The Great Euro Crash with Robert Peston

For more than two years, Europe's economies have been on the edge

of a financial and economic precipice.

The dream was that you'd bring people together.

The reality is that, in order to save the euro,

the euro elite are destroying the dream.

The crisis has battered Britain too,

and if it isn't sorted out, it could drag us into a devastating slump.

It's a big problem for our economy in general.

We simply cannot cut ourselves off from problems that occur in the eurozone.

This is the story of how some European countries amassed

unsustainable mountains of debt and hid much of it till it was too late.

Greece by now has received 500 billion euros.

It is a huge amount and obviously a bottomless pit.

And it's about how Europe's banks came within days

of an almighty crash that would have been more catastrophic

than the global crisis of 2008.

The banks were dying on their feet, many of them insolvent and illiquid.

This mess has its roots in perhaps the riskiest economic experiment

ever carried out - the creation of a single currency

for 17 very different European countries.

Whether the euro is held together or not, Europe is facing

a lost decade or more.

BAGPIPES PLAY

THEY CHANT: We're not paying the household tax!

We're not paying the household tax...!

Life is very difficult for most people.

The austerity measures that have been implemented,

at the behest of the Europeans, is very draconian.

Ireland is a country in shock.

Until five years ago,

it was seen as one of Europe's greatest economic successes.

Then its economy collapsed, crushing living standards

and forcing the government to slash public spending.

These are a conservative people. They do not protest easily.

We don't turn the cars over.

In France and Italy, in Greece, if they're unhappy,

they go to the streets, they make their feelings felt.

We haven't done that here.

This is a new thing.

Mick Wallace is an independent member of the Irish Parliament.

Today, he's leading a march against the latest austerity measure -

a tax of 100 euros on every Irish household.

It's hard to credit that five out of six people in Ireland

have defied the government and refused to pay.

CHEERING

Politicians do not represent your interests.

They represent big business

and, right now, they're representing the financial institutions.

CHEERING AND APPLAUSE

And I don't think these people should be encouraged.

CROWD: No!

In the small village of Gorey, the anger is palpable and raw,

people at the end of their tether.

We can't live. We're in negative equity,

we're struggling day by day, we've cut back on everything.

I feel betrayed by my country, betrayed by my politicians.

I voted for people who told me lies

and this is how they've driven a knife into the soul of Ireland.

Across Greece, Italy, Portugal, Spain, as well as Ireland,

Europe's citizens have taken to the streets.

Rising unemployment, vast cuts in public spending,

it's the greatest squeeze on their living standards since the 1930s.

There's no great barrier protecting the United Kingdom

from the tumultuous events across the Channel.

The eurozone is our biggest export market,

taking 40% of everything we sell abroad,

and our banks are big creditors of eurozone banks

and also big lenders in Spain and in Italy.

The recession in the eurozone

is one reason why the UK is back in recession,

and if there were financial Armageddon in the eurozone,

well, our banks would be back in intensive care

and our economy would be facing meltdown too.

It's perfectly clear that we're better off not being inside the eurozone.

Can we protect ourselves completely from events there?

Of course not, no. I mean, the British banks

are very international.

The British banking system is a very large portion of our economy,

much larger than other economies,

and if the guarantees that the Government's given for those British banks were called,

which they could be, in the event the eurozone goes down,

we are without doubt the most indebted country in the world.

So how and why did Europe get itself into this appalling predicament?

Its roots go all the way back to the end of the Second World War.

Three times, great conflicts had erupted from French and German soil,

and the idea was after the war,

that this should never happen again.

And money, as well as trade,

and political rapprochement, were all keys to that particular door.

Winston Churchill was clearly very keen that France and Germany

should come together and no longer cause a problem for everybody else.

It is not a movement of parties, but a movement of people.

Europe can only be united by the heartfelt wish

and vehement expression of the great majority

of all the people in all the parties,

in all the freedom-loving countries,

no matter where they dwell, or how they vote.

Churchill was a promoter of a United States of Europe,

though with Britain on the outside.

The UK wasn't one of the European pioneers

which signed the Treaty of Rome in 1957.

At the heart of the new European community

stood the historic enemies, West Germany and France,

together with Italy, the Netherlands, Belgium and Luxembourg.

As these countries removed barriers to trade,

the idea of a single European currency was always in the background,

but made explicit in the late 1960s.

In 1970, on the instructions of governments,

Pierre Werner, Luxembourg's Premier,

presented a plan to merge Europe's currencies.

But the target date of 1980 was unrealistic

and the plan faded away, for a while.

