Download Slide 1

How to save the euro
PX Eurozone crisis debate
27 October 2011
Dr Andrew Lilico
www.europe-economics.com
Outline
• Yesterday’s deal
• Who’s in and who’s not
• Why any form of debt pooling should be rejected
• Different issues in different countries
• Solution for “banking crisis” countries
• Solution for “competitiveness crisis” countries
www.europe-economics.com
Yesterday’s “Deal”
• Recapitalise EU banks (~€100bn)
• 50% haircut for private bondholders
(~€200bn / 2 = ~€100bn)
– No credit event
• Leveraged EFSF four to five times
(perhaps €1tr-€1.4tr)
• Governance stuff
www.europe-economics.com
Strengths and weaknesses
• Strengths
– It could have been even more stupid
• Weaknesses
– Recapitalising banks => shrink balance sheets =>
money stock drop => slump
– 50% Haircut
• Why only private sector? Why did EU rank ahead?
• Target debt/GDP = 120%. No buffer
• Failing to trigger sov CDS a bad mistake => Italian bond
yields up
– Leverage EFSF – just more debt pooling
www.europe-economics.com
Who’s in and who’s not?
• “Saving the euro” = EEC6 in currency union
– No Italy = no euro = no EU
• “Saving the euro” ≠ EMU17 in currency union
– euro can survive exit of Greece and Cyprus
– euro could even survive exit of Greece, Cyprus,
Portugal, Finland, and Slovakia
• Who’s in and who’s not is fundamentally a
political decision
– Proceed on assumption Greece and Cyprus are out
www.europe-economics.com
Reject any form of debt pooling!
• “Debt pooling” = any arrangement under
which Germany, France, Finland, etc.
become responsible for current Italian,
Spanish etc. debts
– “Eurobonds”; “leveraged EFSF”; “ECB
purchases of €trs of PIIGS bonds” are all debt
pooling
• Fiscal union ≠ debt pooling
– Collective debt issuance ≠ responsibility for
legacy debt
www.europe-economics.com
Debt pooling
• Without conditionality:
– In academic studies
(Gneezy, Haruvy and
Yafe, Economic Journal
2004), splitting the bill =>
36% higher bill
• With conditionality:
www.europe-economics.com
Different crises in different countries
2010 figures
(Eurostat)
Govt debt to
GDP
Govt deficit
Bank assets
to GDP
Avg Growth
2000-2010
Greece
143%
11%
173%
2.4%
Cyprus
61%
5%
586%
2.8%
Belgium
97%
4%
182%
1.4%
Spain
60%
9%
335%
2.1%
Ireland
96%
32%
328%
2.4%
Italy
119%
5%
163%
0.2%
Portugal
93%
9%
240%
0.7%
“Unsalvageable”
“Banking crisis”
“Competitiveness Crisis”
www.europe-economics.com
Solution for “banking crisis”
countries
• Disentangle state from banking sector
• Banks distressed => impose debt-equity swaps
– Bring forward EC “bail-in” proposals to now from 2013
• Part of more general special resolution regime for banks
• Do not cast good money after bad (“recapitalisation”)
– Not
• an irrational market error
• a “speculator attack”
• simply insolvency from past losses
– Banking bailouts
• Immoral (tax the poor to spare rich the consequences of their errors)
• Economically destructive (moral hazard; financial instability)
• Failed strategy, even in own misguided terms
www.europe-economics.com
Solution for “competitiveness crisis”
countries
• Raise growth rate enough for countries to
service own debts
• How? Eurozone-only structural funds
(“Eurozone competitiveness funds”)
– Monies spent by Brussels (so no lobster problem)
– Monies spent by Brussels (so no vassal problem)
www.europe-economics.com
Amounts required
– Ireland in 1990s: 0.5% of GDP on structural funds
– Italian + Portuguese GDP = €1.8tr => 0.5% = €9bn
• Might need twice this level in early years to be credible
• cf structural & cohesion funds budget = ~€58bn per year
– Key: spend on investments => GDP growth effect, not
just levels
• Might need to rise over time, even with some growth effect
• cf cost of debt pooling
– Effectively taking German and French debt exposures
to current Italian levels
– add ~ 100bps to funding costs => ~€36bn per year
www.europe-economics.com
Curlicues
• Real money, not “guarantees”
• Initiative principle would be different
– Structural funds match funding to govt projects
• Match funding abandoned
– Brussels initiative to spend => spending sovereignty
centralised
• Accompanied by tighter fiscal policy constraints
– Probably any budget running a deficit above 2% of
GDP to be approved by Brussels
– => fiscal sovereignty centralised
www.europe-economics.com
Longer term
• Funding for Eurozone competitiveness funds:
– Initially fund with Eurozone member contributions
– Later impose special Eurozone taxes
– With a funding stream in place, could issue own debt
• Call these “Eurobonds” if you like, but they aren’t debt pooling
(no legacy debt)
• Eurozone taxes + spending sovereignty, and
curtailed Eurozone Member fiscal sovereignty =>
need for democratic mechs
– Eurozone finance minister, perhaps directly elected?
www.europe-economics.com