What next for the euro if France rejects austerity?

The euro zone is continuing to struggle finding solutions to the current financial crisis that it is in. Countries all over the world are dependent on the euro zone and if the euro zone crumbles then they will continue to see additional financial turmoil.

By Jeremy Warner
6:41PM BST 23 Apr 2012
The Telegraph

At a time when the UK Government is imposing another £16bn of spending cuts, is abolishing pensioner tax reliefs, and is apparently so financially stretched that it needs to tax warm pasties, it has somehow managed to find an additional £10bn to bail out the eurozone. This from a prime minister who declares himself a "eurosceptic". Is it any wonder that the Tories are trailing in the polls?

I've found myself genuinely torn by the debate around new loans to the International Monetary Fund (IMF). On the one hand, I'm a supporter of multilateral solutions, and find the spectacle of so many countries, some of them quite poor, coming together to create a bigger and more credible financial safety net both noble and inspiring.

Britain was one of the founding fathers of the IMF, and whatever the rights and wrongs of the euro, our future is vitally dependent on a stable and prosperous Europe. It would have seemed isolationist and almost gratuitously self-destructive to have stayed out while so many others were participating.

There is also something in the Treasury argument that this is not real money, since all commitments to the IMF come from the foreign exchange reserves and remain largely unused. The additional funds are billed as merely a contingency which could not in any case have been used for alternative, public spending purposes. With luck, it will cost nothing to have participated.

But I also substantially agree with the reservations expressed by the two major refuseniks, the United States and Canada. There is no obvious need for more IMF funding outside the growing likelihood of further eurozone bailouts. We have no idea on what terms the IMF might lend, but what we do know is that the eurozone is struggling to find politically acceptable solutions to its crisis, which, to the contrary, looks ever more intractable.

Future eurozone bailouts are likely to dwarf anything the IMF has done before; at the same time, there is no credible escape route or convincing path back to either growth or debt sustainability offered to any of the afflicted nations. This combination makes future IMF programmes very much more high risk than anything that has gone before.

Take the example of Spain. Should Spain need to become part of the programme, what conditions would the IMF impose? Monetary union precludes devaluation, which is normally key to re-establishing competitiveness, while the Spanish government is already enacting a degree of fiscal austerity and structural reform that is similar in its scope if not beyond what the IMF would recommend. Far from improving matters, this is proving self-defeating and making them worse.

In such circumstances, it is hard to see what additional conditions the IMF could or would impose. Any new lending would in effect be an unconditional bet on the euro somehow muddling through and solving its problems. On the evidence so far, such an outcome looks less than likely.

No new narrative emerged from the International Monetary Fund's spring meeting in Washington last week on how the eurozone periphery might regain competitiveness and thereby pay down its deficits.

Almost every viable solution to the debt crisis has been ruled out. Germany won't accept either fiscal transfers to fund the deficit nations, nor will it tolerate the higher level of domestic inflation that might give the periphery a fighting chance of returning to growth. Instead, a deflationary race to the bottom of wage and entitlement cuts is prescribed.

This will in time undoubtedly make the eurozone more competitive, but for what purpose if a quarter of the workforce is left unemployed and the rest are living in penury? In the meantime, the eurozone looks to the IMF to provide the transfers that Germany and others refuse.

As is evident from political developments over the weekend in France and the Netherlands, support for the approach chosen – austerity and structural reform – is fast eroding. Euroland faces a groundswell of populist rebellion. The political consensus around austerity is crumbling.

But nor yet does there appear to be substantive support, either in Germany or elsewhere, for the other self-evident solution, which is a smaller euro shorn of its troublesome south. All rests on the idea that given time, structural reform will work. Eventually, the faithful insist, markets will be convinced of this, and start lending again. And pigs might fly.

For evidence that the deflationary path back to viability can work, proponents tend to point to Ireland, which has returned to wage competitiveness and current account surplus. Domestic demand, on the other hand, remains flat on its back, with unemployment high and fast becoming structural. This kind of down-at-heel equilibrium is not obviously a model others would want to aspire to.

I'm not sure why anyone found the outcome of the first round of the French presidential election a surprise – it was always expected to result in a Sarkozy/Hollande run-off. Even so, it has helped unsettle markets anew. The prospect of a president determined to tear up the fiscal compact throws another giant spanner in the works.

Flanby (the nickname is derived from a form of crème caramel) rejects the austerity that underpins continued German support for the project. And to judge by the turnout for Marine Le Pen, nearly a fifth of the French vote wants out of the euro altogether.

In Washington last week, Christine Lagarde, managing director of the IMF, qualified her delight in more than doubling the size of the IMF safety net by saying that this was not in itself a solution. Indeed it is not.

On how to restart growth, she was all out of answers. To the extent that she did have a "solution" worth talking about, it was just more and deeper Europe - including Eurobonds and a federal banking system, with a single supervisor and resolution regime. This is a view shared, by the way, by the UK Chancellor, George Osborne. Unfortunately, neither of these two things is for the moment remotely acceptable to Germany.

Time is running out. Support for populist, national alternatives is growing. It is small wonder that the US and Canada won't participate in the IMF fundraising. With no solution in sight, they fear for the safety of their money.

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