In the meantime, the European Community continued to grow.

In 1973, Britain joined, although some would say

the UK has always been a semi-detached and noisy member.

'At least the newest members of the European Community

'made their presence known in a proper manner,

'in one of the most British places in Brussels -

'the Queen Victoria pub opposite the Common Market headquarters.

'Raising the flag was almost an afterthought

'and it was left to the community's concierge to do it,

'for the benefit of a few reporters who bothered to turn up.'

Britain signed up for the wealth that would come from increased trade with Europe.

But bolder constitutional aspirations

were still being nurtured in Germany and France.

In 1981, Francois Mitterrand was elected President of France.

-TRANSLATION:

-During the war he had been a prisoner in Germany

and he escaped three times.

Each time, he met Germans who helped him.

Afterwards, he became obsessed with the idea that

there should never be another war and that Europe should unite.

A year later, Helmut Kohl became Chancellor of West Germany.

-TRANSLATION:

-Kohl grew up only a few kilometres from the French border.

As a youth, he lived through the Second World War.

He lost a brother during that time.

He believed that there should never again be a war amongst the peoples of Europe.

Kohl, because of the history of Germany,

wanted to anchor Germany into Europe to make war impossible,

and Mitterrand had the same objective.

And that is what the euro,

and the European Union to some extent, are all about.

In 1984, they met at Verdun where, for the first time,

these two nations paid tribute collectively to the soldiers

whose lives had been taken in two world wars.

Kohl always put emphasis on symbolism in his politics.

For him, meeting with Mitterrand at Verdun

was a way of marking an end of Franco-German enmity.

The Verdun meeting symbolised the determination

of these towering European figures to forge a more united Europe.

The common vision was to have a single currency,

from the Atlantic, maybe to the Urals,

that in some magical way would do everything.

The scale of their ambition was magnificent, or perhaps foolhardy.

Europe was a place of diverse cultures and economies.

Even its two leaders came from very different backgrounds.

You can hardly imagine two more unlikely people.

Firstly, they had no common language.

They could only converse through interpreters.

Also, they understood nothing of economics.

They were totally disdainful of economists

and they called those people technicians.

The economies of Europe were as divergent as their cultures.

In 1973, when Ireland joined the Common Market,

it was a farming economy,

whose income per head was 40% below the average for Europe.

'Dublin, as the capital city of a sovereign state,

'has always had a cosmopolitan feel.

'Now that the country has entered Europe,

'the international character is even more pronounced.'

Obviously a much more backward place than it is now.

There was less money, how much work was around varied.

I mean, things went up and down.

The European market opened us up to the greater world,

so we started looking a little bit beyond ourselves

and the English markets.

It was sort of the beginning of the Irish opening up.

The great diversity of Europe includes differing attitudes

to how wealth should be created.

We're kind of gamblers at heart.

We like to gamble, right?

That's reflected in the huge interest in horse racing here.

But even though we're conservative in many ways,

we don't mind taking a risk, you know.

And when the opportunity came along, and the cheap money arrived,

let's have it.

We said, I suppose, "We'll take a chance with it."

Other poorer parts of Europe - Portugal, Greece, Spain -

joined in the great experiment.

And right from the very beginning, it was always volatile Italy,

with its rich north, poor south and love of the "dolce vita".

'If you want to find out what's going on, ask a taxi driver.

'In Rome, I met Roberto Masulo.'

-Nice to see you.

-Hi. I'm Roberto.

-I'm Robert.

Roberto, why did you become a taxi driver?

TRANSLATION: It's a job I've always loved,

handed down from father to son.

My grandfather was a taxi driver and I'm the son of a taxi driver.

Italy is notorious for a massive black economy,

business nepotism and restrictive working practices

that limit access to many trades and professions.

In Italy, some people have been used to living beyond their means.

Sometimes we are a little bit too good at bending the rules.

We also feel that in some countries in Europe,

there's more rigour in the payment of taxes, respecting the rules.

Perhaps in Italy in the last few years,

we haven't always been so good at playing by the rules.

'The problem with the good life, Italian style,

'is that it wasn't being earned properly.

'Italy's private sector grew too slowly

'and the public sector was weighed down by massive debts.'

It's all been so different in Germany.

After the war in democratic West Germany,

there was a national mission to rebuild its industrial might

on the values of thrift and hard work,

through manufacturing and exports.

Nowhere is this story of recovery and prosperity more true

than in Swabia in southwest Germany,

home to Mercedes, Porsche, Bosch and Karcher.

