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Charlemagne
Still sickly
Mar 31st 2012 | from the print edition
WHEN the editors of the German tabloid Bild met Mario Draghi recently they gave
him a Pic kelhaube a spiked helmet to remind the Italian that they had last
year depicted him in Prussian garb as the most Germanic of candidates to run
the European Central Bank. It may come in useful: hardliners are taking shots
at Mr Draghi for spraying banks with 1 trillion ($1.3 trillion) of cheap
money. This powerful drug may have side-effects, he says, but it works: The
worst is over for the euro zone.
Don t be so sure. The fever has been rising again in Spain after the government
wildly overshot its deficit target last year. The Italian prime minister, Mario
Monti, expressed alarm (which he later withdrew) that the Spanish illness might
harm his own country s convalescence. Portugal and Ireland are in recession,
and may need second bail-outs; Greece will probably require a third rescue (and
the restructuring of official debt).
As fear returns, so have calls to boost the euro zone s rescue funds. The
mother of all firewalls should be in place, strong enough, broad enough, deep
enough, tall enough just big, says ngel Gurr a, secretary-general of the
OECD, the rich-world think-tank. But Germany prefers a slow, incremental
response. The latest signal is that it will agree, at a meeting of finance
ministers in Copenhagen on March 30th and 31st, to raise the firewall somewhat.
The temporary rescue fund, the European Financial Stability Facility (EFSF),
would be allowed to overlap with the permanent new European Stability Mechanism
(ESM), which is to be activated this summer. By combining the two funds,
perhaps only for a year, the lending capacity could be raised from 500 billion
to about 740 billion.
This may be enough to persuade the Chinese, the Americans and others to allow
the IMF to increase its resources, so helping the defences, but it is hardly
the overwhelming force Mr Gurr a seeks. Germany worries that reducing the
pressure on weak states will lead to complacency. The Germans think that the
only way to make countries reform is to dangle them out of the window, says
one diplomat. This only reinforces the belief in the markets that the euro
zone is on the edge of disaster.
One worrying sign for Germany was Spain s partly successful attempt to loosen
its deficit target this year. Another is growing trouble over the fiscal
compact , a treaty signed by 25 European Union countries to toughen budget
discipline. Ireland, with a history of awkward votes on EU treaties, holds a
referendum on May 31st. The Socialist front-runner in the French presidential
election, Fran ois Hollande, wants to renegotiate the deal to include more
focus on growth. Germany s opposition Social Democrats are making similar
noises. In the Netherlands the opposition Labour Party which is supposed to
support the minority government on European issues threatens to block
ratification if the government imposes austerity to meet next year s deficit
target of 3% of GDP. (Ill-disciplined countries that have received a
tongue-lashing from the Dutch are savouring the irony.)
Even assuming all these difficulties are resolved, the fate of the euro will
remain uncertain. Raising the firewall and ratifying the compact will address
only some of the symptoms. A cure requires treating the whole patient , as set
out recently in a clear-eyed paper by Jay Shambaugh for Brookings, an American
think-tank. It says the euro zone is afflicted by three ills: a banking crisis,
a sovereign-debt crisis and a growth crisis. Dealing with one often makes the
others worse.
A big problem is that the euro zone is only partly integrated. Its members have
given up economic tools, such as currency devaluation and monetary policy, yet
lack federal instruments to cope with shocks. The problem is not so much the
budget deficit (though Greece was certainly profligate) as the net foreign
borrowing by all actors, public and private (say to finance a trade deficit).
The euro zone has only small internal transfers, and its workers tend not to
move far for work. Fiscal stimulus is impossible for most governments, given
their indebtedness. Structural reforms to promote growth can take years to
work.
So redressing the imbalances must come through internal devaluation : bringing
down real wages and prices relative to competitors. This was easier before
1991, when inflation around the world was higher, but has rarely been achieved
since then (Hong Kong is one exception). With the ECB determined to keep
inflation at around 2%, internal devaluation brings severe recession, even
depression. And falling GDP wrecks the debt ratio.
Mr Shambaugh offers some advice. Deficit countries could cut payroll taxes to
reduce labour costs and raise VAT to discourage imports; the effect would be
magnified if surplus states did the opposite. Germany could help by stimulating
its economy, or at least slowing down its budget consolidation. The ECB could
let inflation run higher, especially in Germany, and could declare that it
stands fully behind solvent sovereigns. The EFSF/ESM could recapitalise weak
banks. A Europe-wide bank-deposit insurance scheme would help. Mutualising part
of the national debts would create a risk-free European asset.
The German problem (again)
All these options ultimately run into the same obstacle: Germany. It does not
want to bear bigger liabilities, it wants to set an example of budget
discipline, it refuses to compromise its competitiveness, it is allergic to
inflation, it does not want the ECB to print money and it thinks Eurobonds
create moral hazard.
There is little sign that the chancellor, Angela Merkel, is ready to do much
beyond tweaking the firewall and pushing through the fiscal compact. She talks
of a future political union . If she really wants to save the euro, she will
have to put on a Pick elhaube and lead the way to greater fiscal federalism.
http://www.Economist.com/blogs/charlemagne
from the print edition | Europe