It is now abundantly clear that each and every response by the eurozone (EZ) to the galloping sovereign debt crisis has been consistently underwhelming. This includes, back in May, the joint EZ-IMF operation to ‘rescue’ Greece and, in short shrift, the quite remarkable overnight formation of a so-called ‘special vehicle’ (officially the European Financial Stability Facility, or EFSF), worth up to €750, for supporting the rest of the fiscally challenged EZ members (e.g. Ireland, Portugal, Spain). More recently, European leaders announced their provisional agreement to create a permanent mechanism to replace the EFSF as well as a series of measures for, supposedly, attacking the crisis’ causes, thus ensuring that it is not repeated. Alas, no sooner were those measures announced that the crisis intensified.
THE TWO SIDES OF THE COIN: SOVEREIGN DEBT AND TROUBLED BANK ASSETS
The reason the crisis is intensifying is simple. The EZ is facing an escalating twin crisis but only acknowledges one of its two manifestations. On the one hand we have the sovereign debt crisis which permeates the public sector in the majority of its member countries. On the other hand we have Europe’s private sector banks many of whom find themselves on the brink. Over-laden with paper assets (both publically and privately issued) which are worth next to nothing, they constitute black holes in which the European Central Bank (ECB) keeps pumping oceans of liquidity that, naturally, only occasion a tiny trickle of extra loans to business. Meanwhile, the EZ leadership steadfastly refuses to discuss the private debt crisis, concentrating solely on the need to curtail public debt through a massive austerity drive. In a never ending circle, these fiscal cuts constrain economic activity further and, thus, pull the rug from under the bankers’ already weakened legs. And so the crisis is reproducing itself.
A MODEST PROPOSAL FOR THE SHORT TERM: ARRESTING THE FREEFALL
What we have now is a textbook case of how not to run a ‘bail out’ either for countries like Greece, Portugal and Ireland or for Europe’s stricken banking sector. Without a two-pronged plan for tackling at once the deficit states’ debt and the banks’ problematic assets, markets will continue to speculate on which will be the next domino pieces to fall And thus the crisis is reproducing itself. To tackle it in its entirety, a politically mediated tripartite grand agreement is needed between the following participants:
- Representatives of all high deficit countries that will, potentially, require assistance during the next five years (e.g. not only Greece but also Spain, Ireland, Portugal, Italy)
- The heads of the EZ and the ECB, who will effectively be representing, as is their wont, the interests of the more dominant, low deficit, countries (e.g. Germany, Finland, Holland)
- Representatives of all the main European banks holding the majority of the high deficit countries’ bonds
By bringing these three sides to the same table, it will become possible to tackle the problem in its entirety; to avoid squeezing it in the domain of public debt only to see it balloon in the banking sector; or vice versa. Here is an example of a possible Grand Covenant:
- Europe’s banks agree to limit their demands over the debt of the high deficit countries (i.e. to restructure the debt of Greece, Ireland etc.)
- High deficit countries agree to implement reforms that reduce waste, corruption and parts of their deficit whose reduction will have limited impact on poverty, social cohesion and long term productivity growth (e.g. defence procurement, tax breaks for wealthier citizens, subsidies on environmentally damaging agriculture)
- The EZ-ECB undertakes to come to the assistance of European financial institutions that are stressed by (1) above and, crucially, to utilise the European Investment Bank to increase productive investment throughout the continent, but more so in its recession-hit regions.
A MODEST PROPOSAL FOR THE LONGER TERM: RE-DESIGNING THE EURO’S ARCHITECTURE IN A MANNER THAT ACCELERATES RECOVERY AND PREVENTS FUTURE CRISES
If the euro crisis reveals anything, it is the simple truth that a currency union cannot bank on balanced trade within its regions. Germany will, come what may, have a trade surplus with Portugal. So, if the currencies of the two countries are to be locked up indefinitely, keeping the balance sheets balanced requires either a steady transfer of capital from Germany to Portugal or a constant diminution in Portuguese wages. Though both phenomena are possible, and often observable, life has proved that neither the capital flows nor actual wage reductions are ever strong enough to avert the ever-growing imbalances between deficit and surplus EZ countries. In short, either the currency union will break up or a political-cum-institutional solution will be found. What follows is a modest proposal of what that longer term institutional solution might entail. Why modest? Because it does not call for the obvious solution to the problem, i.e. Federation.
The gist of our proposal is that the current euro architecture is an edifice missing an important pillar. And that this missing pillar is some mechanism for recycling surpluses between its member states and peripheries. The Crash of 2008 put the EZ in its current mess by exposing the imbalances that were expanding during the boom years due to this missing mechanism but which required a nasty shock before becoming apparent. Our proposal for the longer term is that:
- A tranche of around 60% of the sovereign debt of all member states be transferred to EU bonds. This will immediately reduce borrowing costs for the most exposed member states, attract investments from the Central Banks of surplus countries (e.g. China) and from sovereign wealth funds (e.g. Norwegian, Russian, Chinese), stabilise the EZ in the long run and turn the euro into a true, global reserve currency.
- Empower the European Investment Bank (EIB) to fund a pan-European, large-scale, eco-social investment-led program by which to put in place a permanent counter-force to the forces of recession, especially in peripheries which keep dragging the rest of the currency union toward stagnation. There EIB bonds ought to be automatically bought by the ECB if rates exceed specific targets, otherwise EIB is in competition on the markets with increased sovereign issues by everybody and it will be able to lend only at relatively high rates.
- Put in place, as the German Chancellor is constantly requesting, mechanisms that enforce fiscal discipline among EZ member states and which ban all attempts to use one member’s tax system to undermine another EZ member’s investment policy.
- will allow deficit countries to service their existing debts (without choking off their internal recovery) without amounting to a further debt default
- will add the missing pillar to the euro’s architecture, by turning the EIB into the surplus recycling mechanism which provides the EZ with the structural stability it so badly needs (and without the need for any moves toward Federation)
- will make it possible to instil a proper amount of discipline in the member states’ Finance Ministries (once the imbalances have been eradicated by 1 and 2 above)
The above can be part of a longer term negotiation where, for instance, Germany and other surplus countries are compensated for the small increase in their own borrowing costs by some form of (Thatcher-like) rebate of part of their annual contribution to the EU.