Peter Jones: Fire-fighting needs a team response

EUROPE needs to create a cohesive strategy for dealing with problems before the whole edifice collapses, writes Peter Jones

Forest fires are tough things to deal with. You may think the flames have disappeared after dumping millions of gallons of water on them, but then they can erupt again from unseen pockets of underground heat or a few flying sparks. So it is with the eurozone financial crisis, which now looks to be rapidly approaching time for mega-decisions – either rapid moves to major degrees of integration, or an orderly disintegration.

The big problem is that Europe lacks an agreement on a forest-wide fire-fighting strategy. There are lots of ideas, but no agreement on an overall plan. So resources have been rushed to localised flare-ups in Greece, Ireland, and now Spain, hoping that will control the much wider fire. It hasn’t, and further big outbreaks are certain – but Europe is beginning to run short of water.

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Spain’s financial reservoirs, like Ireland’s before it, ran out of the money needed to stop its banks from going bust, so Europe is now prepared to hose it down with up to €100 billion (about £80bn). The markets gave a cheer yesterday morning – then inspected the plan more closely and by late afternoon had concluded the fire was most certainly not out.

Everyone can see where the next flashpoint is: Greece and the elections scheduled for this Sunday. Already Greek politicians are drawing lessons from the weekend Spanish bail-out. Unfortunately, they are mostly the wrong lessons.

The €100bn being set aside from European funds is not going to the Spanish government, but to recapitalise the country’s banks which are faced with a growing mountain of debt from now unsaleable property and defaulting mortgages. Spain is now suffering from too much austerity already – with 25 per cent adult, and 50 per cent youth unemployment rates – so asking its citizens for yet more hardship is impossible.

Nevertheless, the left-wing Syrzia party is campaigning against the same austerity Spain is now enduring, and it is thought likely it will to emerge as the largest party on Sunday. Syrzia argues that the Spanish deal shows the Greek bail-out can be renegotiated and the EU will make the terms less onerous.

Well, it is possible, but I think that anything meaningful is unlikely. An alternative interpretation, advanced yesterday by Royal Bank of Scotland’s European economics analysts, is that the EU support for Spain’s banks is in fact also a firewall, albeit an inadequate one. €100bn is well in excess of the €37bn of potential Spanish domestic bad debt estimated to exist by the International Monetary Fund (IMF), so it looks as though a contingency has been built in to deal with any crisis from the Greek election.

If the election results in an unstable government, or a stable but strongly anti-austerity government, then the prospect of further default on Greek government bonds will rise sharply. This would not send other European banks up in flames, most of which have written off the value of their Greek holdings, but heat would be generated by questions about Spain might also having to default. So EU institutions have moved a firewall in.

While this is a welcome sign of strategic thinking, a much bigger strategy is still desperately needed. The current system is broke and needs fixing, otherwise fires will keep breaking out. One unheralded problem is Cyprus, which looks ominously like another Iceland in the making, but inside the eurozone.

Cyprus built up a large financial services sector and the IMF estimates the debts of its banks to be about £120bn – eight times the GDP of the country, which has a population of just 790,000. Cypriot authorities are desperately seeking additional banking capital, but if they can’t find it, a European bail-out will be needed.

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The European solution favoured by Angela Merkel, Germany’s chancellor, is to move swiftly towards a European federation in which European governments pool their sovereignty over tax matters, creating the fiscal machinery needed to back the single European currency and monetary union.

The outline of this plan is in place, but much more needs to be done, it seems, before Mrs Merkel will approve of the issuing of European, rather than national, sovereign debt.

She has a point. If Europe cannot control, or at least be sure of, the tax mechanisms that will raise the money to repay eurobonds, then the problems which caused the present crisis will still exist.

The other solution is to break up or shrink down the eurozone, a prospect which Europe’s leaders think is just too horrible to contemplate. Apart from it bringing, at best, two years of deep recession, it might even cause the whole EU to collapse. While some apparently sane voices are recommending this as a kind of controlled burn that would extinguish the source of the present fire, I think it would be a conflagration rather worse than the problem blaze itself.

Nevertheless, I am beginning to think that Europe’s leaders are contemplating a small-scale trial of the concept should the Greeks produce a disobliging election result. That would amount to at least threatening the Greeks with expulsion from the eurozone and if that does not bring them to heel, to actually do it.

The calculation would be that, as when Argentina broke its peso link with the US dollar in 2002 as a way of dealing with crippling debts, the disruption to the Greek economy and its people would be so great that the rest of Europe would see the sense of sticking with the euro and associated austerity measures.

There are arguments that this would cure Greece’s problems. That can be debated another time. My point here is that events in Europe are now moving towards a decision on the overall fire-fighting strategy – integration or disintegration.

I have little doubt that integration is the preferred choice of the political elites. And much though we in Britain comfort ourselves that we have miles of sea acting as a firebreak, it will also mean decision time for us. A referendum – now a legislative necessity if there is any question of the EU of which we are part gaining more power – will take place.

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In current circumstances, a Yes vote to leave the EU altogether looks probable. That’s plenty to think about anyway but I can’t resist a final question: would that dampen or fire up the SNP’s hopes for independence, built as they are on absolute faith that Scotland will be inside the EU?