The Currency Spectator

David Cameron’s Finest Hour

As the EU prepares the orchestra for its final immolation.

By 12.16.11

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For the benefit of American Spectator readers, I hereby offer a handy list of Frequently Asked Questions about the Eurozone crisis that can help bring the whole messy picture into focus. I should first point out that many of these questions aren't being asked at all on the Continent, and when they are, they aren't being answered.

What Did the EU Actually Agree to at its Recent Summit?

Good question. The actual results of the summit were somewhat overshadowed by British Prime Minister David Cameron's refusal to join in the Eurozone's suicide pact. Indeed, that's what was agreed -- a suicide pact, not the advertised fiscal union. The heads of government that joined in the pact agreed that they would balance their budgets, which are to be policed by the unelected, unaccountable European Commission. This does nothing to solve the euro's structural problems and rides roughshod over the entire principle of democracy (as I have noted elsewhere). The result will be a devastating, long-term recession in the periphery of Europe, and presumably popular revolt in several countries. Sadly, those popular revolts are more likely to be of the socialist variety than revolutions for liberty.

What Do They Mean by Fiscal Union?

Much of the diplomatic effort involved in the summit was supposedly directed at creating a fiscal union (they ended up with what they called a "fiscal compact"). The rationale is supposedly to make the euro currency union more like the stable U.S. dollar currency union, which is also a fiscal union. Yet the U.S. fiscal union is nothing like the EU fiscal compact. The United States has no power over state budget deficits, and there is an implicit understanding that a state in budget crisis will not be bailed out. That has certainly been the historical case, as when Arkansas defaulted in 1933. The state was eventually forced to restructure its debt to its creditors' satisfaction. Therefore, a fiscal union that gives central control over national budgets and the promise of national bailouts, as in the EU, is completely unlike the U.S. fiscal union.

What Did David Cameron Actually Do?

David Cameron did not veto an EU treaty. There was no treaty to veto. He did not so much veto as demur from further integration. The problem is that his attempt to repatriate some powers to London from Brussels was rejected outright. Any further attempt is likely to be met with similar hostility. This means that his election promise of repatriating powers will be impossible to keep without British withdrawal from the EU. Thus, Cameron may therefore be forced to offer the British people a referendum on EU membership. If the EU is in the process of disorderly collapse, the withdrawal option would probably win. Britain would then be free once more to look to the western seas and the rest of the world for its place in the world, a return to its historical norm.

What Caused This Problem in the First Place?

The problem was one about which British Euroskeptics warned from the start of the European monetary project. European countries gave up a key weapon in combating recession -- the ability to revalue their currency. For example, when Italian and Greek wage levels needed to fall as a result of suddenly decreased demand, those countries could have devalued their currencies, making their economies more competitive quickly. Instead, governments have been forced into austerity, raising taxes and cutting spending, and unable to pursue supply-side reforms because those are forbidden by other pan-European legislation. The inevitable result is deepening recession, requiring more austerity. Their debt, also denominated in euros, is also worth more than they can afford. Not only are they paying high yields because of the probability of default, they cannot offer to pay new debt in a devalued currency, either. That's why they are demanding bailouts.

Where Will the Money Come from?

If the Eurozone is to survive, its member nations need to recapitalize their banks so that they can continue to lend money to the nations and avoid collapse themselves. The problem is that government debt has become a toxic asset worse than any subprime mortgage, because of the chronic weaknesses of those countries' economies, caused by the problems discussed above. The trouble is that the money for capitalization has to come from somewhere. Where? Private savings are already at record levels. There is no growth. The German people refuse to countenance the European Central Bank printing money, and they certainly aren't about to pay off other nations' debts. There is a gaping black hole at the center of the Eurozone's finances. Thankfully, the U.S. has no current plans to fill that hole. And did I mention that international financial regulations decree that government debt is risk-free?

What Can the Eurozone Do to Save Itself?

The answer to this is usually "fiscal union," but unless that is accompanied by a presently unacceptable political union, the democratic deficit is too great for that. The only feasible answer is significant supply-side reforms that will allow German and Italian workers to compete using their own comparative advantages. However, that is anathema to the idea of the Single Market, which is what the euro was designed to facilitate in the first place. Thus, we must face up to the idea that the Eurozone will collapse, either in a structured fashion, with Germany throwing members out of the club, or in a messy fashion, with sovereign defaults, bank collapses, and socialist revolts.

What Will the Eurozone Collapse Mean for America?

In a word, pain. The United States will be badly affected by the collapse, with a lot of value wiped off the markets, bank failures, and a significant reduction in global trade. The worst possible thing we could do is to throw American money at the problem. The structural issues are just too great. We need to prepare ourselves for the worst with genuine supply-side reform here, deregulating our economy to make it more nimble in response to a massive global recession not of our making. At least the price of oil will probably tumble sharply.

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About the Author

Iain Murray is Vice-President for Strategy at the Competitive Enterprise Institute.