Business World

Wednesday 13 December 2017

The top 10 misconceptions of the euro crisis

The United States resolved its debt problem at the last minute and its politicians can now take a quiet break.

But Europe's leaders need to keep their phones on -- yields on Spanish and Italian bonds are approaching levels that will make market financing too expensive and necessitate financing packages.

The US debt problem was exactly what it seemed and required an agreement on how to get finances under control.

The euro crisis is far more slippery and is about who is responsible for debt and whether it can be shared. Markets ask much bigger questions when it is not clear who is responsible for debt.

To make matters worse, Europe's leaders have responded with more confusion than clarity.

Sometimes, this is due to misunderstanding, but confusion has also been planted to seek advantage.

So, as Europe's leaders wait for the phones to ring again, let's have a bit of summer fun and select the top 10 misconceptions -- or deliberate fallacies -- that have beset the euro crisis.

10 The notion -- advanced by Lorenzo Bini Smaghi of the ECB -- that the crisis was solely caused by bad policies in bad countries. If this were so, the crisis would be limited to those countries and would not continue to spread.

And bad policies would have been more evident from the start if not hidden by a common feature.

A better explanation is that that there is a fundamental weakness in the euro system that was long concealed -- and permitted to fester -- by a loose ECB monetary policy.

9 The associated proposition that crisis countries should be punished with high interest rates.

This idea was originally touted by the European Commission, to discourage countries from bad policies, but eventually gave way to the joint realisation that crisis countries did not deliberately pursue suicidal policies and that their recovery was, in any event, better for everyone.

8The suggestion -- usually made by financial types -- that interest rates on rescue programmes need to be higher than market rates to discourage countries from opting for programmes.

But countries surrender economic sovereignty under such programmes and their assistance needs to be approved by creditors. So programmes are exceptional and cannot be entered into at will.

7 This leads on to the notion that the ECB cannot give preferential treatment to banks in programme countries.

This is ridiculous because the ECB is giving the assistance anyway -- to prevent the banking system from collapsing -- and it will only work properly if it is put on a medium-term footing to stop deposits from leaving banks. Programme countries need help and this is not "preferential".

6 The ECB illusion that the euro area has a one-size-fits-all monetary policy that cannot be adapted to individual countries. But the question of whether the common policy is the appropriate policy has to be addressed by examining its effect on individual countries -- not by measuring averages.

Pre-crisis monetary policy was generally too loose but this was only evident in the periphery where it turned strong growth into a boom. It should have been tightened to benefit everyone.

5 Mr Bini Smaghi returns with his contention that Ireland's taxpayers should foot the entire bill for the banks because our supervisors failed.

There is no doubt that Irish supervisors were very lax but the big problems were caused by cross-border lending and this is a shared responsibility.

The eurozone needs common supervision and an associated bank-resolution structure and the ECB failed to propose these.

4Jean Claude Trichet's mantra about a "global consensus to have no restructuring of debt". This is total nonsense and he, as a former head of the Paris Club -- the body that implements debt restructuring -- knows that debt relief is common. He also knows the IMF wants debt reduced now.

3 The Morgan Kelly proposition that Ireland can reject responsibility for bank debt and still maintain a good sovereign reputation.

The notion is appealing but would leave us bereft of assistance and friends at a time when we need both.

Ultimately, as demonstrated by this crisis, sovereign reputations depend on access to adequate assistance -- and this is why questions are now being asked of Spain and Italy. We can propose debt reduction but must wait.

2 The Sinn Fein fallacy that Ireland can default and tell the IMF "to go home and take their money with them". This would leave Ireland's reputation in tatters and would probably exclude us from international markets for a generation or more. The economy would wither in isolation.

1 And the top fallacy of the euro crisis is that countries in difficulty can introduce new domestic currencies and, in one fell swoop, devalue and restore competitiveness.

But it is simply not possible for a country with serious financial problems to introduce a new currency.

The euro would remain as the de facto currency, whatever its legal status, and there would be even more confusion. So we are stuck with the euro and it is time to cut the nonsense.

Gary O'Callaghan is Professor of Economics at Dubrovnik International University. He was a member of the staff of the IMF and has advised numerous governments on macroeconomic policies.

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