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How to Save Europe

Jeff Madrick
The financial crisis is the next great test: it will mark the success of one of the great political and social experiments of our time if the Europeans come together to remedy it; it will be tragic for Europe and for the world if they do not.

Michael Probst/AP Photo

Tents set up by the ‘ Occupy Frankfurt’ movement in front of the European Central Bank, October 26, 2011, Frankfurt

In theory, the European financial crisis can be contained. In fact, the Bush administration’s approach to the 2008 economic meltdown—the Troubled Asset Relief Program (TARP), coupled even more importantly with a combined trillion-dollar guarantee from the Federal Reserve and the Federal Deposit Insurance Corporation—is a fine model. Up to a point. Washington threw all the money it could politically muster at the bad debtors and calmed financial markets that were on the brink of utter collapse. If this hadn’t been done, the financial crisis and ensuing recession, bad as it was, would have surely been far worse.

Europe has the financial wherewithal to do at least what the US did. As I write this, European leaders are meeting in Brussels to try to take an important step in that direction. But what is certain is that many details will be left open. I have just spent ten days in Dublin and Paris and was struck by the intensity of nationalism I encountered. Many Northern Europeans feel they are being made to shoulder the burden of the bail out, and I was on two television programs where I was taken aback by the quick anger toward Greece and other indebted nations in Southern Europe. (Ireland, as a debtor, is an exception among the Northern nations, having itself been a victim of some derision). You’d think no one remembered that it was France and Germany that first broke the silly Eurozone limits on budget deficits and allowed their deficits to rise above 3 percent of GDP seven or eight years ago. Being the biggest boys on the block, they got away with it.

Overcoming this nationalistic rivalry and self-centeredness is of course what the European Common Market was attempting to diminish in the first place by holding out the promise of prosperity. We are now fifty years on and, notwithstanding this fresh vent of nationalism, Europe has come a long way. But it has farther to go. The financial crisis is the next great test: it will mark the success of one of the great political and social experiments of our time if the Europeans come together to remedy it; it will be tragic for Europe and for the world if they do not.

Europe has enough money to bail out Greece, provide support for Italy, Spain and Portugal, and keep its banks whole. But the longer it waits to release these funds, the deeper the financial hole becomes. The Greeks are in way over their heads, and it will require canceling—otherwise known as restructuring—a large part of their debt to effectively address the problem. But to say the Greeks were profligate by running huge budget deficits to support their social programs does not explain the crisis as well as some Americans and Europeans like to think. Equally important was the part played by bankers in Germany, France, England, and America, who lulled them into borrowing and who saw a tidy profit to be made at handsome interest rates that were still too low for the risk. The Germans also know full well that Greece and other importing nations have been fueling Germany’s export boom, buying all the products the Germans can produce, thanks in part to monetary union, which makes German exports much cheaper in Greece than they would be under the Deutsch Mark.

Germany’s situation is not all that different than China’s. But China forces its currency to stay down while Europeans have generally agreed to a fixed euro that is low for Germany but high for Greece and others. The point is that the Germans have an obligation to restore order and pay the price for a system that has made it all too easy to sell their goods and become the strong man of Europe. In my view, so does China, by adding funds to Europe’s rescue mission. But why is this so little understood, or even discussed?

What has to be done is clear, but no one is talking about it: an approach like the TARP, coupled with sovereign debt purchases by the European Central Bank. Unlike in the US case, however, in Europe bondholders, usually the banks, must take losses to reduce the cost to the bailout fund and enable the struggling countries to reduce their debt service adequately. (In this way, Greece’s debt may be reduced by fifty or sixty percent, making debt payments manageable.) This may injure the banks, so a firewall is necessary. Through a new, agreed upon fiscal authority, the Eurozone should issue bonds backed by all seventeen members to finance the banks and the debtor nations. In lieu of this, they can, and are discussing, guaranteeing a certain proportion of the debts held by the banks, thus expanding the money they can lend. But the ECB should also be the lender of last resort, like the Federal Reserve has been.


The Eurozone must also transfer funds to countries like Greece and Italy if European leaders expect them to sharply curtail social programs without going further into recession and entering a cycle of still more reduced tax revenues and higher deficits. (Much in this way, Washington gives, or should give, money to state and local governments to meet unemployment benefits or Medicaid needs.) These transfers should come at no cost.

Instead, of course, as I write this, the leaders of the Eurozone are having trouble agreeing on a program to back bonds or expand their relief fund. More dangerous, the ponderous old guard who run the European Central Bank are not nearly as flexible as our Fed, which was once bad enough. The ECB is still obsessed with forestalling inflation, which is nowhere to be found, and resists buying up sovereign debt if necessary. Under pressure, I think they may change. After all, the Fed has done so under Ben Bernanke. As a Princeton professor, he believed inflation targeting was essentially all that mattered, that depressions could always be avoided through expansionary monetary policy, and that central banks should not worry about asset bubbles. To his credit, in the face of real-world problems, he has done an about face and become more aggressive—though not aggressive enough.

The men I argued with on European TV scolded me that the Eurozone is not the US. They are right. They are not a unified nation that can easily issue Treasury bonds. And here is my main point. In the 1800s, the US was also not the US of today. It learned to unify through necessity and, ultimately, a practical awareness of the advantages of size, a single currency, and federal jurisdiction over an increasingly wide range of issues—that is, national governance.

Giving the Eurozone something approaching this level of unity was never going to be easy and some speculate that Germany’s Angela Merkel will refuse to save Greece, contrary to the advice of many economic commentators, because of some bitter resentment among German voters. I don’t think she will allow Greece to default. I think more Germans recognize their obligations than not. It may require $2 trillion and a European Central Bank that sheds its ridiculous traditions. Old habits die hard, but they are dying. Only a few months ago, Jean-Claude Trichet, the outgoing head of the ECB, resisting aggressive bond purchases to the end, said the problems should not be dramatized. It was the classic error that Walter Bagehot, the great 19th-century economic journalist, warned about. Waiting until crisis forced one’s hand and making it all the more expensive and potentially explosive. Soon enough, he was calling for dramatic action. The incoming ECB chief, Mario Draghi, has now announced a somewhat softer line.

As European leaders meet in Brussels, we can only hope that enough agreement is reached to establish a blueprint for a true and durable rescue. It won’t be easy, but it is not impossible.

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