Thinking the unthinkable
I have lost a lot of money in recent years by listening to the collective wisdom of the Anglo-Saxon high priests of finance on the subject of the euro. They have been universally critical, and frankly ridiculed its chances of survival. As Europe’s sovereign debt crisis has unfolded, the crowing satisfaction from these quarters has been deafening. And yet the euro not only refuses to die, but goes from strength to strength against the dollar. Maybe it is time to turn to an iconoclast to understand what is really going on.
Enter the economist Graham Bishop. An independent thinker whose pedigree encompasses Phillips & Drew, Warburg’s and Solomon’s, he is particularly qualified to opine on this subject, having advised the European Commission, the European parliament and the UK Treasury. (I should declare that I also advised the incoming Blair government on this issue.) In this weighty pamphlet, heavy with the minutiae of European Commission papers, Bishop chooses to think the unthinkable. The recent economic crisis has forced the creation of a financial framework that doesn’t just strengthen the currency’s fortunes, but makes likely “a volcanic eruption…. from which a loose political federation called ‘Eurozone’ may well crystalise.”
Bishop forensically examines progress towards the single market for financial services, and concludes that irreversible achievements have been made. The first of these, the creation of SEPA (the single euro payments area) is the most important in sealing the impossibility of a euro break-up; some 32 European countries now participate in SEPA, 4,400 banks have joined the credit transfer scheme, and 3,000 are in the direct debit scheme. By the end of 2012 all credit transfers, and by the end of 2013 all direct debits, will take place via SEPA.
This entanglement of each European banking system with the others makes euro breakup unthinkable, Bishop argues, and reinforces the magnificent fait accompli of the introduction of the single currency itself. While, in theory, political sovereignty remains with each member state, in reality once in, you’re stuck. As Bishop argues: “Any citizen who fears that his home state is about to leave the euro to implement a major devaluation can (simply) transfer their liquid funds into a bank in another euro-zone state.” In effect, “an instantaneous referendum on government policy”. As Ireland, Greece and Portugal have come to realise, perhaps against their politicians’ wishes, devaluation no longer exists as an escape route in financial crisis.
Bishop demonstrates other single market achievements, such as progress on consumer protection, universal accounting standards and the changed EU role within G20 deliberations. He raises the possibility of corporation tax harmonisation. “Once all corporations in the EU are subject to similar accounting standards…. it must be only a matter of time before…. member states.… align their tax codes with accounting standards for the purpose of calculating taxable profits.”
He also celebrates how progress on the single market has increased Europe’s “soft power”. Some 110 countries have adopted the European style IFRS, leaving the US accounting system somewhat isolated. Europe’s voice is perhaps the strongest in the G20 process on financial reform. In the words of President Barroso, “the EU has provided much of the.… political impetus and substantive thinking”.
These single market achievements have taken several years. But Bishop argues that the real leap forward is happening now, as a consequence of the sovereign debt crisis. At one point the core relationship in the euro-zone, that between Germany and France, seemed to be very publicly fraying. But having stared into the abyss, there seems to be the political will to “lead to a deepening of the relationship that would run well beyond France and Germany, and include all members of the euro-zone”.
At the peak of the crisis in May 2010, the EU heads of government pledged all “necessary reforms to complement the existing framework to ensure fiscal sustainability in the euro area”. The EU realised it had “to reshape some of its financial regulations to reflect the imminent victory of the real world bond market vigilantes”.
Bishop contends that a crucial shift took place last September, when “macro-economic surveillance was added to the stability and growth pact”. It constitutes “a huge step towards a more collective form of economic governance”, where ‘examination’ by the commission “will flow into every aspect of a state’s economic life if imbalances begin to appear”.
And imbalances will appear. The different states of the US issue debt in their common currency, the dollar, but are punished or rewarded by bond markets according to their fiscal probity. This is where we must get to, but the transition will not be easy. The Germans have indicated their desire to specify a date, 2013, after which purchasers of euro government bonds will have the risk of a haircut in the case of default. This, as Bishop points out, together with the capital requirements for banks demanded by Basel III, will hasten the flight from weak sovereign bonds. Pension funds will surely follow suit, particularly when they have an alternative, safer, bond class - those issued by the new European Financial Stability Fund. This all explains the enormous rush by what Bishop terms “problem countries” to have a primary surplus by 2013, and to rush out as much bond issuance as possible before then.
But their efforts will be in vain. Bishop argues that crisis after crisis will unfold as the weaker bond issuers are deserted, justifying further collective European intervention in the economic affairs of individual countries. “At the end of the crisis, Eurozone will have emerged as a political federation - loose in some respects, but with tightly centralised economic governance at its heart. The proven commitment to fiscal probity may even make it attractive relative to alternative investments around the world.”
This is a worthy study, well researched, if at times somewhat opaque. Bishop could do with the assistance of a co-writer if he is hoping to reach a larger audience. But this is an important contribution to the euro debate. Maybe the euro’s supporters will have the last laugh.
Christopher Walker is a writer on current affairs and investment issues and previously was a senior executive in the asset management industry