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How does it end?

Publishing date
13 November 2011

What’s at stake: As benchmark Italian bond yields remain stuck to unsustainable levels, the intersection set between necessary and politically feasible options remains empty, and policymakers openly express doubts on the everlasting intangibility of the euro area, a growing number of commentators seem to be running out of hope regarding a solution for the euro zone. As if it was not enough, the solutions contemplated by euro zone leaders to save themselves through integration have raised fears that this process would lead to a disintegration of the European Union.

The euro: thinking the unthinkable

Martin Wolf argues that the unthinkable – a euro breakup – has become all too thinkable. A eurozone built on one-sided deflationary adjustment will fail. That seems certain. If the leaders of the eurozone insist on that policy, they will have to accept the result. Nouriel
argues unfortunately this slow-motion train wreck is now increasingly likely. If you cannot devalue, or grow, or deflate to a real depreciation, the only option left will end up being to give up on the euro and to go back to national currencies.

Paul Krugman
still finds it hard to believe that the euro will fail; but it seems equally hard to believe that Europe will do what’s needed to avoid that failure. Irresistible force, meet immovable object — and watch the explosion.

Colm McCarthy
writes in the Irish Economy blog that European policy could be characterized as seeking sequentially the set of previously unthinkable measures needed to stop the rot and continually falling short. Working backwards, the bond and interbank markets could be stabilized by the following shock-and-awe package, with lots of moral hazard: (1) Hard default for Greece and for any other countries (not including Italy or Spain) which need them, calculated to make them unambiguously solvent on exit from their programs; (2) compulsory recapitalization for the banks; (3) an ECB reverse tap in the Italian bond market. If this set of actions is politically infeasible, and if no lesser package will work at this stage, the inference is inescapable and will be drawn soon.

Tim Duy
argues that the point of no return was reached when Germany and France openly discussed a smaller Eurozone. In a report that was subsequently denied by French officials, Reuters wrote that German and French officials had discussed plans for a radical overhaul of the European Union that would involve establishing a more integrated and potentially smaller euro zone. The discussions among policymakers in Paris, Berlin and Brussels raised the possibility of one or more countries leaving the zone, while the core pushes to deeper economic integration.

Barry Eichengreen
argues that if Merkel and Sarkozy are serious about preserving the euro, they will have to repair the damage caused by their reckless remarks. Their statements – that it was up to the Greeks to decide whether they wanted to remain in the euro – were designed to beat Greek politicians into submission, and may have succeeded, at least for now. But they also opened the door to destabilizing speculation, repeating the exact same mistake that led to the collapse of the European Monetary System less than 20 years ago. In September 1992, Bundesbank President Helmut Schlesinger made some reckless comments about how devaluations within Europe’s system of supposed stable exchange rates “cannot be ruled out.” Schlesinger’s unguarded remarks signaled that the Bundesbank was not willing to do whatever it took to preserve the system – a signal that encouraged investors to place massive bets against the British pound and Italian lira.

Free Exchange
argues that the difference with the ERM crisis od 1992-93 is that a euro break-up would not, as some seem to believe, be slightly messier. It would be a gigantic financial shockwave. What is vastly under-estimated by advocates of euro exit is the financial and social chaos that would ensue both in the departed country and in the rest of the world.

Brad DeLong
argues that the Fed needs to act now to firewall off the eurocrisis. The Federal Reserve needs to buy up every single European bond owned by every single American financial institution for cash before the increase in euro risk leads American finance to tighten credit again and send us down into the double dip. The Federal Reserve needs to do so now. Tim Duy argues that this is already too late to avoid a recession in the US. The time to move was this summer. To be sure, the ECB could still offer upside surprise by serving as the lender of last resort, which would ease the downside pain.  I don't anticipate the Fed will take on this role.  The Fed is probably still mulling over what they perceive to be the limited US exposure to Europe, just as they did with the US subprime debt.  And the relatively painless demise of MF Global probably reinforces that sense of complacency.  The Fed will react eventually, but US conditions will need to deteriorate markedly before they do so.

The German Council of Economic Experts
proposed the most radical plan yet to emerge from the German economic establishment – to end the eurocrisis. Under the plan, all existing member state debt above 60% of GDP would progressively be transferred into a common “Redemption Fund”, which will have total liabilities of € 2.3 billion. This Redemption Fund would issue bonds with a joint guarantee by member states. Each country would then be obliged to pay down its share of the fund’s liabilities. If it fails to pay, the other member states would, however, step in generating the solidarity needed to decrease funding rates. Member states commit themselves to pay down debt that has been transferred to the Redemption Fund over 20 to 25 years and to limit future sovereign debt by implementing national fiscal rules. If they fail to comply with these rules, they lose the ability to refinance their sovereign debt through the Redemption Fund.

The European Union: integration, disintegration, and a two-speed Europe

Charlemagne reports that Nicolas Sarkozy is causing a big stir after calling on November 8th for a two-speed Europe: a “federal” core of the 17 members of the euro zone, with a looser “confederal” outer band of the ten non-euro members. At first blush this is statement of the blindingly obvious. The euro zone must integrate to save itself; even the British say so. And among the ten non-euro states of the EU there are countries such as Britain and Denmark that have no intention of joining the single currency. But Mr. Sarkozy’s comments are more worrying because, one suspects, he wants to create an exclusivist, protectionist euro zone that seeks to detach itself from the rest of the European Union. In a recent interview, Sarkozy said the following: “I don't think there is enough economic integration in the euro zone, the 17, and too much integration in the EU at 27”.

Olivier Ferrand
– director of the think tank Terra Nova – writes that what is new in this debate is that the federal jump would take place within the framework of a two-speed Europe. This would be the triumph of the Monnet method as the political integration would come as a result of the “integration technique" required for the single currency. In this framework, a two-speed Europe would solve the dispute between the French and British conceptions of Europe.

Ulrike Guerot
– Fellow at the European Council on Foreign Relations – writes that what we need most is the construction of European democracy. We need to quickly undertake the right short term steps that may open the way to good long-term solutions. Frankfurt-Groups are only a distortion of this. And even treaty change to solely create a ‘stability union’ falls short of this goal. A monetary union cannot be run with tougher fiscal surveillance alone. The system needs sticks, but also carrots. Intermediate steps need to be designed and many proposals are already on the table. They go from electing the President of the European Commission to a parliamentarian two-chamber system, or establishing a chamber composed of national parliamentarians as Jean-Claude Trichet and Joschka Fischer recently suggested. Also, one could imagine a pro-rata Eurozone-Parliament, the harmonisation of election cycles within the EU to forge pan-Europeans debates and consensus, or, to follow Andrew Duff, British MEP, a certain percentage of MEPs could be elected on cross-national lists. Whatever the solution will be: the patience of citizens is running out.

*Bruegel Economic Blogs Review is an information service that surveys external blogs. It does not survey Bruegel’s own publications, nor does it include comments by Bruegel authors.

About the authors

  • Jérémie Cohen-Setton

    Jérémie Cohen-Setton is a Research Fellow at the Peterson Institute for International Economics. Jérémie received his PhD in Economics from U.C. Berkeley and worked previously with Goldman Sachs Global Economic Research, HM Treasury, and Bruegel. At Bruegel, he was Research Assistant to Director Jean Pisani-Ferry and President Mario Monti. He also shaped and developed the Bruegel Economic Blogs Review.

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