Published in The Australian (Sydney), 22 December 2010
It’s time for fresh thinking in Brussels about the debt threat.
The summit of Europe’s heads of government is over, yet the continent’s problems remain. After intense negotiations in Brussels, tough decisions on the future of the European currency have been postponed again.
Horace’s sneer “parturient montes, nascetur ridiculus mus” (“mountains will be in labour, and an absurd mouse will be born”) comes to mind.
What was agreed in Brussels is a collection of technicalities: a vague amendment of the European Treaties to establish a permanent rescue mechanism for the embattled euro; a rise in the European Central Bank’s subscribed capital; and an agreement, at least in principle, that private investors shall contribute to future bailout packages, though nobody knows how precisely.
These measures are meagre and inadequate to solve the euro crisis. They could nevertheless lead to a costly transfer mechanism under which rich countries would permanently pay for weaker nations.
To be fair, no one really held great expectations ahead of the meeting. Too many such gatherings have passed throughout this annus horribilis for the EU. Their results had been equally insufficient. Obsessed with treating the symptoms of the fiscal and monetary catastrophe engulfing the continent, its political leaders have displayed a remarkable inability, or unwillingness, to address the underlying causes.
The Irish crisis, the threat of renewed downgrading of Spain’s credit rating and the ongoing speculation about Portuguese funding difficulties underlined the urgency of tackling Europe’s debt problems. Failure to do this leaves the euro as one of the biggest threats for the global economy in the coming year.
Concerns about the solvency of European nations could lead to a sudden implosion of the euro currency at any time.
Governments declaring themselves bankrupt are nothing unusual, and it happens more often than usually assumed. Carmen Reinhart and Kenneth Rogoff list scores of sovereign defaults in their book This Time is Different: Eight Centuries of Financial Folly.
As Reinhart and Rogoff point out, in some cases the same countries may even become serial defaulters without being permanently cut off from the market. A good example is Portugal, which declared itself unable to pay not fewer than six times during the 19th century.
Greece holds a sad record, being the country that spent half the time since its independence in 1829 in default or debt rescheduling.
Europe’s current debt crisis would be like any other traditional debt crisis if it were not for the joint currency. It has become abundantly clear that the euro unites countries that are too structurally different to be bound together by a common currency. Whatever else one may say about Europe, an area suited for monetary union it is not.
The European currency also worsens the effects of a single country’s default and prevents the solutions typically chosen in cases of over-indebtedness.
It is this added complication that European politicians do not come to grips with, as the Brussels summit once again demonstrated. They fear that debt problems in any one European country, no matter how small or unimportant, may undermine the credibility of their currency as a whole.
This is just an unproved assumption, but it causes enough anxiety among policymakers and central bankers alike.
To make matters worse, any default would lead to large write-offs for the entire European financial system. Banks, pension funds and insurance companies would find themselves struggling and would probably once again require support from the taxpayers to be kept afloat.
Afraid of another unpopular bailout round, politicians are trying to avoid this scenario by keeping the debtor nations solvent even if it comes at the price of burdening them with yet more debt.
Finally, the political capital invested in the euro project is huge. Since the Treaties of Rome promised “ever closer union”, every single step in European politics has been towards greater political and economic integration. Giving up the euro currency would be a giant step back on this pathway. For a whole generation of European political leaders this is unthinkable. They would regard it as a humiliating failure.
However, for the political reasons mentioned above, the EU is trying to keep the euro alive. The parties who introduced it do not want to lose face. Nor do they want to trigger another financial crisis. They do not wish to cause a domino effect of defaulting countries either. And, at least for the healthier countries, they have no desire to make their citizens pay for any of the rescue measures.
Such is the Gordian knot that the EU summit failed to untangle.
In the current mess that is monetary union, there is no solution that would be effective, cheap and popular at the same time.
Without the political dead weight attached to the euro, a rational solution to the crisis would be easier.
It would begin with the truistic recognition that over-indebted nations such as Greece need to default on their debt for any chance of recovery.
Imposing further debt and austerity packages on them is a sure way to economic ruin and social unrest.
Instead, they need a normal, IMF-style debt restructuring process. There is no reason why this needs to impinge on the stability of the euro currency. If anything, it would strengthen it by reducing uncertainty.
In addition to enabling sovereign defaults, there should be options for struggling countries to leave the eurozone.
The economic imbalances within Europe have become too great, particularly regarding productivity differences. In order to correct them, it would be desirable for some countries to be able to devalue their own currencies.
Instead of trying to keep such nations within the monetary corset of the euro at all costs, the EU should allow them to depart.
None of these sensible options were even on the table at the Brussels summit.
Oliver Marc Hartwich is a research fellow at the Centre for Independent Studies. His report, Europe’s Painful Farewell: An Essay on the Decline of the Old World, was published by CIS.