OPINION
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DECEMBER 1, 2011
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China's Superior Economic Model
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The free-market fundamentalist economic model is being thrown onto the trash heap of history.
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By ANDY STERN

David G. Klein


Andy Grove, the founder and chairman of Intel, provocatively wrote in Businessweek last year that, "Our fundamental economic beliefs, which we have elevated from a conviction based on observation to an unquestioned truism, is that the free market is the best of all economic systems—the freer the better. Our generation has seen the decisive victory of free-market principles over planned economies. So we stick with this belief largely oblivious to emerging evidence that while free markets beat planned economies, there may be room for a modification that is even better."


The past few weeks have proven Mr. Grove's point, as our relations with China, and that country's impact on America's future, came to the forefront of American politics. Our inert Senate, while preparing for the super committee to fail, crossed the normally insurmountable political divide to pass legislation to address China's currency manipulation. Secretary of State Hillary Clinton, former Gov. Mitt Romney and President Barack Obama all weighed in with their viewsranging from warnings that China must "end unfair discrimination" (Mrs. Clinton) to complaints that the U.S. has "been played like a fiddle" (Mr. Romney) and that China needs to stop "gaming" the international system (Mr. Obama).


As this was happening, I was part of a U.S.-China dialogue—a trip organized by the China-United States Exchange Foundation and the Center for American Progress—with high-ranking Chinese government officials, both past and present. For me, the tension resulting from the chorus of American criticism paled in significance compared to reading the emerging outline of China's 12th five-year plan. The aims: a 7% annual economic growth rate; a $640 billion investment in renewable energy; construction of six million homes; and expanding next-generation IT, clean-energy vehicles, biotechnology, high-end manufacturing and environmental protectionall while promoting social equity and rural development.


Some Americans are drawing lessons from this. Last month, the China Daily quoted Orville Schell, who directs the Center on U.S.-China Relations at the Asia Society, as saying: "I think we have come to realize the ability to plan is exactly what is missing in America." The article also noted that Robert Engle, who won a Nobel Prize in 2003 for economics, has said that while China is making five-year plans for the next generation, Americans are planning only for the next election.


The world has been made "flat" by the technological miracles of Andy Grove, Steve Jobs and Bill Gates. This has forced all institutions to confront what is clearly the third economic revolution in world history. The Agricultural Revolution was a roughly 3,000-year transition, the Industrial Revolution lasted 300 years, and this technology-led Global Revolution will take only 30-odd years.
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No single generation has witnessed so much change in a single lifetime.
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The current debates about China's currency, the trade imbalance, our debt and China's excessive use of pirated American intellectual property are evidence that the Global Revolution—coupled with Deng Xiaoping's government-led, growth-oriented reforms—has created the planet's second-largest economy. It's on a clear trajectory to knock America off its perch by 2025.

As Andy Grove so presciently articulated in the July 1, 2010, issue of Businessweek, the economies of China, Singapore, Germany, Brazil and India have demonstrated "that a plan for job creation must be the number-one objective of state economic policy; and that the government must play a strategic role in setting the priorities and arraying the forces of organization necessary to achieve this goal."

The conservative-preferred, free-market fundamentalist, shareholder-only modelso successful in the 20th century—is being thrown onto the trash heap of history in the 21st century. In an era when countries need to become economic teams, Team USA's results—a jobless decade, 30 years of flat median wages, a trade deficit, a shrinking middle class and phenomenal gains in wealth but only for the top 1%—are pathetic.

This should motivate leaders to rethink, rather than double down on an empirically failing free-market extremism. As painful and humbling as it may be, America needs to do what a once-dominant business or sports team would do when the tide turns: study the ingredients of its competitors' success.
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While we debate, Team China rolls on. Our delegation witnessed China's people-oriented development in Chongqing, a city of 32 million in Western China, which is led by an aggressive and popular Communist Party leaderBo Xilai. A skyline of cranes are building roughly 1.5 million square feet of usable floor space daily—including, our delegation was told, 700,000 units of public housing annually.

Meanwhile, the Chinese government can boast that it has established in Western China an economic zone for cloud computing and automotive and aerospace production resulting in 12.5% annual growth and 49% growth in annual tax revenue, with wages rising more than 10% a year.

