Europe on the Brink

The characterization of the unfolding saga in the eurozone in the financial press has gradually evolved from a liquidity crisis to a solvency crisis to what is now increasingly being viewed as a political crisis. Just over a decade after its formation, the European Monetary Union is facing questions about whether its very existence makes economic, fiscal, and political sense.

At this time, the ultimate fate of the euro is unclear. If anything is clear, it is that Europe faces months and years of difficult challenges as the 17 countries of the eurozone decide whether they have the wherewithal (and desire) to keep the euro intact. Furthermore, the eurozone does not exist in a vacuum, and the progression of events in Europe will inevitably affect markets worldwide.

To learn more about the roots of the crisis, what the situation is today, and the remedies, we invited two prominent experts who have been studying the euro union since its inception in 1999 to participate in this issue’s Morningstar Conversation. George Magnus is a senior economic advisor at UBS. Magnus was one of a handful of economists who warned of a pending global financial crisis as early as 2007. Edward Chancellor is a member of the Asset Allocation Team at GMO. Chancellor has written extensively on the topic of the current crisis, specifically examining the ways in which the eurozone’s predicament differs from historical sovereign defaults.

They both called in from London. Our conversation took place on Dec. 19, 2011 and has been edited for clarity and length.

Ben Johnson: Let’s first discuss the causes of the crisis. George, can we start with you?

George Magnus: Sure. This euro-system crisis is really, in essence, a good old-fashioned balance-of-payments crisis. It seems to be about budgetary discipline and fiscal issues, which obviously have plagued Europe since Greece first appeared on the scene a couple of years ago. But this is just a manifestation of the problem of an incomplete monetary union and coming to terms with the fact that imbalances between member states don’t disappear. And, of course, these imbalances have grown to rather large proportions; France and Italy actually have been chalking up external deficits, which are the largest they’ve been since the monetary union began.

So, I think that’s really what the underlying cause of the crisis is. The misdiagnosis of the crisis is leading Europeans into adopting a flawed agenda with inappropriate policy tools. I don’t really see that they are even close to coming to terms with this as yet.

Johnson: Edward, you’ve done a terrific amount of work examining historical sovereign defaults and trying to provide context for the issues facing Europe today. How is the current crisis similar to past crises and how is it different?