Karcher is a world leader in cleaning systems

where Horst Schuler, a shift supervisor,

keeps it all running like clockwork.

-TRANSLATION:

-I've been working for Karcher since 1978

and I love it today as much as the day I began.

Like so many German companies, Karcher's success

is built on long-term investment and financial prudence.

It's family driven. This means family owned.

A lot of companies are family owned in this area here.

This, of course, has a very stable shareholder base.

These are all ours usually

because most of the shareholders are very modest.

They reinvest most of the money in the company.

And this, of course, is a base for the future.

They're not paying out dividends and taking out money of the company.

And what works for Swabian businesses

works for Swabian households too.

-TRANSLATION:

-The Swabian hausfrau makes sure that she doesn't spend

more money than is in the pot, just like Karcher does.

The Swabians, and I am one of them, begin by saving their money.

Only when they think they can afford something do they actually buy it.

I'll give you an example - a car.

I've never bought a car that had to be financed.

If I couldn't afford it, I bought a smaller car or a second-hand one.

I've done things like that all my life.

Just don't live above your means.

You don't need the big Mercedes to be happy.

You can be content and happy with less.

Agricultural Ireland, black economy Italy, industrial Germany -

monetary union would harness together

wildly different cultures and economies.

It needed a great shock to persuade them

to abandon their national currencies.

The end of communism brought down the Berlin Wall

and the face of Europe was about to change for ever.

But a unified Germany would be an even stronger Germany.

When it became clear that the momentum towards German unification was unstoppable,

the French President, Francois Mitterrand,

needed a way of constraining German power.

Mitterrand knew that the Germans were going to unify.

He knew there wasn't anything in this world that would stop

the Germans from unifying.

The deal that was done was that the Germans, once unified,

would then do everything they could to embark towards a single currency.

For the French, monetary union was as much about politics,

about the balance of power within Europe, as about economics.

The idea was to strengthen the institutions of the European Union,

relative to member countries,

so that the growing power of Germany could be held in check.

The train towards monetary union was rolling.

Europe's leaders assembled in a small Dutch town

to agree a treaty that would shape and shake the continent.

And the point about monetary union

is that it was about much more than money.

I was Britain's negotiator at Maastricht

for the opt-out from the euro.

And I remember the very first time I met Pierre Beregovoy,

the French finance minister, who was later the prime minister of France.

And I remember the shock I felt when he said to me,

"My children will live in a politically united Europe

"and I think that is a great thing."

And what I saw very clearly was the force of the political will

to create a monetary union and a political union.

Mitterrand believed that it was the first step towards political union.

It was both the key to economic union

as well as the first step towards political union.

Monetary union was a political project in economic clothing.

And at its heart was a terrible contradiction.

It was designed by Mitterrand and Kohl to speed up

the creation of a European Federation, a super-state.

But pushing for monetary union

before the political union was in place carried enormous risks.

You cannot have a monetary union that works, without a fiscal union.

You cannot have a fiscal union without, in effect,

a single finance minister,

which means you have to have a full political union.

You can only have a full political union

if the people are prepared to go along with it,

and the people quite clearly are not.

It was an impossible dream that you could build

a single European currency without a single European state.

Everybody knew that it was a risk.

Everybody knew that you were putting the cart before the horse.

It was arrogant because they thought that that way

they could override the democratic veto.

And it was irresponsible because they didn't say,

"Well, this is a high-risk project."

And I think that was a gamble, if you like,

which should never have been taken.

Maastricht is the beginning of a process of irreversibility,

the creation of economic and monetary union.

But the monetary union would be without one of the biggest economies - Britain.

You know, the attitude was slightly condescending,

"Oh, Norman, you say you don't agree with this,

"but when the time comes, you will join."

That was what many people said.

I remember one prominent figure, in the dead of night,

about two in the morning, over whisky, saying to me,

"Well, everything you say is right, but it's going to happen."

There was a precursor to full monetary union,

introduced before Maastricht, called the Exchange Rate Mechanism.

Britain was involved and it prevented the pound

and other member currencies from rising or fall

more than a set amount relative to Germany's Deutschmark.

Britain joined the ERM because it had tried many mechanisms

to get inflation rate down, all sorts of monetary devices.

John Major saw the strong, successful D-mark,

and he was fascinated by the Bundesbank.

So he said, "We'll have a little bit of that."

51, 51, 51.5, 51.5, 69% turn-up.

The fate of Britain in the ERM shows the dangers

of linking currencies when economies and governments aren't unified,

foreshadowing today's euro crisis.

