Europe must be persuaded to make a permanent fix

June 18, 2012

As the G20 leaders prepare to conclude their meeting today, once again good news has had a half-life in the markets of less than 24 hours. Just as news of European plans to stand behind Spanish banks rallied markets and sentiment for only a few hours, a Greek election outcome that was as good as could have been hoped did not even buoy markets for a day. There could be no clearer evidence that the current strategy of vowing that the European system will hold together, addressing each crisis as it comes in the minimally sufficient way and vowing at every juncture to build a system that is sound in the long term has run its course.

Nor is the G20 likely to change anything, at least not immediately. The troubled European economies and their sympathizers will demand more emphasis on growth, lower interest rates on their official debts and more transfers. The Germans will show sympathy with the objective of reform but will insist that financial integration must coincide with political integration, noting that no one gives away a credit card without maintaining control over its use. And the rest of the world will express exasperation with Europe’s failure to get its act together and demand that more be done. Officials blessed with more diplomatic ability than economic insight or courage will produce a communiqué that politely expresses a measure of satisfaction with steps under way, recognizes the need to do more, and looks forward to continued coordination and dialogue. The only good thing is that expectations are so low that this is not likely to disappoint the markets very much.

The unfortunate truth is that European debtors and creditors are both right in their main lines of argument. The borrowers are right that austerity and internal devaluation have never been a successful growth strategy, certainly not in an environment where major trading partners are stagnating. The suggested counterexamples, where fiscal consolidations have preceded growth, involve either stagnation relative to previously attained levels of income (Ireland and the Baltics) or buoyant demand associated with surging export demand, increasing competitiveness and low borrowing costs (many euro members in the early years). They are also right in their claim that even a previously healthy economy will quickly become very sick if forced to operate for several years with interest rates far above growth rates, as is the case across Southern Europe. And experience is clear in suggesting that structural reform is always difficult and slow-acting but much more difficult when an economy is contracting and there is no sector to absorb those displaced by reform.

Those chary of institutionalizing financial integration without major political integration are right as well. A sound system must involve those with deep pockets who are on the hook for liabilities, either as borrowers or guarantors, having control over borrowing decisions. A system where I borrow and you repay is a prescription for unsustainable profligacy. This is why there is now so much discussion of eurobonds and Europe-wide deposit insurance being linked with much deeper political integration. But there are two problems that lie behind the soft references to greater integration. The first is the question of who really has control. If decisions are to be made on a genuinely euro-area basis, it is far from clear, especially after the French election, that there is any kind of majority or even plurality support for responsible policies. If the idea is that the euro area’s future will be on the ECB model – a European façade behind which Teutonic policies are pursued – it is far from clear that this will or should be acceptable across the continent.

The second is the magnitude of the transfers that could be involved: A good guess would be that during the U.S. savings and loan crisis the American southwest received a transfer equal to at least 20 percent of its GDP from the rest of the country. Is there a real will to commit to potential transfers of this magnitude in Europe? Maybe all of this can be resolved, but it will surely not happen quickly.

Not all problems can be solved. It is not certain that the full repayment of all currently contracted sovereign debts, sustainable growth for all, and maintenance of all nations currently on the euro will prove feasible. The private sector, through its actions, is making clear that it recognizes this painful reality. Official-sector planning needs to recognize it as well. Outside of Europe, even as leaders hope for the best, they need to plan for the worst, ensuring adequate liquidity and demand in their economies even if the European situation deteriorates rapidly. The fortification of the IMF is a start in the right direction, but consideration needs to be given to national policies, to trade finance and to social safety nets as well.

