The longer-term refinancing operations launched by the European Central Bank last month have relieved the liquidity problems of European banks, but not the financing disadvantage of the highly indebted member states. Since high-risk premiums on government bonds endanger banks’ capital adequacy, half a solution is not enough. It leaves half the eurozone relegated to the status of developing countries that became highly indebted in a foreign currency. Instead of the International Monetary Fund, Germany is acting as the taskmaster imposing fiscal discipline. This will generate tensions that could destroy the European Union.
I have proposed a plan, inspired by Tomasso Padoa-Schioppa, the Italian central banker, that would allow Italy and Spain to refinance their debt by issuing treasury bills at about 1 per cent. It is complicated, but legally and technically sound. But the authorities rejected my plan in favour of the LTRO.
The difference between the two schemes is that mine would provide instant relief to Italy and Spain, while the LTRO allows Italian and Spanish banks to engage in a very profitable and practically riskless arbitrage but has kept government bonds hovering on the edge of a precipice – though the last few days brought some relief.
Contrary to the current discourse, the long-term solution must provide a stimulus to get Europe out of a deflationary vicious circle: structural reform alone will not do it. The stimulus must come from the EU because individual countries will be under strict fiscal discipline. It will have to be guaranteed jointly and severally – and that means eurobonds in one guise or another. Continue reading »