Euro’s not dead and buried but change is needed
For some, it's almost time to pop open the champagne. Those who thought the euro was, from the beginning, a madcap idea are already saying: “I told you so”.
With protesters marching in Dublin — the capital of a nation which, until now, has been admirably stoical in the face of mounting austerity — and with the cost of borrowing rapidly rising in Portugal and Spain, it's easy enough to believe that the death throes of the euro are upon us. But are countries really on the verge of going their separate ways, with the re-introduction of marks, francs, pesetas and punts? Or, instead, can a solution be found that will deal with the euro's obvious weaknesses?
The euro's difficulties stem from a fundamental paradox, namely the combination of a single currency with many nation states. Plenty of monetary unions work perfectly well, but only because they also tend to be associated with political union.
If the Scottish Nationalists had their way, they'd probably take Scotland out of the sterling area (although — rather perversely — some of them would immediately plonk Scotland into the euro instead). For now, however, the 1707 Act of Union serves its purpose. Scottish bank notes may still exist but it's the Bank of England which pulls the monetary strings on either side of the border. And the Old Lady can do so with relative ease because England and Scotland are fiscally joined at the hip.
When it comes to fiscal sustainability, no one worries about the Scottish deficit, the English national debt, or the Welsh cost of borrowing: in the UK's case, it's all for one and one for all.
In the eurozone, however, it's a completely different affair. Creditors lend to the individual Irish, Greek, Spanish, Portuguese and German governments in much the same way that, in the event of a disunited Kingdom, they might have to lend individually to England, Scotland, Wales and Northern Ireland.
How would creditors treat the individual members of the UK? Would they regard each of them as equally safe?
For much of the euro's existence so far, investors rather naively believed that each of the member states within the single currency were more or less equally safe.
The single currency removed the risk of ‘virtual default’ because countries within the eurozone no longer had their own currencies. But it was always wrong to assume that the removal of the risk of “virtual default” also removed the risk of outright default.
Indeed, by getting rid of the ‘virtual default’ option, the risk of outright default actually rose. And the sudden realisation of this new reality lies at the heart of the crisis now doing so much damage to the euro.
The United Kingdom deals with this problem through the use of a political arrangement which allows for incomes in one part of the Union automatically to be transferred to another part.
And because it's a transfer, not a loan, there is no sense in which one part of the Union can default to another, one reason why we don't spend our waking hours worrying about the individual fiscal arithmetic in, say, Scotland or Wales. But when it comes to the eurozone, investors do worry about these matters.
They worry about the size of Irish government debt or Greek tax receipts precisely because the financial arrangements which govern the UK's cross-border fiscal arrangements don't exist within the eurozone.