Eurozone crisis: A light at the end of the tunnel?
Mohamed El-Erian
December 2, 2011
Everyone is on tenterhooks in the countdown to next week’s critical European summit. The outline of the grand solution being pursued is becoming clearer as a growing number of officials take to the air waves. What is emerging seems to be a pretty good approach, provided – and this is vital – Europe agrees on the details while avoiding some highly pernicious traps.
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To be clear, it is now the region’s moment of truth. To avoid a very costly and disorderly fragmentation, Europe may well be embarking on the road to embracing a smaller, stronger and less imperfect monetary union in the future. And it is down to just four carrying the heavy burden of responsibility of offering a credible hope for stabilising Europe’s crisis, namely German chancellor Angela Merkel, French president Nicolas Sarkozy, Mario Draghi, president of the European Central Bank, and Mario Monti, Italy’s prime minister.
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Over the next few days, these leaders need to unite on ways to enhance the institutional underpinnings of the union, to reduce the risks imposed by the banking sector, to delineate clearly between solvency and liquidity cases, and to stop the latter from tipping into insolvency.
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Should they fail, the probability of a disorderly collapse of the eurozone would increase materially. Accordingly, six key risks must be managed proactively.
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They need to agree quickly on the anchor for a stronger zone. As indicated in her powerful speech to the German parliament on Friday, Ms Merkel insists on a strong legal and institutional basis. Mr Sarkozy seems to favour something less rigid, while Mr Draghi speaks of “fiscal compacts”. There is absolutely no room for differences of views or interpretations.
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Second, as he puts the finishing touches on the economic programme scheduled to be announced on Monday, Mr Monti must combine fiscal adjustment with concrete steps to increase actual and potential growth in Italy. If he fails, he will lack the legitimacy needed for sustained implementation. And he must avoid a repeat of the flawed programmes that continue to predictably disappoint on virtually all fronts in countries such as Greece.
Third, armed with assurances of these two points, Mr Draghi should show no hesitation in taking the ECB “all in” and, thus, provide a credible balance sheet bridge. Discussion of the ECB lending to the IMF in order for it to lend back to European countries is intriguing but potentially detrimental. There is no substitute to direct and forceful engagement by the ECB as part of a holistic and durable solution.
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Fourth, the banking system will need to play, or be made to play a more constructive role. Injections of exceptional liquidity from the official sector should be used to encourage in new private capital rather than finance its continuous exit. In some cases, this could happen endogenously; in others, it will require more forceful intervention by both national and regional authorities.
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Fifth, Ms Merkel will need to be brutally honest in its engagement with its European partners. To be part of a proper solution, other leaders must be credibly able and willing to commit. Germany needs to call out those that cannot, and also to proceed without them.
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Finally, communication must not be bungled yet again. Domestic and global audiences should be informed in a consistent and clear manner. This means conveying a clear vision along with accompanying steps. It is certainly not the time for the type of conflicting and competing remarks from European officials that have undermined virtually every recent attempt to halt this crisis.
.
There is a lot of work to be done in the next few days, and quickly. Leaders will need to resist the natural tendency to cut corners and please each other with unsustainable compromises.
.
If they again succumb to shortcuts and partial answers, history will mark this as an enormous failure to deliver on one of the last, if not the final, opportunity to save a union that is key to the region’s wellbeing, as well as that of the global economy.
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The writer is the chief executive and co-chief investment officer of Pimco
.
To be clear, it is now the region’s moment of truth. To avoid a very costly and disorderly fragmentation, Europe may well be embarking on the road to embracing a smaller, stronger and less imperfect monetary union in the future. And it is down to just four carrying the heavy burden of responsibility of offering a credible hope for stabilising Europe’s crisis, namely German chancellor Angela Merkel, French president Nicolas Sarkozy, Mario Draghi, president of the European Central Bank, and Mario Monti, Italy’s prime minister.
.
Over the next few days, these leaders need to unite on ways to enhance the institutional underpinnings of the union, to reduce the risks imposed by the banking sector, to delineate clearly between solvency and liquidity cases, and to stop the latter from tipping into insolvency.
.
Should they fail, the probability of a disorderly collapse of the eurozone would increase materially. Accordingly, six key risks must be managed proactively.
..
They need to agree quickly on the anchor for a stronger zone. As indicated in her powerful speech to the German parliament on Friday, Ms Merkel insists on a strong legal and institutional basis. Mr Sarkozy seems to favour something less rigid, while Mr Draghi speaks of “fiscal compacts”. There is absolutely no room for differences of views or interpretations.
.
Second, as he puts the finishing touches on the economic programme scheduled to be announced on Monday, Mr Monti must combine fiscal adjustment with concrete steps to increase actual and potential growth in Italy. If he fails, he will lack the legitimacy needed for sustained implementation. And he must avoid a repeat of the flawed programmes that continue to predictably disappoint on virtually all fronts in countries such as Greece.
Third, armed with assurances of these two points, Mr Draghi should show no hesitation in taking the ECB “all in” and, thus, provide a credible balance sheet bridge. Discussion of the ECB lending to the IMF in order for it to lend back to European countries is intriguing but potentially detrimental. There is no substitute to direct and forceful engagement by the ECB as part of a holistic and durable solution.
.
Fourth, the banking system will need to play, or be made to play a more constructive role. Injections of exceptional liquidity from the official sector should be used to encourage in new private capital rather than finance its continuous exit. In some cases, this could happen endogenously; in others, it will require more forceful intervention by both national and regional authorities.
.
Fifth, Ms Merkel will need to be brutally honest in its engagement with its European partners. To be part of a proper solution, other leaders must be credibly able and willing to commit. Germany needs to call out those that cannot, and also to proceed without them.
.
Finally, communication must not be bungled yet again. Domestic and global audiences should be informed in a consistent and clear manner. This means conveying a clear vision along with accompanying steps. It is certainly not the time for the type of conflicting and competing remarks from European officials that have undermined virtually every recent attempt to halt this crisis.
.
There is a lot of work to be done in the next few days, and quickly. Leaders will need to resist the natural tendency to cut corners and please each other with unsustainable compromises.
.
If they again succumb to shortcuts and partial answers, history will mark this as an enormous failure to deliver on one of the last, if not the final, opportunity to save a union that is key to the region’s wellbeing, as well as that of the global economy.
.
The writer is the chief executive and co-chief investment officer of Pimco
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