Under the scheme, the interest rates for the UK were, in effect,

set by Germany, but the right interest rate for Germany

turned out to be ruinous for Britain

and the UK was forced into a humiliating exit from the ERM

on Black Wednesday, 1992.

Today has been an extremely difficult and turbulent day.

The Government has concluded that Britain's best interests are served

by suspending our membership of the Exchange Rate Mechanism.

The ERM debacle should perhaps have served as a warning about

the dangers of linking currencies of very different economies.

But, instead, it was full steam ahead to a single currency,

but with new rules that were supposed to minimise economic tensions,

including a new ceiling on government debts.

Initially one had said,

"Anyone who has a debt

"above 60% of GDP cannot participate."

That would have kept the euro small.

The southern countries, over-indebted countries,

would not have been able to participate

and, had they not participated, we would not have today's problems.

Italy in particular had huge debts and the government debt criterion

would have kept Italy outside the euro.

TRANSLATION: You cannot have a common currency in Europe

in the EU without Italy.

When it comes to the ratio of debt to GDP,

Italy has always broken the criteria.

But Italy, as a founding member state of the EU,

was too important to be excluded.

The French insisted at the time

that the southern periphery of Europe participate

and so they argued that the 60% criterion,

which was a firm entry criterion of the Maastricht Treaty, was waived.

The requirement that debt should be 60% or less of GDP was dropped.

Instead, a country simply had to show

it was reducing debt towards that ratio,

which Italy could do.

Of the major European economies, only Britain stayed out of the euro

when it was launched in 1998.

The risks associated with it became clearer

and, you know, the phrase for... the Tony Blair phrase from 1997,

he "would only join if the case is clear and unambiguous".

Well, we didn't have a clear and unambiguous case.

The currency was born at a seemingly auspicious time.

..zero.

For the Western world, it was a time of sustained growth, cheap debt

and a consumer boom,

which would last for the best part of another decade.

Even in such benign conditions, some countries only just met

all the euro membership tests.

How did they squeak in?

In the late '90s, an Italian economics professor, Gustavo Piga,

was researching the way that governments borrow.

I was working on public debt management at the time.

I knew that there was this new trend.

I started saying, "Well, let's go around Europe to learn more."

One tricky hurdle for joining the euro club

was that a government's deficit,

the gap between what it spends and tax revenues,

had to be 3% or less of GDP.

Piga became suspicious that banks had been helping governments

to understate their true deficits.

I got a sense that, in that period,

some governments were using derivative transactions

to reduce their public deficit,

so as to ensure that the level of the threshold of 3%,

required to enter into the euro area, was respected.

These complex financial derivative deals, arranged by banks,

helped governments hide what they were borrowing.

One day, I was interviewing one of these public debt managers

and this person gave me a contract.

She thought that I knew little of derivatives and she said,

"Oh, Professor, if you want, I can show you an example,"

and she gave me a photocopy.

I started looking at it and I saw that it was a peculiar contract.

And then I started getting excited and I said, "What is this?"

And I understood that these contracts

were meant exactly to reduce public deficit today,

to enlarge it 10 to 15 years later,

in a way that an accountant would have said, "This is not proper."

A late entrant to the euro

turned this kind of creative accounting into an art form.

Well, clearly a number of countries

fiddled the criteria,

most countries did, but Greece in a heroic way.

The Greeks, with the assistance of Goldman Sachs,

cooked the books totally.

Even the Germans could only just about fulfil that 3% criteria.

They were willing to turn a blind eye to the other countries.

If we'd known that Greece's figures were wrong

then we'd have made a different decision.

But decisions were made

on statistics provided by the European Commission.

We had no reason to be suspicious of those figures.

There was also an attempt to prevent members of the euro

from borrowing too much after the euro was launched.

A stability and growth pact said

annual deficits should never exceed 3% of GDP.

But, in an extraordinary move, in 2003,

Europe's two most powerful members killed that rule.

Can I just ask what your emotional reaction was when France and Germany

asked for the rules of the stability and growth pact to be weakened?

Well, we were, I would say, shocked, of course.

We had ourselves expressed a major, major concern.

Very grave concerns, I said.

Major countries in the euro area had decided that it was not for them

and, of course, they had the view that this pact should be destroyed.

I myself explained tirelessly in my own country

that you need a framework,

you need rules to be respected

and you need surveillance to be sure that the rules are respected.

Was it a big moment, I mean, in terms of the mess we're in now?

I think it was a big moment. It was a big moment.

Had the major countries continued to say it is essential,

we would probably have been in, I would say,

a much stronger position when the crisis came.