For those of us who love this country and believe America has every asset it needs to remain the No. 1 economic engine of the world, it is troubling that we have no plan—and substitute a demonization of government and worship of the free market at a historical moment that requires a rethinking of both those beliefs.

America needs to embrace a plan for growth and innovation, with a streamlined government as a partner with the private sector.

Economic revolutions require institutions to change and maybe make history, because if they stick to the status quo they soon become history. Our great country, which sparked and wants to lead this global revolution, needs a forward looking, long-term economic plan.

The imperative for change is simple. As Andy Grove pointed out: "If we want to remain a leading economy, we change on our own, or change will continue to be forced upon us."
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Mr. Stern was president of the Service Employees International Union (SEIU) and is now a senior fellow at Columbia University's Richman Center.
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Copyright 2011 Dow Jones & Company, Inc. All Rights Reserved

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Last updated:November 30, 2011 6:32 pm

What the IMF should tell Europe

By Martin Wolf illustration showing a lorry representing the IMF tipping euros in to europe

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Can the International Monetary Fund save the eurozone? No. But it can help. The world, whose interests the IMF represents, has a stake in what happens. That gives the IMF the right to act. The question is how.
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The world has reached a new and potentially even more devastating stage of the financial crisis that emerged in the advanced countries in the summer of 2007. Its epicentre is the eurozone. Unwilling to focus on the critically ill patient in front of it, eurozone leaders spend their time on designing an exercise regime to ensure he never has another heart attack. This is displacement activity.
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Click to enlarge


In the view of many policymakers outside the eurozone, “they just do not get it”. Its members, above all Germany, the most important player, seem paralysed by domestic politics. That is not surprising, since politics remain national. But it also suggests that the project was premature at best, and unworkable at worst.

The latest economic outlook from the Organisation for Economic Co-operation and Development paints a grim picture. Even if catastrophe is avoided, the economy of the eurozone is forecast to stagnate next year. But, notes the OECD, “serious downside risks remain”. Moreover, “a large negative event would ... most likely send the OECD area as a whole into recession, with marked declines in the US and Japan, and prolonged and deep recession in the euro area”. Even emerging markets would suffer.

How bad might things become? The OECD explores a downside scenario that starts from a disorderly sovereign default in the eurozone. The outcomes of such events are unpredictable. But a default by a significant advanced country is likely to be a huge blow to confidence. Adverse effects would be felt directly – and via contagion – on both other sovereigns and financial institutions and markets. Other countries might be directly affected by the need to rescue their banks.
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As economies weakened, fiscal positions would come under greater strain everywhere. A vicious downwards spiral in confidence and activity could emerge, with results far beyond the eurozone itself.

Exit from the eurozone would not necessarily follow a sovereign default. But that outcome could not be ruled out. The OECD uses apocalyptic language: “[T]he political fall-out would be dramatic and pressures for euro area exit could be intense ... Such turbulence in Europe, with the massive wealth destruction, bankruptcies and a collapse in confidence in European integration and co-operation would most likely result in a deep depression in both the exiting and remaining euro area countries as well as in the world economy.”

