What is the long-term euro vision?

May 21, 2012

What should be the long-term vision for the euro zone? The standard answer is fully-fledged fiscal, banking and political union. Many euro zone politicians advocate it. So do those on the outside such as David Cameron, Britain’s prime minister, who last week called on the zone to “make up or break up”.

The crisis has demonstrated that the current system doesn’t work. But a headlong dive into a United States of Europe would be bad politics and bad economics. An alternative, more attractive vision is to maintain the maximum degree of national sovereignty consistent with a single currency. This is possible provided there are liquidity backstops for solvent governments and banks; debt restructuring for insolvent ones; and flexibility for all.

Enthusiasts say greater union won’t just prevent future crises – it will help solve the current one. The key proposals are for governments to guarantee each other’s bonds through so-called euro zone bonds and to be prepared to bail out each other’s banks. In return for the mutual support, each government and all the banks would submit to strong centralised discipline.

But the European people are not remotely ready for such steps. Anti-euro sentiment is on the rise, to judge by strong poll showings by the likes of France’s Marine Le Pen and Italy’s Beppe Grillo. Germany’s insistence last December on a fiscal discipline treaty has stoked that sentiment.

An attempt by the region’s elite to force the pace of integration with even more ambitious plans could easily backfire with voters, particularly in northern Europe. They would fear being required to fund permanent bail outs for feckless southerners. Premature integration might not even help with the current crisis if it backfired with investors. They might start to question the creditworthiness of a Germany if it had to shoulder the entire region’s debts.

In contrast, the principle of “subsidiarity” – the Maastricht treaty’s specification that decisions should be taken at the lowest possible level of government that is competent to handle them – is good politics and good economics. Of course, even advocates of political union such as Wolfgang Schaeuble, Germany’s finance minister, subscribe to this principle. The issue is to define the minimum conditions needed for the sustainability of the single currency. There are probably three.

The first is that insolvent entities – whether they are governments or banks – should have their debts restructured. One of the main reasons states and lenders were allowed to leverage themselves so much in the boom was because there was a widespread view that they couldn’t go bust. The complacency sowed the seeds of the crisis.

Meanwhile, a key mistake in managing the crisis was the failure to restructure Greece’s debts as soon as they became unbearable. If that had been done, private-sector creditors would have taken the hit. Instead, they were largely bailed out – with the result that 74 percent of Athens’ outstanding 274 billion euros in debt is now held by governments and the International Monetary Fund, according to UBS. This means taxpayers will be on the hook when the big fat Greek default occurs.

Of course, if Greek debt had been restructured earlier, banks in the rest of the euro zone would have had big holes in their balance sheets. Some would have needed bailouts from their governments. But that would have been better than the current debilitating long drawn out sovereign-cum-banking crises.

What’s more, in the future, insolvent banks shouldn’t be bailed out either. Their creditors should be required to take losses before taxpayers have to stump up cash. The failure to do so explains why the government of Ireland, previously financially solid, become infected by its lenders’ folly.
The second minimum condition for monetary union to flourish follows the first: there should be liquidity backstops for banks and governments that are solvent.

With banks, the natural liquidity backstop is the European Central Bank. The quid pro quo is that lenders have to be properly capitalised. Time and again throughout the crisis, euro zone governments have ducked this issue. Only this month, France and Germany conspired to dilute the Basel 3 global capital rules as they apply to Europe, while Spain imposed another half-hearted restructuring on its banks. If the euro zone’s leaders want a successful single currency, this nonsense has to stop.

For governments, the natural liquidity backstop is the European Stability Mechanism, the zone’s soon-to-be-created bailout fund. To do its job properly, it will need extra funds – as it isn’t be big enough to help both Spain and Italy. One option could be to allow it to borrow from the ECB.

Again, the quid pro quo would be solvency. Insolvent government would only get access if they restructured their debts. And illiquid but insolvent ones would need credible long-term plans to cut their debts. Italy, with debt over 120 percent of GDP but huge private wealth and state assets, might one day find itself in the latter category. In return for liquidity, it might have to agree a multi-year programme to privatise real estate and to tax wealth.

The final minimum condition for a successful monetary union is much more flexibility, particularly in labour markets. This is the key to restoring competitiveness in southern Europe and enabling the zone to respond to future shocks.

If the euro zone can do these three things – restructure insolvent institutions’ debts, provide liquidity to solvent ones and improve flexibility everywhere – nations will be able to keep both the euro and much of their sovereignty. That’s a preferable vision to either a euro super-state or the chaos of disintegration.


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I just dont see southern europe becoming as productive as northern. if they want to keep a common currency then the wealthy northern states will have to accept a wealth transference to the south. A currency breakup is much more likely then your suggestion.

Posted by thebeorn | Report as abusive

Hugo, well reasoned and cogent. But the fly in the ointment remains the same – politicians who make rules, then bend or brake them at will i.e. Basel 3. Greece, Italy, Spain, etc. all made the same fundamental error. Politicians who wanted to be elected catered to special interests and promised the electorate pie in the sky. The only cure for this is to remove some level of sovereignty from individual countries. If a government fails in its fiduciary duties, it has to be removed forthwith and a more responsible team put in place. This obviously opens up a new bucket of worms. But so long as politicians in democratic governments want to be elected and stay in office, and particularly when there are numerous countries with a huge variety of internal issues, this type of crisis will not go away for any length of time.

