As the euro zone scrambles to extricate itself once again from a mess of its own making with what appears to be an 11th-hour deal to save Greece from imminent default, the markets should keep their relief in check. At the heart of the euro-zone crisis lie a series of deficits: fiscal deficits, bank capital and liquidity deficits, and productivity deficits. But the biggest deficit of all is the shortage of political leadership. As so often over the past year, politicians have found just enough resolve to avoid immediate disaster. But without far greater bravery from Europe’s leaders, the next crisis won’t be long averted.
![[AGENDA_LCE]](https://i0.wp.com/si.wsj.net/public/resources/images/EI-BL378_AGENDA_DV_20110531184901.jpg)
European Pressphoto Agency
The biggest leadership deficit lies in Greece. Athens kick-started the euro crisis last year when it revealed that a combination of fraudulent accounting and widespread tolerance of tax evasion had saddled the country with a far bigger deficit than anyone had imagined. Prime Minister George Papandreou’s government triggered the latest problems by backsliding on its commitments to the
European Union,
European Central Bank and International Monetary Fund to embark on major privatizations and structural reforms. Instead, it wasted precious months this year holding the euro zone to ransom with threats to restructure debts.
Only now its bluff has been called has Athens agreed to deliver on its promises in return for further bailouts. The alternative is a disastrous default and likely exit from the European Union. But even now the government is reluctant to shrink its bloated public sector, preferring to put the bulk of its fiscal consolidation on tax measures. Meanwhile, the opposition plays party politics over issues of national survival, undermining public acceptance of the program. No wonder other EU governments are reluctant to trust Mr. Papandreou and want strict conditionality to any loans.
Not that the rest of Europe is blameless. For too long, European governments turned a blind eye to weaknesses at the heart of their project. The single currency was always going to depend on member states exercising fiscal discipline and boosting their competitiveness to achieve convergence. Yet the
Stability and Growth Pact that was supposed to deliver these goals lacked teeth; Europe stood by as Germany and France flouted the Pact by running excessive deficits. Greece wasn’t the only country to reap the benefits of lower borrowing costs while refusing to reform; protectionist efforts to flout single market laws remain rife.
Worse, the architects of the euro launched it knowing it contained a fatal design fault: euro-zone government bonds were zero-weighted for bank capital purposes even though, unlike normal government bonds, they were not backed by a government with the power to issue its own currency and therefore were exposed to credit risk. That gave banks an incentive to load up on higher yielding peripheral country bonds, driving down borrowing costs and fuelling a disastrous borrowing binge. This crisis was predictable–and predicted.
But now the crisis has arrived, where are the statesmen prepared to spell out the hard choices to save monetary union? A default now would be catastrophic, not least because of the contagion effects upon government and bank borrowing costs. Yet instead of putting pressure on Greece to stick by its promises, some politicians destabilized markets with unrealistic talk of a debt restructuring. Worse, the rhetoric of the past few weeks has reduced the political space for the hard decisions needed to draw a line under the crisis. Last year, governments watered down a new competitiveness pact by refusing to hardwire tough sanctions into the rules. The euro zone has also ruled out issuing euro-zone bonds that might ease the funding costs on troubled euro-zone sovereigns. Meanwhile, it has failed to tackle the crisis in the banking system.
The latest round of bank stress tests may improve the capital position of Europe’s banks, but the really big problem is liquidity. Greece, Ireland and Portugal already face a credit crunch given their banks’ reliance on ECB funding; rising Spanish and Italian bank borrowing costs are the biggest risk to those countries hitting their growth targets. Yet measures that might improve bank funding—such as allowing the European Financial Stabilization Fund to take pressure off sovereigns by taking stakes in banks and guaranteeing funding— remain firmly off the agenda. The logic of the crisis is that banks should be regulated at a European level; until governments recognize this, the pressures on individual states—and the political risks to the euro—will be immense.
As things stand, the only European institution prepared to spell out these truths is the European Central Bank. This is a dangerous place for a central bank to be, reinforcing the perception the EU is run by unelected bureaucrats and lacks a mandate. European leaders consistently say they are determined to do whatever it takes to save the single currency, but have too often been prepared to duck hard choices, leaving the ECB to go to the outer limits of its mandate to preserve stability.
Europe needs leaders with the courage to spell out the hard choices and the inevitable loss of sovereignty. Few people voted for this kind of Europe, few want it now, people have a right to feel angry. But the option of turning back the clock 20 years doesn’t exist. A break-up of the euro zone would be a political and financial calamity that would threaten the survival of the European Union. On the other hand, it is still just about possible the euro zone could exit this crisis more united, more powerful, more transparent, more accountable, more competitive, more prosperous.
Greg Lance - Watkins (Greg_L-W)
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