June 18, 2012
Once again good news has had a half-life in the markets of less than 24 hours. Just as news of Spain’s bank bailout rallied markets and sentiment for only a few hours, a Greek election outcome as good as could have been hoped did not buoy markets for even a day. There could be no clearer evidence that the strategy of vowing that the European system will hold together, doing the minimum to address each crisis as it comes and promising to build a system that is sound in the long run has run its course.
Nor is the Group of 20 leading economies, whose leaders conclude their meeting today, likely to change anything soon. Europe’s troubled economies will demand more emphasis on growth, lower interest rates on their official debts and more transfers. The Germans will show sympathy with the aim of reform but will insist that financial integration coincide with political integration. The rest of the world will express exasperation with Europe’s failures and demand more be done. Officials blessed with more diplomatic than economic insight or courage will produce a communiqué expressing a measure of satisfaction with the steps under way, recognising the need to do more and looking forward to continued dialogue. The only good thing is that expectations are so low this will barely disappoint markets.
The truth is that Europe’s debtors and creditors are both right. The borrowers are right that austerity and internal devaluation have never been a successful growth strategy, certainly not when major trading partners are stagnating. In the few cases where fiscal consolidations have preceded growth, they have either involved stagnation relative to previous levels of income (as in Ireland and the Baltics) or buoyant demand associated with surging exports, increasing competitiveness and low borrowing costs (many euro members in the early years). The borrowers are also right to claim that even a previously healthy economy will quickly become very sick if forced to operate for several years with interest rates far above growth rates, as is the case across southern Europe. And experience clearly shows that structural reform is always harder when an economy is contracting and there is no sector to absorb those displaced by reform.
Those wary of institutionalising financial integration without serious political integration are right as well. In a sound system, those with deep pockets who act either as borrowers or as guarantors must have control over borrowing decisions. A system where I borrow and you repay is a prescription for profligacy. This is why there is now so much discussion of eurozone bonds and Europe-wide deposit insurance being linked with much deeper political integration.
But there are two problems lying behind the soft references to greater integration. The first is the question of who really has control. If decisions are genuinely to be made at eurozone level, it is far from clear that there is any majority or even plurality support for responsible policies. If the idea is that the eurozone will be modelled on the European Central Bank – a European facade behind which Teutonic policies are pushed – it is far from clear that this will or should be acceptable across the continent.
The second problem is the scale of the transfers that could be involved. A good guess would be that during the US savings and loans crisis, the American south-west received a transfer from the rest of the country equal to at least 20 per cent of its gross domestic product. Is there a real will to commit to potential transfers of this scale in Europe? Maybe all of this can be resolved but it will surely not happen quickly.
Not all problems can be solved. It is not certain that the full repayment of all currently contracted sovereign debts, sustainable growth for all, and the eurozone retaining all its current members will prove feasible. The private sector is making clear that it recognises this painful reality. Official sector planning needs to recognise it as well. Outside Europe, even as leaders hope for the best they need to plan for the worst, ensuring adequate liquidity and demand in their economies even if Europe’s situation deteriorates rapidly. The fortification of the International Monetary Fund is a start but policy makers need also to consider national policies, trade, finance and social safety nets.
But a eurozone collapse would be a disaster that might define our era. Its prospect must focus the minds of all at the G20 summit on action. Non-Europeans must persuade Europeans that the rules change when the stakes rise. The ECB’s credibility will mean little if there is no longer a common currency.
Setting the right precedent seemed far more important 24 hours before Lehman’s collapse than 24 hours after it. Now is the time for radical cuts in the rates charged by official creditors to European sovereigns; for a willingness to subordinate official debts; and for expansionary monetary policies in Europe that prevent deflation and encourage the growth that can create jobs and reduce debts. Only if the system is preserved can its future be debated.
The writer is a former US Treasury secretary and Charles W. Eliot university professor at Harvard.
Copyright The Financial Times Limited 2012.