EU to-do list

First, the core problem is that the euro zone as currently designed is a failure. It has proven wrong to blend so many disparate nations into one currency, and then manage the currency according to relatively hawkish German preferences.

This is an unfortunate loss of face for the eurozone policy elite, but they need to get over this and move on.

The euro zone in its current form needs to be wound down, most likely being reduced to a core of countries that are sufficiently similar – and without the presumption that others will soon be admitted. The weaker countries badly need currencies reflect their national fundamentals. Germany does not need a weak currency, but Greece, Portugal, Ireland and Spain today do.

A depreciation of the euro against the dollar and other major currencies would help. But these nations trade more with each other more than with non-euro countries, so they need to change competitiveness relative to each other.

Even if by a miracle the worst outcomes are now averted, what will prevent problems like this from happening again if the euro zone stays in place? The euro authorities have demonstrated repeatedly they are incapable of regulating banks well at the eurozone or EU level – it is unimaginable that the 16 eurozone countries could get together around a table and declare that any one regulator has been seriously derelict.

The planned budget reforms at the EU level will push towards more discipline, but you need an incentive structure to get that and the consensus-based decision-making does not work for that. If this weekend only produces a reaffirmation of platitudes in this regard, next week will be very bad. This is fiddling while cities burn.

On top of all this, shocks to economic performance that are different across nations will persist. Sharing one currency across these very different and insufficiently convergent countries simply does not make sense.

Second, there needs to be an orderly plan for debt restructuring across the euro zone. This needs to be done quickly (this weekend works, but realistically it will take several weeks), while the exit to a new currency could take longer. Since most euro zone nations bonds are issued under domestic law, such restructurings should be able to proceed quickly (in emerging markets, most of the bonds are often under US or UK law, which generally makes restructuring much harder).

But do not think that Greece can restructure its debts without having broader repercussions. All the weaker eurozone countries must proceed together on this front or there will be chaos.

Third, the G20 needs to assist in the euro restructuring project. This body can authorize the International Monetary Fund to help each affected nation declare a standstill on debt, and then draw up a plan to restructure debt. The IMF should play a key implementation role in helping to decide which nations should restructure their debts and then support this process – not because it is particularly good or suited to this task, but simply because no one else is available.

During the next few years each troubled euro nation will need liquidity support from the ECB, and they will need fiscal financing from the IMF and core nations in the EU. Probably the G20 should commit more resources, at least as a back stop. These programs can be drawn up quickly, and, they should include a transition to a new currency where appropriate.

There is no real leadership in the EU, combined with complete unwillingness to admit the fundamental error of the euro zone itself. The Germans are happy to let other nations suffer for their past mistakes, so they will do nothing until there is a more complete crisis.

The ECB, as witnessed by Mr. Trichet’s news conference on Thursday, has decided that they will play the hawk, and so offer nothing of support to the nations in the periphery. Meanwhile, bond markets have closed for the periphery. This can only mean bond yields keep rising, there are runs on the banks in many nations, and then eventual economic collapse. This, unfortunately, is the path of least resistance for all parties.

So, someone needs to take leadership. Who can do this? Not the IMF by itself – it is too weak and conflicted with Dominique Strauss-Kahn clinging to his position as managing director (against increasing pressure from the United States). Indeed, Strauss-Kahn should leave the IMF so he can launch his run for the French presidency – it would be appropriately ironic if he were to win; as an architect of the eurozone, he is the perfect person to dismantle it. A much more independent person with international stature should replace him.

President Obama needs to step in personally to help this process work smoothly. The president can rightly claim that this is an international issue, not just a euro zone issue, since it impacts global trade and financial stability. All the world’s large banks are closely linked through debt, derivatives contracts, and other finance.

It would be irresponsible to presume that American banks will smoothly sail through the impending financial collapse in the euro zone. If this is left to the Europeans, as we learned this week in markets, there is a clear danger that Europe’s problems will topple the world into a new recession and a serious round of financial instability this year.

Someone needs soon to bring clarity and restore confidence. If not President Obama, who?

Written by Simon Johnson

May 7, 2010 at 8:57 am

Posted in Commentary

Tagged with eurozone crisis
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58 Responses

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1.

The “perfect” storm, as it has been described. Here is the opportunity (for the president) to bring confidence and calm back into the markets worldwide, the new realities being “All the world’s large banks are closely linked through debt, derivatives contracts, and other finance.”

Beth

May 7, 2010 at 9:13 am
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2.

Simon, thanks for making clear that there are too many inept and corrupt politicians in Europe as well as a number of jokers disguised as economists that are willing to advise them about how to continue the destruction of wealth. The most interesting part of your post is that a U.S. politician is the Only Savior. I can hear the Joker laughing.

E. Barandiaran

May 7, 2010 at 9:14 am
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3.

“If not President Obama, who?”

Gordon Brown…..

Peter Mountford

May 7, 2010 at 9:45 am
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4.

RESPECTFULLY, I disagree with Professor Johnson on this. If Germany and France want to stick their neck out, it’s dumb as H$LL, but fine, the French banks’ knees are shaking now, so they want to present themselves as innocent angels, fine it’s their business. But If President Obama spends one more red American penny on this (that includes indirectly with funds that haven’t already been given to the IMF) he’s a fool. A damned fool. And I don’t think President Obama is a fool…but that would be the action of a fool.

Just ask yourself one simple question : What would any of those European countries do (or did they do in Oct-Sept 2008) that would help America when our back is up against the wall???? Answer: ZERO

Ted K

May 7, 2010 at 9:49 am
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Ted, look into the details surrounding the Central Bank Liquidity Swap engineered by Bernanke and the other central bank heads around the world in the fall of 2008. It seems to have worked. The US Federal Reserve Banks took on a trillion bucks worth of these critters as an asset. The counterparties were the central banks of the world. The deposit quickly, almost immediately, travelled onto the books of the US banks as Reserve Deposits at their Federal Reserve Bank.

It might have been a trick but it worked until the Central Bank Liquidity Swap was mostly replaced by Mortgage Backed Securities guaranteed by Fannie and Freddie.

Jerry J

May 7, 2010 at 1:08 pm
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