The views I will express are personal ones, and not representative of any organisation with which I am associated.
I will start my speech with a quotation from Martin Wolf in today’s Financial Times.
“What is at stake today is not only the stability of the European, and perhaps the world’s economy, but the most successful and certainly most civilized effort to unite Europe since the fall of the Roman Empire 1535 years ago”
He goes on to criticise what the calls the “just enough, just in time” approach of EU leaders to dealing with the rapid loss of confidence in the sovereign bonds of euro zone countries. This approach has turned out to be too little, too late.
At this stage, I believe we need the outline of a comprehensive solution, with a timetable for its implementation, at the level of each of the 17 euro zone member states and at euro zone level. Each must fit into , and be contingent upon the other. 17 national plans and one European plan, synchronised each with one another, would give the markets a sufficient sense of direction that they would stop their destructive fear driven flight from the bonds of one European country after another.
WHY IS IT THAT EUROPE IS UNDER PRESSURE, WHEN ITS DEBTS ARE LESS THAN UNITED STATES DEBTS?
In the eurozone, the aggregate Government debt to GDP ratio is 87%, whereas in the US it is 100%
In all the eurozone countries, while there is some difficulty in some countries in implementation because of low growth rates and vested interests, there is broad agreement on measures to reduce these excessive deficits and debts where they exist, whereas in the US the Congress and the President cannot agree at all.
In that sense, the eurozone has the makings of a plan, whereas ,so far, the US has none, just a deadlocked all party committee of politicians who are trying to place one another in a false position. So why then is it Europe that has a problem, and not the United States?
The United Kingdom has an even bigger debt/deficit/and private borrowing problem that the euro zone has on average, and yet it is regarded as a safe haven while lenders flee from Italy, which actually has a primary surplus, that is to say that, apart from interest payments, its Government revenue exceeds its spending .
THE FOUR REASONS
1.) Although they is not willing to do so just now, the US Federal authorities have the legal capacity to levy taxes to pay off debts, whereas the EU does not itself have that ability. It has to rely on its individual member states to raise the taxes.
2.) There are bigger problems with Europe’s banks. The gross debt of the eurozone banks comes to 143% of zone’s GDP, whereas US banks debt only come to 94% of US GDP. Furthermore eurozone banks owe twice as much, proportionate to their assets, as US banks do.
3.) The assets of eurozone banks are disproportionately in the form of bonds issued by Governments. So if Governments are in financial trouble, that means trouble more trouble for banks in Europe, than would be the case for banks in the United States. In Europe the banks problems are the Governments problems and vice versa, in ways they are not in the United States. This unhealthy situation was, in part, the perverse result of rules designed to make banks sound, which encouraged banks to buy Government bonds as reserves, but which assumed, wrongly, that Government bonds were risk free.
4.) The US Federal reserve can, and does, ease money supply ( print money) to keep the economy moving, whereas the EU Treaties make it much more difficult for the European Central Bank to do this, partly because of historic German fears of inflation. For example, article 123 forbids the ECB to extend credit to member states. In a sense, it could be said that the euro was designed as a “fair weather currency”, rather than be able to cope with foul weather too.
WHAT IS TO BE DONE?
Not everything in these plans needs to implemented immediately, so long as people believe it will actually be implemented in a reasonable time.
The crisis we face is really as much a crisis of belief, as it is a crisis of finance. The finance is actually there, but the belief is not, at the moment. Part of the reason for the lack of belief is that markets sense that there is no shared analysis among European leaders about what is to be done.
Germans and their allies initially seemed to believe that the sole problem was one of foolish and blameworthy borrowers . Now all recognise a that the problem is also one of foolish and blameworthy lenders . That is why a haircut is being imposed on Greek sovereign bond holders. Understandably that has led to fears among bondholders of other states . That was foreseeable and must be catered for.
