Germany’s Choice

FRANKFURT – The euro crisis has already transformed the European Union from a voluntary association of equal states into a creditor-debtor relationship from which there is no easy escape. The creditors stand to lose large sums should a member state exit the monetary union, yet debtors are subjected to policies that deepen their depression, aggravate their debt burden, and perpetuate their subordinate position. As a result, the crisis is now threatening to destroy the EU itself. That would be a tragedy of historic proportions, which only German leadership can prevent.

The causes of the crisis cannot be properly understood without recognizing the euro’s fatal flaw: By creating an independent central bank, member countries have become indebted in a currency that they do not control. At first, both the authorities and market participants treated all government bonds as if they were riskless, creating a perverse incentive for banks to load up on the weaker bonds. When the Greek crisis raised the specter of default, financial markets reacted with a vengeance, relegating all heavily indebted eurozone members to the status of a Third World country over-extended in a foreign currency. Subsequently, the heavily indebted member countries were treated as if they were solely responsible for their misfortunes, and the structural defect of the euro remained uncorrected.

Once this is understood, the solution practically suggests itself. It can be summed up in one word: Eurobonds.

If countries that abide by the EU’s new Fiscal Compact were allowed to convert their entire stock of government debt into Eurobonds, the positive impact would be little short of the miraculous. The danger of default would disappear, as would risk premiums. Banks’ balance sheets would receive an immediate boost, as would the heavily indebted countries’ budgets.