PERSPECTIVE: Curing Eurozonitis

By bne IntelliNews March 25, 2011

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March's round of EU summits was supposed to bring a measure of calm back to the Eurozone, but with Portugal on the brink of joining Ireland and Greece in the bailout club, EU countries are clearly still in fire fighting mode. Strange, then, that so many are managing to look optimistically beyond the immediate crisis for the euro.

The leaders of the 27-nation EU gathered in Brussels for two days of talks on March 24, during which they put the finishing touches to a package of measures designed to shore up the single currency, following more than a year of instability since the Greek debt crisis exploded onto our TV screens in 2010.

Then on the eve of the summit, Portuguese Prime Minister Jose Socrates resigned after the parliament rejected his minority government's latest austerity plan. Socrates was hoping to avoid having to apply for a similar multi-billion-euro bailout to those given to Greece and Ireland last year. The euro's recent advance against the dollar was halted in its tracks and the fear of "contagion" reared its ugly head again as Moody's Investors Service cut the ratings on 30 smaller Spanish banks. In the words of Yannos Papantoniou, a former Greek finance minister, the meeting needed to come up with a cure for "Eurozonitis" before it spreads and becomes chronic.

And in the early hours of March 25, EU leaders managed to thrash out a deal that crucially included a permanent bailout package to replace the temporary one that's expected to deliver about €80bn to Portugal in the near future. This new European Stabilisation Mechanism (ESM), which will enter force in mid-2013, will be increased to €80bn in cash, with another €620bn in "committed callable capital." A decision to raise the lending capacity of the temporary European Financial Stability Facility (EFSF), currently in place, from €250bn to €440bn has been put off until June.

The summit also agreed a "Pact for the Euro" - which was finally dubbed the "Euro Plus Pact" because it managed to gain six extra adherents like Poland, Lithuania, Latvia and Romania who are not also members of the Eurozone. Though watered down since it was first developed on the sly by Germany and France in February, this pact was the price demanded by Berlin to increase the bailout fund as it tries to instil some Teutonic rigour into the free-spending Mediterranean economies. The pact includes a set of non-binding targets for harmonising policy in a range of areas, from labour markets and retirement ages to debt and corporate taxes, though the latter has been bitterly opposed by smaller euro countries like Ireland and Slovakia that use lower rates to attract investment. (One anonymous Polish diplomat dismissed the pact to Reuters as "worth nothing.")

Rearing PIIGS

Will all this be enough? Unfortunately, at several junctures throughout this euro crisis the EU has acted, only to find its action brought only temporary relief. Many believe this time won't be any different. The real danger, then, is the crisis spreads across the Iberian peninsula into Spain and then on to Italy, the remaining two PIIGS; as one anonymous European official told The Economist last year: "The EU can't afford Spain."

However, it may not come to this. In the run-up to the EU summit, Spanish markets were showing some signs of decoupling from Portugal's crisis. If a line can be drawn under Portugal, then some argue the crisis could be considered, on the whole, to have actually been a good thing, since it touched countries that were small enough to be dealt with, and hasn't come further down the line to engulf the Eurozone's major economies. A problem nipped in the bud; "the perfect laboratory," one EU official told bne.

Certainly, it can't be disputed that the famously profligate countries on the EU's periphery are undertaking reforms that two years ago would've been unthinkable. In fact, it is because of the euro that they are restructuring their economies in exactly the way that the UK, for example, has been banging on about for years for them to do.

While certain sections of the UK press that are notoriously hostile to the euro (if not particularly well informed) continue to gloat over the euro's troubles, they fail to see that what they have always argued for is now actually happening.

These euro-critics like Peter Oborne of The Telegraph believe the only alternative is having individual currencies, the devaluation of which is a magic wand to regain competitiveness. However, they either wilfully ignore (or are ignorant of) the basic economic reality that any devaluation would inevitably be followed by higher wage growth and inflation, with no sustained improvement in competitiveness. Greece's recent economic problems are indeed a loss of competitiveness since it joined the euro in 2001, but that's down to the structural weaknesses, including fiscal profligacy and a rigid labour market, that wouldn't be solved by devaluing the drachma. The Baltics won plaudits from around the world for keeping their currencies pegged to the euro (Estonia joined the single currency in January) during the depths of the crisis and instead restructuring their economies, not relying on the short-term fix of a devaluation - the so-called "internal devaluation" where wages are lowered instead of the value of the currency against the dollar.

Looking at the coverage of the euro crisis in the UK from outside, one can't help feeling a bit like those TV viewers who amused themselves by watching Truman Burbank live out his daily life on the "Truman Show", in ignorant bliss of anything happening outside of his bubble.

Ultimately, say EU officials and economists that bne has spoken to, the crisis in the euro could finally get many of the Eurozone countries to accept what they signed up for when they adopted the euro in the first place: very liberal economic policies. And if that fundamental change happens in the PIIGS, then the euro will have achieved what decades of preaching and carping has failed to do.

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