Eurozone Crisis

Lord Lamont of Lerwick Excerpts

Thursday 1st December 2011 Grand Committee

Moved By

[Lord Lamont of Lerwick]

That the Grand Committee do consider the economic situation of the United Kingdom, including the impact of the eurozone crisis on the United Kingdom and other non-eurozone members.

[The Deputy Chairman of Committees (Lord Brougham and Vaux)]

Good afternoon, my Lords. I am sorry about the delay, but we had to have a sound engineer so that Hansard could report.

The House yesterday agreed a Motion to limit the debate in today’s Grand Committee in the name of the noble Lord, Lord Lamont of Lerwick, to four hours.

[Lord Lamont of Lerwick]

My Lords, I am very delighted to have the opportunity to introduce this debate. I ought to explain that this debate originated as a question put down by myself and the noble Lord, Lord Flight, intended for the dinner break, and was to be a debate entirely and only on the euro crisis. Somehow the Motion has metamorphosed into something wider, and the debate that was originally intended to be in the Chamber has now been relegated to the Moses Room. In view of the attendance here today and the importance of the subject, which can hardly be underestimated, perhaps it would have been more appropriate had it been in the Chamber in the first place.

I hope that noble Lords will forgive me if, despite the widening of the Motion, I confine my remarks almost entirely to the issue of the eurozone. Of course, I will listen extremely carefully to the points made by other noble Lords—notably, the noble Lord, Lord Eatwell, from the Front Bench, the noble Lord, Lord Myners, its other spokesman, and, of course, my noble friend Lord Wolfson of Apsley Guise, who is going to make his maiden speech during this debate. He is notable for many things, but one other notable thing that he has done has been to offer a very large prize—I shall not mention the exact sum of money—for anyone who can given him the solution as to how to dissolve a monetary union. During the course of my speech, I hope to name at least one candidate for the prize.

I will say just one brief word on the Autumn Statement and the position of the British economy. The critics of the Autumn Statement criticised the Chancellor and the Government yesterday for not having achieved their borrowing targets and for having increased borrowing, yet these were the same people who were urging them the day before to increase borrowing further. They seemed to believe that if we had borrowed more money last year, we would be borrowing less money this year. If only life were as simple as that.

As the Chancellor of the Exchequer said the day before yesterday, you have only to turn on your television to see that everywhere in Europe other countries are reducing their budget deficits and taking drastic action to do so. Indeed, we are probably doing so less quickly than many other countries in the eurozone. The Government’s starting point was the situation that our annual deficit as a proportion of GDP was equal to that of Greece, around 12 per cent. Of course, as is fairly, rightly and frequently pointed out, we had the advantage of a low stock of debt, but if you are adding to that at the rate of 12 per cent per annum, that advantage will quickly disappear. In today’s world, the Chancellor was absolutely right to embark on the programme of fiscal consolidation that he has.

One reason for having a debate on the eurozone crisis by itself is that I believe it represents a large threat to our economy and that of the world. One commentator yesterday compared the Chancellor’s task to that of a doctor treating a patient on board the “Titanic”, and the approaching iceberg was the eurozone. If anyone doubts the seriousness of the situation, just look at the front pages of the newspaper, with Mr Van Rompuy and Mr Barroso sitting opposite the President of the United States in the White House; they were not invited there just to have a cup of tea. Indeed, the action by central banks yesterday to increase dollar liquidity and the liquidity of banks in other currencies via swaps was expressly done, according to the spokesman of the United States Government, to offset the effects of the eurozone crisis and the threat to the banking system.

Denial has been a theme of the eurozone crisis. Outstanding examples of denial have been the constant assertions that eurozone banks have adequate capital, a debt default within the eurozone could never happen and the break-up of the eurozone was unthinkable. We have had extraordinary suggestions from Commissioner Barnier—the noble Lord, Lord Myners, had some observations about him the other day—who went out of his way to suggest that credit agencies should be banned from expressing opinions on the economies of member states that had received financial assistance. It seems extraordinary that, in a European Union where we have Charter of Fundamental Rights that enshrines the freedom of speech, this should not extend to credit agencies expressing an opinion about the state of different European economies. We have had many hobgoblins, not just credit agencies. We have had short sellers, credit default swaps, hedge funds and derivative traders—all have been blamed for the increasing and exacerbating crisis within the eurozone.

