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New Year, Same Crisis

DAVOS – The measures introduced by the European Central Bank last December, especially the Long Term Refinancing Operation (LTRO), have relieved the liquidity problems of European banks, but have not cured the financing disadvantage of the highly indebted member states. Since high-risk premiums on government bonds endanger the capital adequacy of banks, half a solution is not enough.

Indeed, that supposed solution leaves half the eurozone relegated to the status of Third World countries that have become highly indebted in a foreign currency. Instead of the International Monetary Fund, it is Germany that is acting as the taskmaster imposing tough fiscal discipline on them. This will generate both economic and political tensions that could destroy the European Union.

I have proposed a plan that would allow Italy and Spain to refinance their debt by issuing treasury bills at around 1%. I named it in memory of my friend Tomasso Padoa-Schioppa, who, as Italy’s central banker in the 1990’s, helped to stabilize that country’s finances. The plan is rather complicated, but it is legally and technically sound. I describe it in detail in my new book Financial Turmoil in Europe and the United States.

European authorities rejected my plan in favor of the LTRO. The difference between the two schemes is that mine would provide instant relief to Italy and Spain. By contrast, the LTRO allows Italian and Spanish banks to engage in a very profitable and practically riskless arbitrage, but has kept government bonds hovering on the edge of a precipice – although the last few days brought some relief.