Will the eurozone survive? The leaders of France and Germany have now raised this question, for the case of Greece. If policymakers had understood two decades ago what they know now, they would never have launched the single currency. Only fear of the consequences of a break up is now keeping it together. The question is whether that will be enough. I suspect the answer is: no.
Efforts to bring the crisis under control have failed, so far. True, the eurozone’s leadership has disposed of George Papandreou’s disruptive desire for democratic legitimacy. But financial stress is entrenched in Italy and Spain (see chart). With a real interest rate of around 4.5 per cent and economic growth of 1.5 per cent (its average from 2000 to 2007, inclusive), Italy’s primary fiscal surplus (before interest rates) needs to be close to 4 per cent of gross domestic product, indefinitely. But the debt ratio is too high. So the primary surplus has to be far bigger, the growth rate far higher, or the interest rate lower. Under Silvio Berlusconi, none of the necessary changes are going to happen. Would another leader fix things? I wonder.
The fundamental difficulty throughout has been the failure to understand the nature of the crisis. Nouriel Roubini of New York University’s Stern School of Business makes the relevant points in a recent paper.* He distinguishes, as I did in a column on October 4, between the stocks and the flows. The latter matter more. It is essential to restore external competitiveness and economic growth. As Thomas Mayer of Deutsche Bank, notes, “below the surface of the euro area’s public debt and banking crisis lies a balance-of-payments crisis caused by a misalignment of internal real exchange rates.” The crisis will be over if and only if weaker countries regain competitiveness. At present, their structural external deficits are too large to be financed voluntarily.