Eurozone Running Of Time As Economists Run Out Of Metaphors

Eurozone Running Of Time As Economists Run Out Of Metaphors

The situation facing the eurozone isn't particularly easy to explain using metaphors.

Potential images are everywhere, but none seems to fit. The rock and the hard place … The tightrope walker unable to turn back without falling off the rope … Even a battle between two giant monsters - in which whoever wins the city ends up being destroyed - isn't far off, if a bit niche.

The crisis is almost too hideously complex to explain in soundbites, says Ben Jones from the Economist Intelligence Unit's Western Europe team, who have just released a new analysis in which they have raised the chance of a eurozone break-up to 40 per cent.

"If you want to put it simply, is about who pays the bill for the failure of the last ten years," Jones says, doing his best. But of course it's a bit more complicated than that…

So like Godzilla staring down Mothra, let's try and tackle the problem.

At the heart of the crisis in Europe is a combination of massive public and private debts held by governments and institutions. The scale of those debts, combined with wider economic uncertainty, has reduced confidence among investors that the debts can be honoured. That has led to spiralling costs for governments when issuing bonds, demands for austerity cuts and serious concerns over the future of the economic and monetary union itself.

Greece, whose economy has already been bailed out once and earlier this year before essentially being declared partially insolvent by the eurozone, was bad enough. And now Spain and Italy have been hit too, which the EIU says that has taken the crisis "to a new dimension".

It's decision time. So what will the eurozone do?

In the short term, Jones says that the European Central Bank must continue to buy up back debt, as it did recently when it purchased billions of dollars worth of Italian and Spanish bonds.

"There's no doubt about that," Jones said. "The ECB is the only institution that has the financial firepower to do so. But a year down the line questions are going to be asked about the ECB's independence, because the more debt it takes onto its balance sheet the greater the risk. The ECB is owned by the national treasuries. So one way or another if the eurozone is set upon providing this level of support then the creditor countries are taking the risk."

In the medium term the debate now centres on two possible outcomes. Either the eurozone countries move closer together, into what the leaders of France and Germany have called an 'economic government', and surrender sovereignty to a collective treasury and issue 'euro bonds' as opposed to individual ones, or they break up the eurozone.

"To keep the eurozone together over the medium term the euro bond idea, some form of it, will probably take off," Jones said. "There's certainly growing interest among the German opposition and some members of the German government. I think the French are much more open to the idea but they don't want to push the idea too aggressively because they don't want to antagonise Germany … A euro bond really does seem the only way this could be done."

In practice this amounts to a loss of sovereignty for member states. But that's just something they will have to swallow, Jones said.

"What we've seen over the last decade is that the integration of the financial markets has outpaced the political integration," he said. "And now you have a situation in which any debt in one part of the eurozone can bring down the other. The public is yet to wake up to the fact that when they joined the eurozone they basically lost control over their budgets. The solution is when finally politicians make that clear to electorates, and they're very reluctant to do that."

Even if closer integration happens there could be could some difficult consequences, including political instability in member countries.

"If the German coalition can't get a majority to approve all the things that were agreed in July its days are numbered," Jones says. "In Greece over the summer they came very close to not being able to pass austerity measures, and they need to do this at regular intervals."

Social unrest is also a possibility.

"You might have the public fighting back. Already you've seen huge protests in Greece, the risk of a breakdown of social order is not something that can be totally discounted."

The alternative - the break-up of the eurozone - would be even more of a disaster.

"Governments might turn round and say 'enough'," Jones says. "We (the EIU) have put the chances at 40 per cent that this could happen. That's the highest chance of something going wrong we can use without saying we think it's actually going to happen."

George Soros (the billionaire investor) said this week that a break up would trigger a global depression.

"I think he's right," says Jones. "It would make Lehman Brothers look like a tea party. The return of counter-party risk and the total freezing up of the money markets means the dollar would go through the roof, and any country that had its currency pegged to the dollar would also be in trouble. You're talking about global economic meltdown."

Of course for any long term solution to stick the eurozone ultimately needs to grow its economy.

"That's one of the reasons some people think break up is unavoidable because they think that growth is not coming," Jones says. But political and legal reforms will also be needed.

"A eurobond would require a fundamental change in the nature of nation states within the eurozone. It would mean German taxpayers saying 'we stand behind the debts of the Italian government'. But the German taxpayer has no control over the spending decisions of the Italians. This isn't mere tinkering, this is a fundamental step forward in the integration of economic and monetary union."

The good news, if there is any, says Jones, is that a reformed eurozone would ultimately be stronger and more efficient. But getting there will be a struggle.

"It might all work!" he suggests, with a prudent air of scepticism. "Five years from now if the eurozone can get through this it might be an economically more dynamic place. The reforms they are making are the reforms they pretended they were doing for the last ten years. So if there is an upside, that's it."

If that that sounds to you like the citizens of a Godzilla-wrecked city looking forward to building new skyscrapers once all the fighting dies down, then we can't blame you.

But then, as we said before, metaphors can only get you so far when it comes to the eurozone.

"There really is no alternative," Jones says. "That's why we're in such a dangerous place, because the road is running out. Something needs to change."

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