The Road from Depression

NEW YORK – Financial markets are driving the world towards another Great Depression with incalculable political consequences. The authorities, particularly in Europe, have lost control of the situation. They need to regain control, and they need to do so now.

Three bold steps are needed. First, the governments of the eurozone must agree in principle on a new treaty creating a common treasury for the eurozone. In the meantime, the major banks must be put under the direction of the European Central Bank in exchange for a temporary guarantee and permanent recapitalization. Third, the ECB would enable countries such as Italy and Spain temporarily to refinance their debt at a very low cost.

These steps would calm the markets and give Europe time to develop a growth strategy without which the debt problem cannot be solved. Indeed, the importance of developing a growth strategy cannot be overstated, because the debt burden – the ratio of debt to annual GDP – rises and falls in part as a function of the rate of economic growth.

Since a eurozone treaty establishing a common treasury will take a long time to conclude, in the interim the member states must appeal to the financial authority that already exists, the ECB, to fill the vacuum. In its current form, the embryo of a common treasury – the European Financial Stabilization Facility – is only a source of funds; how they are spent is left to the member states. Enabling the EFSF to cooperate with the ECB will require a newly created intergovernmental agency, which will have to be authorized by Germany’s Bundestag and perhaps by other eurozone members’ parliaments as well.