July 30, 2012
“Whatever it takes” seems to have acquired a totemic meaning among the world’s central bankers. It has long been among the favored market-calming phrases uttered by Ben Bernanke, chairman of the U.S. Federal Reserve. Now Mario Draghi, head of the European Central Bank, has tried it. “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro,” Draghi declared during a speech in London last Thursday. “And believe me, it will be enough.”
Presto. A rather frightening week in Europe ended in a muted glow of renewed optimism. The yield on 10–year Spanish bonds fell from above 7.5 percent to 6.93 percent—below bailout territory; Italian paper did much the same. Didier Reynders, the Belgian foreign minister, simultaneously called for a new mandate for the ECB, one allowing the Frankfurt-based bank to finance troubled economies (which it cannot now do) and push down interest rates.
Just to finish the week well, German Chancellor Angela Merkel and French President François Hollande announced jointly that they were with Draghi and his allies. The two pledged that they were “deeply committed” to the euro and “determined to do everything to protect it.”
Pretty good choreography. Europe is on the move. There is always the possibility that this latest hint of decisive action will prove another fizzle. But I do not think so. Europe is getting us ready for some major steps toward an exit from the European crisis. That is how the moment looks to me.
What will a full-fledged fiscal, financial, and economic strategy look like? Over the past months and years Europe has lurched toward one problem or another and put its fingers in many holes in the dykes. But it has fallen short of anything comprehensive enough to reassure either the markets or those suffering under merciless austerity regimes. Even the announcement in late June of a new bank supervisory agency was an advance without a convincing context—it was not part of a larger, persuasive whole.
Now we seem to be getting someplace. Last week, 16 of the most capable economic minds in Europe produced a comprehensive, politically dexterous report called Breaking the Deadlock: A Path Out of the European Crisis. “We believe that as of July 2012 Europe is sleepwalking toward a disaster of incalculable proportions,” the document begins. “The sense of a never-ending crisis, with one domino falling after another, must be reversed. This dramatic situation is the result of a eurozone system, which, as it is currently constructed, is thoroughly broken.”
The 11-page report was developed by a council of scholars and intellectuals assembled by the Institute for New Economic Thinking, a policy think tank founded in New York by George Soros, the noted investor. One of the refreshing things about this piece of work is how clear-eyed its authors have been in picking the eurozone crisis apart and addressing its components piece by piece.
There are the structural flaws inherent in the eurozone from the start, INET says, and these must be fixed for the long term. More immediately, there are the “legacy problems”—that is, the consequences of these flaws as we have them before us, awaiting urgent remedies.
A disaster of incalculable proportions? I asked Rob Johnson, INET’s executive director, how near a prospect this is. He located the melting core of the crisis in the danger of funding runs, and in consequence the liquidation of bond portfolios in several banking sectors. “The dynamic is explosive in Greece, nearly explosive in Spain, and in Italy it’s getting close to going wild,” Johnson said.
This means some “urgent short-run measures,” the report argues, and these have to involve a considerable measure of burden-sharing. As a number of commentators have asserted, the “legacy problems” do not belong solely to Greece, Spain, Italy, or Ireland. They belong to Europe because they arose from a debt dynamic in which both surplus and deficit countries participated. “There’s a tendency—in Germany, for instance—to think this crisis is all about the fiscal profligacy of the southern countries,” Johnson said. “We don’t begin to support that idea.”
The steps INET’s brain trust urges in the immediate term reflect this thinking:
• A short-term mutualization of debtor countries’ liabilities. This means an EU guarantee on existing debt in countries making sufficient fiscal adjustments and a guarantee on new debt to an agreed limit. The policy would involve both European rescue funds, the European Financial Stability Facility and the European Stability Mechanism; the latter would obtain a banking license so that it could borrow from the ECB and maintain its funding capacity.
• Privately held debt would be restructured by way of bond swaps that maintained the value of the paper but lengthened maturities. This is intended to create short– and medium-term cash flows for debtor countries.
• Fiscal and structural reforms that lead toward solvency but do not exact an output cost. In other words, find and favor policies that reduce public burdens but do not increase unemployment and force the closing of productive assets.
The burden-sharing is the prickly bit in this list: It will get very political in surplus countries such as Germany. But this leads to one of the interesting thoughts INET developed. The mutualization of debt is strictly limited to immediate-term solutions to legacy problems. “It is important to note what is not in the proposal: a permanent mechanism for common eurozone debt issuance,” INET’s report reads. Johnson explains the thought this way: “It’s to underscore that a finite responsibility is being asked. Anything else would be a complete nonstarter politically.”
What will the future EU look like if these big thinkers hold any sway? Here is the superstructure:
• It will have a banking union, including the financial supervision agency already in preparation;
• The Continent’s financial system will be reshaped to serve the real economy better than it does now;
• The “fiscal compact” agreed upon last March will be amended so as to allow members more latitude in using countercyclical policies. In other words, Athens or Madrid or Rome will have more room to apply stimulus when they are in recession and social stability—see Greece, see Spain, see Italy—is fragile.
• The ECB would take the role of lender of last resort. The European Stability Mechanism may act similarly (and hence the thought that it should get a banking license).
• The ECB would issue a risk-free asset not tied to any given country. This means that in cases of investor anxiety, the capital flight is to an asset class, not another country.
Sounds like a plan, as they say—the first we have had featuring this degree of thoughtfulness. As of this weekend, officials were already talking about one or another aspect of the INET report, notably an enhanced role for the ECB. Let us see. As usual, a hundred flowers are likely to bloom in Brussels before a consensus emerges. And they are likely to bloom slowly.