This crisis has also been characterised by drift. Perhaps that is inevitable because of the nature of the eurozone. When the eurozone was first set up, many people argued that having a currency without a government was a strength; but, in fact, being a currency without a government has turned out to be one of its fatal weaknesses. Thus we have had a whole plethora of attempted solutions at the crisis. First, we had the Irish bailout, then the first Greek bailout, then the Portuguese bailout and then the second Greek bailout. We had the European stability facility, which, as the director of the IMF said, was probably introduced illegally. We then had the European Financial Stability Facility, the EFSF, and we have the proposed ESM in 2013.

We have had lots of different versions of the EFSF. First, it was going to be leveraged; nothing much seems to have happened on that. Then we were going to have co-investment by other countries in it. Then, despite the extreme criticism of credit default swaps, it was going to be made into some sort of insurance mechanism doing exactly what credit default swaps do. Finally, de haut en bas, it was decided that the bailout should be funded by the Chinese—the richest countries in the world were going to ask some of the poorest countries in the world to bail them out. I think that there is an average income of $24,000 per annum in the eurozone compared with $5,000 per annum in China.

It is not just the policies of the eurozone that are the problem. One of the anxieties has been about the ability of the eurozone to execute any solution. Many weeks have passed since the first proposed 50 per cent haircut on Greek bonds was announced. The terms have still not been agreed by private holders, full interest is still being paid on Greek bonds, and the eurozone still wants to deny that there has been a Greek default because, of course, it wishes to maintain the myth that sovereign bonds in the eurozone are risk-free.

We all have different views about the euro and the eurozone and how it was set up, but there seem to me two fatal flaws in the eurozone that have received inadequate attention. The first was the German insistence on the no-bailout rule. That, of course, has been breached not once but several times, but it is still very dear to the German heart for reasons perhaps to do with their own experience of monetary union. It is something that they have surrendered very reluctantly, and it is, I believe, one reason why the German reaction at each stage of the crisis has been to do the minimum necessary in order to keep the euro afloat. For them, there will not be a big bazooka.

The second flaw, which has been pointed out by the economist Andrew Smithers and which again, I think, has received inadequate attention, is the misconstruction of having one central bank coexisting with 17 sovereign Governments. Normally, of course, a central bank must be able to print money. The Bank of England and the Federal Reserve board are owned by their Governments, whose bonds they buy and sell with no credit risk in their daily operations with the banking system. In a currency area, there should, of course, be local governments, but their borrowing should be tightly controlled from the centre, as it is in the UK, or they should be able to default, as is the situation in the United States. In Europe, the pretence is that the debts of the member states are without credit risk; so the European Central Bank is unable to avoid putting risks on its balance sheets in its day-to-day operations with the banking system. It is hardly surprising, therefore, that the Germans are so opposed to the European Central Bank being forced to buy more bonds. It is one thing for the European Central Bank to be the lender of last resort to the banking system, but one can understand the Germans thinking why should it be the lender of last resort to Governments that have overspent and overborrowed?

Until recently, talk of restructuring the eurozone, or of the departure of some members, or of the break-up of the eurozone, was unthinkable. That all changed, of course, at the Cannes summit, when some Greeks made it clear that they did not want to accept the terms of the write-down but wanted to remain within the eurozone. They were then threatened with expulsion from the eurozone—what was unthinkable suddenly became possible. We know that the Financial Services Authority and indeed the Treasury have been drawing up contingency plans. The FSA has been putting questions to companies about a change in the structure of the eurozone. I am not advocating or supporting a change in the eurozone’s structure or saying that a country should depart, but it would be foolish not to recognise that this is now on the agenda and requires thinking about. It is not inconceivable that in a couple of years’ time the shape of the eurozone could be different from how it is today.

