Europe is Closer to Resolving the Eurozone Crisis...with an Outline of a Plan

“I’ve said it before and I’ll say it again, this is a marathon not a sprint”. Thus spoke Jose Manuel Barroso, European Commission president, after unveiling the latest rescue package designed to solve the euro crisis once and for all. Yet the fact that the details of the rescue package were agreed upon after the general summit during an all-nighter of fraught negotiations paints a picture of prevarication, uncertainty and lack of political leadership which evokes harrowing memories of the US’s responsible politicians engaging in political brinkmanship over the debt ceiling this summer. 

Last night’s plan is comprehensive in many respects, perhaps more so than previous plans have been, such as the one agreed last July. The fact that shares in European markets rose when news of the deal emerged is reassuring and helped assuage fears that eurozone leaders had fudged the task yet again.  It touches upon the three main points that I deemed essential for resolving the crisis in my last article, namely imposing a significant haircut on private holders of Greek debt, adding to the European Financial Stability Facility’s (EFSF) firepower and recapitalising European banks which are severely exposed to Greek debt. Banks holding Greek debt have accepted a 50% loss which should cut Greece’s debt from a projected 180% to 120%; this is close to Italy’s level and thus should prove more manageable. The EFSF will see its firepower boosted to about €1tn from its present paltry €440bn, with the current remaining €250bn leveraged around 4-5 times. There are two main options for achieving this. One entails the EFSF acting as an insurer on eurozone members’ debt so as to lower borrowing costs for countries in trouble, such as Italy and Spain. The alternative is to set up a special investment vehicle which could receive contributions from big public and private investors (notably China). However, the details have not yet been finalised so it is unclear where exactly this money will be coming from for now. Finally, banks have been asked to raise €106bn in new capital by June 2012 so as to protect them from any ensuing losses from government defaults and to protect larger economies such as Italy and Spain from market jitters. Again, how the banks are expected to raise this amount of capital is left unclear.

The package can therefore be said to have achieved one of its principal aims, namely to buy the eurozone precious time so that Greece may concentrate on fixing its finances and countries like Italy and Spain can implement structural reforms to avoid being sucked into the quicksand. To claim that the dilemmas lurking over the Eurozone have been solved though is flippant at best. Alen Mattich, writing for the Wall Street Journal, claims that Europe’s latest generation of politicians have been trying to build a pig out of sausage as they wrestle with half-measures rather than having a fundamental rethink of the project itself. He believes that unless the European Central Bank (ECB) takes on a prominent role in the solution, politicians will simply stumble from eurofudge to eurofudge. The ECB is the only institution with the wherewithal to shore up Europe’s banks and countries such as Italy and Spain which need to refinance their debt as they work towards rectifying their crooked finances. It can do this directly or indirectly by giving the EFSF access to its mighty “printing presses”, but the intransigence of its previous president, Jean-Claude Trichet, seems likely to persist as the new incumbent, Mario Draghi warns that it is up to European countries to solve the debt crisis. Yet even Mattich states that the ECB’s role is merely a stopgap for much deeper problems which have stalked the eurozone since its inception.

Gavin Hewitt, writing for the BBC, does not cast doubt on the ambition of the European leaders to extract themselves from the mess that is the eurozone, but is wary of the technical details of the plan which are yet to be unveiled. The Greek haircut is all very well but even a 50% write down looks rather paltry if one takes into account that its economy is shrinking fast and years of austerity loom, hardly a prognosis for growth. Furthermore, a public debt to GDP ratio of 120% is still regarded as twice what is deemed to be economically healthy, let alone when the economy is seemingly contracting inexorably. With regards to the EFSF, many experts regard €1tn as too little to protect bigger economies like Italy and Spain should they run into trouble. The technical details have been left vague yet they are crucial in determining whether the EFSF really will be strengthened this much. Furthermore, it may pass the test by lowering their borrowing costs, but does not even come close to tackling the underlying problem of growth. Uncertainty also looms over how Europe’s banks will raise the amount of capital that has been required of them, with many suggesting that national governments will have to step in entailing what is effectively another bailout.

The fundamental problem, however, remains growth, and this latest package does precious little to tackle it. It is intended to provide breathing space for Europe’s leaders as they attempt to find another plan to kick start growth, but it remains unclear to me how they are supposed to do this if they cannot even finalise the technical details of the interim plan. Jose Manuel Barroso ought to stop his political grandstanding by announcing bullishly that “Europe is closer to resolving its financial and economic crisis and to getting back on a path of growth”. Europe will not resolve its financial and economic crisis until it gets back on a path of growth; however it will not get back on a path of growth until it resolves the financial and economic crisis. The 50^th anniversary of Joseph Heller’s Catch-22 is ironically pertinent when it comes to the euro crisis.