European policymakers like to extol the strength of the euro zone: relative to the United States, it has a much lower fiscal deficit (four per cent of GDP, compared to almost 10 per cent for the US). Moreover, unlike the US, the euro zone does not have an external deficit, which means that the monetary union holds enough savings to finance all of its members’ budget deficits and resolve their debt problems.
But, despite this relative strength, the European Union’s (EU’s) leaders seem incapable of resolving the euro zone’s sovereign-debt crisis. Despite meeting after meeting, heads of state and finance ministers have failed to reassure markets. Now, Europe’s policymakers are appealing for help from the International Monetary Fund (IMF) and Asian investors.
This appeal for outside help is misguided, given the reasons that have caused the euro crisis to go from bad to worse, despite the EU’s abundant resources. The key problem is the distribution of savings within the euro zone. The countries north of the Alps have excess savings, but Northern European savers do not want to finance indebted Southern European countries like Italy, Spain, and Greece. That is why the risk premium on Italian and other Southern European debt had risen at one time to five per cent, and why, at the same time, the German government can issue short-term debt at negative real interest rates. Northern Europeans’ reluctance to invest in their southern neighbours is the problem behind the problem.
The German government could change this if it were willing to guarantee all Italian, Spanish and other euro zone debt. But it is understandably loath to do so, owing to the high risk involved. The European Central Bank (ECB) could also help solve the problem by agreeing to buy debt that has been shunned by financial markets. But, like Germany, the ECB understandably lacks enthusiasm about this solution.
So the stand-off continues, and the crisis worsens. The world’s major central banks recently agreed to make more dollar liquidity available, mostly to European banks. This has eased the immediate liquidity crisis, but the fundamental debt problem remains, because the Italian government cannot fund itself at reasonable interest rates.
Because the euro zone finance ministers could not agree on an internal solution, their latest idea is to call on the IMF to finance an extra-large support package for Italy. But this might be wishful thinking. Why should the IMF’s non-European members agree to finance a massive support programme for a member of the G7 and the euro zone that has no external balance-of-payments problem and stronger public finances than most other developed countries?
A month ago, the euro zone’s heads of state arrived at another way to appeal for foreign funds: the European Financial Stability Facility (EFSF) could package euro debt and sell it to foreign investors such as the Chinese and other Asian central banks. Here the same question arises: why should China buy Italian debt when Germany shuns it? Even if China agreed to buy the debt, it would likely consider buying some of the special paper that the EFSF plans to issue only if it obtained some political concessions and an implicit guarantee from Germany.
But it makes no sense for Germany to pay a political price for doing something – guaranteeing other countries’ debt – that it has consistently refused to do. The political concessions that China would probably demand – for example, EU recognition of the country as a market economy, or a greater voice within the IMF – may be overdue. Nevertheless, these issues should not be linked to the euro zone’s inability to solve its own problems.
Moreover, a large inflow of funds from the IMF, China, or elsewhere could do more harm than good to the extent that it puts upward pressure on the euro’s exchange rate — and thus makes recovery in the crisis countries even more difficult. German growth could survive a stronger euro, because its exports are much less price-sensitive, but countries such as Italy and Greece, which must compete on price, would be weakened further.
Europe’s policymakers cannot offshore the euro zone’s problems. Europeans can and must deal with this crisis themselves.
One option discussed these days is a special fund, financed by the ECB’s major national central banks and placed at the IMF’s disposal to help Italy and Spain. This would harness the ECB’s resources without formally violating the EU’s Lisbon Treaty, which forbids central-bank financing for governments.
This plan would have the advantage of forcing the euro zone to rely on its own resources. But it would also fully expose Europe’s political weakness and lack of coherence. Indeed, if it turns out that a detour through the IMF is needed to allow the ECB to provide liquidity to countries like Italy and Spain, the rest of the world will ask why Europe cannot be more candid about the ECB’s central role in this crisis. Good question.
The writer is director of the Centre for European Policy Studies © Project Syndicate, 2011
