Who's Going to Save the Euro?

Model of the ECB's new headquarters.Model of the ECB new headquaretersImage via Wikipedia
Is the Euro dying? After the Irish debacle, ideas are floating around on how to save the Euro.The media is full of suggestions:

1. Transforming Europe's financial rescue fund, the 750 billion-euro ($975 billion) European Financial Stability Facility, into a European equivalent of the International Monetary Fund. This was first proposed by Mr. de Grauwe, a professor at the Catholic University of Leuven, in a paper comparing the current Euro crisis to the collapse in the early 1990s of the precursor to the euro, the European Exchange Rate Mechanism. At the time, it was investors betting on devaluations, today it's bondholders taking aim at the weakest economies, Greece first, now Ireland and Spain next.  But the European treaty revisions required to bring to life a European IMF would be hard to carry through in the current political climate, as most European governments fear having to go the referendum route and face European voter discontent. A related proposal is to expand the rescue fund by at least another €100 billion to meet other challenges. The fiscal emergency in Spain is on everybody's mind. As Spain is the Euro's fourth largest economy, its problems are twice the size of Ireland and Greece combined. A hair-raising prospect! But one hundred billion more would simply not be enough.

2. Asking bondholders to take a "haircut". That means forcing them to accept a share of the losses so that they are not all weighing down on taxpayers, who are, let's not forget it, the ones financing bailouts - so far some €200 billion to save Greece and Ireland. Daniel Gros, the head of the Center for European Policy Studies in Brussels, recalled how investors of Dubai World accepted to share the pain in return for a rescue by Abu Dhabi. Will European bondholders do the same? That's what Germany would like to see happen and Ms. Merkel talked about including "liability clauses" in new bonds to force bondholders to accept cuts as soon as next year. That proposal instantly sent the Euro down to a ten-week low, killing that idea.

3. Another idea is the Brady plan for indebted European economies. It was recently put forward by a former Treasury secretary, Nicholas F. Brady, who led an effort in 1989 to help Mexico and other Latin American economies restructure debt. The plan, criticized at the time — it required bondholders to take a loss of 30 percent in exchange for new, longer dated debt with lower rates backed by the United States -,  is now seen as the first step in Latin America’s recovery. The New York Times touts it but the trouble is that it's really nothing more than a subtle variation on the above "haircut" proposal. And remember, the US backed the Brady plan. Who is going to back a European version of it? Germany? You bet! One constant of German policy is that they don't want to pay for their Euro-partners' faults. Ask Merkel and she'll tell you: forget Europe!

4. Yet another idea is to float bonds issued jointly by Euro-zone countries. It seems that the European Central Bank would like that, but European governments are reluctant - particularly the Germans who fear that interest rates on such bonds would automatically rise to accomodate the weaker Euro countries - and of course, they're right: it's only logical. Thus Trichet is leary of pushing it too soon. So far, the only thing Euro-zone governments can agree on is to "follow the IMF model", whatever that might mean. And it might mean providing flexible credit lines to countries in trouble (like the IMF recently did for Poland) but so far it hasn't happened.

5. Flooding the economy with cash from the European Central Bank. That's the "quantitative easing" route followed by the American Federal Reserve. That lovely, somewhat obscure term just refers to  printing money: that's the one fundamental sovereign right of a country and a major tool to support (or depress) the value of its currency. The European Bank so far has done a "fair amount" of bond buying but unless it is given free access to the printing press, that is not going to be a route it can follow far, the way the Fed has. And indeed, up to now, its bond-buying has had modest results:  it hasn't prevented the growing difference in yields between German bonds and the others, the so-called countries in the "Euro periphery"  - Greece, Ireland, Portugal, Spain and more recently Italy and Belgium - Who would ever have believed that Belgium one day would become part of the periphery?

What is certain is that the European rescue fund would need  "twice the firepower," as de Grauwe said, pointing out that Ireland’s average interest rate on the bailout of 5.8 percent is “punitive.” That's not too surprising.  Ireland was viewed by Germany as a "sinner" and had to be made to pay for its sins. Fine and good. Ireland's political class had certainly acted in a stupid, irresponsible way when it guaranteed bank deposits 100 percent - something no one else has ever done anywhere in Europe or America. A crazy move that has had awful consequences when the real estate bubble burst American-style and banks began to fail because of their reckless investments.

The trouble is that such an interest rate on the Irish bailout, as Bloomberg points out, "jolts confidence by showing that European governments aren’t sure they’ll get their money back". Of course, they're not sure! If austerity programmes and measures to control budget deficits will cause further recession - and everyone is almost certain they will - there doesn't seem to be much of a way out, does it?

Any ideas? I believe we need to go back to the fundamentals and consider how the Euro was built. Remember it has only ONE leg to hobble on (provided by the Central Bank) and it's missing its SECOND LEG (a treasury - like the dollar has). In other words, it is missing a harmonized fiscal system.

The case of Ireland is illuminating: Ireland got us into all this trouble - and as one of my followers wrote in a recent comment, the Celtic Tiger turned into a miserable cat - because of several stupid decisions by its political class. Not only did the government guarantee bank deposits without any coordination with the rest of its Euro partners, but it had applied for a long time a whole series of taxes at much lower rates than the rest of Europe. Most notably the famous 12.5% rate on corporations that has turned Ireland into a tax haven and a Trojan Horse into Europe: major American corporations are headquarted in Dublin (eg. Google) and others are thinking of coming provided Ireland keeps its corporation tax untouched (eg. Microsoft). So in its proposed austerity package, Ireland has raised taxes but, bowing to the demands of multinationals, it has been careful not to touch that particular tax.  Euro partners in the bailout haven't even reacted. Or if they have, it didn't show up in the press. Amazing! Yet, the austerity package proposed might have been more contained if that particular tax rate had been tweaked upwards, by say one percent. Surely that would not have discouraged Microsoft from moving to Dublin!

I am totally convinced that without fiscal harmonization the Euro will not survive. And Europe will have missed out the opportunity of a lifetime to bring about the ideal of a United Europe. I know that's a tough road to go, particularly in the current climate with a meek political class afraid of taking any risks, but there really isn't any other...

What do you think? What are your bets that the Euro will survive? Who's going to save the Euro? Is there somebody out there with the guts to do it?


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