The eurozone appears to be trying to do things the hard way. It has softened conditions on Greece, while promising an unlimited fund to buy debt of the other PIGGY governments and supporting the creation of a supranational banking regulator. In the short term, this has quieted market speculation. In the long term it has increased the probability of a break-up of not only the eurozone but the European Union itself.
Growth in the eurozone has run just below the flatline this year, with The Economist team of forecasters expecting 0.5% shrinkage of the eurozone economy in 2012 and a tiny 0.1% growth in 2013. Only inflation is creeping up, expected to reach 3% this year as the European Central Bank's various monetary "stimulus" policies have their inevitable side-effects.
Euro M3 money supply rose only 2.7% in the year to September, a reasonable rate, but in the same year credit to government rose by 8.3% while credit granted to the private sector declined by 1.3%. In other words, the eurozone monetary crisis is squeezing the private sector while its banks contribute further to the perpetual aggrandization of government.
The real problems are arising in the countries being bailed out. Greece is being given an additional 16-18 billion euros (US$21-$23 billion) through 2016, and in return will be expected to allow direct EU "advisory" interference in its tax collection and budgeting.
Good luck with selling that on the streets of Athens!
Italy faces an election in March in which neither Silvio Berlusconi, the most important figure of the past two decades, nor Mario Monti, the darling of the EU technocrats, will officially run. The country ranks 92nd on the Heritage Foundation's Index of Economic Freedom, just below Azerbaijan, while public spending runs at 52% of gross domestic product (GDP) and debt above 100% of GDP. The country's relatively lavish living standards are now wholly incompatible with its third-world economic policies.
Spain is relatively well run under Mariano Rajoy, but its task has been made harder by the previous socialist government's outrageous overspending, which led to a public sector deficit of 9.2% of GDP in 2011, a year in which the country already claimed to be undergoing austerity. More worryingly, its largest and most productive province, Catalonia, has called an election and threatened to seek independence, thus greatly increasing the market's doubts about Spain's future.
I am more optimistic about Spain than about either Italy or France, but much could certainly go wrong. Certainly the market thinks so; the international bond market just allowed Bolivia, a very poor country run by a Marxist fruitcake, to do a 10-year deal at 4.875% while requiring a 5.5% yield on Spanish debt.
As for France, with its current policy mix it is committing economic suicide. The increase in the top marginal rate of income tax to 75%, combined with a substantial wealth tax, makes the effective tax rate on wealthy Frenchmen well over 100%. Britain tried this in 1968, with a 135% rate of tax on high incomes, and the result was not pretty.
Similarly France with free movement of labor within the EU will find most of its best and brightest decamping - not just the famous ones like LVMH chairman Bernard Arnault, and mostly not to Belgium, but leaving nonetheless.
The Economist forecasters predict 0.4% growth for France in 2013; I would regard that as much too high, with the real outcome likely to be a 3-4% decline in GDP. That in turn will make France's fiscal and debt problems insoluble, and lead it straight to the indigents' line for a handout at the European Central Bank. At some point pretty soon, the markets will realize this, and will raise the yield on French government 10-year debt from its current ridiculously low 2.26% to the 5% (more in crises) of Spain, Italy and Bolivia.
The new plans for central regulation of EU banks will in the long run make matters worse if they are implemented. We have seen from the Basel regulations that unaccountable government regulators use the regulatory system to favor outrageously the demands of the public sector, allowing banks to lend unlimited amounts to government borrowers without being required to put up any capital against those loans.
A central EU regulator will similarly be in hock to the demands of EU politicians; it will allow the banks to make unwarranted loans to the public sectors of EU countries in difficulty, while maintaining tight prudential controls on private-sector lending.
We have seen where this turns out in the current ECB figures quoted above. More than 100% of credit creation is devoted to the public sector, while the private sector is put on a strict diet. Needless to say, the sector that is able to obtain resources effectively for free (since interest rates are below zero in real terms) will grow uncontrollably, while the sector that is put on tightly rationed credit will scale back expansion plans, lay off workers and build up cash balances for use in emergencies.
If Germany allows the ECB to buy French, Spanish and Italian government debt ad infinitum, and provides modest bailouts as required to Greece (and if necessary to the problematic but small countries of Portugal, Ireland, Cyprus and probably Slovenia) the system can muddle on for a while.
However 2013 is an election year in Germany, and it seems unimaginable that the German electorate will allow itself to be quietly impoverished by the gigantic liabilities run up through this system. After all, the Bundesbank already has 695 billion euros in "Target 2" balances owed to it by the dodgier credits of southern Europe - admittedly down from 751 billion the previous month. The latest economic figures suggest that even the German economic engine is slowing to a standstill, not surprising when it is being expected to pull all the deadweight of the eurozone behind it.
In the long run, the German electorate's reaction will not matter. A system cannot last that allows the least productive countries in a union to build up debt uncontrollably, that controls centrally the union's banking system, forcing it to subsidize this buildup and that allows foolish governments in the debtor countries to raise taxes so far that their most productive citizens flee to safer climes.
With German acquiescence in money printing and central control of the banking system, the eurozone may last four or five years, but its economic growth will be minimal during that period (since massive resources are being extracted from the productive and devoted to the useless) and by 2017-18 the system will be in total collapse, with no way out.
If you've seen Atlas Shrugged 2 (released just this month), you will have seen a foretaste of the eurozone, even Germany, in five years' time - only alas there are no redeemers hidden in Alpine or Carpathian hideouts waiting to emerge and sort the continent out.
Given the normal bureaucrat response to difficulties, there will no doubt be a number of Ayn Rand-villain attempts by the EU bureaucracy to shift costs to non-eurozone members of the EU or roll back the economic tides in some other way. For competently run non-eurozone members, this will be the time at which it becomes obvious that exit from the EU itself is the only viable option.
Needless to say, there is a better way. Eliminate the malinvestment, as Austrian economists would say. Cut Greece free to sink or swim on her own (albeit remaining a member of the EU as a whole). Split the remaining euro countries into two, with Germany, Finland, Estonia and those northern countries subjecting themselves to fiscal monetary and economic discipline remaining in a "northern euro" while France, Spain, Italy, Slovenia, Portugal and Ireland either form a southern euro of their own or became entirely independent. (In my view it would be a foolish country that wanted to link itself to the indiscipline, corruption and leftist theorizing of France or Italy, but that would be their choice.)
Abandon all thought of a centrally controlled banking union as a bureaucratic, politicized nightmare that would subsidize all the wrong things. In such a situation, at least part of the current eurozone countries would remain prosperous and would pull up with them the non-eurozone countries like Sweden and Britain which had competitive economies.
That better future is still available, but it is directly contrary to the interests of the EU bureaucracy, of ECB centralizers like Mario Draghi and, for political reasons, of the foolish German Chancellor Angela Merkel. The EU has taken too many decisions in areas as disparate as trade, economic intervention and global warming in which political or sentimental considerations have been allowed to trump scientific and economic reality. The costs of this foolishness are about to come due.
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