The Corner

Enough to make a Difference?

The telethon coordinated by the IMF’s Christine Lagarde appears to have raised over $400 billion (at least in theory) to add to the Eurozone’s firewall.

The Daily Telegraph’s Jeremy Warner is predictably skeptical about quite how good such a firewall would be, but then gets to the heart of the problem:

By flooding the battered European banking system with cheap liquidity, the European Central Bank has bought time, but for what? There are still no convincing answers on how the eurozone periphery is going to be returned to competitiveness.

Almost every viable solution has essentially been ruled out. Germany won’t accept the higher rate of domestic inflation which would allow the periphery an easier path back to relative competitiveness, but nor will accept permanent transfers to finance the south’s continued current account deficits.

All rests on the idea that structural reform will in time deliver the wage and price competitiveness the south needs to close the gap with Germany. The European Commission has been set the task of explaining how it thinks competitiveness will be restored, with numbers attached. Will this give markets the confidence they need to start funding the stricken eurozone periphery once more? This seems unlikely.

Spain has become the flash point du jour. Unlike Greece, which was primarily a fiscal crisis caused by excessive public spending, Spain is primarily a banking crisis caused by a credit and construction boom. Here in Washington, the Spanish delegation has indicated that it intends finally to grip the banking problem through the well tried solution of separating out the rotten assets and placing them in hived off bad banks. However, details remain sketchy and there is no certainty this can be done without recourse to outside funding. If the state is to assume responsibility for all the bad assets, this will make its fiscal position even more precarious.

But even if this does succeed in stemming the immediate banking crisis, it doesn’t address the more fundamental problem of lost competitiveness, highlighted in a widening current account deficit which one way or another has to be financed.

The bottom line is that there are really only three ways in which the euro crisis can be resolved. Two of these options – a smaller eurozone shed of its uncompetitive south, and permanent fiscal transfers from north to south to finance the deficits – have been rejected. That leaves the euro’s future entirely dependent on restoration of competitiveness through austerity and structural reform. Can this succeed? I doubt it. Repeated rounds of austerity is undermining support for structural reform, which in any case cannot in itself restore the domestic demand necessary for decent levels of growth.

Someone is either going to have to give in or move on

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