So what is to be done?
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First, there needs to be a credible commitment to halt the contagion, for sovereigns, banks and markets. One possibility would be to guarantee financing of rollover of public debts and fiscal deficits for Italy, Spain and Belgium for 2012 and 2013. That would cost up to €1,000bn ($1,300bn), though even this might be insufficient to arrest the contagion, given its current extent (see chart). The resources needed could come from leveraging the European Financial Stability Facility or from the European Central Bank or both, with the former taking on the risk of loss and the ECB offering liquidity. In the longer term, a conditional eurobond may provide a workable answer, as John Muellbauer of Nuffield College, Oxford, has argued.
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Second, the eurozone must have policies for economic growth and adjustment. Moreover, these cannot solely be on the supply side. The eurozone now clearly suffers from deficient aggregate demand.
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Moreover, the more vulnerable countries will be unable to recover without restoration of their external competitiveness. Without that, they are doomed to a downward spiral of fiscal austerity, weakening demand, higher unemployment, poor fiscal outcomes and then even more austerity. In the years before the crisis, the financial surpluses of eurozone households were absorbed by the deficits of non-financial corporations and, to a lesser extent, of governments (see chart). After the crisis, companies’ deficits disappeared as profits fell and they slashed investment, leaving the burden of supporting demand on governments. If fiscal deficits are to disappear, households and companies have to spend more. Policy must help to achieve this.
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Third, the eurozone also needs long-term reforms that address its true weaknesses. But these will fail if Germany insists that fiscal discipline is all that matters. Fiscal indiscipline did not cause this crisis.
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Financial and broader private sector indiscipline, including by lenders in the core countries, was even more important. If the eurozone introduced reforms to make it work far better in future, rather than to continue as a machine for generating financial and fiscal insolvencies in weaker countries, confidence would return.
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What role can the IMF play? Not much of one. It lacks the firepower: its total uncommitted usable resources are only about $440bn. True, it might raise more money from interested outside countries.
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But it cannot hope to make up for the reluctance of the eurozone’s leading players to provide the support needed. Even if it had the resources, programmes for individual members would surely fail.
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The only programme that would make sense would be one for the eurozone as a whole, since programmes for troubled countries would have to include a reasonable prospect for higher aggregate eurozone demand.

Without that, there is little chance for success by, say, Italy or Spain. Ireland can adjust as a small, open economy by displacing tradeable output elsewhere, where necessary. If Italy and Spain both tried to do this, they would be engaging in a costly and probably hopeless effort at beggaring their neighbours: costly, because the main way to do so would be to drive down wages via yet higher unemployment; and now hopeless, because the competitive advantage of Germany is so strong.
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So how might the IMF help? Now is the time for what John Maynard Keynes calledruthless truth-telling”. And what is the truth that it should tell? It is that the eurozone has a choice between bad and calamitous alternatives. The bad alternative is radical policies to promote adjustment, while warding off a wave of sovereign debt restructurings, financial crises and a true depression. The calamitous alternative is that depression, along with a break-up of the project. The IMF should speak up for the world’s interest in the less bad outcome. The eurozone alone can make the choice.
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Copyright The Financial Times Limited 2011.


Fed saves Europe's banks as ECB stands pat
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Stripped to essentials, America is once again having to rescue Europe from itself. The joint offer of currency swap lines by the central banks of the US, Britain, Japan, Canada, Switzerland and the ECB preserves the polite fiction that this was to "ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit". Photo: EPA

By Ambrose Evans-Pritchard, International business editor

9:01PM GMT 30 Nov 2011

The interwoven banking and sovereign debt crisis in the eurozone has become so dangerous for the world that the US Federal Reserve has been forced to take emergency action, acting as global lender of last resort to shore up Europe's banking system.
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That it should have to do so as Germany and the European Central Bank hold back for legal reasons and refuse to commit decisive power adds a strange diplomatic twist.
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The move came once it was clear that Europe's prostrate banks would struggle to roll over $2 trillion (£1.3 trillion) of debts denominated in dollars. Data from ratings agency Fitch shows that US money markets have slashed funding for French banks by 69pc and German banks by 50pc.
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Strains have been ratcheting up over the past two weeks. European banks are mostly shut out of the dollar market, or only able to raise money for a week at a time.
The so-called "stress alarm" – the euro/dollar three-month cross currency basis swapspiralled down to minus 166 points early on Wednesday, uncannily like the last days before the Lehman crisis metastasized in October 2008.
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The joint offer of cut-rate currency swap lines by the central banks of the US, Britain, Japan, Canada, Switzerland and the ECB preserves the polite fiction that this was to "ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit", but this was a Fed action to provide cheap dollar funding and head off a lethal crunch in Europe.

China took its own precautionsperhaps in concertcutting its reserve ratio for the first time in three years to boost liquidity.

"Concerns have been building that Europe's banking system could go into meltdown," said Marc Ostwald from Monument Securities. "But the central banks may also have been worried that eurozone politicians will fail to deliver much at their December summit, so they need a mechanism in place to cope with the fall-out."

