With the entire burden of adjustment being shifted to the eurozone's debtor countries, the next step in European integration must be clearly acknowledged alongside implementation of the EU’s crisis-resolution mechanism. Otherwise, deficit countries will have no reason to hope that they can escape their predicament.
NEW YORK – The so-called euro crisis is generally seen exclusively as a currency crisis, but it is also a sovereign-debt crisis – and even more a banking crisis. The situation’s complexity has bred confusion, and that confusion has political consequences.
Indeed, Europe faces not only an economic and financial crisis, but also, as a result, a political crisis. The various member states have forged widely different policies, which reflect their views rather than their true national interests – a clash of perceptions that carries the seeds of serious political conflict.
The solution that Europe is about to put in place will be effectively dictated by Germany, whose sovereign credit is necessary for any solution. But this ignores Germany’s major share of responsibility for the currency and banking crises, if not for the sovereign-debt crisis. France’s efforts to influence the outcome are ultimately limited by its dependence on its close alliance with Germany for its AAA sovereign ratings.
Germany blames the crisis on the countries that have lost competitiveness and run up their debts. Consequently, Germany places all the burden of adjustment on debtor countries. But this ignores Germany’s major share of responsibility for the currency and banking crises, if not for the sovereign-debt crisis.
When the euro was introduced, it was expected to bring about convergence among eurozone economies. Instead, it brought about divergence. The European Central Bank treated all member countries’ sovereign debt as essentially riskless, and accepted their government bonds at its discount window on equal terms. This induced banks that were obliged to hold riskless assets in order to meet their liquidity requirements to earn a few extra basis points by loading up on the weaker countries’ sovereign debt.
This lowered interest rates in the so-called PIIGS countries (Portugal, Ireland, Italy, Greece, and Spain) and inflated housing bubbles just as reunification costs were forcing Germany to tighten its belt. This caused both the divergence in competitiveness and the banking crisis in Europe, which affected German banks more than others.
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In fact, Germany has been bailing out the heavily indebted countries as a way of protecting its own banking system. For example, Ireland’s massive sovereign debt arose because eurozone authorities, intent on saving the banking system, forced the Irish to nationalize their banks as a condition for keeping them afloat. Thus, because the arrangements imposed by Germany protect the banking system by treating outstanding sovereign debt as sacrosanct, debtor countries must bear the entire burden of adjustment.
This is reminiscent of the international banking crisis of 1982, when the World Bank and the International Monetary Fund lent debtor countries enough money to service their debts until banks could build up sufficient reserves to exchange their bad debts for Brady Bonds in 1989. That meant a “lost decade” for Latin America’s economies. Indeed, the current arrangements penalize debtor countries even more than in the 1980’s, because they will have to pay hefty risk premiums after 2013.
There is something inconsistent in bailing out the banking system once again and then “bailing in” holders of sovereign debt after 2013 by introducing collective-action clauses. Moreover, the competitiveness requirements demanded by Germany will be imposed on an uneven playing field, putting deficit countries in an untenable position, one that might even drag down Spain, which entered the euro crisis with a lower debt ratio than Germany. As a result, the European Union will suffer something worse than a lost decade; it will endure a chronic divergence in which the surplus countries forge ahead and the deficit countries are dragged down by their accumulated debt burden.
Germany is imposing these arrangements under severe domestic pressure, but the German public has not been told the truth, and is therefore confused. Because the rules to be put in place at the end of March will set in stone a two-speed Europe, they are bound to generate resentments that will endanger the EU’s political cohesion.
Two fundamental modifications are required. First, the European Financial Stability Facility must serve to rescue the banking system as well as member states. This would allow sovereign debt to be restructured without precipitating a banking crisis. Despite this added task, the size of the rescue package could remain the same, because any amount used for recapitalizing or liquidating banks would reduce the amount needed by governments.
Bringing the banking system under European supervision, rather than leaving it in the hands of national authorities, would be a fundamental improvement that would help restore confidence. And it would have the additional merit of enlightening the German public about the true purpose of the rescue operation.
Second, to create an even playing field, the risk premium on the borrowing costs of countries that abide by the rules will have to be removed. This could be accomplished by converting the bulk of their sovereign debt into Eurobonds. Individual countries would then have to issue their own bonds with collective-action clauses, paying the risk premium only on amounts that exceed the public-debt limit (60% of GDP) set by the Maastricht criteria.
The first step could and should be taken immediately; the second will have to wait. The German public is a long way from accepting it; yet it is clearly needed in order to reestablish a level playing field in Europe.
The EU has been built step-by-step, with its architects knowing in advance that each step was inadequate and that additional steps would be needed. They could be confident, however, that when the time came to correct a deficiency, the necessary political will could be summoned.
This time, by contrast, the prospect of a two-speed Europe is bound to undermine Europe’s political cohesion – and thus its ability, when necessary, to act in unison. That is why the need for the next step in European integration must be clearly acknowledged alongside implementation of the EU’s crisis-resolution mechanism. Otherwise, deficit countries will have no reason to hope that they can escape their predicament no matter how hard they work.
