After a long and costly delay, European officials’ narrative about the debt crisis is changing. This is the good news. The bad news is that Europe still lacks the political and technical leadership needed finally to catch up with this damaging crisis. As a result, Europe will soon be forced to consider radical options.
For too long, Europe has pretended that the crisis in its periphery was liquidity-driven rather than solvency-induced. Officials dismissed the need for debt restructuring, preferring a bail-out for Greece, Ireland and Portugal that piled new debt on top of an already unsustainable burden.
At first glance, this had the merit of delaying decisions that involve highly complex – and uncomfortable – financial engineering and political agreements. It also gave time to the weaker entities, be they countries or banks, to reduce their vulnerability.
But the delay has been costly. Peripherals implementing courageous austerity measures have been losing the support of citizens who feel, rightly, that their sacrifices have done little to improve prospects for their country.
Healthy balance sheets, including that of the European Central Bank, have also been contaminated by debt that will most likely be restructured. Sizeable liabilities have been transferred from the private to the public sector. And less sickly European economies – most recently Italy – have been undermined by the general loss of confidence in Europe’s ability to deal with a homegrown crisis.
Ironically, it was left to George Papandreou, prime minister of Greece, to acknowledge these disappointments this week, and to point to a better way forward. In a powerful letter sent to Jean-Claude Juncker, president of the Eurogroup of eurozone finance ministers and prime minister of Luxembourg, he argues that “going from crisis to crisis at such a weak stage of recovery, with such a cacophonous press and frightened public, is not any longer an option Greece can sustain”.
Mr Papandreou is right to point to the need for a better solution that covers debt sustainability, access to markets and growth. He is also right to warn of the danger of allowing politics to undermine the proper design of technical solutions. If Europe’s policymakers take the Greek prime minister’s words to heart they will conclude that the time for a strategic retooling of the eurozone is approaching.
This will be done in one of two basic ways. Europe could opt for greater fiscal union, first de facto and then de jure. Cost-effective guarantees and transfers, rather than just loans, would stabilise the region’s debt dynamics through the aggressive use of a unified European balance sheet. In return, individual countries would sacrifice a significant amount of national sovereignty and fiscal policy discretion.
If this is politically impossible to implement, and I suspect it may be, Europe should opt for a restructuring of the debt of the weak peripherals, recapitalising the ECB, protecting the payments and settlement system, countering other collateral damage, and restoring conditions for growth. At some stage, this could even involve a country taking a sabbatical from the eurozone – but not the EU - in order to regain the policy flexibility needed to restore competitiveness.
Neither of these approaches is easy or pleasant to implement. Each involves significant dislocations and requires skilful damage containment – a consequence of delaying necessary but difficult decisions. But the alternative of continuing to muddle along with a discredited approach would have even higher costs, and would quickly undermine the institutional integrity of the eurozone as a whole.
Mr Papandreou is right. It is “crunch time” and Europe is at “a fateful juncture”. The longer European officials dither, the smaller the scope for catching up with the spreading crisis.
The writer is the chief executive and co-chief investment officer of Pimco