Desperate moments call for desperate measures. In June 1940, the British War Cabinet led by Winston Churchill offered a total national merger to a shattered France.
“France and Great Britain shall no longer be two nations, but one Franco-British union,” read the declaration.
“The constitution of the Union will provide for joint organs of defence, foreign, financial and economic policies. Every citizen of France will enjoy immediately citizenship of Great Britain, every British subject will become a citizen of France.”
The text was drafted by Jean Monnet, the father of the European Project. If alive today, he would be pounding on the door of the Kanzleramt, exhorting Angela Merkel to offer a total fiscal union to all members of the eurozone before everything falls apart, and to be enshrined in EU treaty law forever.
“All debts of Greece, Cyprus, Italy, Spain, Portugal, and Ireland will be fused immediately with German debt; a single treasury will control spending, and issue euro-bonds for all Euroland,” or some such formula.
This is the sort of game-changer that may now be required to save EMU and the Monnet dream. Germany must contemplate doing for Euroland what it has done for its own Volk in the East over the last 20 years – pay big transfers – or watch its strategic investment in the post-War order of Europe collapse with a bang, and in hideous acrimony. Tough call.
It is clear to those working in the bond markets that the debt crisis in the EMU periphery is nearing danger point, and risks spiralling out of control as quickly as the Lehman-AIG-Fannie-Freddie crisis in 2008.
Prof Willem Buiter, chief economist at Citigroup, said last week that Portugal is likely to need a rescue before the end of the year and that Spain will follow “soon after”.
Klaus Baader from Societe Generale issued a report the same day entitled “Eurozone sovereign debt crisis: next stop Spain”. He suggests that the EU bail-out fund raises money to buy Spanish bonds pre-emptively. Nice idea, but what would the German constitutional court have to say about that?
At Deutsche Bank, Thomas Mayer said Spain might soon need a flexible credit from the IMF. Informed opinion has turned.
Markets are already pricing a 23pc chance of default in Spain (34pc for Portugal, and 39pc for Ireland). If the country needs a rescue, it instantly exhausts the credible financial and political firepower of the EMU system.
The EU’s €440bn (£372bn) rescue fund “looks small, very small, too small”, says Dr Buiter. Alleged plans for a double-up are circulating “en coulisses” in the Berlaymont, but Berlin squashed the idea as “completely over the top”.
In any case, we are beyond the point where escalating bluffs can achieve anything. Markets doubt that it makes sense to heap further debt on states that cannot service existing debt.
The EU strategy of hair-shirt austerity and 1930s debt-deflation for crippled economies has been tested in Ireland, and has led to the same doleful outcome as the 1930s. Tax revenues have collapsed. The deficit has hardly shrunk at all. The policy is based on mechanical theories of the “fiscal multiplier”, and is patently self-defeating. Sinn Fein’s landslide victory in Donegal is a condign response to this academic hocus pocus.
Should the EU really impose a 6.7pc interest charge on Ireland’s bail-out loans, it should not be surprised if the new Irish government in January walks away from the whole stinking arrangement, and pulls the plug on Europe’s banking system. Many might cheer.
However, it is Spain that determines EMU’s fate. Spanish premier Jose Luis Zapatero said there is “absolutely” no chance that his country would need a rescue. “Those investors shorting Spain are making a big mistake.”
As Keynes once said, blaming economic crises on speculators is “not far removed, intellectually, from ascription of cattle disease to the “evil eye”.
Has Mr Zapatero read the IMF’s devastating Article IV report on his own country? It states that the government’s “gross financing needs” for 2011 will be €226bn, or 21pc of GDP. “Spain’s financing requirements are large and, retaining market confidence will be critical. Spain has exhausted its fiscal space. Targets should be made more credible.”
Madrid must attract €226bn of good money from Spanish savers, German pension funds, French banks, Japanese life insurers, and China’s central bank, so that an incompetent government (this one happens to be socialist, but the Greek conservatives were worse) can continue to run budget deficits of 7pc to 8pc of GDP in 2011. Why should they lend a single pfennig, having already been told by EU leaders that they will face scalping if Spain ever needs a rescue?
“The economy is highly indebted and has one of the most negative international investment positions (IIP) among advanced countries,” said the IMF. Its external accounts are under water by 80pc of GDP.
Furthermore, Spanish banks will need to roll over €220bn in 2011 and 2012, according to Enrique Goñi, head of Banca Cívica. “We’re in the antechamber of a new liquidity crisis. We’re living through a financial pre-collapse,” he said.
Now, before yet more Iberian brickbats fly my way, let me say that Spain’s public debt will be a modest 63pc of GDP this year (though total debt is over 270pc, which is what matters). The savings rate is high.
The Banco de Espana has been heroic, but then it needed to be given that Spain no longer has control over its policy levers. The country had to contend with real interest rates of minus 2pc during the long boom, and cannot offset the horrendous bust with monetary stimulus or a properly valued peseta.
Spanish readers like to point out that British failings are comparable or worse. Whether or not that is true, it is irrelevant. Britain is not a prisoner of EMU. You might as well compare chalk and cheese.
We can argue whether the overhang of unsold properties in Spain will reach 1.5m, or six years’ supply, as claimed by Madrid consultants RR de Acuna, but there is little doubt that the "Cajas" and smaller banks have played a game of “extend and pretend” to disguise the true scale of losses on their property loans.
This then is the headache facing Angela Merkel. By the time she inherited the EMU debacle, imbalances were already chronic, and she certainly does not have popular mandate for Churchillian gestures right now.
Even so, it is remarkable that Berlin is not even allowing the European Central Bank to pursue the first and obvious line of defence, which is to calm eurozone bond markets by using its financial stability powers to buy Irish, Portuguese, and Spanish debt on a nuclear scale.
As the storm rages, the ECB is tightening monetary policy by draining liquidity (the Eonia rate is up from 0.4pc to 0.8pc since mid-year) and by signalling that they may soon shut the lending window that keeps Greek, Irish and Iberian banks alive.
Frankfurt is doing this even though the eurozone’s M3 money supply contracted on a month-to-month basis in both September and October, as did private credit. Is this just incompetence, or is somebody pushing PIGS into the slaughterhouse?
As for Britain’s offer in 1940, it is hard to see how such a union could ever have worked over time. It was rejected by the French cabinet, though premier Paul Reynaud pleaded in favour. One Gallic patriot said that utter destruction was better than becoming a “dominion of the British Empire”.
By the same token, today’s eurozone patriots might ask whether it is really worth giving up ancient sovereignty to keep a currency.
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