As I argued in Sunday’s Business Post, the best solutions to Ireland’s problems are Europe-wide. On the other hand, Wolfgang Münchau believes that Europe’s political class are simply not up to the job. A growing number of commentators are arguing for a ‘big bang’ solution to the Eurozone crisis; and yet last night’s Eurogroup meeting had nothing new to announce.
It is not surprising that Europe’s finance ministers are finding it difficult to agree on a way out of the Eurozone crisis. They have boxed themselves into a corner in which this is almost inevitable.
The Eurozone is suffering from several major problems right now. The first is the lack of nominal exchange rate flexibility, but let’s leave that aside for now. A second major problem is that the solvency of its banking system is currently guaranteed by a series of stress tests that Ken Rogoff described yesterday as ‘pathetic’.
Let us assume that less pathetic stress tests were to reveal that there were holes in the European banking system that needed to be filled. The question then would be how to fill these holes. Assume that private investors will not fill the holes on their own until they are confident that the underlying problems of the banking system have been solved. That leaves three options. The holes could be filled by the ECB. The holes could be filled by existing bondholders, with their claims on the banks being converted into equity. Or the holes could be filled by European taxpayers. My guess is that the optimal solution would be an interior one, involving a little bit of each. But Europe’s politicians are determined to force us into a corner solution, one senses out of timidity as much as anything else.
If we rule out the ECB option on political and legal grounds, that leaves bondholders and taxpayers. If Europe’s political class rules out the bondholder option, then taxpayers will be stuck with the entire bill.
In such a situation, the only relevant political question is: whose taxpayers should pay, either explicitly, or implicitly via some sort of Eurobond arrangement? This is an inherently divisive question, and it is hardly surprising that Europe’s finance ministers are finding it difficult to achieve consensus in such circumstances. The prospect of the major cleavage in European politics in the years ahead being one between furious core taxpayers, and equally furious periphery taxpayers, is a good reason to be pessimistic about the future survival of the Eurozone.
If bondholders were brought back into the picture, the politics would be less poisonous: European taxpayer interests on one side, bondholders on the other. Exclude that option and you are setting up a slow-burning confrontation with potentially disastrous consequences.
History is littered with examples of international economic institutions that were intended by their architects to last forever, but which failed. This is typically because while the economics of the situation demand particular solutions, political constraints rule these out. By unnecessarily ruling out the bondholder option, Europe’s politicians are making it more likely that the Euro will one day be added to the list of failed institutions.
On the upside, we would then regain our exchange rate flexibility, which would be a very good thing. But it’s a gain that would come at a pretty steep cost.
Update: I just saw this article in the FT, on the growing political gap between Northern and Southern Eurozone countries. Expect to see more of the same…