The world wants the eurozone to act, to do something that impresses the financial markets, a “big bazooka”, as David Cameron puts it. Among the recommendations generally given are an increase in the size of the European financial stability facility; a debt-monetisation programme by the European Central Bank; standby arrangements by the International Monetary Fund; bank recapitalisation, and a once-and-for-all resolution to the Greek debt problem. No matter what you do, do it now, and do it big, eurozone leaders have been told.
This is unhelpful advice, and if followed, it would make the crisis worse.My argument is not about symptoms and causes. It is about financial stability. A big bazooka, without a simultaneous commitment to a fiscal union in the distant future, could turn out to be extremely destabilising.
When the EFSF was first agreed last May, it was supposed to be the big bazooka. A shock-and-awe strategy, as one analyst famously called it. But it turned out to be a crisis propagator. The fundamental problem of the EFSF is that everybody guarantees each other in a game of domino. Italy’s guarantees make up 18 per cent of the system. But this 18 per cent lacks credibility. Italy is hardly in a position to pay its own debt, let alone guarantee someone else’s. While France is healthier, its guarantees to Italy also lack credibility. And so do German guarantees for France. If you follow the line to the end, there is no ultimate backstop.
If you double or treble the size of the EFSF without changing its underlying structure,all you do is double or treble the lack of credibility. If you really want to increase the size of the EFSF without destroying it, then you are left with two options: you have to back it through an unlimited guarantee by the ECB, the only organ in the eurozone that is in a position to give such a commitment. Or you have to change the EFSF’s legal status through the adoption of joint and several liability. This means that member states jointly agree everybody’s debt. The two options ultimately mean the same. The liabilities of the system will be shared jointly by all of its participants. If you want to annoy certain people, you could also call the latter a eurobond.
The fallacy of the national guarantees also applies to a recapitalisation of the banking sector. I would strongly favour an across-the-board increase in the core tier 1 capital ratios for all banks. But if member states end up providing the cash, the overall risk of the system remains the same. That also applies if the EFSF were to recapitalises the banks, since its ultimate liability also rests with member states. The best option to handle the bank recapitalisation would be through the European Investment Bank if only because it has unlimited access to ECB funds. Again, some form of joint and several liability is needed, or the facility of an unlimited ECB bailout. Both options are, of course, precluded by current law, and would require deep changes to national constitutions and European treaties. We are not talking about a bazooka here, but about some of the biggest political changes in the history of European integration.
If the European Council were to agree a three-stage for a fiscal union by 2025, the big bazooka might just work. The prospect of joint and several liability, and a eurozone treasury in the distance could pave for a temporary backstop of infinite size today.
But without even a faint prospect of a fiscal union, any increase in the size of national liabilities is politically and financially unsustainable. Just look at what happen in Slovakia this week, where the parliament vote against the ratification of the latest and comparatively modest EFSF treaty, forcing the resignation of the prime minister. This will not be the last political upset. So far, nobody has even transferred a single euro cent across their borders. Just imagine the politics and the financial contagion, once your doubled or treble guarantees fall due.
We have reached the end of the line with the present system of a monetary union that refuses to be a fiscal union. We are right at the edge of what is legally, politically and financially possible under the current legal and political structures. That is why the Europeans are tinkering, and not firing. To move, they need a new monetary union.
I always thought that the eurozone would eventually reach a bifurcation point when it will have to decide whether to adopt a fiscal union or break up. We are getting closer to this point. A big bazooka, not backed by any credible commitment to fiscal union, sounds like a great idea, but it would end up accelerating the break-up. If you want to preserve global financial stability, the message you should send to Angela Merkel and Nicolas Sarkozy is adopt joint and several liability, rather than encourage them to search for another elusive quick fix.
The writer is an associate editor of the Financial Times and president of Eurointelligence
Wolfgang Münchau is right to argue that simply shifting financial liabilities around does not make the underlying problems go away. Precarious banks will still be precarious and governments will still need to find pathways to fiscal consolidation.
But the reason for deploying the “big bazooka” is not so much about actually firing it, as persuading markets that it is there and could be fired. Knowing this, markets will be more hesitant about picking on the next victim, be it a bank or a sovereign. In this game of poker, the big bankroll does make sense because the speculators risk being burnt. Having it in place sooner rather than later must make sense.
Between them, governments and central banks unquestionably have the ability to generate large amounts of liquidity – it used to be called printing money. Even if the Italian contribution is open to doubt, the Austrians, the Germans and the Dutch are not constrained and a bigger commitment from them alone could make a huge difference. It is also arguable that, despite its formal structure, the current EFSF would in practice become joint and several guarantees if it ever actually had to cover for defaults.
Mr Münchau is also right to argue that a choice will soon have to be made between fragmentation and fiscal union, but he doesn’t spell out what the latter means. Fiscal union in the sense of commitments to fiscal rules is slowly taking shape in the euro area – too slowly perhaps and with the critical issue of compliance still to be tested, but far-reaching nonetheless.
Gradually, too, the euro is moving towards fiscal union in the sense of mutualising liquidity provision. Eurobonds are the logical end point of this form of union. It can be argued that we are now only one or two crises away from even the visceral German opposition to such a development being overcome.
Fiscal union in the sense of Germans paying directly for Greek public services is so far beyond the pale that it has become a pretext for inaction. Nor does it have any real bearing on the immediate financing challenges. Instead, what is needed is a short-term strategy for crisis management and a longer-term redesign of euro governance that includes eurobonds. A big and rapidly deployed bazooka is part of the former. Let’s not confuse it with the longer term solutions.
The writer is professorial research fellow at the European Institute at the London School of Economics and Political Science.