Recent news on bond yields and credit ratings continues to tear at the very fabric of the euro project. Italy was forced to offer record interest rates in its latest treasury issue, making prime minister Mario Monti’s task of reforming the ailing economy just a little harder. Despite a $78 billion rescue package from other Eurozone member states and the IMF, Portugal had its credit rating cut to junk status by Fitch and will have to reverse the market view of its prospects before it seeks more commercial lending in two years’ time.
Although, outside the Eurozone, Hungary is committed to adopting the single currency and it too had its sovereign debt relegated to junk status, in this case by Moody’s. In any case, Budapest’s enthusiasm for the single currency must have been dented in recent months. Taking a wider view, the chasm between German yields and those of southern European states continues to grow ever wider, while London’s splendid isolation saw its long-term cost of borrowing fall below even Berlin’s.
The end result is that a crucial failing in the euro scheme is becoming ever clearer, even to supporters of the project. While a single currency with a unified central bank seemed the ideal way of creating the world’s biggest single economic area, the ability of member governments to issue their own bonds was clearly asking for trouble. Those with the weakest finances have been able to accrue more debt, creating a vicious circle of higher interest rates, more expensive lending, greater debt and more dangerous economic instability. At the same time, investors have pulled out of Greek and Italian bonds and piled into German and British sovereign debt.
Yet while many analysts point to debt as the main economic problem facing Europe, this is not strictly true. The real predicament is the systemic shortfall between revenue and expenditure, which can be reduced by boosting income as well as by curtailing spending. Revenue can be increased by improved tax collection, particularly in the case of Greece, but more generally by more rapid economic growth. Most governments are opting to concentrate on reduced expenditure, as favoured by many international financial institutions.
Attempting to grow our way out of trouble is by no means unthinkable and would certainly be electorally attractive, in the short-term at least. The jury is out on which method would be the better solution, particularly as governments seem reluctant to attract the ire of the markets by sustaining spending. Perhaps Brussels should organise a control test, with two comparable economies adopting contrary approaches? One could take the standard IMF medicine of lower public spending and fiscal restraint, while attempting to promote growth where possible. The other could adopt a Keynesian-style strategy of higher public spending to create employment and provide much needed infrastructure. Are there any volunteers out there?