Avoiding apocalypse

Business strategist Rob Millard explores the role of lawyers in developing solutions to the eurozone crisis

“I am sure the euro will oblige us to introduce a new set of economic policy instruments. It is politically impossible '¨to propose that now. But some day there will be a crisis and new instruments '¨will be created.”
– Romano Prodi, EU Commission president, December 2001

The crisis that Romano Prodi foresaw is clearly upon us. '¨Whether it proves seminal or apocalyptic for the eurozone will likely emerge during 2012.

It is clear that things must change. Nations cannot freely accumulate debt as some did in the decades preceding the global financial crisis. Constant growth is not inevitable. The notion of a post-industrial economy as a higher economic order than a manufacturing economy is dubious at best. It turns out that the maxim ‘money in must exceed money out’ is as true for countries as it is for households.

Only three ways exist to alleviate the debt burdens that triggered the crisis. All are unpopular – to a greater or lesser degree in different European Union member states – with electorates and markets.'¨

1. Severe austerity measures, cutting government spending and increasing tax collections to the point where revenues cover costs.

2. Restructuring the debt (with investors taking an inevitable ‘haircut’).

3. Inflating the debt away by devaluing the euro. '¨

Taken as a whole, the eurozone is actually in good shape. It has a balanced current account and adequate reserves to address its public finance problems. In this way, it compares favourably with other large common currency economies such as the United States and the United Kingdom.

At four per cent of GDP, the eurozone’s fiscal deficit is far lower than the US’ ten per cent. Inflation is lower '¨than in either the US or the UK. Over the past decade, growth in GDP per capita has been almost exactly the same as in '¨the US. Given these strong fundamentals, the demise of the euro or the collapse '¨of the eurozone are by no means '¨foregone conclusions.¹

Unlike either the US or UK, however, the eurozone consists of widely different countries speaking different languages. '¨EU member states north of the Alps, especially Germany, have built up healthy trade surpluses and strong savings, in '¨part through the export of goods and services to EU member states south of '¨the Alps that have been able to finance their imports through cheap credit.

Following the global financial crisis, interest rates for EU sovereign debt have rocketed, especially in the south. EU member states have invested heavily in each others’ sovereign debt and financial institutions. In the event of a sovereign default, the risk of contagion is severe.

There has been much debate about whether and how EU member states should or might secede, or discard the euro as their national currency, and the likely results.

There has also been much focus on why the EU was formed historically (especially as a mechanism for discouraging future wars), rather than on how current policy decisions will impact Europe’s economic and geopolitical prominence in the radically different world that is evolving today.

The conflicts between the current interests of individual nations has also received much attention, rather than how those individual nations would benefit (or not) from a sustainable and prosperous Europe in future, versus alternative futures that might emerge.

Global macroeconomic and geopolitical balances have deeply and systemically shifted since the Maastricht Treaty was negotiated in 1991. At stake today is no less than whether, in years to come, the nations of Europe will collectively be a force on the global stage, or a disparate and largely irrelevant group of nations plagued by systemic debt, stagnant growth and declining populations.

Key to this is the survival and further development of the euro. Achieving this will be no simple matter. There are three key issues that determine the stability '¨of a common monetary union.'¨

1. Labour market mobility: the ease with which workers move across the union, from areas where demand for their services is low to where it is high.'¨

2. Labour market flexibility: the ease with which businesses can flex labour costs by reducing or increasing '¨wages, or reducing or increasing worker headcount, as demand for '¨their products and services varies.'¨

3. Fiscal transfers: the movement '¨of money across the union. '¨

Citizens of any EU member state can live and work in any EU member state. In reality, though, they move countries far less frequently than, for instance, Americans move between states. Language is clearly a major barrier and this is unlikely to change soon. Significantly increasing labour mobility presents no viable short-term solution.

Industrial action is a virtual certainty '¨if businesses attempt to reduce wages. '¨At worst, even civil insurrection is possible. Reducing headcount is easier but increases unemployment. In some '¨EU nations, labour-centric legislation '¨and strong trade unions also present significant obstacles.

This leaves fiscal transfers. It is this contentious topic that has cartoonists creating caricatures of thrifty Germans bailing out profligate Greeks. It is very difficult to conceive of a sustainable solution for the eurozone that does not involve fiscal transfer, though.