Andrew Roberts, rates chief at RBS, said European bank stress was reaching extreme levels. "They couldn't allow a sudden stop to the system. This at least takes away the precipice risk for now, but Europe is not going to able to tackle this crisis properly until Germany agrees to cross the Rubicon and accept massive bond buying by the ECB," he said.

There is little evidence yet that Berlin is willing to lift its veto on eurobonds or an ECB blitz. Chancellor Angela Merkel said it was "not appropriate" for to Germany drop its objections as a quid pro quo for backing from other EU states for treaty changes to police budgets. German finance minister Wolfgang Schauble said mass bond purchases and eurobonds are both illegal under EU treaties and remain "out of the question".

However, Germany is increasingly isolated, both in EU capitals and on the ECB's governing council. Austrian, Dutch and Finnish ministers have all opened the door over recent days for a bigger role for the ECB.

The Bank of France's governor Christian Noyer appeared to break ranks on Wednesday with the German-led bloc of ECB hawks, reflecting the political rift between Paris and Berlin on crisis strategy. "It is essential to stabilise European bond markets. We have to recognise that the necessary degree of fiscal adjustment is heavily dependent on the level of market confidence," he said.

Jacques Cailloux from RBS said the ECB will cut interest rates to 1pc – perhaps 0.75pcnext week. It will take action to back-stop the financial system but will not yet open the floodgates to bond purchases or resort to quantitative easing.

"While the ECB is not the lender of last resort for sovereigns, it is for banks," he said. The measures are likely to include extending unlimited credit to lenders under its Long-Term Refinancing Operation (LTRO) to two or three years, with a broader range of collateral accepted, such as certificates of deposit and even dollar assets.

Whether such steps can bring Euroland back from the brink is unclear. Eurozone ministers appear to have little up their sleeves, hoping that the International Monetary Fund can do part of the heavy lifting. "We envisage a greater role for the IMF: that will be sufficient together with the EFSF," said Jan Kees de Jager, Holland's finance minister.

Yet the IMF is short of money. A US Treasury official said Washington is not willing to pay more into the IMF at this point, while Jim Flaherty, Canada's finance minister, said the Fund should not be used to bail out rich countries.

The drama always comes back to the ECB. Will it blink?


The risks of sleepwalking into a war with Iran

David Miliband

December 1, 2011

Iran’s challenge to global order has been among the most complex and confounding tasks for international diplomacy since that country’s 1979 Islamic revolution. A regime with declining domestic legitimacy has increasingly sought to channel discontent towards foreign enemies, imagined and real, and preserve its hold on power by any means.

As surprised and disoriented by the Arab awakening as everyone else over the past year, Tehran has been scrambling to respond to the shifting sands of regional geopolitics, amid intensifying rivalries within the leadership itself.

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This is the critical context for the escalation in the nuclear crisis now threatening to replace diplomacy with war as the west’s response to the Iranian threat. The recent comprehensive International Atomic Energy Agency report on Iran’s nuclear programme; public debate in Israel about the wisdom of a military strike, without much pushback from outside the country; private mutterings about the bestwindow” for such an attack; and now the serious diplomatic consequences of the assault on the British embassy and its staff, are combining to deepen the chasm of distrust to new and dangerous levels.
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We subscribe to the view that the price of a nuclear-armed Iran would be very highunacceptably high. Iran’s capacity to destabilise the region would increase considerably. The response from Saudi Arabia, Turkey and others would mean the end of the non-proliferation treaty. The chance that nuclear weapons would actually be used would be much closer.
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But that is not an argument for military action now or in 2012. We are not talking about a discrete – or discreet strike here. Avowed Iranian nuclear facilities are numerous and the regime does not lack for ammunition or targets in return. In addition to its own missile stores, Iran is invested in regional proxy armies, such as Hizbollah. All the war games show that targets as diverse as Saudi Arabia and the Emirates, Israeli and US facilities, and the Straits of Hormuz would come into play.

For these reasons we must avoid military action becoming a self-fulfilling prophesy. Diplomacy must take the lead in preventing a major war with Iran – for that is what it would be. What is more the regime faces at least four serious challenges of its own.

