EU BUYS ITSELF TIME / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( HIGHLY RECOMMENDED READING )

EU buys itself time

By Wolfgang Münchau

Published: Last updated: May 10 2010 09:58

In the end, there was no choice. Faced with an existential threat, the European Union has demonstrated that it can act fast if necessary. European leaders deserve respect for finally getting ahead of the situation.

That said, we should also realise that by throwing money at the problem, mostly in the form of backstop guarantees, the EU has merely bought itself time to sort out the eurozone’s governance mess. The real test is yet to come.

There are important parallels to the EU’s guarantees for the financial sector in October 2008 following the collapse of Lehman Brothers. That decision, also made in a dramatic session over a weekend, solved an immediate liquidity problem of the European sector, which was on the verge of a meltdown. But the decision did not, and could not, address the sector’s underlying solvency position, which is still a problem two years later.

The same applies here. We know now that Greece, Portugal and Spain will always be able to refinance their government debt, but the long-term solvency position of the Spanish state remains unchanged. The private sector is massively indebted. The prices of assets that serve as collateral are still falling. The Spanish government, as guarantor of the banking sector, will be lumbered with rising debts at a time of stagnating economic growth. We should remember that solvency is not primarily related to financial markets’ willingness to lend. That’s liquidity. You are solvent when you can stabilise your debt as a proportion of income. Southern Europe’s solvency position is thus unaffected by the billions.

So this deal is going to be ineffective beyond the very short term, unless it is followed up by substantive reforms – the introduction of a single European bond, an agenda to co-ordinate economic reforms with specific relevance for the monetary union, policies to reduce economic imbalances, much tighter supervision of fiscal policies that kick in well before budgets have already been announced, and, in my view also a kernel of a fiscal union – in essence all the things over which the EU has been, and still is, in denial.

It is my judgment that hardly any of those will happen. I thus remain sceptical about the long-term prospects of the eurozone. The time will come when throwing money at problems without structural change will cease to work, and even to impress.

Copyright The Financial Times Limited 2010.