Saturday 21 October 2017

Five ways to save Europe

Europe's response to the debt crisis has so far fallen flat. How else can the eurozone's debt rot be stopped, asks Louise McBride

THE European debt crisis escalated sharply last week amid growing fears that Greece would soon default on its debt -- with Ireland to follow suit.

A default by Greece could drag other countries down with it -- including Spain, Italy and Belgium.

The threat of Greece being forced out of the euro also loomed larger after the Greek EU commissioner Maria Damanaki became the first senior European official to warn that the debt crisis rocking her country could force it leave the euro.

If this happens, the eurozone could rapidly collapse.

Europe's response to its debt crisis clearly isn't working. It needs to come up with solutions fast before a union that is over 50 years old starts to fall to pieces. What options does it have?

EUROBOND

Some believe the answer to Europe's debt crises lies in the creation of a new bond, dubbed the eurobond. EU countries would essentially pool their government debt by issuing eurobonds, which would then be held by a central European debt warehouse. Doing so would allow troubled economies to refinance their existing debt at lower interest rates, improving their solvency and making it easier for them to raise money. Only a certain amount of a country's debt would be allowed to be put into this debt pool. To prevent the eurobond promoting reckless lending, it would only be available to help countries repay responsible borrowing.

Proponents of the eurobond believe it would represent far less of a financial risk to Europe than to actively bail a country out. They also believe it would enable debt-ridden countries to get back on their feet quicker and make them less likely to default, thereby increasing the stability of the eurozone.

"Lending money to debt-ridden countries is not a solution in itself," said Ronan Reid chairman of Dolmen Securities. "The European Central Bank (ECB) needs to create a structure where they buy back some of the debt and create a warehouse for that debt. Creating a eurobond is one way of doing that. Getting agreement on that will be fraught with difficulty, however, as it moves some of the liability from countries such as Ireland permanently to the ECB. Buying out some of the debt is a big risk for the ECB, but it either does that or it will have to write off some of the debt if a country defaults."

Alan Gray, managing partner of the economic consultants Indecon and a former director of the Central Bank, however, is wary of the eurobond. He believes the eurobond could trigger future property bubbles and inflation as he says that euro-denominated sovereign bonds -- which are already in existence -- are partly to blame for the current debt crisis. "These bonds fostered property bubbles based on euphoric assessments of the appropriate yields for each country's sovereign debt," said Gray.

GROWTH BOND

Central Bank governor Patrick Honohan last month suggested that Ireland's debt bill should be linked to its economic growth.

Honohan advocated GNP-linked bonds, where Ireland would pay back a greater share of the repayments on bonds issued by the European Financial Stability Facility (an EU bailout fund) if its economic growth was strong. Conversely, Ireland would have to pay back less if its economic growth was weak.

The advantage of such an approach is that it would prevent hefty debt repayments from stalling a country's economic recovery and ensure that a country's debt repayments were not beyond its means.

SOFTER BAILOUT

Gray believes that the best way to resolve the debt crisis is for Europe and the International Monetary Fund (IMF) to give countries such as Ireland and Greece a longer time to clear their debts. He also believes Europe and the IMF should reduce interest rates.

"An immediate step that should be taken is for a more reasonable interest rate to be applied to the Irish loans," said Gray. "This will not be a panacea for Ireland but will ease the adjustment it must make (to repay its debt) in some small measure. Countries such as France should stop the nonsense about seeking changes in the Irish corporate tax rate and realise such a requirement could never be met by an Irish government and would also not be appropriate.

"Unless Europe acts quicker in accepting that Europe must play a greater part in facilitating Ireland and other indebted countries, the crisis in the euro will remain."

Simon Tilford, chief economist of the Centre for European Reform, believes that Europe will eventually have to write off about half of the debt of countries such as Greece and Ireland.

"Far from improving access to the financial markets, the support packages for Greece and Ireland have left these countries facing record borrowing costs," said Tilford. "The markets do not believe that the struggling euro countries are going to grow rapidly enough to service their debts.

"The outlook for Portugal is similar, notwithstanding the slightly less draconian terms of its agreement. Initially, the EU will no doubt try and get away with 'soft' restructurings, involving a combination of longer maturities and lower interest rates. But this will not work and by 2013 there will be no viable alternative to 'hard' restructurings (default) comprising debt writedowns of 50 per cent or more.

"Unfortunately, in the case of Greece and Portugal at least, even this will not guarantee continued membership of the euro."

ECONOMIC REFORM

Greece, Ireland and Portugal must get back on their feet economically -- otherwise any moves to resolve their debt crises will be meaningless. They would continue to find it impossible to raise money on the open market at any anything but prohibitive costs.

To prevent a similar crisis re-occurring, Reid believes the ECB needs to lay down some simple rules for EU banks.

"The ECB also needs to change its mandate to one that fosters economic growth rather than one which controls inflation and ensures the stability of the monetary system," said Reid.

The ECB should also encourage mergers of banks across the eurozone, according to Reid.

"In the US, they encouraged the merging of banks (after the subprime crisis)," said Reid. "Driving mergers takes out costs and make the banks more profitable."

ONE EUROZONE

ECONOMY

Some believe the only way to stop debt-ridden countries like Greece and Ireland dropping out of the euro is to create a eurozone with tighter political and fiscal integration. In a report last month, where he compared the eurozone crisis to similar problems in the US banking system in the 19th century, Adalbert Winkler, a professor of finance at Frankfurt's School of Finance and Management, said: "A substantially more comprehensive economic union might be needed."

The problem with a single eurozone economy is that it is "politically near-impossible", said Alan McQuaid, chief economist with Bloxham Stockbrokers.

"Not only would it mean surrendering sovereignty -- few issues are more sovereign than collecting taxes and running and financing a budget -- but it would be the bailout to end all bailouts. Wealthy central and northern European countries such as Germany and the Netherlands would quite literally assume the collective debts and risks of the likes of Portugal and Greece.

"It would also mean that those countries 'rescued' would face no incentive to overhaul their economies to make themselves more competitive and grow. They would be more likely to go on as they have done, knowing they are protected under the eurozone banner. Yet even if the whole idea of deeper fiscal and political union is unthinkable for a decade or more, the long-term trend for the eurozone points in that direction."

The Portuguese Prime Minister Jose Socrates echoed such sentiments: "The European project faces a challenge, and this challenge has to be answered by deepening the European project . . . the common currency is defended by deepening economic integration. It's best if we all work together."

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