To deal with this insolvency we need to restructure the debts of those nations, but in a way that does not destabilize Europe’s fragile banking system. And it needs to be credible enough so that once restructured, the troubled nations will easily be able to finance themselves. Europe now has the €750bn package of assistance in place and they should use it to fix the problem once and for all. The ingredients for a solution include:
- Announcing an orderly restructuring of the periphery countries’ debt (Greece, Portugal and probably Ireland). This should start with a standstill budget.
- Regulatory forbearance explicitly provided to all European banks, with a backstop of ECB liquidity and a €500bn support programme to provide capital injections – as happened in the United States in 2008-09.
- The nations not restructured need to be supported via ECB liquidity lines that guarantee the rollover of their government debt.
- The G20 needs to provide support to prevent chaotic foreign exchange markets, but also accept a further devaluation of the euro. At some point, the G20 will need to intervene to support the euro via central banks.
Such a comprehensive package of measures would be painful, but it is the only realistic solution to this chaos. It would also restore some credibility to Mr. Trichet and the ECB, who, at this stage, appear captives of the fiscal crises in the eurozone.
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