There was now little to rein in

eurozone public spending and borrowing.

It was part of a climate of fiscal permissiveness

that allowed advanced economies and their sovereigns

to build up unprecedented peacetime public debt burdens,

and that, we now know, is dangerous.

This was an era of cheap debt for households, businesses

and governments all over the Western world.

Debts soared outside the eurozone too, in Britain and America.

But for the likes of Greece, Spain, Ireland, Portugal and Italy,

the cost of borrowing was made even cheaper by joining the euro.

Pre the euro, each euro member state borrowed at different interest rates,

because their credit risk,

their risk of being able to pay it back or not, was different.

Germany - you know they're going to pay you back.

Greece - probably less so.

Then the euro was created and suddenly everyone said,

"Well, does that mean that Greece's borrowing costs should be the same as Germany's?"

Well, it's one currency. And that's exactly what happened.

So, the idea of credit risk for each individual sovereign state

went out the window and every euro sovereign nation

could effectively borrow at the same rate as Germany.

What that did for some of these periphery countries

is give them VERY cheap debt and they all went slightly wild

on that very cheap debt, and they had a fabulously cheap debt party.

All this easy money fuelled a frenzied property boom,

especially in Spain and Ireland.

A small street in Dublin is one example of this lethal bubble.

Ten years ago, Mick Wallace wasn't a member of the Dail,

Ireland's Parliament.

He was a property developer,

looking to join the growing list of Ireland's multimillionaires

by building a little Italy by the Liffey.

It was originally just a rundown area.

There was a couple of old antique shops on the site.

People thought I was mad at the time,

building something like this on the north side of the river.

Mick bought the site for half a million euros

and turned derelict wasteland into apartments, cafes and shops.

At the peak of the market,

the 36 apartments on their own were worth 24 million euros.

And across Ireland,

house prices more than trebled between 1995 and 2007.

At the height of the boom, more houses were being built in Ireland

than in England, with its population 13 times as great.

Dublin property prices even outpaced those of inflated London.

The prices were rising by a couple of thousand every week

on apartments and houses.

It was frightening.

People were queuing to buy apartments and houses,

and the price was rising as they were queuing.

The people at the front of the queue got them cheaper

than people at the back.

It wasn't just Ireland.

In Spain, five million new homes were built between 1997 and 2007,

increasing the number of homes in Spain by a quarter.

But the increase in Spanish households was just 2.5 million.

This building boom was financed by cheap loans

from banks on a lending spree.

NEWS REPORTS MERGE

From boom to bust - the first sign it was all going horribly wrong

appeared in the US and spread to Britain.

The collapse of huge banks

such as Lehman Brothers and Royal Bank of Scotland

rocked the global economy.

European leaders saw it as an Anglo-American mess,

caused by the recklessness of Wall Street and the City of London.

Germany's Chancellor Merkel made a pointed contrast

with the thriftiness of the Swabian hausfrau.

And while Britain and America were mending their banks,

the eurozone did too little to strengthen its banks.

In the summer of 2009, Europe experienced its own earthquake.

As the global slowdown began to bite,

a new Greek Government revealed massive hidden debts.

Greece essentially lied about its debt position.

The political class in Greece manipulated the numbers for years.

They manipulated the numbers to get into the eurozone

and once they were in the eurozone,

they manipulated them for a good few years afterwards.

Greece disclosed that government debts were 300 billion euros,

129% of its GDP, and the debts were to become bigger and bigger,

because the global recession led to a slump in the payment of taxes.

Growth hides debt.

Once the economic growth disappears

then you suddenly realise a lot of the growth was fuelled by debt

and in fact, the country's debt position deteriorates rapidly.

The Greek Government slashed public spending

and raised taxes, causing riots.

Lenders to Greece began to fear they wouldn't get their money back and stopped lending.

So, Greece had no choice but to ask for a bailout from the EU and the IMF,

even though the Maastricht rules had prohibited bailouts.

The rules can always be bent.

The most blatant example of that was the first bailout of Greece,

which was done under an article of the treaties,

which was actually meant to deal with

natural disasters like floods and earthquakes.

With a bailout of 110 billion euros for Greece,

the centre of the financial and economic storm shifted

from Wall Street and London to the eurozone,

as the Chairman of the US Federal Reserve

ruefully pointed out to his European counterpart.

Ben Bernanke was only telling me approximately at that time,

"Jean-Claude, now it's your turn."

It was clearly the illustration of the fact

that we were in the epicentre of a crisis.

