April 12, 2011
Eurozone project can either change or go down the drainPosted in Sunday Business Post · 98 comments ·
When was the last time you pulled a cork from a bottle of wine? In the wine industry, there is a debate raging about whether the cork itself is to blame for wine being ‘corked’.
Whether this can definitively be proved or not, the upshot of the cork being blamed for the oxidation – and the subsequent mustiness – of the wine’s taste has led to a dramatic shift in the way wine bottles are sealed.
Increasingly, wine producers are switching from corks and towards screw tops. Could this switch become the norm?
And, if it does, what is the connection between the wonderful ceremony of popping a cork and hearing the delicious gurgle of new wine cascading into a glass, and the latest, supposed ECB/IMF ‘bailout’?
If you have ever driven through Portugal, You may have seen the thousands and thousands of cork forests populating that beautiful country. Many years ago, while in Alentejo, I remember taking a nap in one of these splendid orchards, bees buzzing all around, snoozing in the afternoon sun . . . heaven.
Today, Portugal is the world’s largest exporter of cork. But what happens if the market for cork is undermined by a structural shift in the wine industry, which Portugal can do very little about? It means the demand for cork will fall, along with its price.
This fall means that the average Portuguese farmer will have to sell more and more cork in order to buy, let’s say, a VW Polo. In economics, this shift in the value of exports is called a downward shift in its terms of trade.
As the demand for cork falls, Portugal will see its trade deficit rise.
Therefore, it will run a current account deficit and will have to borrow to cover this. If it is shut out of the markets, it can only borrow from the ECB/IMF.
But – and here is the rub – the only way it can get back on to a growth path is to reduce government spending massively, which the ECB is now advocating.
But in a country like Portugal, this will cause the economy to contract and it will suffer the twin pressures of internal and external contraction, leading to more Portuguese waiters in west London, more Portuguese grape-pickers in the south of France and more Portuguese workers in Munich Airport.
It also points to the fact that the European elite has now officially presided over a two-speed, two-tier Eurozone, where the voters on the periphery are second-class citizens and those in the core are a protected species, shielded from the internal contradictions of the monetary union.
If those who lend money to either Irish banks or the Portuguese government are insulated from the implications of their reckless lending, and the citizens of these countries are forced to bear all the burden, what hope does the currency have?
After all, this is the third time the IMF has been in Portugal since the 1970s.
What more signals do you need? All this evidence was ignored in the ECB-inspired lending bonanza of the past few years but now, financial reality has hit.
The eurozone will be divided between debtor countries and creditor countries, where the citizens of the debtor countries bear all the cost and those of the creditor countries get a free lunch.
Could it be possible that ECB president Jean-Claude Trichet wants to scupper the euro himself and cement this division? It certainly looks that way.
The countries on the periphery of Europe – the ones with the huge debts – need lower interest rates and looser monetary policy, yet Trichet has moved to increase interest rates and, therefore, he has tightened monetary policy.
This will exacerbate the strains between the creditor and debtor nations, making it more difficult for the debtor nations to pay their debts, ensuring more austerity, which will contract those economies further and thus begin the gradual process of a two-speed economy in the eurozone.
After awhile, the politics of this move are pretty straightforward.
Whether it was 100 per cent true or not, this approach to the debtor nations will increase opposition in the periphery to the euro, and Europe in general. Such opposition, whether it is effective or not, will lead to lingering question marks over those countries’ commitment to the euro project, which will further heighten financial market tensions.
Such tensions will be manifested in higher risk premiums for the periphery countries, keeping interest rates high and undermining the very fiscal adjustment policies that Trichet wants to enforce.
To keep the eurozone from a trophying, the elite – two of whom are Portuguese (European Commission president JoseÂ¤ Manuel Barroso and ECB vice-president Vitor Constancio) – will have to come up with a new blueprint.
Most likely, they will push for further political integration, which the European electors – both in the core and the periphery – have voted against.
So they will have to go back to the solution that has been screaming at them for ages, which is that debts have to be restructured periodically in a monetary union made up of countries that make corks and countries that make cars – or countries where the population is old and saving, and others where the population is young and spending. We need a clean break.
Sticking with our wine theme, what the European elite is trying to do now by pretending that the system is not broken is nothing more than putting ‘new wine in old bottles’ – corks or not. In the Bible’s parable of new wines in old wineskins, Jesus said: ‘‘And no man putteth new wine into old bottles; else the new wine will burst the bottles, and be spilled, and the bottles shall perish. But new wine must be put into new bottles; and both are preserved.”
He was trying to make a clean break between his new Christianity and the old religion, Judaism, suggesting that the disciples couldn’t just graft on to Judaism the bits they liked and continue as before. According to Jesus, they had to create a totally new faith or the new wine would simply break the old bottles.
Therefore, they had to start afresh.
The same could be said for the financial architecture of Europe. If the elite tries to preserve the old system, rather than trying to re-think the whole thing now, they are only buying time, and the old system, like the old bottles, will break apart.