countries that belong to the eurozone –Germany and France, especially.”
Nevertheless, a lot of other experts, including Michel Camdessus, honorary governor of the Bank of France and former managing director of the International Monetary Fund (1987-2000), believe such an option is unlikely. Camdessus said at a conference sponsored by the Rafael del Pino Foundation that “it is stupid to think that these difficulties could make the euro tremble, much less collapse.”
Tornabell goes further, predicting that “for the time being, there is no danger for Ireland, which is reducing its public spending at an accelerating pace, or for Portugal. And so, there is much less danger for Italy and Spain.”
Rather than focus on the possible fall of the euro, other experts call for measures to create a real union between the different countries that use the currency. The absence of any clear plans to resolve the current situation is reflected by trends in financial markets: The euro depreciated by 10.6% between December and February, dropping from 1.51 to the U.S. dollar to only 1.35. Meanwhile, the prices of the differentials and credit default swaps (contracts that protect against the nonpayment of bonds) have shot up on the public debt of some countries.
One option is a possibility that the EU’s finance ministers have suggested: The European Central Bank would assign its own credit ratings to the public debt of the member countries so that the decisions taken by S&P, Moody’s and Fitch do not have so much influence on the economy of the region. In fact, as Pampillón notes, “Investors already distinguish between different countries, although all of them have the euro as their currencies, and so there are differentials for Spain and Greece, compared with the German bond.”
Everything indicates that the EU is facing a historic period that will determine its very existence, vitality and credibility. In addition to new demands placed on the financial sector, experts expect to see measures that will avoid similar situations in the future, and that will make the EU more flexible when it emerges from its worst moments. “The EU moves forward on the basis of crises, and the euro was born out of one of those crises. The current crisis can wind up promoting the greater integration of the EU,” says Mascareñas.