Www.europe-economics.com How to save the euro Dr Andrew Lilico PX Eurozone crisis debate 27 October 2011

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How to save the euro

Dr Andrew Lilico

PX Eurozone crisis debate

27 October 2011


Outline

• Yesterday’s deal

• Who’s in and who’s not

• Why any form of debt pooling should be rejected

• Different issues in different countries

• Solution for “banking crisis” countries

• Solution for “competitiveness crisis” countries


Yesterday’s “Deal”

• Recapitalise EU banks (~€100bn)

• 50% haircut for private bondholders (~€200bn / 2 = ~€100bn)– No credit event

• Leveraged EFSF four to five times (perhaps €1tr-€1.4tr)

• Governance stuff


Strengths and weaknesses

• Strengths– It could have been even more stupid

• Weaknesses– Recapitalising banks => shrink balance sheets =>

money stock drop => slump

– 50% Haircut• Why only private sector? Why did EU rank ahead?

• Target debt/GDP = 120%. No buffer

• Failing to trigger sov CDS a bad mistake => Italian bond yields up

– Leverage EFSF – just more debt pooling


Who’s in and who’s not?

• “Saving the euro” = EEC6 in currency union– No Italy = no euro = no EU

• “Saving the euro” ≠ EMU17 in currency union– euro can survive exit of Greece and Cyprus

– euro could even survive exit of Greece, Cyprus, Portugal, Finland, and Slovakia

• Who’s in and who’s not is fundamentally a political decision– Proceed on assumption Greece and Cyprus are out


Reject any form of debt pooling!

• “Debt pooling” = any arrangement under which Germany, France, Finland, etc. become responsible for current Italian, Spanish etc. debts– “Eurobonds”; “leveraged EFSF”; “ECB

purchases of €trs of PIIGS bonds” are all debt pooling

• Fiscal union ≠ debt pooling– Collective debt issuance ≠ responsibility for

legacy debt


Debt pooling

• Without conditionality:– In academic studies

(Gneezy, Haruvy and Yafe, Economic Journal 2004), splitting the bill => 36% higher bill

• With conditionality:


Different crises in different countries

2010 figures (Eurostat)

Govt debt to GDP

Govt deficit Bank assets to GDP

Avg Growth 2000-2010

“Unsalvageable”

Greece 143% 11% 173% 2.4%

Cyprus 61% 5% 586% 2.8%

“Banking crisis”

Belgium 97% 4% 182% 1.4%

Spain 60% 9% 335% 2.1%

Ireland 96% 32% 328% 2.4%

“Competitiveness Crisis”

Italy 119% 5% 163% 0.2%

Portugal 93% 9% 240% 0.7%


Solution for “banking crisis” countries

• Disentangle state from banking sector

• Banks distressed => impose debt-equity swaps– Bring forward EC “bail-in” proposals to now from 2013

• Part of more general special resolution regime for banks

• Do not cast good money after bad (“recapitalisation”)– Not

• an irrational market error

• a “speculator attack”

• simply insolvency from past losses

– Banking bailouts• Immoral (tax the poor to spare rich the consequences of their errors)

• Economically destructive (moral hazard; financial instability)

• Failed strategy, even in own misguided terms


Solution for “competitiveness crisis” countries

• Raise growth rate enough for countries to service own debts

• How? Eurozone-only structural funds (“Eurozone competitiveness funds”)– Monies spent by Brussels (so no lobster problem)

– Monies spent by Brussels (so no vassal problem)


Amounts required

– Ireland in 1990s: 0.5% of GDP on structural funds

– Italian + Portuguese GDP = €1.8tr => 0.5% = €9bn• Might need twice this level in early years to be credible

• cf structural & cohesion funds budget = ~€58bn per year

– Key: spend on investments => GDP growth effect, not just levels

• Might need to rise over time, even with some growth effect

• cf cost of debt pooling– Effectively taking German and French debt exposures

to current Italian levels

– add ~ 100bps to funding costs => ~€36bn per year


Curlicues

• Real money, not “guarantees”

• Initiative principle would be different– Structural funds match funding to govt projects

• Match funding abandoned– Brussels initiative to spend => spending sovereignty

centralised

• Accompanied by tighter fiscal policy constraints– Probably any budget running a deficit above 2% of

GDP to be approved by Brussels

– => fiscal sovereignty centralised


Longer term

• Funding for Eurozone competitiveness funds:– Initially fund with Eurozone member contributions

– Later impose special Eurozone taxes

– With a funding stream in place, could issue own debt• Call these “Eurobonds” if you like, but they aren’t debt pooling

(no legacy debt)

• Eurozone taxes + spending sovereignty, and curtailed Eurozone Member fiscal sovereignty => need for democratic mechs– Eurozone finance minister, perhaps directly elected?

Documents

Www.europe-economics.com How to save the euro Dr Andrew Lilico PX Eurozone crisis debate 27 October 2011