Other hugely indebted eurozone countries

also found themselves boycotted by investors.

Ireland and Portugal were next to be bailed out,

at the price of having to implement brutal cuts to balance their books.

In Italy, the condition for restoring calm to markets

was the ejection from office of the Prime Minister, Silvio Berlusconi.

The Irish economy, especially its property market, was ruined.

I remember coming back. I came home and I sat down with the accountant

and he said, "We're in trouble."

The banks changed their mood dramatically.

People who used to come to us to have talks said,

"Now you come to us."

People who were our friends treated us like we were rubbish.

Before the crash,

I would have been conservatively valued at about 70 million.

Now, the banks are moving in on the assets,

they're selling them for peanuts.

They would probably realise about ten million for them.

So what was worth 70 is now valued at 10.

Mick still owes the banks 40 million euros, which he hasn't got.

Hundreds of Irish property developers were in the same parlous state,

and if they were bust, so too were the banks that lent to them.

So, the Irish Government nationalised almost the entire Irish banking system

and promised to honour their debts

at crippling cost to Irish taxpayers.

The European banks, ACB, EU, in Germany in particular,

did not want our banks to collapse,

because it meant that their banks wouldn't have got their money back.

And the notion that the taxpayers should actually

be taking care of the problems of badly run, failed, useless banks

has been a bitter pill.

By December 2011, European leaders gathered,

with the euro perilously close to collapse.

There were growing fears that the Italian and Spanish Governments

wouldn't be able to repay their massive debts.

Europe's leaders tried to restore calm by reviving and toughening

the constraints on borrowing by governments

that had been abandoned just six years before.

In Britain, the headlines were all about how David Cameron

made it harder for eurozone leaders to reform the currency union.

It's important that we get the things that Britain needs

and so I decided not to sign that treaty.

But while eyes were on bickering European leaders,

something much more important and more dangerous

was taking place in the ether of financial markets.

In the autumn of 2011, the eurozone's banks

were finding it increasingly hard to borrow.

They were being boycotted by giant US money market funds

who were refusing to lend them even a dollar.

Big European banks, like these here in Frankfurt,

were increasingly wary of lending to each other.

Now, when banks can't borrow, they can't lend and, in a worst-case,

they find it hard to repay their debts and they go bust.

The eurozone was facing

a full-scale, potentially devastating, banking crisis.

'At the Frankfurt headquarters of the European Central Bank,

'it was red alert.'

How dangerous were the conditions in the eurozone banking market

in the autumn and running up to December?

In the autumn of 2011, the conditions were very dangerous.

European banks were facing very severe difficulties

to fund themselves, to access finance, and we were very close from

having a collapse in the banking system in the euro area

which, in itself, would have also led to a collapse in the economy

and to deflation, and this is something the ECB could not accept.

-Good morning, Mr Draghi.

-Good morning.

A new boss of the European Central Bank, Mario Draghi,

made a dramatic and unexpected intervention.

The Governing Council decided the following.

First, to conduct two longer-term refinancing operations,

otherwise called LTROs, with a maturity of 36 months.

This was a banking rescue unlike anything the world had ever seen.

The ECB provided more than a trillion euros of emergency three-year loans

at a miniscule interest rate to hundreds of banks.

Was it to prop up the banking system?

Was that the main reason that you offered these three-year loans?

No, the main reason the ECB decided to offer these three-year loans

is that liquidity in the banking sector

is vital for the economy to function.

So, the role of the ECB is not to prop up the banking sector per se.

We're not working for banks.

We're working for the economy of the euro area as a whole.

So, was it, in a sense, a beneficial side effect

of the decision to provide these loans

that it also, frankly, saved the banking system?

It may have saved the European banking system,

but this was for a purpose, which was to support Europe and the economy.

But little of the trillion euros has found its way into the real economy.

It's gone somewhere else.

LTRO was a cash-for-trash scheme

so that the European banks

are not forced to pay for their own reckless decisions.

The ECB is giving them cash at 1% for three years.

With that cash, they are investing in government bonds.

So, bust banks are propping up bust governments with free money

on dodgy collateral and calling it success.

Is the money trickling out into the economy?

No, on the contrary.

The money's getting stuck in the balance sheet of the banks.

We've seen the statistics, your statistics, which show that

they used quite a lot of the new money

to lend to the Italian and Spanish Governments.

The paradox is this -

part of the reason why creditors of the banking system

thought that the banks were weak

is because they felt that they were too exposed to these governments,

and yet these banks are now doubling up on their exposure.

Does this make sense?

