Dated: 7 April 2011
On the day that Portugal has sought a bail out from the EU, the Institute of Directors publishes a new report on the future of the eurozone. The report concludes that the euro is unlikely to survive in its current form. Monetary unions can survive sovereign defaults, but this appears less and less likely.
The most immediate threat to the status quo is a default on sovereign debt by one or more of the PIGS (Portugal, Ireland, Greece and Spain) economies within the next 12-18 months. The default option may appear less severe for a country than exit from the euro, but a default would see bond yields rocket so much as to hasten euro exit.
With interest rates so far in excess of GDP growth, public debt is set on an explosive upward path, unless the PIGS economies can run a primary surplus (before debt interest payments) sufficiently large to offset. Bond markets are merely reflecting the view that politicians are not prepared to implement such austerity measures.
Other key points in the report:
- A perfect storm threatens the PIGS economies. They face a very steep uphill challenge, given weak euro-zone growth prospects, a big loss in competitiveness and the huge swing in fiscal policy required for a primary budget surplus. Sovereign defaults look impossible to avoid.
- Currency unions can survive sovereign defaults but in order to do so probably require a fiscal union which is surely not attainable or desirable.
- The primary balance is the fiscal surplus or deficit before interest payments on the national debt. Given the differential between the interest rate on public debt and GDP growth, PIGS economy governments must run a primary surplus in order to prevent the debt to GDP ratio from increasing ever higher.
- The massive swing from primary deficit to surplus looks politically impossible. Politicians fear austerity angst may turn into anger.
Commenting, Graeme Leach, Chief Economist at the Institute of Directors and author of the report, said:
“If something is unsustainable it will end. History teaches us that monetary unions either end in political union or failure. Simple debt arithmetic, together with the need for the PIGS economies to make giant competitive gains, suggests that the euro won’t survive in its current form.
He also said:
“The PIGS economies face the challenge of how to escape when there is no escape. Exiting the eurozone may seem attractive because it would lead to a devalued currency, but debt liabilities would still be in euros. There could be a run on the banking system and there would be the chaos of switching back from one currency to another, changing software, prices and cash dispenser machines”.
To obtain a copy of the IoD report please contact the press office on 020 7451 3278.