Dismantling the Time Bomb

by Andrew Stuttaford

A month or so ago, I linked to a piece by the FT’s Gideon Rachman on the German view of the euro zone crisis, quoting, in particular, this:

Behind the scenes, however, some of the brightest minds in the German government have a sense of deep foreboding. Twice in the past year I have found myself sitting next to different senior German officials at a dinner who have proceeded to tell me that the whole single currency was a terrible mistake. Speaking of the euro, one of my companions said: “It seems to me that we have invented a machine from hell that we cannot turn off.” The image was so bleak and Strangelovian that I laughed. But, I am afraid, it’s not really very funny.

Rachman returns to this topic (more or less) today, highlighting (reasonably enough) the danger that even a partial break-up of the euro zone could pose, but then he notes this:

…the [fate of the] euro will be decided in countries such as Greece, Spain, Italy and, above all, Germany. So it is significant that, behind the scenes, a debate about the break-up of the euro is also taking place among senior figures in the German establishment.

 There was always a group of top German economists – call them the Bundesbank tendency – who had deep misgivings about the whole single currency project. Now some of these German sceptics believe their concerns are being vindicated and are even suggesting that – despite the current calm in the markets – Greece may have to leave the euro within months.

 One scenario doing the rounds in Frankfurt and Berlin is that the crisis could be provoked by the Greek elections, which are likely to be held in early May. A new Greek government might seek to unpick the latest debt deal, provoking a chain of events leading to Greece leaving the euro. Technically, it is said that this would involve the sudden declaration of a temporary bank holiday, during which all euro-notes in Greek banks are stamped, to show that they are being reissued as drachmas. One obvious danger is that – as soon as this step was announced – there would be bank-runs in other vulnerable euro-area countries such as Portugal, as anxious account-holders rushed to move their money out of the country. This would be counteracted by the provision of massive emergency liquidity from the European Central Bank to financial institutions in vulnerable countries.

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 Doubtless, there are many flaws in this plan. But the very fact that such stark scenarios are doing the rounds in Germany may help to account for Chancellor Angela Merkel’s recent decision to give interviews proclaiming her belief in Greece staying inside the euro and suggesting that the single currency’s break-up would be a political disaster for Europe.

 Ms Merkel’s view that the whole euro project would be gravely damaged by a Greek exit seems right. If, as the doomsayers predict, Greece was plunged into economic chaos after leaving, the rest of Europe could not simply stand by and watch. It would be sucked back into the resulting political and economic mess.

Fair enough, except that the rest of Europe is already sucked into Greece’s profoundly Augean mess, and whatever happens there will, one way or another, lead to more large transfers of cash from the euro zone (and, almost certainly, the rest of the EU) to Athens. But if Greece is unshackled from the euro there is actually a chance that all this money might be part of a cure rather than expensive palliative care.

But back to Rachman:

On the other hand, if a Greek exit went well, then other countries that are struggling inside the eurozone would be severely tempted to follow suit. There are senior Spanish officials, for example, who fear that another round of budgetary austerity – when youth unemployment is already at 45 per cent – could lead to political and economic devastation in Spain. They argue that financial and economic crises in other European nations have rarely been solved by structural reform alone. In the cases of both Sweden in the 1990s and Iceland over the past couple of years, they also involved a major devaluation of the currency to boost competitiveness – something that is impossible inside the euro. The implication is clear. Spain has to get out of the euro.

So far, these siren voices are being ignored because Spanish ministers – like their British counterparts – have been told that a euro break-up would lead to disaster.

Time to dust off the ‘Northern Euro’, I reckon, long past time.