First, it is clear that sanctions, cyberwar and covert operations have impaired Iran’s progress towards a nuclear weapons capability, with most estimates holding that the regime is at least two years away from achieving it. To be clear, no one has made the case that such an achievement is imminent.
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Second, IAEA inspectors continue to monitor key installations and operations, providing a tripwire presence able to signal any dramatic change in policy or practice by Tehran. It would be disastrous if the fallout from the Iranian storming of the British embassy included the harassment or expulsion of inspectors by the regime.
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Third, Iran’s strategic influence in the region is waning. Its sole ally in the Arab world, the Syrian regime, is badly weakened, and more likely entering an end game. Among the Arab public, Iran’s popularity has plummeted since the highs of the 2006 Lebanon war.
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Fourth, and too often neglected, are the aspirations of the Iranian people. They have often showed that they do not share the regime’s hostility to the world, and instead aspire to the same kinds of open government that the youth of the Arab world are reaching for.
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At a time like this, diplomatic drive and creativity are needed more than ever. Now is the time to support, directly and indirectly, the pressures on a regime currently fractured on all matters except the nuclear programme. And in this endeavour, war talk weakens our handstrengthening the most uncompromising forces within Iran and corroding global cohesion in opposition to the programme.
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Non-military options have not yet succeeded, but nor have they failed. However exasperating the diplomatic track, growing talk of a military option risks creating a logic all of its own, where the appalling consequences of a military strike are set to one side and a precipitate and unwise move to war becomes acceptable wisdom.
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Nature abhors a vacuum and so does international politics. It cannot be filled by nudges and winks about military options. A concerted diplomatic effort on Iran is needed now to prevent the world sleepwalking into another war in the Middle East.
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This article was co-written with Nader Mousavizadeh, who is chief executive of Oxford Analytica and was special assistant to former UN secretary-general Kofi Annan. David Miliband, MP for South Shields, was British foreign secretary from 2007-10

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November 30, 2011

Money Flows, but What Euro Zone Lacks Is Glue

By STEVEN ERLANGER


PARIS — As European Union leaders prepare for yet another crisis summit meeting next week to discuss fundamental changes in economic governing, there are growing concerns that the latest potential approach — a more aggressive intervention by the European Central Bank — will not be enough to stabilize the markets and preserve the euro.

The assumption has been that if political leaders can convince voters in their countries that they are capable of enforcing greater discipline and centralized intervention in national budgets, as Germany demands, then the European Central Bank will have the political breathing space to move more aggressively to support the bond sales of Spain and especially Italy. The thought is that the bank can flood the market, driving down interest rates to tolerable levels, buying time for Europe to fix its debt problems and overhaul laggard economies.
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But with Europe veering toward recession and with increased skepticism that discipline will solve the deep structural imbalances in the euro zone, the markets’ concerns have passed from doubts about the solvency of individual countries to fears for the euro zone as a whole. Those doubts now include Germany, which cannot by itself, even if it wishes to, guarantee the credibility of Italian and Spanish debt, which totals more than $3.3 trillion.
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For Kenneth S. Rogoff, an economics professor at Harvard, the biggest problem for the euro is not money so much as structure, or the lack of it. “This is a deep constitutional and institutional problem in Europe,” Mr. Rogoff said. “It’s not a funding problem.”