There is also the belief that , if everybody adopted the German model of super competitiveness, reducing wage costs and enhancing savings, we could come through the difficulty. The difficulty with this is that approach is twofold
*Germany already is an export oriented economy, the eurozone as a whole is not (in fact it exports as little proportionately as the US does)
*For Europe, or Germany, to run an export surplus to pay off its debts, someone else somewhere must be able to run an import surplus, and someone must be willing to finance the borrowing undertaken to finance that import surplus. It is not obvious who that will be. Both the US and China are cutting back.
For these reasons, I find the prescriptions for Europe laid out in the resolution on Europe, passed at the CDU Conference this week in Leipzig, incomplete and unconvincing.
*They are right to condemn deficits, but wrong to ignore chronic surpluses that create those deficits.
*They are wrong to rule out a euro bond unconditionally.
* They are wrong to try to change the voting weights in Europe in favour of big countries, but right to say that Europe needs more democracy and that the EU President should be elected by the people, not selected on a take him or leave him basis by heads of Government meeting in private
The ECB must act unpredictably, and with discretion, if it is to discipline the markets and return them to sanity. It must also act independently of Governments, so that no Government can rely on the ECB buying its bonds , as a substitute for getting its own finances in order.
2.) The second thing we need to do is deal with Europe’s banking problem.
Our banks have been allowed to grow too big to fail, relative to the small size of the tax bases of some of the countries who implicitly or explicitly guarantee their depositors.
Banks should be in a position that they can be allowed to fail, like other businesses.
If we had a Europe wide retail banking market, a Europe wide deposit guarantee scheme, and a Europe wide banking supervision system (as envisioned in the Maastricht Treaty but strangled by big countries who wanted to keep prying eyes away from their banks), we could allow banks to fail because few if any of them would be too big to fail in European context. Those that might be too big could be forced to divest themselves of part of their business.
3.) The third thing we need to do is enforce a Eurozone wide system to remedy economic imbalances. This should include excesses of private borrowing as well as excesses of Government borrowing. It should also address excessive surpluses which often destabilize markets as much as deficits do.
There are provisions to do all this in the recently agreed EU excessive imbalance procedure, which is not confined, as was the Stability and Growth Pact, to Government finances only. If there have to be EU Treaty changes in this field, they must address all types of economic imbalance, not just fiscal imbalances
4.)The fourth thing we need to do is produce a credible proposal for a Euro bond that could act as a much better and timelier means of disciplining Government borrowing , than fines under the Stability and Growth Pact ever could.
I think we will only get our economies going again, if we can restore belief in a fixed measure of value that will provide a capital base for banks, the role that gold performed in the past, and which the sovereign bonds of wealthy countries did until recently.
That is where the proposal for a euro bond could be helpful. It could be a lot more than a short term fix. It might work as follows.
All the 17 euro area Governments could agree that they would all mutually guarantee the repayment of a new collective euro bond, and that in addition it would have first call on (say) a fixed share of all VAT receipts.
They might also agree that, while no euro area country would be obliged to issue euro bonds, it could do so in limited circumstances, namely.
a,) that its budget law, and five year projections, had been approved in advance by the European Commission and
b.) the euro bond could only be issued cover a limited proportion of its total borrowing, as long as their overall debt/GDP ratio was more than (say) 60%.
This would have a number of advantages.
It would guarantee a minimum borrowing capacity to all euro area states. Because of the collective guarantee, the interest rate on the euro bond would be less than that on most national bonds.
It would, however, penalize countries for allowing their debt /GDP ratios to be over 60%, because they would be forced to borrow commercially and pay higher rates of interest on the extra borrowing, which would be a strong incentive to them to get their debt level down as quickly as possible to 40% or below. That would be a better discipline than retrospective fines, which are the form of discipline we now rely on.
Because it would be guaranteed by all euro area Governments, and have a prior call on VAT receipts, the new euro bond would have real credibility globally, as well as within the EU.
Banks who held such new euro bonds would then have something of real and certain value in their capital base, on the strength of which they could confidently base their lending decisions. In that way, credit would start flowing again, jobs would be created and permanent structural damage to our economies avoided.
If this happened, Europe, rather than being the world’s economic problem, could be the provider of part of the world’s economic solution