THERE is an immediate crisis in the eurozone, as well as serious doubt over its long-term viability. There are two tasks, the prevention of a macroeconomic train-wreck over the next few months, and the re-engineering of a proper monetary union for Europe.
The measures needed to deal with the short-term crisis are straightforward and readers deserve to be spared yet another recitation from me. So here is an extended quote from former UK Chancellor of the Exchequer Alistair Darling, writing in the London Independent on Friday: "There are three things Europe's leaders need to do right now. First, even with a new Greek government there is no one who seriously believes that the present Greek fix will work. A plan that leaves Greece with debt at 120 per cent of its GDP in 2020 -- more than it had when it went into this crisis -- is doomed to fail. We know that. So why not fix it now?
"Second, bank recapitalisation cannot wait until next summer. If Greek, Italian or Spanish banks begin to falter, what happened in 2008 will seem like a squall compared to the hurricane that would be unleashed in Europe, and soon.
"Third, the rescue fund does not exist. Nor does it look like existing any time soon. The European Central Bank does exist and should be allowed to buy bonds from distressed countries. In a crisis you have to use what tools you have to hand."
The US economist Nouriel Roubini put it like this in the Financial Times, also on Friday: "Only if the ECB became an unlimited lender of last resort and cut policy rates to zero . . . could we perhaps prevent disaster."
There is nothing to add, really. This crisis could run out of control very quickly: the spread on AAA-rated French 10-year bonds is already 1.7 per cent above Germany and the markets could decide to skip Spain and proceed directly to France next week. The triumvirate of France, Germany and the ECB that has assumed leadership through the crisis is drinking in the Last Chance Saloon.
The short-run response will play out over the next weeks and months in a manner outside Irish influence. Provided adequate measures are taken to avoid a eurozone break-up, bank failures and disorderly defaults, Ireland is not affected by unaffordable bond market interest rates in the short-run, since we are out of the market.
It is in our interests that the leaders act to prevent a catastrophe in the short term, but also that the European sovereign bond market be reconstructed on a durable basis, since Ireland must regain the ability to sell sovereign debt in due course. The market has been laid waste by the design flaws in the currency union and the lacklustre response to the Europe-wide banking crisis as much as by fiscal irresponsibility. This crisis was not caused by excessive budget deficits in a few small countries, however comforting that explanation might be to the designers and guardians of the single currency project.
If the long-term problem is just a budgetary and debt crisis, a new scheme to address it may be at hand and it has
come from Germany, where ignoring the immediate crisis has been popular.
On Wednesday, Germany's Council of Economic Experts proposed a European Redemption Fund to ease the retirement of sovereign debt. The basic idea is that each eurozone member would be responsible for its sovereign debt up to the level of 60 per cent of GDP. The balance would become the responsibility of a joint European fund and the interest cost would be an average of what the various countries currently face.
There would be strict conditionality and everyone would be expected to run budget surpluses large enough to retire the debt over 25 years. The scheme would ease the burden on the most indebted countries, without differentiation as to the sources of their debt.
The Council of Economic Experts is an influential group appointed by the German government which pronounces from time to time on economic policy issues. Its five members are prominent German economists and their reports invariably create a stir in the German media. Their proposals are worthy but incomplete, and quite unattractive to Ireland.
Almost 50 per cent of GDP has been added to Ireland's debt resulting from its contribution to the costs of rescuing the eurozone banking system. The average eurozone member has contributed no more than 4 or 5 per cent. The proposal from the Council of Economic Experts proceeds as if all distressed sovereign borrowers excluded from the markets or in danger of exclusion are burdened with debt arising solely from domestic fiscal excess.
This is not the case in Ireland, which complied better with the fiscal rules than Germany did in the years leading up to the crisis. Ireland's peak debt ratio would be no higher than the figure for Germany were it not for the cost of rescuing banks. The costs include payments to bondholders in bankrupt banks already closed down by the regulators and made at the unexplained insistence of the ECB.
German banks foolish enough to buy dud assets in the United States did not get compensated by the US taxpayers, but they did get compensated by Irish taxpayers for purchasing Anglo Irish Bank liabilities.
Fund managers who purchased AAA-rated European sovereign bonds five or six years ago are nursing huge losses. Those clever enough to purchase bonds issued by banks that have lost multiples of their capital have received 100 cents on the dollar. There appears to be no willingness in the German commentariat to engage with this issue, and the Irish Government has failed dismally to put the point across.
The German Council of Economic Experts offers no advice on the immediate decisions that have to be faced and no redesign of a common currency system that might endure. It has been the undeclared priority of the European Central Bank since 2008 to place bank creditors at the head of the queue and to avoid bank resolution. The result has been a festering and unresolved banking crisis and the destruction of the European sovereign debt market. You reap what you sow. When the authorities persistently subjugate sovereign creditors to bank bondholders there are predictable consequences.
The construction of a durable currency union and the restoration of solvency to its sovereign borrowers is a long-term project, which will require treaty changes. There is no plausible architecture for a proper monetary union in Europe under the existing arrangements, and the silence of the German experts, whose report is ostensibly focused on the longer-term, on this central question is alarming.
As the IMF has stressed on numerous occasions, a durable currency union needs centralised bank supervision, centralised bank resolution and a centralised system of liability insurance for banks. The delegation of these functions to 17 eurozone member states has contributed to the severity of the current crisis and increases hugely the risk of another one.
The reluctance of Irish politicians to embrace the prospect of a referendum on treaty change is not a policy, it is an understandable gut reaction shared, no doubt, by electorates throughout Europe. But it makes no sense to reject treaty changes sight unseen, particularly if the seeds of the current turmoil can be found in the inadequacies of the existing treaties.
No treaty change means, for example, persisting with the European Central Bank in its current form. How many policymakers think that this would be a good idea? Alternatively, if the currency union had to be designed all over again, who thinks that there is no room for improvement?
If the eurozone is to become a credible currency union for the long haul, assuming it survives the efforts of its rescuers, there will have to be treaty changes. It is foolish to dismiss the possibility that sensible treaty changes, worthy of support even from countries damaged by the bungling response to the crisis, cannot be envisaged.
These treaty changes could involve a loss of fiscal sovereignty for Ireland. But Ireland has lost its fiscal sovereignty already.
There is, in any event, no cost in accepting a regime of fiscal discipline to which any sensible country would willingly subscribe.
The real issue is whether Europe can create a proper central bank and accountable decision-making authority to go with its premature currency union. If this can be achieved, the euro is worthy of rescue.