But a euro-area collapse would be an economic disaster that might define this quarter century. Its prospect must concentrate the minds of all those in Los Cabos, not so much on reform as on immediate action. Little needs to be, or probably should be, said publicly. But those outside Europe must persuade those inside Europe that the rules change when the stakes rise. The ECB’s credibility will mean little if there is no longer a common currency. Issues of setting the right precedent seemed much larger 24 hours before Lehman than 24 hours afterwards. Now is the time for radical reductions in the rates charged by official creditors to European sovereigns, for a willingness to subordinate official debts – not for the purpose of privileging private creditors but to offer a prospect for systemic preservation – and for expansionary monetary policies in Europe that prevent deflation and encourage the growth that can create jobs and reduce debt burdens. Only if the system is preserved can its future be debated.

PHOTO: An Oxfam activist wearing a mask of Mexican President Felipe Calderon holds up a checklist during a protest in Los Cabos June 17, 2012. G20 leaders will kick off two days of meetings in the Pacific resort of Los Cabos on Monday. REUTERS/Andres Stapff


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The only good advise here from Mr. Rentier Capitalism is the rate reductions needed to avoid further shrinking of economic growth. Wealth transfer need not be as generous as Summers suggests as his motive is to both absolve responsibility from fraud, such as what occurred with both the S&L scandal and the TARP concealed investment bank crimes, but to assure that the so called investors can collect their continuous revenue stream, backed of course by taxpayers.

Posted by Greenspan2 | Report as abusive

I thought neoliberalism was the way of the future? What happened? Tell us again how awesome globalization is for everyone. You mean there is no such thing as unlimited growth and money doesn’t grow on trees? Someone should tell the governments and the banks. I can’t wait until the rest of the world adopts the mindless consumption model.

In a world dominated by creditors, trying to save the creditors will not fix the long term. The financial sector needs to be cut to half it’s current size at least. Like government, it s bloated, irresponsible, driven by greed and lacking morals and ethics. These financial crises are borne in the private sector.

Posted by TheUSofA | Report as abusive

The question is whether a people’s sovereignty over their lives and their land can be sold. Should the highest bidder rule? I think obviously not. Yet that is the system we use in the USA. And the highest bidder, the ruler, can choose war or peace and with whom. They can take and take in the form of taxes, abrogate obligations to the people as a whole, and stuff their pockets at the public treasury. They can print money without limit, and force “their” people to accept that script as payment.

There is no point whatsoever in repaying “loans” that were made to others without your consent. When law is twisted to cancel rights of freedom, it is no longer “law” but “edict”. Be careful who you loan money to and use your head to determine whether you are likely to be repaid.

Posted by usagadfly | Report as abusive

You promise to fix the US economy permanently Mr. Summers and I can assure you the EU will fix its accordingly!

Posted by SvenBolin | Report as abusive


“These financial crises are borne in the private sector”

Are you serious???

The government borrows too much money, cannot repay. So government forces bond buyers to take a loss by defaulting on its obligation. This results in people too scared to buy government bond driving the bond yield up.

The addition now is that some banks (in Spain) even guilty of blowing up real estate bubble now are eating up loan loss, don’t have enough money to buy Spain’s bond either. Yield go up even higher.

But at the end, the problem is the government! period!

Posted by trevorh | Report as abusive

Prosperity comes from less government and less government spending. A great nation will have zero debt, except in time of war; in fact it should have a cumulative surplus.

It is not the purpose of government to provide economic benefits to its citizens. Government is about rules and fair play, with no concern about the results.

Censorship is evil.

Posted by ALLSOLUTIONS | Report as abusive

If we accept that the Eurozone broadly has a core and a periphery who need different rates and values the only way this can be achieved is to have two Euros. The exchange rate between the two can be managed by the central bank as can the respective interest rate. This provides immediate but managed devaluation to the periphery. Certainly Germany will suffer as part of the core but much less than a total collapse. It also avoids the dreaded fiscal transfer. As the economies of the periphery improve then the value of Euro2 can be managed back towards that of the central Euro. The time taken to do this can be used to put in place a structure for future full fiscal integration. Not a perfect solution by any means but neither is doing nothing and hoping that something will turn up.

Posted by pavlaki | Report as abusive

The permanent fix is to run budget surpluses and pay down the debt.

Posted by mulholland | Report as abusive