Real challenge is to save euro zone

Riot policemen stand between anti-austerity and pro-EU protesters in front of the parliament building during a rally calling on the government to clinch a deal with its international creditors and secure Greece's future in the Eurozone, in Athens, Gr
Riot policemen stand between anti-austerity and pro-EU protesters in front of the parliament building during a rally calling on the government to clinch a deal with its international creditors and secure Greece's future in the Eurozone, in Athens, Greece, on June 22, 2015. Euro zone finance ministers welcomed new Greek proposals for a cash-for-reform deal on Monday but said they required detailed study and it would take several days to determine whether they can lead to an agreement to avert a default. PHOTO: REUTERS

EUROPE'S leaders will have the unique opportunity to commit two mistakes in a single week.

Yesterday, Europe's leaders were due to meet to decide on the future of Greece. On Thursday and Friday, they will meet again to discuss, among other things, the future governance of the euro zone. The latter is more important in the long run: A healthy euro zone may even withstand a Greek exit from the single currency and prosper. But a crippled euro zone would be no less crippled if Greece were to remain a member. A dual failure would be a disaster.

When I heard Ms Christine Lagarde complain about the lack of "adults in the room" last Thursday night, I knew that things were getting out of hand. Whatever the purpose of the remark by the managing director of the International Monetary Fund (IMF), it was not helpful to dish out personal insults. It makes the search for a compromise even harder.

The impact of Grexit would probably not be a sudden financial crunch. The more insidious danger is a slow realisation by investors, and more importantly by citizens, that the euro zone ceases to be a genuine union if it forces out a member state.

If the leaders fail, we are looking at a sequence of events that may include default, capital controls, the introduction of a parallel currency and possibly a Greek exit from the euro zone.

What then?

The impact of Grexit would probably not be a sudden financial crunch. The more insidious danger is a slow realisation by investors, and more importantly by citizens, that the euro zone ceases to be a genuine union if it forces out a member state.

The pretence of irreversibility is what distinguishes a monetary union from a fixed exchange rate system with a shared currency.

Grexit would mark the moment when the European Union moves from integration, via stagnation, to disintegration. The economic and geopolitical impact would be colossal. Not all of that would be visible immediately to everybody, which may be why so many EU leaders appear so fearless.

The counter-argument is that Grexit would forge a much closer union among the remaining members. This rather optimistic hypothesis will be tested at this week's second EU summit. By Friday, we will have a clearer picture because this is when the leaders will discuss the future of the euro zone. I fear that they will fail abysmally.

There are several competing reports on the euro zone's future on the table - from member states and the so-called four presidents' report, written by the heads of four EU institutions. All have in common that they are monumentally lacking in ambition. Various drafts have circulated, but it is clear that not a single country or institution will stand up on Thursday and speak truth to power: "The euro zone, as it stands today, is not sustainable. We face the choice to learn from our mistakes and to change the European treaties to make it sustainable. And if that is not possible for political reasons, we should perhaps follow Greece into monetary independence."

None of the drafts I have seen comes even close. A change in the treaties is needed to do anything meaningful. Without treaty change, it is impossible to create a road map to a fiscal union.

Nor is it possible to create a genuine banking union with a joint deposit guarantee fund, and a banking resolution mechanism. The euro zone has pretty much exhausted the scope of what it can do inside the existing treaties.

If the euro zone goes down the path of no ambition, it will find it progressively harder to handle future crises.

Apart from the consequences of a Grexit, the other big foreseeable problem is the macroeconomic imbalances. The current account surpluses of Germany and the Netherlands are heading towards 10 per cent of gross domestic product per annum - a position that is neither sustainable, nor self-correcting: a bad combination.

The summits confront the euro zone's dual demons - a mismanaged crisis and the lack of a small fiscal union that can act as an economic and financial stabiliser. Without tackling them, we will still be talking about the euro zone crisis in 2030, if it lasts that long.

The EU's leaders would have been called upon to fix Greece yesterday, the rest on Thursday and Friday - or at least start a process that gets them towards economic integration. There is more than a chance that they could fail in at least one of those respects, if not in both.

Europe's finance ministers and Ms Lagarde signalled at last week's disastrous meeting in Luxembourg that they, like the Bourbons of the 18th century, have learnt nothing, and forgotten nothing.

The research department of the IMF admitted some time ago that austerity did not work in Greece - as Athens also insists. The fund's leadership is now telling us that such criticism is inconsistent with adult behaviour.

It is Chefsache(a matter for the boss) now, as they say in Germany. My hope is that the bosses grasp what is at stake. My experience tells me this may not be so.

THE FINANCIAL TIMES

A version of this article appeared in the print edition of The Straits Times on June 23, 2015, with the headline 'Real challenge is to save euro zone'. Print Edition | Subscribe