Editorial

It's been a year since Greece's incoming Socialist finance minister publicly announced that the country’s deficit was twice the size of what the previous conservative government had predicted, namely 12 percent of GDP, with a debt of 120 percent of GDP. The announcement sent an uneasy ripple effect through European financial markets and triggered a feverish debate about the sustainability of the euro. Suddenly, the European economic and monetary union seemed like a daunting obstacle course.

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Premise: It’s useless to blame greedy speculators when an unexpected a shock wave, including what in the case of Greece amounted to a public accounts hoax of sensational proportions, destabilizes the European Union (the same holds true for issuing blame in connection with the disruptions cause by the U.S. sub-prime mortgage crisis). Bearish speculation, which in extreme cases cause institutional investors to withdraw from the auctions that treasury ministries rely on daily to replenish securities and keep ahead of debt deadlines, represents nothing more than a knee-jerk defense against the limitation of potential future losses (“a flight toward quality”) by those entrusted with managing the life savings of millions of families. A time long ago, a country’s public debt (its so-called “sovereign debt”) resided almost exclusively in household portfolios and resident banks. Neither had much opportunity move toward better-quality securities.

The globalization of today’s financial markets makes risk-induced movement toward safer securities more physiological than pathological. Investors worried about their returns will inevitably bolt toward more secure options. They can.
Promises of improved economic policies and domestic reform issued byacrisis-ridden country don’t by themselves represent a remedy when a euro-zone nation stands on the verge of defaulting on its sovereign debt (even if it’s only partial default, as in rescheduling). Before they return to auction pit, investors and speculators need to believe in the most basic of terms that governments and central banks (starting with the European Central Bank) have a bottomless well of ammunition to use against default. They need to be convinced that they can safely purchase the shares of a member nation with troubled sovereign debt, thus preventing a collapse in prices and reserves, knowing all the while that they’ll later be able to reinvest the shares when the default risk has diminished or vanished altogether. That, in a nutshell, was the message issued by Brussels on May 10 when it delivered its €750 billion anti-crisis package (€440 billion came from euro zone countries, €220 from the International Monetary Fund). The package constituted aloan-guarantee vehicle for euro nations in distress. Any rescue package also depends concrete plans made by the troubled nation to correct its fiscal shortcomings and imbalances, carried out under close supervision of the rescuers.

In the Greek case, the EU had only one alternative, which was to write nthe Greek case, the EU had only one alternative, which was to write off the Greek debt. But that choice in turn risked inviting the same situation to arise in Portugal and Spain (and other potential member states) with the obvious risk of zone-wide infection and the collapse of European financial markets. The prospect of that kind of systemic crash hardly bothered some American academics, including John Cochrane of Chicago Business School, who, in an opinion piece published in the May 18, 2010 edition of the “Wall Street Journal” (“Greek Myths and the Euro Tragedy”) paradoxically sustained that sovereign debt default could be the decisive test of survival of a eurogoverned by a new set of rules. By those rules, each member state would be solely responsible for its own national fiscal policy. The Treaty of Maastricht, which outlined the parameters of fiscal deficit and debt in terms of GDP (already violated by “good guy” nations such as France and Germany, both under pressure from growing unemployment and low growth between 2002 and 2004), would go out the window. So would the notion of arranging rescue packages. Instead, imprudent investors would be left entirely on their own to deal with the meltdown in securities caused by the defaulting nation.

In short, until political Europe managed to forge a united fiscal policy it was pointless to insist in coordinated fiscal policies and disciplinary action that would come undone at the first hint of a storm. To those worried that the default of a euromember state, however small, might dangerously infection of the European banking system and its financial markets, Cochrane blithely responded: “If everyone knows there are no ‘bailouts,’ you won’t get contagion.” Pity that the reality faced by governments doesn’t always work like the toy models conjured by economists. Moreover, as the respected Italian economist Luigi Spaventa pointed out on several occasions, the Maastricht Treaty had no provision for a euro member state leaving the currency without also leaving the EU - with the foreseeable disruption on European expansion that such a withdrawal would inevitably produce.In a morerealistic vein, Harvard economist Martin Feldstein (“Washington Post,” May 18, 2010), long skeptical regarding the success of a monetary union that lacks any federal management of public finances, nonetheless praised Germany’s ratification of a constitutional clause that called for the introduction of balanced budgets by the year 2020. He hoped Germany’s example would induce all euro zone member nations to introduce constitutional amendments similar to those that already operative
in the United States, which permits individual U.S. states to borrow only based on the cost of investments. But doubts still persist regarding both the plausibility and effectiveness of extrapolating German- or American-style constitutional amendments for application to the euro zone, if not to the entire European Union. Based on the pressure of repeated crises, what Europe appears to believing through at the moment is slow and laborious approach to the creation of a political, or federal, Europe, whose absence continues to represent the fundamental element of weakness in the monetary system governed by the ECB. Recent crises provide an incentive (and an opportunity) to inch closer to community governance. While Maastricht formulas need review, its treaty’s substance does not. It should help give rise to an embryonic Euro-zone treasury. At the start, such a treasury wouldn’t even begin to replace national ministries. What it would do, however, is guarantee emergency intervention in support of the sovereign debt of member states. It would also introduce effectiveand legally-binding supervisory bodies that limit the amount of sovereign debt in terms of GDP.

It’s worth pointing out that in addition to the matters of debt and financial stability, Europe increasingly faces problems regarding its competitiveness. Old and new competitors (and clients) are beginning to make their global economic mark. This competitiveness isn’t measured in terms of export and trade balance numbers alone, but also, according to useful definition provides by the OECD, the “ability of nations to pass the test posed of international markets, while at the same time maintaining and increasing the real income of its own population.” Using this second and significant demand as a baseline, nations with strong, export-oriented economies that are weak went it comes to the growth of domestic demand (Germany and Japan are two) fall shortof winning plaudits. This is the fundamental challenge posed by the co-called “Lisbon strategy,” which should be revived in the name of the Treaty of Lisbon, which called for a “highly competitivesocial market economy” (no, not an oxymoron). A number of recommendations in support of such thinking is contained in the report “A New Strategy for the Single Market,” which Italian economist Mario Monti turned over to European Commission President José Manuel Barroso in May. In the longer term, “Project Europe 2030. Challenges and Opportunities” also issued May findings. Among the long-term challenges that can’t be postponed indefinitely, three stood out: Finding alternativeenergy sources (including safe nuclear power), the issue of mobility and flexibility in the labor market under the concept of “welfare to work,” namely competition between regions
to attract federal capital and to better value the resources of human capital.

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