Solution to the Eurocrisis

Time to end the eurozone’s ad hoc fixes – FT.com.

Mr. Rhodes’ plan to solve the Eurocrisis is a good start. The problem is that his suggestions remain “inside the box.” A challenge of this magnitude requires innovative thinking, and radical measures ensure that the solution will be unpalatable to each and every one of the Eurozone countries.

A unified financial system, also known as a banking union, is a good place to start. This must be a real, reformed system and not a politically expedient plan to stop the markets from having a tantrum until the next summit. A genuine banking union will, at a minimum, contain these six elements:

  1. A joint depository insurance scheme
  2. The type of institution to be regulated (virtually all financial institutions should be included)
  3. A set of regulations
  4. An implementation schedule
  5. A way to legally allow countries outside the eurozone to participate in an ECB-led banking union
  6. A plan to deal with banks that are already in trouble or have been bailed out.

I write about these in detail here:

https://dareconomics.wordpress.com/2012/10/19/no-agreements-on-euro-banking-union/

The two main sticking points will be #2 and #6. For #2, no one wants the ECB controlling their local banks. For the last point, Germany and the Netherlands have some of the most overleveraged banks in the world and definitely do not want an outside party poking its nose around them. As I said, a solution to the Eurocrisis will be unpalatable to all concerned.

The author then mentions the ESM, EFSF and other bailout mechanisms created since the onset of the Eurocrisis. These programs are all clever ways to obfuscate the fact that the European taxpayer is now jointly and severally liable for the first few hundred billion euros worth of government debts in the countries that are to be bailed out.

I say dispense with this illusion and have all the eurozone members become jointly and severally liable for each others debts. The leaders need to lead. Explain to the people the severity of the crisis and that this step has to be taken to prevent the currency union from dissolving and causing a Great European Depression.

This step has a precedent. As part of the deal to replace the Articles of Confederation with the U.S. Constitution, the thirteen states transferred their debts to the newly created federal government. They all got into trouble as a result of their union against the British Empire, so they all decided to get out trouble together, too.

This brings us to the next step necessary to solve this crisis. Since Germany and the rich countries are kind enough to guarantee the debts of the periphery, all countries must agree to strict Teutonic budget discipline. Just like the American states must deliver balanced budgets every year, so must the new United States of Europe.

At first, this will cause even more pain and misery as austerity often does, but in the long run it will be worth it to ensure the stability of the currency. This step will allow the whole eurozone to slowly pay down their debts to sustainable levels over the next decade or so while ensuring that they remain out of trouble.

My last additional recommendation is a set of economic reforms for all the eurozone countries, not just the periphery. While the PIIGS suffer from over-consumption relative to the strength of their economies, the northern tier does not consume enough. This imbalance is at the heart of the eurocrisis and needs to be resolved to keep the eurozone out of trouble; the extra growth is also needed to help pay for these reforms.

While the periphery needs freer labor markets, countries like Germany must free their markets for goods and services to increase consumption so that they are not running perpetually large trade surpluses at the expense of their neighbors. A good set of reforms will anger all countries concerned equally.

Any plan to save Europe  must contain all of these elements. If it does not, you just have another can-kicking exercise.

While it’s really simple to devise a plan like this, the problem is implementation. While these four steps are a realistic way to address the Eurocrisis, I do not envision these countries curtailing their sovereign powers, which is central to the plan.

Politicians wish to grow their power, not surrender it. This is exactly why Rajoy has not requested a bailout for Spain and why there is so much infighting amongst the Greek parliamentarians regarding austerity.

Furthermore, the Germans, Dutch, Finns and Austrians will be financing this whole scheme. Kyle Bass said it more succinctly than I can write it, “Would you take on joint and several liability for your relatives’ debts?”

Bold action from a respected leader is what is needed here, but I do not see any George Washingtons only a Rajoy, a Samaras and a Merkel.

Advertisements

Leave a Reply

Please log in using one of these methods to post your comment:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s