12 December 2010

Euro Needs True Leadership

Today it’s barely a surprise to anyone following the developments in euro area, that euro is in crisis even though this may not be publicly recognised by the authorities.

Debt crisis spreads (skyrocketing CDS spreads of weaker EU countries, concerted selling of government bonds). It started from Greece; now it has hit Ireland; Portugal is on the edge; Spain and Italy are likely to be next in row; Belgium bond yields surge as investors question its ability to cut the euro region’s third-highest debt load, overshadowing the country’s economic performance.

The European Financial Stability Facility in the amount of EUR 750 billion is too small for solving everyone’s troubles, and it is far from a common agreement of whether the Facility should be enlarged or not.

Belief into ECB’s ability to control the situation is eroding.

There are large differences between countries within the euro area: while stronger and more competitive countries like Germany are now performing well, the weaker ones in southern part of Europe are not competitive and still suffer declining economy, extremely high unemployment, soaring government debt and interest payments all combined with the need for significant austerity measures and an internal devaluation. Imbalances between countries’ current accounts are huge and not much improvement could be expected.

There is no certainty about the financial standing of the European banks and not even about their real exposures to the so-called PIIGS countries (Portugal, Ireland, Italy, Greece, Spain). The stress test conducted in July 2010 has turned out to be too mild at best, which is illustrated by the fact that some of the banks that were declared to pass the test have already needed government support (Bank of Ireland; Allied Irish Banks PLC).

In reality, deposit insurance funds are too small to honour their promises to the depositors if any of the big banks should fail (one should also take into account that the failure of such a bank triggers domino effect in the banking system).

All the talks about spreading debt crisis, too-big-to-save’s and break-up of euro area may well be self-fulfilling prophecies.

Europe needs solutions. The world needs solutions. While in longer perspective the fundamentals of money and currency regimes need to be revised, including but not limited to the economic reality that monetary union is not sustainable without political union, right now we are in the mood of crisis management. All the bailout packages to the governments and banks, the talks about the recovery being on track, ECB buying government bonds – all this only enables to gain some more time.

There are voices that say: “Better a horrible end than an endless horror.” They forecast euro zone break up, some of the countries leaving euro, dividing euro zone into north and south etc. The thing is that these extreme measures are not likely to make the situation any better as nicely discussed e.g. in the recent Economist article “How to resign from the club”.

Euro zone leaders and key decision makers both in public and in private sector, finest economic analysts and best brains in finance are now to show up the true leadership. Neglecting severity of the situation and hiding the problems has to be stopped. This has to be replaced by clarity and full understanding of the state of affairs. There needs to be courage to admit the mistakes made, and openly discuss the possible future scenarios and –alternatives.

Gradual write-downs of parts of sovereign debts (so that the depositors would not suffer because of problems in banking sector) may be the best option available at first (structural reforms, dealing with imbalances between countries etc. are of course necessary as well, but they are next in the row). Euro zone leaders have to prove that they are in control of the situation in the sense that they can do it in an orderly manner. The only way to avoid panics is to be fully transparent in what and why is being done. Sure, statements made by the officials so far complicate the matter. Sure, banks and investors need to cooperate, recognise the losses for the risks that they have taken and otherwise behave responsibly. Progress made shall be possible to track publicly.

It can’t be that there is no solution. Lack of true willingness and conflicting powerful vested interests are those that cause crisis on euro area to persist. This sounds absurd, but unfortunately seems to be the case.

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