Southern Europe Bail Out

Bail out? yes, but jumping out, not injecting more cash.

There is much talk, again, about raising further loans to shore up the euro. The time has come for this delusion to cease.

In a sustainable single currency there must be a mechanism to transfer funds from the strong to the weak regions. A batch of further loans to deeply indebted southern European countries – which it would be impossible to repay – is not a solution.

A default on loans could help the euro to limp on with its full complement of the existing membership for months, or even years if the default was large enough. Default on loans made through the European Stability Mechanism could have the same effect as a transfer of funds from the weak to the strong Europe economies. The UK should be careful not to be exposed and drawn into such an arrangement. A loan with a good prospect of repayment at some point in the future is low risk (and may even make a profit for the UK if it is made at an interest rate above the UK’s cost of borrowing) but a loan made on the unspoken understanding that it is the first stage of a controlled default would be highly damaging. The UK is outside the euro and not therefore subject to the same commitment to transfer funds to weak euro members. This is the job of the strong members inside the euro zone, such as Germany whose exporters have done exceedingly well from a lower exchange rate than would have been the case if Germany had retained the Deutschmark.

In a single currency, weak regions will need support and strong regions will have to foot the bill. These are the simple economic facts played out within every national economy and a requirement of every successful currency union. The sticking point is whether Germany will pay the price. If not, it would make logical sense for the highly indebted countries to bail out of the euro and go back to national currencies. This is not the ‘bail out’ that the politicians are discussing now but it has a much more realistic chance of success than adding further loans to a flawed system.

The frustrating aspect of all this is that it has been obvious for many years that the euro has fault lines. The solution for greater macroeconomic stability in European economic affairs is through collaboration between separate economies building on the relative strengths of each, not through a union in which one-size-fits all. Europe is a wonderful mix of countries, cultures – and economies. We should accept reality, celebrate diversity and encourage the southern European countries to get on with bailing out of a foolhardy project. The consequences will be unpredictable, and could be terrible in the short term, but not so dire as failing to act yet again.