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Daniel Gros and Thomas Mayer’s proposal to set up a European Monetary Union might have had some merit at the time of the Euro’s launch in January 1999. However, over the past decade, the world has changed fundamentally in a way that today renders their proposal a non-starter.
The economic fundamentals of Greece, Spain, Portugal, and Ireland have all deteriorated to a point where markets are now seriously questioning these countries long-run capacity to service their debt. It does little good to close the stable door now after the horse has long since bolted. At the same time, a very large part of these countries’ sovereign debt is now securitized. This makes that debt very much more difficult to reschedule than was the case when sovereign debt preponderantly took the form of bank loans.
Willem Buiter correctly notes that for Greece it is five minutes to midnight. Since adopting, the Euro, Greece has lost more than 25 percent in competitiveness, which has contributed to a widening in Greece’s external current account deficit to more than 10 percent of GDP. At the same time, Greece’s budget deficit has ballooned to 12 percent of GDP, while its public debt to GDP ratio is approaching 120 percent, or double the Maastricht criteria. It is fanciful to think that markets will patiently hold onto their Greek paper while the Europeans take their sweet time to set up as far-reaching an institutional change as Gros and Mayer are now proposing. It is also difficult to see how the gimmicks they propose for their Monetary Fund would do anything to reverse the enormous damage that has already been done to the Club Med countries’ economic fundamentals.
The recent strong public outcry in Germany against the notion of bailing Greece out should give one pause before suggesting that a new European Monetary Union should be set up and should be funded by market borrowing backed by member country guarantees. The German public will rightly ask how different would lending by the proposed European Monetary Union to member countries in distress be from the sort of sovereign bailouts that are supposed to be proscribed by existing Euro-zone agreements. They will also understand that it would be the German taxpayer rather than the markets that would be left holding the bag in the event of any failure by Greece to repay.
It seems to have escaped Gros and Mayer’s notice that sovereign borrowing is now done preponderantly in the securitization market rather than in the form of bank loans. This makes the idea of a Brady Bond-style restructuring obsolete. In this context, it is instructive to recall that almost ten years after it defaulted in 2001, Argentina is still shut out of the international capital market and it is still to come to terms with the holdouts on around 25 percent of its outstanding debt at the time of its default.
If Greece’s external and internal imbalances have indeed reached such a proportion that a default is inevitable, it is not clear that Greece would be well served by delaying its day of reckoning. Nor is it clear that it is in Greece’s interest to be saddled with a mountain of official debt that cannot easily be rescheduled to postpone the inevitable. What is even less clear is why Gros and Mayer would want to reinvent the wheel by creating a European Monetary Fund, when one has the International Monetary Fund that already has the expertise to impose the appropriate conditionality on lending to wayward countries like Greece.
In short, when the house is burning and when it can still be salvaged, it is a good idea to call in a fire brigade with proven credentials. It is better to do that than muse about the future construction of an elaborate edifice that might have been more fire resistant.
Desmond Lachman is a resident fellow at AEI.
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