Posted by steve778936 | Report as abusive

Your arguments do not apply to Greece which is singular case. Greece is an example of failed state which is disorganized, corrupted on a social scale and paralyzed. On the economic level, Greece is really not different from its Balkan neighbours but its standard of life was pumped up to a developed country level. Thus, Greece must return to its natural level. Either by austerity ot by ejection from the euro, the pain will be equal in both cases.

Others, like Spain, Portugal, Ireland can be dealt with.

Posted by wirk | Report as abusive

“flexibility in labour markets” – a euphemism for exploitation

let’s not have euphemisms and other peddling of waffle, say directly what you mean and intend to happen

(quote) “One of the main reasons states and lenders were allowed to leverage ….”

the greek politicians lied to their lenders and spain/ireland sucked up the puke from real estate speculation …. the banks and other corporate scavengers ably assisted this greed, even adding their own toxic investments to swindle “muppets” in the market

let’s talk about taxing financial transactions and maybe follow hollande’s line of thought for nasty surprises against those possessing obscene wealth without merit or endeavour

aka. we need “more flexibility” in taxing the accumulation of obscene wealth from market gambling and relieving its owners of the burden

Posted by scythe | Report as abusive

Greece is insolvent. No amount of creative accounting or restructuring can change the fact that it can’t pay back the money it owes. In reality it can’t even service the debt. It must default and must leave the euro, otherwise the same problem will inevitably arise again in the future.

It would surely be an act of the most monumental folly for the German government, or indeed that of any other eurozone country, to agree to underwrite bond issues of the eurozone as a whole, without having all the control and scrutiny that it currently enjoys over its own regions. Who is going to provide that control and scrutiny? This just isn’t going to happen without the full political union that this article quite rightly concludes, is out of the question for the people of Europe.

So where does this leave us? In a bit of a mess is the answer. There can be no guarantees that Spain, Portugal, Ireland and Italy won’t follow the Greeks into insolvency and/or leaving the euro.

Let’s at least be clear about one thing: who is to blame. The European Commission, which saw the potential for the eurozone project to lock everyone in to the inexorable and inescapable conclusion of full-scale political union. The speed of events has caught them out. There won’t be time now for the “project” to be completed. Let’s just hope that the suffering caused by the “project” unravelling does not lead to other, more terrible, consequences.

Posted by CO2-Exhaler | Report as abusive

the Euro is probably history, they can’t even recycle the Euro without something being stolen

Posted by running | Report as abusive

One problem you didn’t address is the same issue Germany keeps bringing up, and that is strict banking regulations and controls MUST be in place BEFORE advancing any more money.

Failure to do so will result in performing the same task over and over, but expecting a different result each time — a working definition of insanity.

Clearly, it is the system itself that is broken.

First fix the system, then advance more liquidity under very strict guidelines so that it actually reaches those who would ensure growth.

Banks, contrary to popular belief, are NOT interested in growth, but profits — the two are not necessarily the same. That is why banks MUST be strictly regulated to ensure they actually use the liquidity to generate growth.

The absolute NEED to restrain what banks do with the bailout money they are given — instead of the “no strings attached” policy in vogue since 2008 (a problem common to both the eurozone and the US) — should seem obvious to those in power on any level you care to name, but apparently is completely beyond their ability to grasp at even the most rudimentary level.

The continuing failure to do so is the underlying reason for the failure of the economy to recover.

ANY argument made to restore liquidity without strict regulations and accountability is WRONG, and is guaranteed to make the situation worse.

THAT is not theory, but a demonstrable fact!

WHY do we keep taking advice from the same people responsible for this economic disaster?

Clearly, at this point it should be obvious that these people either do not know what they are doing at ANY level of competence, or they are deliberately feigning ignorance for their own purposes.

In either case, it certainly is NOT in the best interests of the vast majority of people who will ultimately end up having to pay for this disaster!

Posted by PseudoTurtle | Report as abusive

“If the euro zone can do these three things … nations will be able to keep both the euro and much of their sovereignty.” (HD)

And if I was 6′-8″ I could slam-dunk a basketball.

Posted by MrRFox | Report as abusive

This vision looks like a nice soviet block where everybody bails everybody. So why not go bankrupt if you get bailed from the center anyway.

Posted by Qeds | Report as abusive

Sure one can fix it by turning Europe into a political en fiscal superstate.
In fact, the ESM Treaty does just that.
However, is comes at a terrible cost: it will do away with the sovereignty of each member state and cross out democracy in one single stroke.
Maybe European economics will be saved, but it will mean the start of a financial dictatorship. The people will very likely suffer.
Given the choice (if they get any), people will probably choose to suffer through an era of poverty in freedom and democracy, rather than choose to live in a Big Brother state that will claim all their tax revenues and will leave them only a glamour of freedom, or no freedom at all.

Posted by SGDB | Report as abusive

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Posted by Dawna Jack | Report as abusive