Me on the Euro, Two Years Ago

I came across this today and had a bit of a laugh at my own expense. Me, two years ago after EFSF was set up. The paper’s a funny read. I certainly underestimated the scale of the existential threat to the single currency. Still, I didn’t get it all wrong:

One can point to a number of issues related to the EU Stabilisation fund that may contribute to undermining the common currency:

1. Countries that avail of the EU Stabilisation fund will have to enforce severe budgetary adjustments. One might argue that, by definition, these adjustments would be required in the absence of a bailout fund. However, it is likely that the EU (and hence the euro) will get assigned much of the blame for the pain associated with the adjustment plan in the same way that the IMF often gets blamed for the pain associated with the adjustment plans to which it provides financial support.

2. If the Stabilisation Mechanism’s goal of eliminating sovereign debt defaults in the eurozone was actually achieved, it would set up a serious moral hazard problem. European governments would no longer have any fiscal discipline imposed on them by bond markets, as these participants would consider eurozone bonds to be risk free because of the safety net. Whether the European Commission would be up to the job of applying sufficient surveillance to ensure the fund would not be needed again is not at all clear.

3. An increased role for the European Commission in budgetary formulation in eurozone countries is an inevitable consequence of the existence of the Stabilisation Mechanism. This development may be welcome in light of the poor budgetary management in many of these countries in recent years. However, the Commission’s role in the budgetary process will be resented by some citizens as undemocratic and will be cited regularly by Eurosceptic groups as a reason to leave the Euro.

4. The Stabilisation Mechanism has been sold as a gesture of cross-country solidarity across the eurozone. The contributions to the Fund are to be provided in proportion to each member state’s share of the ECB capital subscription. However, the truth is that the benefits of this approach are not evenly spread. Some countries are more likely to avail of the fund than others. In addition, because some countries have banks that are clearly more exposed to the debt, a fund to pay off this debt will disproportionately benefit those countries, most likely saving them from further expensive and unpopular banking system bailouts. The realisation that the benefits of the Stabilisation Mechanism are unequally distributed may have negative political consequences in the future.

Over the longer term, the biggest threat to the euro will not come from countries such as Greece choosing to establish a new currency. The biggest threat would come from citizens, and ultimately politicians, in a large EU country such as France or Germany deciding that they are not happy with the single currency. One scenario that could lead to such an outcome would be if membership of the single currency became associated in the minds of citizens of these countries with repeated bailouts of less disciplined peripheral members. While this is not a likely scenario over the coming few years, I suspect that the announcement of the Stabilisation Mechanism has pushed Europe a bit closer to this outcome becoming a reality.

The bits about austerity being blamed on the EU and increased fiscal surveillance being grist for Eurosceptics were correct enough. Unfortunately, with the weak support for Greece staying in the Euro coming from its “partners” in Europe, it looks like I got the “Germans-getting-sick-of-bailouts” threat to the euro right as well.