We have seen currency unions that have been broken up before: the currency union between Britain and Ireland; that of Czechoslovakia; and indeed—often ignored—that of the rouble-zone, where one currency became five, six or seven currencies. It is clear that, in the currency union of the eurozone, financial integration has been very deep, and has accelerated exponentially in recent years. However, the issues that would arise if one country departed are clear. Some of those were outlined in a paper by Philipp Bagus of King Juan Carlos University in Madrid. My noble friend Lord Wolfson might care to both study his report and to bear it in mind for the award of his prize for someone studying how monetary unions might be adapted. He identified the issues of redenomination, the importance of keeping payment systems going if one country departs, derivative contracts, cross-border loans and the capital banks.

I entirely accept that, in the eurozone, the departure of one or several members would be highly complex and could be extremely expensive. However, while we hear a lot about the costs of breaking up or altering the shape of the euro, the costs of the euro remaining as it is are becoming astronomical and potentially disastrous. Let us start with the bailouts. The two bailouts of Greece cost, respectively, €109 billion and €110 billion. The Irish bailout cost €95 billion. The Portuguese bailout cost €75 billion. These come to a total of nearly €400 billion. If the EFSF reached €750 billion, Germany’s part in that would be €211 billion. Where other countries get into difficulty and are unable to meet their obligations, Germany’s share of that would rise. For this reason the EFSF looks a little like a pack of cards or, as one distinguished central banker called it, a gigantic Ponzi scheme. If it increased to €1.45 trillion—and given that the guarantee of Italy and some other countries in that situation would be worthless—Germany would have to guarantee nearly €800 billion, or 32 per cent of German GDP. If France were to lose its AAA status, the German share would rise to €1.385 trillion, or 56 per cent of German GDP. These may be contingencies; they may be theoretical. However, merely to examine the numbers is to understand why Germany recoils from ploughing more and more money into the EFSF and recoils from the big bazooka.

The European Central Bank has accepted Governments of the peripheral countries as collateral from the banks. If any of the eurozone Governments were to default, they would probably bring down with them part of their domestic banking system. The banks in that situation would be unable to repay the loans to the European Central Bank, which would be left with the collateral. Open Europe calculated Greece’s 50 per cent haircut alone would cost the ECB between €44.5 billion and €65 billion—and that is just one country. Again, one can see why the Germans are reluctant to put more into the EFSF and reluctant also to let the ECB do what so many people have urged it to do: buy more and more bonds.

Which direction will the Germans go in? They talk of fiscal union, but do not mean what we in our debates mean by a fiscal union. We tend to mean a common treasury and tax system. The Germans mean simply more peer pressure and more supervision of national budgets. That is unlikely to work. So what is the German solution? It seems to be to do the minimum possible at each stage. Each country that is in difficulties is expected to deflate for long enough to become competitive with Germany and to put its public finances on a sound footing. However, given the dire state that some of these countries are in, I question whether that is a sustainable solution. The eurozone threatens to asphyxiate its members.

If there were a real fiscal union requiring treaty changes, it would of course be vital to protect our national interests. I would have no objection to the Government agreeing treaty changes that did not affect us, but it is vital that our national interests should be protected. I hope that the Minister will give us some assurance on that. However, I do not think that that is the route Germany will go down. I have said what I think it will try to do. With this minimalist approach, we can look forward—alas—to recurring crises. They could come every few months. They could go on, possibly for years. I think that it was Adam Smith who said,

“there is a lot of ruin in a nation”.

There is probably a lot of ruin in several nations put together. Such a continuing crisis would be extremely damaging to confidence. It would sap it continuously and would mean that the already bleak outlook for growth would become even grimmer.

Such an approach may keep the eurozone and the currency afloat. However, the great risk is the possibility of an accident occurring in the mean time while adjustments take place. It could happen somewhere else in the financial system; for example, in the marking to market of sovereign bonds. We could see a major crisis in a major bank or in another financial institution. It is far better now to look at restructuring the eurozone and not to take it as a given that it must continue in its present form. The effect of delay will be simply that in the longer run the costs of adjustment will become greater. There is no painless solution, but let us hope that somewhere in Brussels, someone is working secretly to prevent this crisis turning into complete chaos.