Why The Euro Crisis Is Far From Over

THE ECONOMIST

 OCT. 20, 2014

REUTERS/Thomas Peter

Poland’s Prime Minister Ewa Kopacz (L) and German Chancellor Angela Merkel address a news conference at the Chancellery in Berlin October 9, 2014.

“The Euro Trap: On Bursting Bubbles, Budgets, and Beliefs” By Hans-Werner Sinn. Oxford University Press; 380 pages.

“The 13th Labour of Hercules: Inside the Greek Crisis” By Yannis Palaiologos. Portobello; 270 pages.

THE euro crisis never seems to end. From an acute phase of worries about public debt and whether the single currency might break up it has moved on to a chronic condition of near-zero growth and fears of deflation.

The signs are that the euro zone is now back in recession, with even the German economy, the central powerhouse, slowing sharply. And that is creating new pressure on Germany’s chancellor, Angela Merkel, to borrow and spend more for the sake of Europe.

Yet there is strong resistance to this inside Germany, led by “ordoliberal” economists such as Hans-Werner Sinn of Munich University and the CESifo Group, whose latest book, “The Euro Trap”, sets out his rationale. Mr Sinn believes the European Central Bank has become too accommodating and that its plans to buy sovereign debt are illegal (the European Court of Justice has just heard arguments on this). He also reckons the euro-zone bail-outs of the past four years have created moral hazard, allowing feckless Mediterranean countries to get away with minimal reforms and only limited fiscal discipline.

Mr Sinn is particularly obsessed with Target 2 (the first German version of his book was called “The Target Trap”) liabilities, which refer to the accounts of national central banks with the ECB. The German Bundesbank is a large creditor of the system, and most Mediterranean central banks are large debtors. The worry is that German taxpayers might end up with a massive bill. Yet Target 2 is essentially an accounting matter that would only become a real issue if the euro were to break up and the ECB be dissolved.

The paradox is that the risk of that happening is increased by German-inspired austerity and a lack of growth. Mr Sinn’s solution to the euro’s problems is also problematic: he wants some countries to leave the euro and re-enter at a lower rate. As it happens, Mrs Merkel and her advisers have thought hard about a Greek exit (or Grexit), as Mr Sinn notes. But every time they looked at it, they concluded that it would be costlier, including to Germany, than doing what is needed to keep the currency together. That remains true.

REUTERS/Yannis Behrakis

Presidential guards are framed through a burned EU flag in front of the Tomb of the Unknown Soldier by the parliament in central Syntagma square in Athens May 1, 2013 following a May Day rally.

Mr Sinn would not take much comfort from Yannis Palaiologos’s searing account of Greece’s nightmare of the past five years. Poor tax collection, entrenched corruption and a dysfunctional state may lead one to ask how Greece was let into the euro in the first place. The pain caused by a fall of around 25% in GDP since Greece’s first bail-out of May 2010 has been immense.

Yet Greeks still want to stay in the euro. And reforms have now improved competitiveness and even rekindled growth. There may still be political upsets–the author’s analysis of the far-right party Golden Dawn is troubling–but at least Greece is on the mend. The current concerns, as Mr Sinn notes, are France and Italy, which are both too big to fail and too big to bail out.

No wonder the euro crisis is not over.