The Euro’s Real Trouble

Written on July 18, 2011 by Ángeles Figueroa-Alcorta in Europe, Foreign Policy, News, Political Economy

The crisis of the single currency is political as much as financial.

Anyone struggling to understand why Europe has proved incapable of putting an end to the euro’s crisis might find answers in a bad-tempered dinner at a summit on October 28th 2010. The argument was over a demand by the leaders of Germany and France, made days earlier at Deauville, for a treaty change to create a permanent system to rescue countries unable to pay their debts. Everyone groaned. It had taken years of tribulation to agree on the European Union’s Lisbon treaty, which had only recently come into effect. But they bowed to Angela Merkel, the German chancellor, who wanted to prevent any challenge to the new system by Germany’s constitutional court.

However, Jean-Claude Trichet, president of the European Central Bank (ECB), worried about something else: her demand that future bail-outs must include “adequate participation of private creditors”, meaning losses for bondholders. That could only alarm the markets, he thought, still jittery after the Greek crisis in the spring. “You don’t realise the gravity of the situation…” began Mr Trichet. But he was cut off by the French president, Nicolas Sarkozy, who interjected, one Frenchman to another: “Perhaps you speak to bankers. We, we are answerable to our citizens.” Mrs Merkel chimed in: taxpayers could not be asked to foot the whole bill, not when they had just paid to save the banks.

The politicians won the day. But Mr Trichet’s worries have also been vindicated, as contagion has spread and is now engulfing Italy (see article). The dinner-table row illustrates how, throughout the sovereign-debt crisis, the requirements of financial crisis-management have collided with political, legal and emotional priorities. Indeed, the euro’s woes are as much about politics as about finance. European officials such as Mr Trichet parrot that the euro zone’s overall debt and deficit are sounder than America’s. Yet Europe lacks the big federal budgets and financial institutions to redistribute income and absorb economic shocks. And it has no single polity to mediate tensions within and between member countries. It is hard enough to get Californians to save Wall Street bankers; no wonder Germans bristle when they are asked to rescue Greek bureaucrats.

But Europe’s politicians cannot blame everything on their lack of tools. Their inconsistency, even incoherence, over getting creditors to pay has done much to spread contagion. Their first emergency loans imposed tough conditions on Greece, but none on the bankers. Indeed, the creation of a big bail-out fund was meant to make default unthinkable. At Deauville, though, Mrs Merkel and Mr Sarkozy wanted default to become a possibility: current debt would be safe, they said, but leaders later agreed that from 2013 countries should issue new types of bonds that could be more easily forced to take a hit if a country ran into trouble. Now Greece needs another rescue, default is nearer and the Germans and Dutch, threatening to stand in the way, want private creditors to contribute right away. This has led to an open dispute with Mr Trichet, who says even the mildest of debt rescheduling risks an upheaval comparable to the collapse of Lehman Brothers; he has threatened, if there is any sort of default, to cut off credit to Greek banks—pushing many into bankruptcy. Is it any surprise that investors are fleeing vulnerable euro-zone bonds? Read more…

As published in www.economist.com on July 14, 2011.


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