A tragedy of errors

It probably doesn't make any difference at this stage, but it's important to remind ourselves that critics who say that the Euro was "flawed from the outset" or "doomed to fail" don't know what they are talking about. The technocrats who designed the single currency knew perfectly well that the currency bloc would only survive if the key economic fundamentals of the participating countries were more or less in alignment.  To ensure this, they devised a series of tests, generally known as the Maastricht criteria, to monitor and enforce  the so-called "convergence" process.

There were three separate criteria, relating to inflation, exchange rate stability and budgetary performance. The rules set by the technocrats were so strict that, not long before the Euro was due to come into existence, only one would-be member met all three criteria: Luxembourg!  So the politicians, fatefully, got themselves involved.  It was decreed that actual compliance with the Maastricht criteria would not be a sine qua non for membership, as long as a country was deemed to be heading in the right direction.   Even on this basis, the experts warned that Italy was not ready for membership, but as it was one of the original six members of the old EEC, and as excluding it would have been politically unthinkable, it was admitted alongside its more compliant neighbours.

Once that decision was taken, the floodgates of Euro admission were well and truly open,  with little regard to the underlying condition of the economies of the candidate countries, as measured by the Maastricht criteria. The most egregious example is, of course, Greece, which secured admission to the single currency through bare-faced mendacity about its true fiscal situation (ably assisted by its friends at Goldman Sachs).  

Briefly stated, it was not the Euro's architects that set the currency on a dangerous course, but the politicians, through their reliance on expediency and deal-making rather than sound principles.  That pattern of political grandstanding and fudging continues to this day, and largely explains why a tricky but manageable crisis has been allowed to career towards the brink of disaster.  

Consider last weekend's bailout of Spanish banks, for example.  Instead of finding a way to solve the problem directly by recapitalising the institutions themselves, the EU deemed it necessary to lend the money to the Spanish government as an intermediary.  Spain's debt-to-GDP ratio, which was not excessively high before the bailout, suddenly rocketed.  Moreover, since the EU's loans are deemed to rank above those of other creditors, it immediately became riskier and more expensive for Spain to raise money in the markets.  The result?  Ratings agencies are falling over themselves to downgrade all things Hispanic, and today the country's 10-year bond yield hit 7%, the level at which (at least in the minds of lazy journalists) a bailout of the country itself will soon be inevitable.

And there's more.  Even though the bailout funds were loaned directly to the Spanish government, the EU did not impose a new austerity package as part of the deal.  On one level this is fair enough: Spain's government has already imposed stringent controls on public spending.  However, it sends a very odd message to Ireland, which had to swallow very tough EU-mandated measures when it needed a bank bailout.  More significantly, it may well reinforce the anti-austerity-but-still-in-the Euro position of the Syriza party in Greece, ahead of this weekend's elections.

Most bizarre of all, the bailout loans to Spain are the several responsibility of the other Eurozone members, in proportion to their share in the region's GDP.  This puts Italy on the hook for about 20% of the bailout (of up to 100 billion Euros).  It will be receiving 3% interest from Spain -- on money that it must itself borrow at rates of 6% (and rising).  Little surprise, then, that Italy is being tagged as the next domino to fall.

It's hard to think of any recent decision, by any government anywhere, that threw off unintended, adverse consequences in so many directions at once.

The EU's biggest error, of course, is its bullish insistence that austerity is the only way out of the crisis.  Everyone but Angela Merkel now seems to realise that what's urgently needed is growth.  Word to the Chancellor: the ratings agencies and the bond vigilantes are going to squawk whatever you and your fellow leaders do. It's long past time to ignore them, and just do the right thing.