16 December 2011

Graham Bishop's blog from Vienna: If the euro breaks up, will we go back to the 1930's?

Participated in OKB’s 21^st Annual Roundtable of leading economists and the mood was particularly sombre as two strands ran through it: how to restore growth and would/should one (or more) countries leave the euro?

The search for growth quickly runs into a basic difficulty as most observers equate that drive with an expansion of public spending. But the “bond dealers” now seem unwilling to buy the bonds that would enlarge public debts - yet again. It may be easy to demonise the bond dealers but, on deeper examination, they turn out to be merely the representatives of the pension funds and life insurers who are investing the savings of “the people”. The people are averse to risking their life savings! If public debts simply have to be reduced because savers will not finance a renewed expansion, the most senior professor present calmly stated that perhaps we will just have to go back to the 1930’s. That evening, walked past the Head Office of the old Creditanstalt and wondered if the history of the 1931 “run” could repeat itself so precisely. Fortunately, Creditanstalt is shrouded in scaffolding for a renovation so that bit of history cannot be re-run!

Should the euro break up? This is the existential question for Europe and one that political leaders “on the Continent” answer with cataclysmic statements that they never elaborate. But there is now a growing feeling  of crisis fatigue … the catastrophe has been at hand for years now and most people see that nothing so dramatic has happened. Are the leaders exaggerating? We heard quantification that a total break-up could be associated with a drop in GDP of more than 10 per cent in the major countries. If Greece alone left, then it could suffer a 40 per cent decline in GDP.

Are these numbers plausible? It could be dangerous to hold our breath waiting for the European Commission study on the impact of a break-up of the eurozone. So who else will provide an authoritative study that the political leaders can grasp? Only then can the leaders explain to their electors why it is much better to stay together as the eurozone - even if some aspects become very uncomfortable in the period ahead. I argued that the private sector now has the duty to examine the implications of a euro break-up in some detail. Only then can political leaders credibly put to electors both sides of the argument for ratifying the new “international agreement on a re-enforced monetary union”.

That agreement will only reinforce the original Treaty of Maastricht’s demands for sound public finance but – crucially – now provide mechanisms to ensure that the Member States actually stick to the rules they agreed to exactly 20 years ago. It is fashionable to say the design in the Maastricht Treaty was flawed at the outset. But the reality is that the major flaw has turned out to be the weakness of the elected politicians in applying economic policies that are sound in the long run, but uncomfortable ahead of the next election. This is the challenge for 2012: bind into national legislation sensible constraints on elected euro area ministers of finance, or face imminently a future that will probably be very unpleasant.

© Graham Bishop