Saturday, March 6, 2010

An exit strategy for the euro crisis

The Italian Finance minister (Corriere Sera 6 March) is right to say that there is no exit strategy at the moment, but only a crisis management. The Greek debt crisis has highlighted the limits of the eurozone governance and the need for a durable solution to the euro crisis. The measures taken by certain governments like Latvia, Portugal, Spain and Greece to cut wages to restore fiscal consolidation are unpopular and may also have some deflationary consequences. Soaring budgets deficits in almost all European countries are not the cause, but the consequence of the crisis. The situation might also be different in other more developed countries: for example in the United Kingdom, the government has increased public investment because private investment has declined. The experience of Japan deflation in the 90s confirms that if private sector is de-leveraging- reducing spending to reduce its debts- then public sector cutting its deficit will deepen, not lighten recession. This is what Keynes called the 'paradox of thrift'.

The debate between 'laxist' countries (the so-called 'Pigs') and those defending financial rigor is a sterile one. It is evident that the Greek issue has become an European one, but this is also the case for the other countries at risk such as Spain or Portugal. French and German banks hold more than 60% of debts in those countries, but why creditors are pushing them in the hands of speculation and eventually to a 'default' situation?

This means that European solidarity is inevitable to avoid a possible disaster and new forms of economic governance need to be invented. There has been a lot of hesitation about the idea of an European loan of 25 billion euro to provide liquidity to the Greek economy, but now the IMF seems in pole position to act as a last resort lender, undermining the foundations of the Economic and Monetary Union.

The Greek debt crisis is a serious one and the government has to act in a responsible way to restore its credibility. But what happens in Greece is in fact a massive speculative attack which might extend to the whole European continent. This is largely caused by the absence of measures to regulate financial markets after the financial crisis of August 2007 and the solvability crisis of September 2008 (with the collapse of Lehman Brothers). EU leaders cannot simply impose new austerity measures to the Greek government without any help. While the EU has helped non-eurozone states (Hungary, Latvia and Romania) struggling with balance of payments difficulties, it has no power to intervene when it comes to helping one of its 16 members. This means that Greece is less protected against speculation than a non member of the eurozone.

The Greek people cannot accept further sacrifice, while Goldman Sachs continues to sell CDS (Credit default swaps) without any transparency and scrutiny. This requires immediate action: the future EU authority in charge of financial regulation should bring this to an end and call for further investigations on conflict of interest of Goldman Sachs. The European Commission, the watchdog for competition matters, has the power to act against such illegal practices.

In terms of economic governance, the Lisbon treaty (art.122) provides the opportunity to set up a financial stability mechanism managed by the European Investment Bank 'EIB) in order to help member States victims of speculative attacks. The proposal put forward by the European socialists of the European Parliament is a step toward the construction of a European market of sovereign debt. Other recent proposals include the creation of an European debt Agency (Belgian PM), the emission of euro-obligations (Tremonti) and even a European Monetary Fund.

It is a time for radical reforms to regulate finance, so that 'creative finance' is brought to an end and does not generate transfers to those who gamble with the nations'resources. It is also a time to design an exit strategy that allows the public sector to serve the fundamental needs of the economy. We cannot return to the status quo ante.

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