We are told with boring monotony that Greece leaving the euro would represent an ‘existential’ threat to the common currency. I doubt this is true, just as I doubt that exiting would immediately set Greece on its own road to freedom. That is not to say that I think the creation of the euro was a good thing for most of the participants. Far from it – I think it means that the eurozone as a group will achieve a sub-optimal rate of growth, and will for the foreseeable future grow more slowly than would have been the case had each country been able to take independent monetary policy decisions.
The problem for Greece is that it has no leverage; it is entirely reliant on the beneficence of others. Greece can threaten default, but this has long been the most likely outcome. As Martin Taylor of the Bank of England’s Financial Policy Committee put it: “If the creditor nations really do believe they are going to get their money back, we are in an even worse situation than I think we are". In or out of the euro, Greece requires a rescue package. In or out of the euro, Greece is going to find it very difficult to tap international capital markets in its own right for a long time. The new Greek government is relying on the fact that although it is very small in the context of the wider eurozone, it can cause economic damage far in excess of its relative size. While that is true, it may still not prevent it from being excised if it does not become more compliant. Had one or all of Italy, Spain and Portugal jumped to Greece’s defence, then it might have got more of a hearing in northern Europe, but this was not the case.
As I have suggested in previous articles, there is a severe risk that, for weaker southern European countries – the so-called periphery – the euro becomes a permanently deflationary force. On this basis, Greece might be well advised to reinstate its own currency, even though it might take some while for it to re-establish its economic credibility in financial markets. The eurozone is flawed in many different ways. The biggest problems derive from our understanding of the intrinsic nature of an economy and of the ways in which individual economies function. By and large, we are taught economics as if it were a quasi natural science, incorporating a set of immutable laws. This is far from being the case. The economic behaviour of a country is simply the reflection of the society (or societies) that comprises that country. Just as individual societies and countries have very different social personalities and structures, so they will also have very different economic personalities and structures. This is not necessarily an indication of one economy being better or more successful than another, it is simply about being different. It may even be, for instance, that hot countries function differently to cold countries in an economic sense.
Whatever the reasons for the differences between economies, having separate currencies allows them to travel at different speeds, without causing the gears to grind too obviously. A common currency area is much more demanding, and will work effectively and optimally only if there is significant convergence, not just in terms of economics attributes, but also politically and culturally. Whether this is what the populations of Europe want (or realise) is a different matter.
For as long as economic characteristics remain divergent, the eurozone can continue to function, albeit sub-optimally, but only if there is a willingness on the part of economically wealthier countries to make ongoing fiscal transfers to poorer ones – not loans, but outright transfers. This will tend to happen almost without a murmur within a nation that regards itself as a single country. However, in cross border terms, most countries remain very tribal. Psychologically, unless the response from a Frenchman, German or Greek to the question “What country do you come from?” is “Europe”, I doubt there will be willingness for permanent and ongoing fiscal transfers of the substantive nature that is required. Equally, I cannot see the support for the degree of fiscal union that would be necessitated. And even if there were fiscal union, there would be massive scope for dishonesty, manipulation and moral hazard (mild terms for what might actually take place).
For the architects of the euro, the crisis which is still unwinding was to be expected – perhaps even welcomed. They thought that the logical consequence of such a crisis would be closer economic union. The mistake they made, I think, was to fail to understand that for a common currency to work, there needs to be a high degree of cultural homogeneity. At the present time, the political trends becoming manifest in many countries suggest this is unacceptable.
This article is issued by Cazenove Capital which is part of the Schroder Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon our current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements. All data contained within this document is sourced from Cazenove Capital unless otherwise stated.