Yesterday, Moody’s, the US ratings agency, warned that the rapidly escalating Eurozone crisis is threatening the standing of all the region’s governments as their ability to raise capital in the markets is increasingly questioned.
The OECD warned that as the euro crisis would infect the core European countries, it would “massively escalate economic disruption.”
However, even the warnings are coming months too late.
The big bazooka 2, Eurobonds, and the enhanced powers of the European Central Bank are all partial solutions –too little too late.
Bailing Out “Too Big To Fail” Eurozone Economies
In the past, the Eurozone problems were resolvable because the peripheral countries – Greece, Ireland, and Portugal – each represented less than 3 percent of the Eurozone economy.
However, if Italy or Spain fail to raise money at reasonable interest rates, how could these “too big to fail” economies be saved?
As in the case of the small euro countries, bailing out the two would require covering their public financing requirements for three years. The associated loans would amount to about $2.1 trillion. If the IMF were to fund one-third of the total, as it did in the case of the small peripheral countries, its share would amount to about $700 billion, almost twice the current new lending capacity.
In turn, the Eurozone countries would have to raise $1.4 trillion, which exceeds the available capacity of the current rescue fund by over $1 trillion.
Even if the bailout would be possible, any sudden stop of financing to Italy and Spain would have a recessionary spillover effect on the rest of Europe, the United States, and the BRICs.
Big Bazooka 2
The OECD call for “credible and large enough firepower” in the Eurozone was followed by the extraordinary appeal by the Polish foreign minister Dadoslaw Sikorski to save the Eurozone and the broader European Union from “a crisis of apocalyptic proportions.”
Simply put, the idea of the Big Bazooka 2 is that the Eurozone leaders would garner another large rescue package, which would comprise funds from the IMF, the Eurozone and the ECB.
From the German perspective, such efforts are ridden by moral hazards because the net effect would mean a disincentive to structural reforms and effective austerity programs. Further, huge sums of money would again have to come from Germany where growth is now slowing.
To deter such an outcome, Chancellor Merkel and President Sarkozy have sought to pave way for a fiscal union, but without Italy or Spain – that is, a de facto layered Eurozone.
Print Money, Be Happy?
President Obama has urged bolder, quicker and more decisive action in the Eurozone, or what the Europeans call the American way: Print Money.
The ECB could assume the role of the Eurozone’s lender of last resort. After all, it has tools to offer a bridge to illiquid individual financial institutions and sovereigns, including emergency liquidity assistance (ELA) and the securities markets program (SMP).
Unlike the Fed, however, the official mandate of the ECB is to focus on price stability, not employment. Mario Draghi, the new ECB chief, has been willing to cut rates, but is reluctant to go further, without Germany’s support.
Of course, the contagion prospects in the Eurozone’s periphery and now in its core is shifting increasing pressure on the ECB to expand its balance sheet more aggressively. But it would be naïve to expect that there will be supply just because there is demand.
The sheer size of exposed countries’ financing needs, along with moral hazard concerns in creditor countries, increase the likelihood of an IMF-co-sponsored international crisis response, with Eurozone countries assuming the first loss risk.
Besides, the option of printing money is no option to Germany and certain other creditors who fear a déjà vu with hyper-inflation.
Eurobonds, anybody?
After Brussels’ technocrats had denied the need for euro bonds for months, they are now trying to push them under the name of “stability bonds.”
The idea is to transfer a share of national debt issuance, say 40-60% of GDP , to the Eurozone, while the remainder remains at the national level, subject to idiosyncratic market and credit risk.
Over time, a liquid Eurobond market could augment that of the U.S. Treasuries. The bad news is that the realization of the Eurobond market is like an ambivalent love story: it takes time.
In the short-term, an important drawback is that the stability bonds mean potentially higher borrowing costs for creditor countries, which is why Chancellor Angela Merkel rejected the option quickly. The wider the gap between fiscally sound and struggling economies, the more difficult it is to reconcile the interests of these two sets of Eurozone countries.
In the long run, however, the creditors could be persuaded to join in, given sufficient conditions and fiscal guarantees at national level. But as Keynes once said, in the long run we’re all dead.
So what’s left?
Lehman Risk Multiplied
Three years ago, the Eurozone economies were still in better shape. Today, unemployment rates are very high. Monetary policies have been largely exhausted. Stimulus packages and recovery measures have dissipated. Old leaders have been discredited. Governments have been voted in and out.
In the United States, the “Lehman episode” took months; in the Eurozone, it could require years. Now the stakes are higher, and more global. In the U.S., the subprime mortgage market peaked at $1-$1.5 trillion, whereas the outstanding debt of the peripheral Europe amounts to $4.6 trillion.
The Eurozone’s systemic economic problems require comprehensive solutions, which lack political support. Meanwhile, time is about to run out.
Dan Steinbock is research director of international business at India China and America Institute (USA), visiting fellow at Shanghai Institutes for International Studies (China) and in the EU-Center (Singapore).