Well, they're not doubling up their exposure.

They are kind of compensating part of the...

of the exposure that they had lost or that they had to...

they had to cut, due to the financial crisis.

And so the... the decision of banks to buy,

say, government bonds, it's a business decision.

The banks were dying on their feet, many of them insolvent and illiquid,

and this LTRO has turned them instead

into still insolvent, but at least highly liquid banks.

In addition, of course, the LTRO has been used to buy up

significant amounts of sovereign debt that would not have been bought otherwise,

so it has been useful in keeping the sovereign show on the road as well,

but the hard work is still to be done.

By injecting a trillion euros into failing European banks,

the ECB was putting an enormous sticking plaster

on the haemorrhaging eurozone.

But even the ECB admits

that the loans do no more than buy time for a proper cure to be found.

It is a painkiller, but a very powerful one.

Now, this period of calm has to be used properly by governments

to fix the underlying issues,

the fiscal issues and the competitiveness issues,

that European countries are facing.

For two years, there's been crisis after crisis in the eurozone,

affecting Greece, Portugal, Ireland, Spain, Italy,

and many of the region's biggest banks.

These crises have been met with fire-fighting

which, for a period, have put out the flames.

The big question now is whether the currency union

is up for the kind of fundamental reform that's necessary

to ensure its long-term survival.

So, what's necessary for the euro to survive?

Well, its member countries each have to be competitive,

otherwise the weaker economies

are unable to pay their own way in the world.

They consume more than they sell abroad

and become more and more indebted.

The remedy available to other uncompetitive countries of devaluing

to make their exports cheaper isn't available inside the eurozone.

We are pretending that we have a currency. We don't have a currency.

If you have a currency, like Britain has,

you can print it when you're in problems,

which is what you're doing.

You can devalue it, which is what you're doing.

That's the essence of a currency. We don't have a currency.

Our elite say, "Our currency, the euro."

It's got nothing to do with us.

If you can't devalue your currency

because you're locked into a monetary union,

the only answer is to become more competitive by reducing costs.

That means slashing public services, cutting wages, making people poorer.

The bitter truth is that

some European countries have become too expensive

and they have to devalue within the euro, becoming cheaper.

This is a very painful process, but there's no way out.

If they don't become cheaper,

their current account deficits will persist for ever.

It's a lesson that was learnt in Germany more than a decade ago.

The Germans understood the competitive pressures

that were coming from China and India and the rest of the world.

They sat down with the unions in the late '90s.

They decided to have wage moderation, changes in the ways work works,

changes in productivity. They did their job right.

We adopted a really severe programme and saw it through

despite some serious difficulties.

In the end, it cost me my job. This was the price we had to pay.

But today, Germany is doing far better

than most other countries in the EU.

Here's what's pulling the eurozone apart.

Since 2000, the costs of employing workers in Italy, Spain, Ireland

and Portugal has risen between 30% and 40% more than in Germany,

which makes their businesses very uncompetitive.

It means that in order for Spain, Italy and the rest to stop living on credit,

living standards for their people may have to drop by a third.

Some European countries would have to reduce their prices,

the prices for their own goods, by 30%.

How can you do that?

It's easy to talk about it, but it's very difficult to do that.

You have to change millions of prices, millions of wage contracts.

The unions will be in the street.

Enabling a country like Spain or Italy to compete with Germany is going to be hard.

Italy's new Prime Minister, Mario Monte, an unelected technocrat,

is slashing public expenditure.

He's also trying to reduce the costs of public sector and private sector

by reforming the rights and privileges of workers.

The good life, Italian style, is under threat.

Italy has endured years of low growth.

It's a malaise that must be cured.

The problem is, the medicine's turning out to be extraordinarily painful, to put it mildly.

Look around you.

The taxis aren't moving. The economy's sick.

The business is gone.

We're living on a knife edge here. Our livelihood is very precarious.

In Italy, taxi driving has traditionally been a closed shop.

It's one of the first trades that Mario Monte wants to open up to competition.

Do you understand why the government of Mario Monte

is trying to shake up your industry,

is trying to abolish lots of the rules that control the taxi trade?

If they want to create some jobs without spending any money

by letting anyone drive a taxi, and not like we had to,

waiting our turn, buying a licence which we had to pay for up front,

it's going to turn nasty.

The dismantling of restrictive employment practices

has already led to national protest.

Transport workers, pharmacists, lawyers and many in the public sector,

as well as taxi drivers, have all been on strike.

The future for many looks challenging.

15 years ago, I would have been happy for my son

to carry on the family tradition of taxi driving.

