I have for long felt that, culturally, ideologically and geopolitically, the UK is perhaps more comfortable as the 51st state of the US rather than a card-carrying member of the European Union (EU). One manifestation of this is the policy towards the financial sector: the UK is far more comfortable with the adventures of finance capital, about which Germany, France and other European countries remain highly sceptical, if not suspicious. No wonder the UK was the lone dissenter at the recent summit meeting of EU countries, insisting on the EU agreeing to all changes in financial regulations subject to unanimous approval. The UK’s condition was obviously aimed at protecting the interests of the City of London as a global financial centre: one proposal which the UK does not like at all is the imposition of a financial transactions tax (FTT) which most euro zone members seem to favour.


While the proposed inter-governmental agreement on fiscal deficits may well strengthen the euro zone over the medium term, it does nothing to help solve the immediate problems in Greece, Italy and Spain. This was evident in the market reaction: the euro fell from around $1.35 pre-summit to $1.31 at the time of writing. Yields on Italian and Spanish government bonds increased after the summit.

The basic macroeconomic problem in the EU is that, while the euro zone as a whole has a rough balance between its savings and investments (or its current account), there are major variations within it. The countries in difficulties, principally from the southern part of the zone, have large deficits on the current account even as Germany records a large surplus. In other words, the same euro is overvalued for the southern countries and undervalued for Germany, leading to savings investment imbalances. (To be sure, problems in Ireland and Spain had a different origin.) Huge fiscal deficits in the troubled countries have obviously contributed to greater consumption (and therefore lower savings), and persistent dependence on capital inflows to balance the books. To my mind, this is the basic cause of the sovereign debt crisis in the euro zone, which is also affecting the banking system given its exposure to the debt of the southern countries.

In principle, there are two ways for countries facing unduly large sovereign debts to bring them down to a more acceptable ratio in relation to the gross domestic product (GDP). One is fast growth and inflation which would, hopefully, increase the denominator of the debt to GDP ratio faster than the numerator. This would also need to be accompanied by an external devaluation of the currency. However, given that monetary policy in the euro zone is made by a supranational central bank, individual countries have no way to engineer inflation or an external devaluation.

The other way is what I would refer to as an “internal devaluation" achieved by a sharp fall in the domestic consumption levels. The conditionality imposed on Greece, for example, forces it to cut down public sector salaries and pensions by up to 30% helping reduce domestic consumption and making domestic costs more competitive—i.e. an internal devaluation.

There is a major question mark whether years of austerity and lower living standards can be made acceptable to the mass of the people as necessary sacrifices, in any democratic country. Many countries are experiencing strikes and street protests against the austerity programmes.

Would, at some stage, countries such as Greece start seriously reviewing whether the cost of staying in the euro zone is becoming unacceptable, that the costs of leaving the single currency may be more palatable?

Overall, the successive summits leave many question marks about the future of the single currency.

A.V. Rajwade is a risk management consultant, columnist and author

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