Time for a Euro-wide strategy to deal with the systemic crisis

2011-09-15

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A new strategy that will address all three dimensions of the crisis is what we need. Core issues are growth, healthy banks, stable fiscal finances. Image Source: Wikipedia

The latest events in the spiraling crisis of the euro lead to a single logical conclusion: The crisis is systemic and requires system-wide solutions. To remind you what are these events and starting from the negative, major French banks, Societé Générale and Credit Agricole were downgraded by Moody’s due to fears of their exposure to the periphery’s debt. Yields on Italian bonds are rising as market fears increase. Greece naturally missed its budget targets due to the overall slowdown in the European and global economy, which resulted in the need for further self-defeating, front-loaded austerity, while everyone now accepts that austerity is not the solution to the problem including Nobel economics prize winner Joseph Stiglitz.

On the other side we have some positive events, first the emerging economies of Brazil, Russia, India, China (aka BRIC) as well as South Africa and others have stated their determination to support Europe in its efforts to overcome the crisis. Also the President of the European Commission Jose Manuel Barroso has vowed to present options on eurobonds soon. Finally today on EurActiv we get a report about the systemic nature of the crisis (what I have been advocating all the time), which starts as follows:

European finance ministers have been warned confidentially of the danger of a renewed credit crunch, as a “systemic” crisis in eurozone sovereign debt spills over to banks.</p> As I said all these events lead to the conclusion that the crisis is systemic and that system-wide solutions are the only means of dealing with it. This means that all my criticism on the ad hoc half-measures of European leaders, which aimed at pointing out the real structure of the crisis was proven to be correct (and will continue to be proven correct as events unfold). By now every honest person in Europe has realized that the crisis is a triple crisis of (a) debt crisis across the eurozone, (b) quasi-bankrupt banking sector crisis, (c) under-investment crisis, all over the euro area, with few exceptions, but especially in the periphery.

The crisis is deeply rooted in the structural flaws of the euro, namely in the lack of a fiscal union (that however cannot be created today due to all sorts of constraints – see my analysis Federalism for the future – Realism for the present) that would incorporate in the heart of the single currency a harmonized fiscal policy together with a vitally important surplus recycling mechanism that would take the accumulated surpluses and recycle/reinvest them with profit in deficit regions so as to achieve balanced growth, economic stability and convergence. Alas a fiscal union is not feasible within the current conditions, yet there are alternative solutions for European leaders to act within the current institutional framework.

What our leaders need to do today is to revise their failing self-defeating policies and their much-vaunted “fiscal discipline” delusions. They need to put aside the misleading rhetoric of the “debt crisis” of certain countries and focus on ways to address all three dimensions of the systemic crisis at once. This means to formulate a coherent strategy that would:

1. Alleviate the pressure on public finances and the need for self-defeating austerity, through the issuance of ECB-backed, ECB-guaranteed Eurobonds that will attract surpluses outside of the EU and thus put an end to the need of using taxpayer money to fund projects. Eurobonds will be sold like hot cakes to the BRICs and to other surplus countries or wealth funds and Central Banks.
2. Unify the banking sector and clean it from all the toxic waste that it has accumulated (the pre-2008 financial derivatives and the post-2008 sovereign bonds of nearly insolvent states). To do so the EFSF must be given the role of a supervisory banking sector authority that will have the responsibility to carry out objective stress tests (not the sort of exercises in fraudulent accounting that we had these last two years) and will have the power to recapitalize banks in exchange for shares. This is the ideal chance to take advantage of the desperate need private banks have for capital to impose stable rules and regulations.
3. Mobilize the European Investment Bank to act as this much needed surplus recycling mechanism in order to massively contribute to economic growth. Growth is the only means of pushing the European cart out of the mud where it has currently stuck. The EIB has twice the funding capacity of the World Bank and can with ease contribute to huge amounts of investment that will create externalities and bring private investment as well, thus cutting short the current recession.

All these are steps that can be made within the current institutional framework and do not require cumbersome Treaty changes (if they did they would not be solutions to our current short-medium term problems). The only thing that is required for this change in strategy is for politicians in all countries to put aside populist talk and nonconstructive proposals. All must accept the reality that European countries are tied together like climbers on a hill where if one falls all fall together – thus cooperation of all members is the only means of survival – the only means of climbing the cliff.

I believe that events are putting the pressure on our leaders to revise their approach to the crisis and to go beyond the political rigidities of the system that prevent the formulation of a rational system-wide strategy to deal with the systemic crisis of the euro, otherwise their current policies will lead with mathematical accuracy to the collapse of the euro. I remain optimistic that reason will prevail and all will understand the importance of these times and the responsibility they have.

—To see a concrete proposal for saving the euro, within the current institutional framework, one that will not imply any fiscal transfers or any pooling of the debt that everyone rightfully objects at this point, see the Modest Proposal for Overcoming the Euro Crisis by Varoufakis and Holland. The above ideas are heavily influenced by that paper.—