Bill Jamieson End game?

COMMENT

BILLJAMIESON | Executive Editor of The Scotsman

End game?

As Germany seethes, a money-rush plan to save the euro.

From Cyprus to Slovenia, to Italy to Portugal and back to Cyprus in between: who still believes the worst of the euro crisis is over?

And how is it that tiny inconsequential economies like Cyprus and Slovenia could hold up a eurozone recovery? How has it all come back to this?

Well might European Central Bank governor Mario Draghi seek to douse public attention on the eurozone’s continuing crisis. “Move along. Nothing to see here” has been the prevailing attitude at the Bank as it delayed moves last month to loosen monetary policy.

Yet no sooner did the Cyprus crisis appear to be cauterised – at horrific cost to its economy and its banking system – than it became clear the country needed to raise even more money. The cost of the bail-out has turned out not to be €17 billion but €23 billion. And as the IMF-ECB-EU troika is not prepared to chip in any more, the extra €6 billion has to be found – by Cyprus. That immediately sparked concerns in other ‘Club Med’ euro members that they, too, may soon be back in the firing line – only this time with the precedents of strict capital controls and a raid on bank deposits as legitimate measures firmly established in the armoury of official responses.

So far the worst-hit economies have backed away from the option of leaving the single currency because of the big hit that would be suffered by pension funds and bank depositors.

But with the pain of staying in continuing to mount, Cyprus may now have been pushed to a tipping point: the pain of staying in may be greater than pulling out. And pressure to exit would be intensified were the country to seek to raise the extra cash by further raids on those big bank deposits or be forced to impose, as Germany has suggested, a property wealth tax. This would intensify capital flight and kill the country’s tourism industry.

Now Slovenia is feeling the heat. A highly critical OECD report on the country’s banking system has triggered fears that, as its banking system is largely state-owned, bank liabilities in the event of default would readily become state liabilities, pushing the country’s debt-toGDP ratio, now 55 per cent, to more than 120 per cent.

Excluded from market borrowing, the country would have no option but to turn to the ‘troika’ for help. But questions have already been raised as to the imprudent nature of its bank lending. More than one in seven loans are said to be ‘non-performing’. Approval for a bail-out may thus not be forthcoming.

In the face of a capital flight from many eurozone banks and mounting apprehension about a domino-style exit from the euro, the ECB may now finally embark on a large and sustained monetary loosening.

Slowdown continues

This continuing atmosphere of instability and uncertainty has contributed to depressed confidence and continuing slowdown in the economies of the eurozone. While the US looks to be on the recovery trail, GDP across the single currency area is set to shrink both this year and next.

Nor is economic contraction confined to southern member states. France is likely to suffer recession this year. And the Dutch economy has been under pressure, with revised GDP figures for 2012 showing a 1.2 per cent fall on the previous year. And the tougher life gets in the north, the greater the likelihood of a taxpayer revolt – particularly in Germany – against any further bail-out support.

Little wonder then that savers and bank depositors in the southern eurozone countries have started to fret that they will suffer a similar fate to those in Cyprus. Haircuts in one country trigger fears that the barber may soon be knocking on their own bank door.

A ‘last-resort’ option is now looming large at the ECB. In the face of a capital flight from many eurozone banks and mounting apprehension about a domino-style exit from the euro, the ECB may now finally embark on a large and sustained monetary loosening.

Mario Draghi may have ‘talked the talk’ last year when he declared he would do ‘whatever it takes’ to save the euro. But he has shown a marked reluctance so far to ‘walk the walk’.

If the experience of America and the UK is anything to go by, the resort to Quantitative Easing would have to be substantial and sustained to have any appreciable effect in pulling the weak eurozone economies out of their nose-dive. It would of course have the double benefit of providing much-needed liquid capital for the banks and triggering a fall in the euro.

For the economies of Spain, Portugal, Italy, Ireland and Cyprus, such devaluation, working to make the price of their exports more competitive, could not come soon enough.

However, it would effectively expose the eurozone to higher inflation. And as a result, reaction in Germany could prove politically explosive, confirming the fears of many voters that the Deutschmark should never have been surrendered for the euro.

And it would be perfectly timed to boost the new euro sceptic Alternative for Germany party which has decided to run in the 22 September general election.

Its prospects have been written down by the pundits. But looking at the way events are unfolding across the eurozone, it would be dangerous to place bets on such an outcome. n