terça-feira, 25 de outubro de 2011

Europe: put your money where your mouth is

In August, I and Fernando Alexandre wrote a post on "the end of Europe as we know it". There we argued that resolution of the crisis requires further, and decisive, transfers of fiscal sovereignty to Europe, though short of a full-fledged "European government", which we believe to be unrealistic at present. We also wrote that France and Germany appeared to be moving towards a solution of this sort.

As far as I can understand from recent news and previews of tomorrow's European summit, it appears we were wrong: France and Germany are still trying to make us believe that minor changes to the European treaties (focused on after-the-fact punishment), plus a drastic haircut and some sort of a European "fund" or "mechanism", with one, two or three billion Euro and in charge of negotiating and overseeing austerity measures, will be enough to end the crisis. The presumption, I believe, is that financial markets will from now on charge interest rates on European governments' bonds that, though sustainable, will (together with the memory of recent events in Greece) force them to maintain sound public finances, thereby avoiding the need for a significant revision of European treaties to allow for before-the-fact intervention.

I am inclined not to believe that these proposals (amendment+haircut+fund) will convince the financial markets. The shock waves from a drastic haircut will affect many other countries and assets. Soon the amount given to the "fund" will (again) appear too low to protect other endangered countries. I therefore suggest the following to European leaders: If you really believe that the proposed amendments to the treaties and the haircut will be enough to make European countries solvent, then tell the "fund"/European Central Bank to freely buy European governments' bonds, so as to fill any gap left by "irrational" financial market behaviour.

Note that "funds" or "mechanisms" are just masking the essential: it is the ECB who is holding the real bazooka, i.e., the printing press. Making the ECB lend a slingshot to a "fund" and announcing that a few more slingshots may be lent will not keep away the wild beasts. The fund/mechanism is only a mediator between troubled countries and ECB money: its duty is to make sure that countries deserve their funding. But, given the size of European public debts, without full access to ECB money it will always appear to be too small.

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