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The escalating war in the Middle East must be understood in a broader context. The fact that the Iranian regime felt emboldened to risk a direct strike on Israel attests to a changing world order in which Western power is increasingly open to challenge.
considers the implications of Iran’s unprecedented decision to launch a direct strike on Israeli territory.
NEW YORK – The so-called euro crisis is generally seen exclusively as a currency crisis, but it is also a sovereign-debt crisis – and even more a banking crisis. The situation’s complexity has bred confusion, and that confusion has political consequences.
Indeed, Europe faces not only an economic and financial crisis, but also, as a result, a political crisis. The various member states have forged widely different policies, which reflect their views rather than their true national interests – a clash of perceptions that carries the seeds of serious political conflict.
The solution that Europe is about to put in place will be effectively dictated by Germany, whose sovereign credit is necessary for any solution. But this ignores Germany’s major share of responsibility for the currency and banking crises, if not for the sovereign-debt crisis. France’s efforts to influence the outcome are ultimately limited by its dependence on its close alliance with Germany for its AAA sovereign ratings.
Germany blames the crisis on the countries that have lost competitiveness and run up their debts. Consequently, Germany places all the burden of adjustment on debtor countries. But this ignores Germany’s major share of responsibility for the currency and banking crises, if not for the sovereign-debt crisis.
When the euro was introduced, it was expected to bring about convergence among eurozone economies. Instead, it brought about divergence. The European Central Bank treated all member countries’ sovereign debt as essentially riskless, and accepted their government bonds at its discount window on equal terms. This induced banks that were obliged to hold riskless assets in order to meet their liquidity requirements to earn a few extra basis points by loading up on the weaker countries’ sovereign debt.
This lowered interest rates in the so-called PIIGS countries (Portugal, Ireland, Italy, Greece, and Spain) and inflated housing bubbles just as reunification costs were forcing Germany to tighten its belt. This caused both the divergence in competitiveness and the banking crisis in Europe, which affected German banks more than others.
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Access every new PS commentary, our entire On Point suite of subscriber-exclusive content – including Longer Reads, Insider Interviews, Big Picture/Big Question, and Say More – and the full PS archive.
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In fact, Germany has been bailing out the heavily indebted countries as a way of protecting its own banking system. For example, Ireland’s massive sovereign debt arose because eurozone authorities, intent on saving the banking system, forced the Irish to nationalize their banks as a condition for keeping them afloat. Thus, because the arrangements imposed by Germany protect the banking system by treating outstanding sovereign debt as sacrosanct, debtor countries must bear the entire burden of adjustment.
This is reminiscent of the international banking crisis of 1982, when the World Bank and the International Monetary Fund lent debtor countries enough money to service their debts until banks could build up sufficient reserves to exchange their bad debts for Brady Bonds in 1989. That meant a “lost decade” for Latin America’s economies. Indeed, the current arrangements penalize debtor countries even more than in the 1980’s, because they will have to pay hefty risk premiums after 2013.
There is something inconsistent in bailing out the banking system once again and then “bailing in” holders of sovereign debt after 2013 by introducing collective-action clauses. Moreover, the competitiveness requirements demanded by Germany will be imposed on an uneven playing field, putting deficit countries in an untenable position, one that might even drag down Spain, which entered the euro crisis with a lower debt ratio than Germany. As a result, the European Union will suffer something worse than a lost decade; it will endure a chronic divergence in which the surplus countries forge ahead and the deficit countries are dragged down by their accumulated debt burden.
Germany is imposing these arrangements under severe domestic pressure, but the German public has not been told the truth, and is therefore confused. Because the rules to be put in place at the end of March will set in stone a two-speed Europe, they are bound to generate resentments that will endanger the EU’s political cohesion.
Two fundamental modifications are required. First, the European Financial Stability Facility must serve to rescue the banking system as well as member states. This would allow sovereign debt to be restructured without precipitating a banking crisis. Despite this added task, the size of the rescue package could remain the same, because any amount used for recapitalizing or liquidating banks would reduce the amount needed by governments.
Bringing the banking system under European supervision, rather than leaving it in the hands of national authorities, would be a fundamental improvement that would help restore confidence. And it would have the additional merit of enlightening the German public about the true purpose of the rescue operation.
Second, to create an even playing field, the risk premium on the borrowing costs of countries that abide by the rules will have to be removed. This could be accomplished by converting the bulk of their sovereign debt into Eurobonds. Individual countries would then have to issue their own bonds with collective-action clauses, paying the risk premium only on amounts that exceed the public-debt limit (60% of GDP) set by the Maastricht criteria.
The first step could and should be taken immediately; the second will have to wait. The German public is a long way from accepting it; yet it is clearly needed in order to reestablish a level playing field in Europe.
The EU has been built step-by-step, with its architects knowing in advance that each step was inadequate and that additional steps would be needed. They could be confident, however, that when the time came to correct a deficiency, the necessary political will could be summoned.
This time, by contrast, the prospect of a two-speed Europe is bound to undermine Europe’s political cohesion – and thus its ability, when necessary, to act in unison. That is why the need for the next step in European integration must be clearly acknowledged alongside implementation of the EU’s crisis-resolution mechanism. Otherwise, deficit countries will have no reason to hope that they can escape their predicament no matter how hard they work.