The Euro has no Defence

Deepest England, 9 October.  This week the IMF declared “Among advanced countries, the United States and the United Kingdom are leaving the crisis behind and achieving decent growth”.  Indeed, the IMF expects the UK economy to achieve “sustainable growth” of 3.2% in 2014 and 2.7% in 2015.  At the same time the IMF has cut deeply its growth forecast for the Eurozone, most notably and most worryingly the three biggest Eurozone economies; France, Germany and Italy.  There is no schadenfraude here in Britain (well not much) because a strong Eurozone is clearly a British interest but there is deep concern.  Leaders are doing nothing to resolve the inherent contradictions of the Eurozone.  It is again politics at the expense of strategy and the implications are terrifying. 

The enormous scale of the challenge faced by the Eurozone is put into stark relief by the contrast in fortunes between the Euro-free British and the Eurozone.  The French economy is slated by the IMF to grow by no more than 0.4% this year, mighty Germany is now downgraded from 1.7% to 1.4%, whilst the Italian economy has not grown in real terms since the creation of the Euro in 1999 and is again contracting.  Worse, the IMF suggests there is a 40% chance of a triple dip recession in the Eurozone and a 30% chance of deflation.  The ‘best’ way to prevent deflation according to the IMF is for debt-laden Eurozone governments to flood their economies with even more debt.  That will only lead to stagflation and the worst of all Euro-worlds, a chronic mix of economic stagnation and inflation. 

This wholly EU-made mess has been caused by a cacophony of disastrous decisions.  First, the creation of a currency was a political project rather than a shared financial instrument established on sound economic and fiscal fundamentals.  Second, a one-size fits all interest rate policy for wildly divergent economies first stimulated insane borrowing and now prevents competitive devaluation by weaker economies locked into the Euro.  Third, the Stability and Growth Pact implied a set of rules rather than imposed them.  Fourth, the refusal of big states to observe those rules when politically inconvenient, as France has again done this month by missing its 3% debt-to-GDP target has undermined by the credibility of the currency and its governance. 

Worst of all few of the vital structural reforms have been enacted that would make weaker economies with over-regulated labour markets more competitive.  Indeed, several Eurozone countries simply lack the political stability or sufficiently strong political institutions to cope with such reforms.  The consequence is that taxpayers such as me in a few formally rich countries such as Germany and the Netherlands are bankrolling the Eurozone crisis whilst its leaders fiddle the books to give the appearance of a solution to the crisis where there is none.  Locked into their own inaction Eurozone leaders vaguely hold out the prospect of world growth as the panacea for all the Eurozones many problems.  It is not therefore not without some pathos if not indeed tragic irony that the IMF also makes clear that the greatest threat to world growth remains the Eurozone.  In truth the Eurozone could well be trapped in a near-zero growth no man’s land for at least a decade with leaders simply trying to mask the extent of their own failure from their increasingly irate, ever more unemployed and eventually impoverished voters. 

Nor are the consequences of such failure merely academic or economic.  This week a 1200 page report by auditors KPMG and lawyers Taylor Wessing came out on the state of the German armed forces.  Its main conclusion is that after years of cuts and under-investment the German armed forces are in no position to undertake any new assignments.  This deplorable state of affairs reflected poor project management and delays in equipment delivery which imposed extra costs now totalling €50bn or 66% of the entire German defence budget.  Germany has pledged to provide 60 Eurofighters to support an ally under attack.  In fact Germany has difficulty deploying 6 aircraft or half a squadron.  However, the core of the problem is the eternal Eurozone crisis. 

Indeed, the plight of the German armed forces is reflected if not magnified across the Eurozone as austerity and zero growth bite into government budgets.  To maintain core services such as health and welfare defence budgets are being raided in countries across the Eurozone.  The consequence is that Europe’s security and defence is ever more at risk. Moreover, with no end in sight the Eurozone crisis is now placing NATO and indeed the wider transatlantic relationship at severe risk of collapsing. 

The EU today is a mutual impoverishment and insecurity pact precisely because to all political intents and purposes the EU and the Eurozone are one and the same.  The hard truth is that the Euro cannot survive in its current form and yet the choices leaders face are to say the least stark.  1.  Deepen the political and economic integration of the Eurozone at the expense of its member-states and democracy.  This will cost an immense amount of taxpayer’s money, will almost certainly trigger a Brexit and increase Europe’s strategically-inept self-obsession.  2. Split the Eurozone up into a core area of fiscally-strong economies focused on northern and western European states and allow states such as Italy to return to their former currencies so they can competitively devalue.  This will also cost an immense amount of money as the new/old currencies would need to be underpinned by an EU fund to soften the social impacts of leaving the Euro. 3. Simply end the single currency.  That would mean an end to the European Project beloved of the elite and would also cost an awful lot of money.  Given the difficulties of all three choices Eurozone leaders will instead adopt the Merkel Approach and do next to nothing.  In time that option will prove to be the most expensive of all.

For the Euro to be fixed its power-brokers need to realise that the Euro itself is the problem.  If not the Euro could destroy Europe.

The Euro has no defence.

Julian Lindley-French