Today, I hope the future will be more rosy for him

and that he'll find a better job.

Since the crisis, living standards in Ireland

have been squeezed by around a fifth.

That's a great strike.

When we joined the euro, we became part of a bigger currency.

I thought it would be to our benefit and it probably was for a while.

Now, of course, we realise

we all weren't playing on the same level playing pitch.

Good strike there.

The Wexford Youths, our football club,

we're not good enough to play with Bayern Munich.

And that's what we're trying to do in economic terms.

Come on.

At the moment, we're working in three shifts because of the current high sales volume.

We had to start working a third shift because two shifts couldn't cope with the high demand.

Hour for hour, worker for worker,

Germans like Horst are far more productive

than their Italian and southern European competitors.

Where Italy and Ireland are massively indebted,

German efficiency has created the largest surpluses in Europe.

There's no doubt that the euro is a success for Karcher.

Our sales abroad is 85%.

The total sales of the group is 1.7 billion euro.

We doubled our business the last 10, 11 years,

so our growth rate is double-digit every year.

That is our target also.

But Horst and other German taxpayers fear they'll end up with

a huge bill for bailing out the weaker economies.

It was a good decision to have the euro in Germany,

but at the same time, I don't think it's fair

that we are getting a bit punished

when it hasn't been such a success in other European countries.

Germany, which is paying for the rescues of the troubled economies,

is insisting that bailed-out countries live within their means.

Not everyone likes taking the supposed medicine.

Listen, I never voted for Nicolas Sarkozy.

I never vote for Angela Merkel.

So, I didn't vote for them to tell me what to do.

Some would say Europe is now being run by the government with the deepest pockets, Germany,

precisely the opposite of what President Mitterrand hoped monetary union would achieve.

That may be because the political union he thought would follow

monetary union is yet to happen.

The crisis at least makes one thing obvious. We need more of Europe.

Political union is the only way to save the stability of the euro.

It seems to me that Europe could go for a federation.

This is the citizen who speaks there, the citizen of Europe.

I'm not speaking as former governor of the ECB, but as a citizen.

Of course, it's a decision which has to be taken by the people of Europe.

The creation of a fully fledged United States of Europe,

a federal super-state, with taxing, spending and borrowing

all decided centrally,

may be how to save the euro and restrain German power.

But recent elections in France and Greece show voters rejecting austerity.

The eurozone is becoming less united, politically and economically.

The underlying forces are still driving the countries apart.

The divergence is getting wider

and the perspectives of the various countries

are more and more at loggerheads.

Spain, buckling under the weight of huge debts,

is causing particular concern.

Spanish banks remain weak and need to be strengthened

with a big injection of capital to absorb potential losses.

The Spanish banks are very vulnerable.

They've clearly got a very large local banking sector

which is controlled by local authorities,

and if you want to look for sort of crony capitalism, corruption

and, as a result, very large loan losses, look for that sort of thing.

And if you can combine that with a construction boom, you're really off to the races.

And Spain now has more unsold housing units

than United States of America, which is a pretty startling statistic.

Spain manifests all the eurozone's flaws - a bloated property market,

huge debts burdening businesses and households,

ailing banks, a government unable to balance its books.

But with a quarter of the workforce unemployed,

will Spain be the next to turn against the cuts?

To impose fiscal austerity forces reduction in public employment,

so you already have 48% of the Spanish young people out of jobs.

So, the danger of social unrest is getting bigger and bigger.

Whatever happens, millions of Europeans in the highly indebted countries are becoming poorer,

year after grinding year.

Having voted against austerity, the Greeks have been told to grin and bear it

or get out of the eurozone.

But a Greek exit could kill the euro,

and that could lead to a chain reaction of collapsing banks,

which would pose terrible dangers for Britain.

Our banking sector is very international

and we simply cannot cut ourselves off

from problems that occur in the eurozone.

We've actually got a financial services sector

that's probably of the order of six times bigger

than our underlying economy,

if you gauge it against places like North America.

And so, it's both a big problem for our banks,

and a big problem for our economy in general, if that occurs.

The choice confronting the eurozone looks profoundly unappealing.

If it survives, millions of Europeans

face years of squeezed living standards.

But if it were to fall apart,

well, households, businesses, banks, governments

would face the risk of going bust.

And that would have a devastating impact on Britain,

on our banks, on our living standards.

So, although the cost of saving the euro may seem high,

the price of letting it collapse,

well, that could lead to

the kind of economic depression and financial mayhem

we haven't seen since the 1930s.

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