Europe, here comes your pitch

September 22, 2011

By Mark Dow

As I write, financial leaders from around the world have assembled in Washington DC for a long weekend of hard thought. The initial signs are not encouraging. Many top European policymakers, especially in Germany, still appear to be in denial about the gravity of the situation and the need for a holistic solution. There seems to be too much attention paid to Greece and Italy, too much adherence to hidebound rules and compacts, too great a desire to punish the misbehavers and combat market forces.

Germany is the lynchpin. Germany, understandably, objects to two things: committing more fiscal resources and further compromising the integrity of the ECB. Yet, any pitch needs to find a way to mobilize sufficient resources to:

  • A. Recapitalize the banking system
  • B. Provide ample liquidity to ensure financing of core countries (e.g. Italy, Spain and France)
  • C. Keep enough ammunition on hand to enforce the credibility of Europe’s commitment to the core

Against the backdrop of these challenges, the rest of the world at present is very, very concerned. If Europe goes down hard—and on current trajectory, it will—we all suffer. I can’t remember the stakes ever having been this high. This weekend may represent the last good chance for the ROW to come together and engage Europe in a forceful, coordinated solution, before global deterioration—which has already accelerated sharply—goes non-linear.

This is the pitch I think the IMF and the ROW should be making this weekend.

  1. Combine the resources of the EFSF (approx. € 445b) with those of the IMF’s NAB (New Arrangements to Borrow, roughly $500b)
  2. Use the ECB (perhaps with the support of other Central Banks) to leverage the EFSF and NAB funds. This will give Europe a de facto unlimited balance sheet with which to achieve A, B, and C above.
  3. Coordinate a deep restructuring of Greek, Portuguese and Irish debt.
  4. Do NOT kick Greece, Portugal and Ireland out of the single currency, at least for now

This would get Germany most of the way around its two objections, and could be embraced by most—if not all—of the EU. A deep restructuring of Greece, Portugal and Ireland would indicate that the EU “gets it” and finally has the resolve to take the pain and cut its losses.

Points 1 through 3 are relatively self-explanatory. The interesting element is number 4. Good economics would suggest that Greece, Portugal and Ireland need to regain a competitive position as soon as possible, and structural reforms, productivity gains and deflation is not a realistic game plan. And, in fact, I would imagine many EU citizens wouldn’t mind “kicking out the misbehavers”. However, the practical reality is that building a ring fence around Greece, Portugal, and Ireland would be much more expensive and challenging if these countries were to be forced out of the single currency. It would significantly increase the likelihood of bank runs in Italy and Spain. Martin Wolf in a recent article makes this point very well.

Unfortunately, this would extend the horizon of bleak growth prospects for the “mauvaises élèves” (Greece, Portugal, and Ireland). It is therefore ironic that these countries, in the aggregate, are strongly inclined to stay in the euro. But they associate the euro with a prosperity and stability that had proved elusive for long stretches of their histories. It is also something they have relied on to temper the extremes of their often unwieldy political processes. And, from the perspective of the rest of the EU, compromising growth in Greece, Portugal, and Ireland is almost certainly a price worth paying in the name of the greater good. It would be in everyone’s interest, eventually, to have the countries that do not fit well by economic and financial criteria in the single currency to leave. But for now, the urgent task is to take the looming prospect of a deepening financial and economic crisis off the table. In words I remember from the emerging market policy crises of the 90s: first you put out the fire, and then you worry about rewriting the fire code.

Good luck.


Comments are closed.