Eurozone crisis non-solutions

A broader mandate for the ECB is not just the most desirable resolution to this crisis -it is by now the only solution to the crisis.

The ongoing debate about the way forward to resolve the Eurozone crisis is being hampered by a series of non-solutions that are being flogged by different parties. These false solutions do not help with resolving the crisis, but instead reflect existing national bias'. It is a toxic brew of lazy thinking and flippancy.

I intend to address a few in turn. Eurobonds; closer budgetary scrutiny; treaty change.



EUROBONDS.
Many commentators have spoken for Eurobonds, claiming that they will extend the creditworthiness of the Eurozone as a whole to each country, allowing those currently locked out of the markets to borrow. There are well rehearsed and real problems with this, in particular, that it will reward the profligate at the expense of the prudent and encourage further bad behaviour. It will in fact return us to the same pattern of misaligned incentives that amplified the problem in the first place. This alone should be enough to rule this approach out of consideration (though Ireland, typically unsure what to do, is actually supporting this daftness), but it is moot as far as I'm concerned, because apart from the problems of agency -it just won't work.

The Eurobonds idea creates an ultra safe investment asset for MSs to sell, up to the value of 60% of their GDP. It also accepts that national bonds sold after this are potentially defaultable (though why it would be more acceptable for this to happen after common European debt has been issued as opposed to now is a bit of a mystery). As most of the troubled countries have existing debts far greater than 60% of GDP, as they borrow, they will be making their existing debts increasingly risky, and expendable. In effect, Eurobonds will put an end to national bonds, only Eurobonds will be sellable, and once troubled MSs have sold 60% of their GDP's worth of Eurobonds, they will be unable to issue national debt to refinance their remaining loans -we will be back to square one. Eurobonds are a red herring.



CLOSER BUDGETARY SCRUTINY
I am not opposed to closer European budgetary scrutiny. Indeed in Ireland, it would be refreshing to have any budgetary scrutiny at all. However, this plan will not help the current crisis. Firstly, it presupposes that the external controls on national budgets will prevent financial disasters such as happened in Ireland and Spain. Given the excellent fiscal status of both Spain and Ireland in the years running up to the crisis, it is difficult to see what budgetary scrutiny would have changed. Low debts, high surpluses -just what are we to believe budgetary scrutiny would have done? In Greece, the statistics were falsified to obscure the truth -what would scrutiny have achieved here? Indeed, the countries that have come through this crisis best are those which consistently ran deficits in the run up to the crisis. It may perform some political function to allow central European politicians sell the upcoming losses to their electorates, but it serves no real purpose in the current crisis. Closer budgetary scrutiny is a red herring.



TREATY CHANGE
Treaty change is quite impossible in a useful timeframe -furthermore, the ratification process will introduce a new aspect of uncertainty into an already volatile situation. In particular, the likelihood of the UK passing a referendum on closer economic cooperation with the dysfunctional Eurozone is remote. Significant treaty changes will lead us into a world of pitfalls that we must avoid. Treaty change is a red herring.



QUANTITATIVE EASING
I have been quite a fan of quantitative easing in the US and the UK. I have a long standing belief that a small amount of inflation is a very healthy thing as it prevents money hoarding and compels wealth to be invested productively and profitably. In short it prevents depressions. Quantitative easing involves the Central Bank printing money, and then using this new cash to purchase government debts. The new liquidity released into the system creates a stimulus and prevents deflation. In a highly leveraged economy (such as Ireland), deflation is the path to disaster.

Nonetheless, at present in the Eurozone, inflation is running at over 2%, so deflation is not a problem except in certain localities. This does not bode well for the consequences of QE.

However, this will not last for long as forced austerity is probably going to descend on the continent once national budgets are agreed in December. Inflation will likely tick downwards as austerity bites, and perhaps then Quantitative Easing can be used to ease the money supply and relieve the debts of Greece. Finally, it must be made clear that this is a once off, and we must convince markets, funds etc. that the next time there is a sovereign crisis in Europe, they will have to eat their losses. A first step towards this would be to prevent financial institutions from using sovereign bonds as Tier 1 capital. Increasing their risk exposure to these assets should concentrate minds.

However, that is not an end to it -Quantitative Easing poses particular problems in the Eurozone. As it is a common currency, all holders of Euros across the Eurozone will lose wealth as the supply of money expands, while all indebted persons will benefit from the reduction in the value of their debts, and the proceeds from this money printing will be used to relieve the national debts of just a handful of highly indebted countries (or probably only Greece). This is undoubtedly unfair. It rewards personal and national bad behaviour and could be seen to give encouragement to the profligate.

However, unlike the other solutions currently being discussed -it will work. It is not a red herring, it is a real solution, and therefore, for all its lack of appeal, I support this approach. Combined with a coordinated austerity drive to balance Eurozone budgets, Quantitative Easing will increase the money supply, relieve the debt burden of Greece cause only modest, controllable inflation and save the Euro.