Yet, with even German interest rates rising, the markets are now worried about the sustainability of the euro zone as a whole, said Simon Johnson, a former chief economist for the International Monetary Fund and a professor at the M.I.T. Sloan School of Management. “The market has signaled that the risk is relative currency risk, not sovereign risk,” Mr. Johnson said. “So a ‘big bazooka won’t work for Europe now, because of worries about the euro itself breaking up and German interest rates going up.”
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The last plan that was supposed to stop the rot, agreed upon last July but not put fully into place until mid-October, was the European Financial Stability Facility, with a lending capacity of 440 billion euros, or about $587 billion. While large enough to cover, as intended, a second Greek bailout, Ireland and Portugal, it is far too small for Italy and Spain, which are now in play.
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And efforts to “leverage” the fund upward, a crucial element of the “big bazookaMr. Johnson referred to, are falling considerably short of the $1.35 trillion target, European officials acknowledged Wednesday. That failure is in large part because, as Mr. Johnson noted, the bond spreads for even the AAA-rated euro zone countries are going up, leaving less leeway for leveraging.
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Mr. Johnson is a euro hawk, predicting a breakup of the euro zone. Others say Europe has more time, especially if the European Central Bank can intervene to support Italy more forcefully, which by its charter it is not supposed to do, at least not directly.
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If so, Mr. Rogoff said, “the Europeans can stretch it out a long time, they have the money.” Nevertheless, he said, they “need to take a big step toward economic and political union, whoever wants to be a part of it.” Germany “is right to hold out for systemic changes,” he said. “The Europeans hoped to have 30 to 40 years to integrate more fully. Right now they don’t have 30 to 40 weeks.”
Some say they have far less than that.
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“We are now entering the critical period of 10 days to complete and conclude the crisis response of the European Union,” said the bloc’s economics commissioner, Olli Rehn, on Wednesday.
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France and Germany are concentrating their efforts on a fundamental shift in powers among the 17 European Union states that use the euro, seeking to amend the bloc’s treaties to allow more centralized oversight of national fiscal and budget policies, and more centralized interference in them, too.

Penalties would be assessed on those countries that violate the rules of economic discipline, which will be tightened and clarified.

Those proposals, if accepted in principle at the summit meeting on Dec. 8 and 9, will bring about a major restructuring of the European Union and the institutionalization of a two-speed Europe, French officials said, with more economic and governmental integration among euro zone countries.

President Nicolas Sarkozy of France intends to speak to his country on Thursday to explain the ideas for a treaty change, and Chancellor Angela Merkel is expected to do the same in Germany on Friday.
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Such changes, because they involve some further ceding of national sovereignty and powers, will require ratification by the nations involved, and very possibly by all 27 members of the European Union, which would mean referendums in a few countries. So France in particular is willing to move to a treaty just of the euro zone itself.
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While treaty change can be a lengthy process, the hope is that the effort will create enough momentum for economic convergence and discipline that will provide the political cover for Germany’s leaders to allow the European Central Bank to step in much more forcibly to defend Italy and Spain and try to stabilize the market.

But experts say it may already be too late for that plan to work.

New rules for discipline may help prevent future maladies, but they are a distant cure for the current disease. New disciplinary rules do little to address the structural flaws in the euro zone, where countries of very different economic levels, models and export potentials share the same currency, creating persistent trade and credit imbalances. Structural reforms inside countries, no matter how valuable in the long run, take a long time to work. And austerity alone cannot produce economic growth, which is the main cure for too much debt.

The endgame is constitutional change. But in this middle game, “there must be enough momentum for constitutional change to provide political cover” for the central bank “to step in,” Mr. Rogoff said. “But that’s only buying more time. They can’t finance everything, and Germany can’t declare that it’s paying for an open bar for Europe.”
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Nouriel Roubini, the economist who has been accurately pessimistic for the most part, argues that Italy must restructure its debt now, from about 120 percent of its gross domestic product to 90 percent or below. If not, he said, it risks a disorderly default and the collapse of the euro.
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With interest rates on the 10-year bond between 7 and 8 percent and zero growth, Italy would need a primary surplus — excluding interest payments — of at least 5 percent of its G.D.P. to stabilize its debt, Mr. Roubini wrote in an op-ed article in The Financial Times. But interest rates are rising and growth is slowing, and the austerity demanded by Germany and the European Central Bank, he argues, will push Italy deep into recession and risk a Greek-styledebt trap,” in which the debt grows faster than the country’s ability to pay it.
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Mr. Rogoff said that “they need to pray that Italy is solvent.” He is not sure, “but they need to give it a chance, because if Italy blows, the whole thing would become unraveled, with big risks in all directions.”
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Mr. Johnson contends that there is nothing much wrong with Italy that a vacation from the euro and a 20 percent devaluation of the currency would not solve — the traditional, pre-euro way Italy promoted growth and kept solvent.
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He said that “there is always a feeling of foreboding and failure at the end of all exchange-rate arrangements,” but that European economies are largely strong. If the common currency does end, he said, “I don’t think it’s the end of the European project.”