Europe needs to move from demure to decisive. It is hard for any bystander to rationalize the tepid and timid moves proposed by either the European leaders or the European Central Bank (ECB) regarding their sovereign debt crisis.
While the Americans’ prefered solution to the financial crisis is quantitative easing — flushing the markets with fresh liquidity and injecting capital into the financial institutions — the Europeans want to follow a fundamentally different path: Treating the root cause of the problem rather than its immediate after-effects. The European approach is similar to treating a patient dying from acute asthma with a long-term steroid treatment rather than prescribing a couple of puffs from an inhaler that will keep him alive long enough to see the long-term. Their approach — even if executed and implemented in its utmost detail — will lead to a collapse of financial markets, not only infecting Europe but also having spillover effects throughout the global system.
Peripheral European countries have unacceptably high levels of debt compared to gross domestic product, with that of Greece at more than 160 percent and Italy nearing 120 percent. The weakest links — Greece, Italy and Spain — together have accumulated more than $3.5 trillion in debt. Greece is effectively bankrupt and illiquid, while Italy and Spain are on life support. In its most recent effort to raise debt, and despite historically high yields, the German government was not able to place a third of its issuance last month — a historical first and a testimony to the fact that investors consider all such debt toxic — while, despite frantic calls by the French and the German tandem, the last European Union Summit to tackle the crisis came up horribly short.
Against this very negative landscape, there is still a way out. European leadership needs to act swiftly and decidedly to reignite the confidence of financial markets and address the root causes of the problem.
In the short-term, both the ECB and national governments in Europe need to ensure that liquidity is available in the markets. First and foremost, Italy and Spain need to be “ring-fenced” to stop contagion and enable them to remain solvent and get necessary help to finance their debts at affordable yields. The ECB has a major role to play here by standing as the lender of last resort and effectively guaranteeing all such debts. Second, a serious recapitalization program of the banks is required, similar to the US Troubled Asset Relief Program in 2008. Finally, Europe needs to help Greece through an orderly default of its debt. None of those points can be left to individual nations to decide upon; instead a coordinated and common approach is required.
In the longer-term, Europe needs to deal with the root causes of its paralysis. At the heart of it is the fact that individual nations are clasping to sovereign rights at the expense of the stability and longevity of the Eurozone.
Europe needs to strengthen the monetary union by changing the mandate of the ECB. It cannot act as an independent monetary authority as long as it does not have the financial wherewithal and weapons to deal with the financial crisis without going back to all its member nations. Its mandate has so far been to ensure price stability and nothing else, a purpose deeply rooted in the history of hyperinflation that hit Europe at the end of World War One. But the mandate now needs to reflect the reality of today’s financial markets: Adding an economic growth objective to its line of fire and becoming the lender of last resort thus allow it to instigate programs of quantitative easing without resorting prior authorization from France, Germany and the parliaments of all remaining nations. Second, the European monetary union is facing a serious fiscal dis-union. As long as different Eurozone nations have structurally different fiscal needs and objectives, monetary union will be cracking at the seams. Authority and decision-making will have to move away from Paris, Berlin and Rome towards Frankfurt and Brussels.
The stakes are too high to let the Europeans test whether their long-term approach would work. Decisive actions are needed. They were due yesterday.
HENRI CHAOUL is the general manager of Master Capital Group in Lebanon