Still think it’s a financial crisis?
After receiving several hundred billion euros in emergency loans and debt relief, the Greek government still asks for more loans it knows well it will not pay back entirely. The Spanish government - while also requesting money from the European Financial Stabilisation Mechanism (EFSM) and the European Central Bank, no strings attached - affords itself a lower VAT rate than Germany, canceled its deficit target, and delayed the recapitalisation of its banks for so long that the deadline agreed last October will be missed by those most in need of it. Failing to sustain reform progress, the Italian government had proposed behind closed doors that the ECB break the EU Treaty and finance the Italian budget directly from the printing press - until the European Council told the European Stability Mechanism (ESM) to do essentially the same. François Hollande chooses to simply ignore concerns about both his country’s current account and public deficits being worse than Italy’s.
David Cameron, representing the massive southern European interests held by Europe’s biggest financial center London, demands that Germany underwrite eurozone debt but does not accept contributing a penny. Angela Merkel, advocating austerity across the eurozone, has not proven her mettle in a single such reform during her seven years in office. Finally, as for the European Commission, it is questionable for markets to still consider it a credible guardian of the fiscal compact and the EU’s finances after the institution was at the forefront of bringing down the no-bailout rule in all but form and still proposes a large-scale mutualising of eurozone debt. Still think it’s a financial crisis? This is a political one.
As long as rules are constantly called into question, potential lenders - both private and public - must be forgiven for hesitating. True, it hurts if interest rates come back to the status quo ante after a decade of cheap money, which, for example, saved Italy some five percent of GDP annually in debt service. But to keep interest rates low, you have to show determination to consolidate and to serving your debt. It has worked in Latvia, is beginning to work in Ireland, and has not yet failed in Italy. Mario Monti’s only allies are the financial markets; there is no doubt that with the safety of Eurobonds, Silvio Berlusconi would be back in power within days.
The departure of a country from the eurozone must not be taboo
The crisis resulted from interest rates that were too low and a collectivised risk through financial market interdependence. Taxpayers bailed out banks and insurances, with a strong national bias. Europe’s recovery must start from here—it must not build on the wishful thinking that Spanish productivity will explode by 20 percent to realign it with price levels. Given the constantly growing Greek and Spanish external debt of over 90 percent of GDP, sustaining consumption will only perpetuate this at the expense of debtor credibility. Instead, for a lasting recovery the most basic incentives must be resurrected: Markets and interest rates must be allowed to differentiate between bad risks and good ones, between Greece and Italy. There must be rewards for reforms and consequences for failure, otherwise the latter will be externalised and accumulated in the eurozone.
The departure of a country from the eurozone must not be taboo; in fact, without such a taboo, that is less likely to happen. The fiscal compact, seen as a tool of German hegemony, will create much bad blood without having real teeth; the June Council, which again loosened previously agreed conditionality, gave an idea of how things will work in real life. In the end northern governments will also succumb to the short-termism of the electoral cycle. But more integration, if it came at the price of a continuing gap between political responsibility and financial accountability, would be a far cry from the “bazooka”-calming financial markets; instead, it would weaken the EU s perhaps fatally.
All of this does not mean that there could not or should not be solidarity. But it must not come on tick. Instead, temporary interest-rate subsidies could help, paid by those countries like Germany that are considered financial safe havens and enjoy a better fiscal situation. This would maintain incentives for consolidation and at the same time help on the short term. Moreover, banks could be forced to re-capitalise from a capital ratio of nine percent to, say, 18 percent. (For comparison: The Turkish banking sector holds an average capital ratio of 15 percent.) True, this would wipe out most of the capital value of current shareholders. But in a situation in which the economic and political architecture of the EU is at stake, and after the European taxpayer has had to face so many bailouts already, such a measure may well appear legally defendable.
Too many grand ideas, too little action where it really matters
This recapitalisation, either with private capital or - above nine percent and under tight conditions - with the help of the ESM, would have to go hand in hand with the abolition of distortive incentives under the Basel agreement to favor banks’ holding of public bonds over private lending operations. It is not a bank’s business to provide liquidity to governments - citizens can do that themselves, as sovereign credit risks are transparent. Instead, banks should finance private sector growth. Next, banks must be forced to diversify portfolio risks, so that the interdependence between governments and “their” banking sector - and thus the contagion risk - would be broken, as it should in a European internal market. Finally, the internal operation of the ECB system would have to be assessed in a similar fashion, including country-specific credit breaks or higher down-payments for mortgages, etc.
In short, exiting from the crisis requires a vision of a medium-term goal, which needs to redress the economic causes that led into the crisis. Now, one may wonder why all of this is not happening. The most likely explanation is the most worrying: that short-term interests of the political actors prevail over those of (future) taxpayers. For a prime minister of a country in crisis, it is too tempting to blame the need for painful austerity on outsiders and ask for painkillers instead. For the German chancellor the tax financing of German solidarity with southern Europe is politically unattractive as long as she can painlessly bankroll it.
As long as the prime minister of the EU’s biggest offshore haven presides over the Eurogroup, as long as France’s and Spain’s banks are most exposed to critical risks and can hope to be bailed out by the ESM, as long as the ECB president comes from Goldman Sachs, and as long as the head of the IMF has her head on the line for dud loans to Greece, it would be naive to expect tough action on banks. Moreover, too many European institutions are keen to ride a wave that appears to carry them to more influence. The upshot is that political energies are wasted while they are most scarce. It’s like that recent popular Monty Python football game between Greek and German philosophers: too many grand ideas, too little action where it really matters.
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Rainer Emschermann is an economist and publicist.
Opinions expressed in this article solely reflect the personal opinions of the author.