MAKING EUROZONE SAFE FROM FAILURE / THE FINANCIAL TIMES EDITORIAL ( A MUST READ )

Making eurozone safe from failure


Published: October 12 2010 22:41

In a three-part series concluding today, the FT has explained how the eurozone’s sovereign debt crisis earlier this year could come to pass, and the choices that now face its leaders. As they make the decisions that will shape the future of the common currency, they should bear in mind the successes of the euro as well as its challenges.

Europe must distance itself from the hysterical notion that the euro skirted disintegration. That was never a great risk. No country can be forced off the euro against its will, and no country would voluntarily abandon it – for the simple reason that the shock of leaving would outweigh any advantage of life on the outside. As Estonia’s imminent accession proves, the monetary union is a club that is still attracting members.


The real danger was and remains a collapse of Europe’s financial system and the slump this would trigger. A sovereign default could easily have repercussions exceeding even those of the Lehman bankruptcy two years ago. The losses would be taken in no small part by banks and other financial institutions in the eurozone’s core. The fact that the aid to Greece was a surreptitious rescue of German banks was an important, if unmentioned, reason for Berlin’s willingness to play along.


Even though financial entanglements between different eurozone countries brought the bloc into trouble, they are what a common currency is meant to achieve. In a single financial market, savings should flow to the most productive investments regardless of national borders. The eurozone’s problem was not macroeconomic asymmetries per se, but that surpluses funded consumption binges (in Greece) and wasteful construction booms (in Spain and Ireland). The task is to ensure that net cross-border financial flows reflect true economic opportunities – not to eliminate such flows altogether.


Achieving this hinges on the economic governance reforms now being discussed. Some proposals – such as better information-sharing on national budgets and measures to ensure that statistics reflect reality – have obvious merit and must be accepted without delay.

The harder question is how countries’ macroeconomic policies should be constrained. Success depends on getting the rules right: giving the extant, misguided, stability and growth pact more teeth is not helpful. It is promising, then, that the European Commission has proposed to supplement the current myopic obsession with fiscal policy by taking into account countries’ overall macroeconomic balance, including private flows.


This wider net would have been able to raise alarm about dangerous private sector bubbles in fiscally exemplary states such as Ireland and Spain. As the crisis demonstrates, excessive private debt ends up turning into public debt: something neither market discipline (by definition lax in a bubble) nor a simplistic focus on present fiscal discipline take into account.


A focus on the current account may also make it easier to point a finger at surplus nations. To be sure, this is not what Berlin has in mind; nor is it politically likely. But at least it will become harder to pretend a nation bent on saving does not fund other countries’ deficits. Surplus nations are not without responsibility if their savings destabilise their neighbours.


That responsibility is more likely to be honoured if lenders face the true risk of their actions. This is why restructuring mechanisms for sovereigns and those who lend to them are necessary. The new European Financial Stability Facility is beneficial. But to confine it to its proper use – temporary liquidity crises – Europe needs a procedure for restructuring the debt of countries proved to be insolvent.


Fear of disaster scared eurozone leaders into resolute action. They must not now let fear of defaults stop them from making the system safe from a future failure.


Copyright The Financial Times Limited 2010.