The Next Steps to Resolve the Eurocrisis
CAMDEN, Maine -- Once again, Europe’s leaders did not brandish the big bazooka that the markets are crying out for. Instead, Europe is doggedly pursuing its step-by-step approach as introduced several summits ago. Given the continuing disconnect between markets and politicians, we know from experience what will likely happen next: After an initially favorable response, the markets will realize that the latest comprehensive plan wasn’t all that comprehensive; that there are not enough short-term crisis resolution measures in Friday’s package to reassure investors about the safety of their assets; and that long-term fixes are impressive, but incomplete. Soon, politicians will scramble for what to do next to prevent a market meltdown.
Therefore, it is already time to map out the next steps. There are at least five:
1. Ensure European Central Bank (ECB) intervention: ECB President Mario Draghi has welcomed the results of the summit because they enforce spending discipline among the countries that use the euro. This positive outcome should reassure Draghi that temporarily enlarging the balance sheet of the ECB is acceptable when the goal is to keep the borrowing costs of southern European countries at a sustainable level. Increasing the volume of the bond purchases on the secondary market when necessary will go a long way toward communicating to the markets that no European country will let the euro fail and that the ECB will provide the bridge funding until the structural reforms work.
2. Prepare a eurobond proposal that Germany can accept: The original draft of the summit’s final statement called for eurobonds. On German insistence, the paragraph was struck from the draft. But German opposition is not as ironclad as it seems. Chancellor Angela Merkel has not said “no, never,” but rather “not now.” She sees eurobonds as the capstone of the European edifice. Last week’s summit results ensure that countries cannot borrow irresponsibly in the future while betting on a European bailout. This outcome should ameliorate Germany’s concern about moral hazard and allow the country to take steps toward formally assuming the joint and several liability that it already has in practice. The temporary “debt redemption fund” that the German Council of Economic Advisors proposed has the best chance of being politically acceptable.
3. Convince the United States to increase the IMF’s firepower: During the summit, the Europeans decided to funnel an additional $ 270 billion through the IMF to help build a wall of money around Spain and Italy in order to contain financial contagion. That’s good, but not enough. U.S. President Barack Obama has said that Europe has enough money to help itself. But the numbers don’t add up. To cover the borrowing needs of Spain and Italy for the next three years (the timespan needed for an adjustment program), $2 trillion will be required. The United States wants Germany to cover the lion’s share of that amount. But Germany is too small to carry such a load. German guarantees for its neighbors already excide next year’s federal budget by 80 percent, and debt already exceeds 80 percent of GDP. The IMF has a remaining lending capacity of $380 billion, now propped up by the Europeans to reach about $650 billion. Clearly not enough. After having travelled to Europe last week to pressure the locals, U.S. Treasury Secretary Timothy Geithner should now travel to Capitol Hill to convey the bad news. No longer do the Americans have the choice whether or not to spend U.S. taxpayer money to address the European crisis. The question is rather whether they would like to pay for the crisis by way of increasing the IMF’s firepower or by way of the global recession/depression that a collapse of the euro would inevitably cause.
4. Work on a growth agenda for Europe: So far, crisis resolution measures have focused on debt and banks. In order to avoid a repeat of the current predicament, Europe needs to rebalance and grow. The next steps toward a fiscal union, as well as the reform packages in the southern countries, need to focus on growth and the restoration of competitiveness. Northern Europe will need to play its part to allow for the adjustment.
5. Bring in Britain from the cold: No Europe without Britain. If British Prime Minister David Cameron’s veto against fiscal union is the first step toward Great Britain leaving the European Union, the summit will have been a pyrrhic victory for the euro-integrationists. Therefore, the countries that agree should present another offer to the dissident from the island. On the face of it, David Cameron’s request for safeguards for the British financial industry is not unreasonable as long as it does not require undoing the structural changes toward fiscal union. Only when Britain remains inside the tent will countries like Hungary, the Czech Republic, and even Sweden be enticed to stay there as well.
The financial markets might accept that no bazooka will be deployed as long as there is a credible plan for the next steps to be taken. “Step-by-step” should not be misunderstood to mean “stumble along.”
Thomas Kleine-Brockhoff, a Senior Transatlantic Fellow and Senior Director for Strategy, directs the German Marshall Fund’s EuroFuture Project.
The views expressed in GMF publications and commentary are the views of the author alone.