The ECB’s Moment of Decision

LONDON – With the crisis of the eurozone’s periphery having mutated into a crisis of its core, the prescriptions for recovery must change. Fortunately, it is not too late, but an effective response must be immediate, overwhelming, and free of the ideological rivalries that have enfeebled the eurozone since the common currency was launched. The European Central Bank is the only institution that can generate such a response.

The eurozone now faces a classic currency crisis. Inevitably, this crisis – manifested, under a fixed exchange-rate system, through bond spreads – threatens to take down debtors indiscriminately, be they governments, banks, or households.

In attempting to save governments through fiscal austerity, banks are threatened with balance-sheet losses and a sudden collapse in confidence, while households suffer much higher unemployment. Attempts to shore up the banks through “stress tests” that lack credible recapitalization facilities and resolution mechanisms have undermined confidence in sovereign debt. In the end, it appears to be taxpayers who are hurt most by attempts to fight a debt crisis with more debt.

At the extremes, the eurozone’s debt problems can be solved through bailouts or default. By promising bailouts in return for fiscal austerity, governments have inevitably been pushed toward the prospect of socializing an unbearable amount of private debt. As the negative feedback loop between banks and sovereigns grows, confidence in a growing number of governments’ debt has steadily been eroded.