It is similarly difficult to conceive of a sustainable solution that does not involve the European Central Bank (ECB) taking on the role of ‘lender of last resort’ in the eurozone.

In December 2011, the ECB advanced €489.2bn to Europe’s banks with its three-year long-term refinance operation (LTRO). With >€254bn in debt maturing between Greece, Italy, Portugal and Spain in the first quarter of 2012 alone, this and further planned LTRO offerings may be sufficient to buy time to develop sustainable solutions. History is full of examples where societies collapsed because leaders dithered, though.²

Role of lawyers

The role of lawyers is clear when it comes to advising clients about the risks involved in an EU member state discarding the euro; a sovereign default and the implications for that client should contagion occur; or even the implications of one or more EU member states seceding from the EU.

These issues are likely to be the primary reason why a client may ask for legal counsel. Wider issues exist, however, about the legal and commercial issues that might emerge in the longer term under different circumstances. Here, advice may not be asked unless the lawyer is truly viewed as a trusted adviser with deeper and wider judgement.

The logic tree in Figure 1 illustrates the course of events that may ensue should Greece, in this instance, default in 2012. Frameworks such as this are useful tools in helping clients to understand the range of possible outcomes that might emerge. They are similarly useful for law firms thinking about how to position their own businesses, so as to be as agile and responsive as possible.

The logic diagram is self-explanatory and clearly shows how a focus only on the immediate issues is folly. Unless the underlying causal factors are addressed, we may expect the eurozone crisis to '¨recur in due course – irrespective of whether Greece’s sovereign debt as '¨a whole is restructured or only its banks are protected, or whether contagion '¨is prevented from spreading to other '¨EU member states.

For greater clarity about how matters might unfold more generally, one might consider four scenarios based upon:'¨

• whether a default is contained within the defaulting EU member state’s economy or whether contagion spreads to other markets; and'¨

• whether once the current crisis recedes, politicians return to ‘kicking the can down the road’ or act decisively to ensure a Europe that '¨is sustainable and competitive in coming decades.'¨

The scenarios, also self-explanatory, are illustrated in Figure 2.

White & Case’s global chairman, Hugh Verrier, recently said: “More important than which law firm ‘wins’ is: how do we, together, face the challenges of our time?”

Lawyers cannot meaningfully define their own roles, he said, without first answering questions about the general roles of lawyers and law firms in society. What role should lawyers and law firms, especially those in Europe, take in helping to develop the solutions that are required to sustain a stable and prosperous '¨future Europe?

There is surely no better group to define what needs to be done by clients and by governments in order to develop the required new order in Europe. History is not short on precedents of when lawyers have, in serving clients, crafted solutions to complex international problems, sometimes even where politicians have failed dismally in the attempt.

One of the more dramatic solutions, involving multiple leading law firms acting collaboratively, was the resolution of the US hostage crisis in Tehran in 1980. Following the abortive US military mission to free the hostages, lawyers from more than half a dozen of New York’s most prominent law firms, acting with firms '¨in the UK and Germany, crafted a series '¨of proposals to engineer the freeing of '¨the hostages. The deal included the release of Iranian funds that had been frozen in Europe and the US and the repayment of loans extended by western banks (the clients of the participating '¨law firms).3

Granted, the current eurozone crisis is far more multifaceted and complex than this was, and the diversity of conflicting interests among the various nations makes its resolution far more difficult. This simply makes it even more imperative for the best possible minds, with the best problem solving skills, to be brought to bear.

If one agrees with Hugh Verrier that lawyers and law firms need to redefine their roles in society, and accepts that ensuring a prosperous and sustainable Europe is as much in the interests of a law firm’s eurozone clients as helping them to manage their short-term crisis-induced legal and commercial risks, then surely this is exactly the role that Europe’s most prominent law firms especially, perhaps also acting collaboratively, should be seeking to fulfil?

robertfmillard@mac.com

Endnotes

1. See ‘The decline and fall of the Euro?’, Daniel Gros, Project Syndicate, '¨January 2012

2. See Collapse: How Societies Choose '¨to Fail or Survive, Jared Diamond, '¨Penguin, 2006

3. See The Partners: Inside America’s Most Powerful Law Firms, James B. Stewart, Simon & Schuster, 1983