Tag Archives: eurozone crisis

What Would It Take To Save Europe?

By Simon Johnson

Last weekend official Washington was gripped by euphoria, at least briefly, as people attending the IMF annual meetings began to talk about how much money it would take to stabilize the situation in Europe.  At least one eminence grise suggested that 1.5 trillion euros should do the trick, while others were more inclined to err on the side of caution – 4 trillion euros was the highest estimate I heard.

This is a lot of money: Germany’s annual Gross Domestic Product (GDP) is only about 2.5 trillion euros, and the combined GDP of the entire eurozone is about 9.5 trillion euros.  The idea is that providing a massive package of financial support would “awe” the markets “into submission” – meaning that people would stop selling their holdings of Italian or Spanish debt and thus stop pushing up interest rates.  Ideally, investors would also give Greece and Portugal some time to find their way to back to growth.

But this is the wrong way to think about the problem.  The issue is not money in the form of external financial support – provided by the IMF or other countries to parts of the European Union.  The real questions are: will Italy get complete and unfettered access to the European Central Bank, and when will we know this? Continue reading

Will The IMF Save The World?

By Simon Johnson

The finance ministers and central bank governors of the world gathered this weekend in Washington for the annual meeting of countries that are shareholders in the International Monetary Fund.  As financial turmoil continues unabated around the world and with the IMF’s newly lowered growth forecasts to concentrate the mind, perhaps this is a good time for the Fund – or someone – to save the world.

There are three problems with this way of thinking.  The world does not really need saving, at least in a short-term macroeconomic sense.  If the problems do escalate, the IMF does not have enough money to make a difference.  And the big dangers are primarily European — the European Union and key eurozone members have to work out some difficult political issues and their delays are hurting the global economy.  But, as this weekend’s discussions illustrate, there is very little that anyone can do to push them in the right direction. Continue reading

Should We Expect Another Round Of Bailouts?

By Simon Johnson

In the wake of recent equity market declines, the clamor for bailouts of various kinds grows ever louder around the world.  Influential voices call for “leadership” from the US and Western Europe, and for policymakers in those countries to “get ahead of the curve”.  This is all code for a simple and familiar plea: Do something that will protect investors, particularly creditors who have lent a lot of money to banks and countries that now appear to be in serious difficulty.

But providing another round of unconditional creditor bailouts in this situation would be a mistake.  What we need is a combination of transparent losses where bad loans were made, combined with a ring fencing approach that protects sound governments and firms.  There is no sign yet that policymakers are willing to make that distinction clear.

The situation around the world is undeniably bad.  As Peter Boone and I argued in a Peterson Institute policy paper released a couple of weeks ago, Europe is most definitely “On the Brink” of a serious economic crisis that could involve widespread defaults or significant inflation or both.  At the same time, Bank of America shares this week fell to their lowest in 2 years; with other large banks under pressure, there is a legitimate fear of rerunning the parts of the financial crisis of 2008-09. Continue reading

Why Can’t Europe Avoid Another Crisis? Why Can’t the U.S.?

By Simon Johnson

Most experienced watchers of the eurozone are expecting another serious crisis to break out in early 2011.  This projected crisis is tied to the rollover funding needs of weaker eurozone governments, i.e., debts falling due in March through May, and therefore seems much more predictable than what happened to Greece or Ireland in 2010.  The investment bankers who fell over themselves to lend to these countries on the way up, now lead the way in talking up the prospects for a serious crisis.

This crisis is not more preventable for being predictable because its resolution will involve politically costly steps – which, given how Europe works, can only be taken under duress.  And don’t smile as you read this, because this same logic points directly to a deep and morally disturbing crisis heading directly at the United States.

The eurozone needs to – and will eventually – take three steps: Continue reading

Restructuring The Eurozone

By Simon Johnson

In today’s Financial Times, Peter Boone and I have an op-ed with proposals for reforming how the eurozone operates.  The current arrangements have proved unstable – encouraging countries to run excessive budget deficits while also giving banks an incentive to both finance profligate governments and also fuel real estate bubbles.

Addressing these problems would require creating a “core” of countries that keep the euro, agree to much more unification of fiscal policy, and put in a place a single strong bank regulator/supervisor.  A move in this direction may not seem likely in the short-term, but the pressures are still building.

Eurozone: The Kitchen Sink Goes In – Now It’s All About Solvency

By Peter Boone and Simon Johnson

The eurozone self-rescue plan announced last night has three main elements:

  1. 750bn euros in a fiscal support program, with 1/3 coming from the IMF (although this was apparently news to the IMF).
  2. The European Central Bank promises to buy bonds in dysfunctional markets.
  3. Swap lines with the Federal Reserve, to provide dollars.

At first pass this package might seem to be in with what we recommended a week ago and again on Thursday.

But the European central banks have come in very early – with government bond prices still high – and there is no sign yet of credible fiscal adjustment for Spain and Portugal.  The eurozone apparently did not even discuss the situation in Ireland, which seems increasingly troubling.

This is a whole new level of global moral hazard – the result of an alliance of convenience between troubled governments in the south of Europe and the north European banks (and implicitly, north American banks) who enabled their debt habit.  The Europeans promise to unveil a mechanism this week that will “prevent abuse” by borrowing countries, but it is hard to see how this would really work in Europe today.

Overall, this is our assessment: Continue reading

The Agenda For Emergency Economic Strategy Discussions This Weekend

By Peter Boone and Simon Johnson

Europe needs a new recovery plan, bigger and broader than anything put together so far.  This weekend is the perfect time to put such a plan together.  But be wary of committing official resources too early in this market downdraft – smart policymakers will calmly let the markets fall further, in order to benefit from the rebound potential.

In the last few days, bond markets have decided that the deflationary adjustments – cutting wages and prices — needed in large parts of the eurozone are not politically feasible.  The deflationary spiral that will come with fiscal cuts causes political turmoil and reduces revenues – that in turn makes it ever harder to service debt; see Greece this week.  Eurozone countries running large budget deficits with substantial outstanding public debt are finding they are cut off from credit markets as a result.  This is a solvency issue, not a liquidity issue.

But do not rush into this gap.  If the European Central Bank (ECB) were to start buying Spanish debt today, for example, they would find an abundance of sellers because the bonds are fundamentally overvalued.  Continue reading