Still optimistic…

10/05/2011 by

Last Friday, after Der Spiegel published a story that Athens is considering withdrawing from the euro zone” I posted an article in which I chose to be optimistic; to see a gleaming silver lining in the fact that an otherwise upright German publication, with known connections to the German political system, published an inaccurate account that, supposedly, the Greek Prime Minister contemplated the unimaginable: exit from the eurozone. In my post I hoped and prayed that Der Spiegel was in cahoots with Germany’s Finance Ministry in causing, intentionally, a mild panic so as to send a message primarily to the German Chancellor but also to the Greek Prime Minister. What message? That it is time to begin the debate which Europe has been avoiding for more than a year. A debate about the need to stop living in the collective illusion that the eurozone’s present course is sustainable. 

As the days go by, I am becoming increasingly confident that this was precisely what the purpose of the Der Spiegel article was. For a couple of hours on Friday afternoon, the mini-panic the Spiegel article spread throughout Europe concentrated everyone’s minds on the terrible prospect of a euro break-up and its hideous consequences for all. The timing of the Spiegel publication (Friday after the markets closed) was carefully selected to minimise the impact on market fundamentals while, still, forcing leaders to re-think some of their assumptions.

Many readers, and some journalists, ask me now if my hopes were dashed or whether I am still hopeful. It is, of course, very easy to lose heart quickly in today’s Europe. Old habits die hard. But they do die. After the Friday Luxemburg meeting, finance ministers came out making, yet again, noises about new loans for Greece, with or without ‘collateral’, of debt rescheduling etc. This was terribly disappointing. The same old ‘remedies’ (that have proven worse than the disease) were given another airing. However, and this is my hope, last Friday’s mini-panic may well prove the harbinger of a new path for Europe.

Which new path? Europe needs to grasp the simple truth that the triple crisis it faces (a debt crisis, a banking sector crisis and a crisis of under-investment) cannot be solved by forcing German taxpayers to guarantee relatively high interest loans that are to be given to insolvent member-states. These loans are simply wasted economic energy. To get these loans Greece et al are forced to introduce savage austerity measures that fuel domestic recession, the result being lower national income, lower aggregate taxes and, inevitably, a higher debt-to-GDP ratio. And what do the recipient governments do with these loans? They use them to repay past debts to (mostly) European banks which, immediately, hoard most of that money (instead of lending it to business) as a result of their own catastrophic financial health (courtesy of the junk derivatives and bonds on their books). In short, the German taxpayers’ money and guarantees end up in a black hole, fuelling recession in the periphery and discontent in Germany.

Is there an alternative? Absolutely! Faithful readers of this blog can see my answer coming: the Modest Proposal of course. But for the benefit of newer readers, let me sketch out its main three components that attack all manifestations of the crisis head on (before recommending that you read its full text here):

  1. Use the funds raised by the European Financial Stability Mechanism (EFSF) to recapitalise the eurozone’s (almost insolvent) banks in exchange for shares in these banks. Once the banks are cleansed, they will no longer need to rely on massive liquidity injections from the ECB (and can even be asked to take a selective haircut on bonds from the periphery). The EFSF then sells the shares and recoups its funds, thus costing the German taxpayer nothing (much like the TARP scheme in the USA).
  2. A conversion loan is organised by the ECB for the part of the debts of member-states which does not exceed the EU’s Maastricht limits (60% of GDP). In brief, the ECB takes on its books forthwith a tranche of the sovereign debt (of all member states that request it) equal in face value up to (the Maastricht-compliant) 60% of GDP and finances this by issuing eurobonds that are its own liability. Naturally, the member-states continue to service their debts (to the ECB now) but at the lower rates (and with the longer maturity) secured by the eurobond issue.
  3. Empower the European Investment Bank (EIB) to fund a large scale investment program by which permanently to counter the forces of recession in peripheries that keep dragging the rest of the currency union (including parts of German society) toward stagnation. How can this happen? By allowing for the 50% of project funding (which now the bankrupt member-states must raise!) to come from the ECB’s net eurobond issues.

Note the great benefits of such a policy mix:

  • German taxpayers do not guarantee/provide any loans to Greece, Ireland etc.
  • The aggregate mountain of EU debt and banking losses shrinks (a development that will calm the markets)
  • No across-the-board haircut on existing debt is involved (thus averting a crisis of confidence and losses in pension funds etc.)
  • The banking sector is revitalised
  • The EU’s two great institutions (the ECB and the EIB) combine forces to bypass ineffective states (like the Greek one) in spearheading Pan-European investment
  • No new institutions (and, therefore, no major Treaty changes) are necessary
  • With the debt-banking crisis over, and investment projects run at the EU level, it will be much easier to introduce balanced budget rules for member-states, in accordance to Germany’s wishes.

Naturally, to get our leaders to agree on such a radical policy mix requires a radical Gestalt Shift throughout our continent. It is our duty to effect it. The Spiegel-induced mini-panic of last Friday might prove a mini-godsend if it helps steer us in that direction. Am I optimistic that it will? Yes, because I choose to be and will remain so until our leaders give me (additional) good cause to lower my expectations. 

Note: A version of this post will appear in Die Zeit in the next few days.

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