Merkel’s Next Step: Shock and Awe
Ahead of meetings of European Union leaders in the coming week, investors are looking for any sign of movement toward a bolder policy on the economic crisis. Expectations are inching higher -- which is good, because Europe’s leaders need pushing, and they know it would be risky to disappoint the markets again.
This time, though, doing the minimum is not good enough. For once, Europe needs to exceed expectations.
The question, of course, is whether Germany will go along. Chancellor Angela Merkel is hemmed in. She thinks more help for the European Union’s distressed sovereign borrowers would put an unfair burden on German taxpayers. She also has to follow strict German rules regarding changes in the EU’s terms of membership. The lower house of the German parliament has only just agreed to the fiscal pact that EU leaders adopted weeks ago. With the upper house still to have its say, Merkel faces demands from abroad for new and more radical measures.
There are signs of movement nonetheless, and for this give the Group of 20 -- often derided as a pointless talking-shop -- some credit. At their meeting this week in Los Cabos, Mexico, leaders of the world’s biggest economies pressed Europe to act more forcefully. U.S. Treasury Secretary Timothy Geithner subtly increased the pressure on Germany. Europe is trying to make sure, he said, that “countries undertaking the reforms, like Spain and Italy, can borrow at sustainable interest rates.” That’s exactly what they ought to be doing, but they still disagree about goals and methods.
Speculation centers on a new proposal by Italy’s prime minister, Mario Monti. He wants the bailout vehicles -- the temporary European Financial Stability Facility and its permanent successor, the European Stability Mechanism, envisioned as a kind of European International Monetary Fund -- to start buying the bonds of Spain and Italy. Those countries’ financing difficulties have lately been most acute. Merkel hates the idea, but this week stopped short of ruling it out. That’s progress by EU standards.
The danger, though, is that Europe will again resort to reluctant half-measures and fail to get on top of the problem. As things stand, the combined EFSF and ESM aren’t up to what’s being suggested. With some funds already committed and rules controlling how much they can lend to whom and when, their usable short-term capacity is less than the ESM’s nominal 500 billion euros.
This effort won’t be seen as serious, let alone adequate, unless at least a trillion euros are on hand. Indeed, setting any upper limit on the resources available risks neutralizing the initiative. To stabilize Europe’s economies, the EU has to surprise the markets with a newfound clarity of purpose. No more half-measures. It’s time for shock and awe.
Yes, that’s a lot of money, but if the bailout fund is big enough, it needn’t be used. By pooling their collective firepower behind sovereigns and banks, Europe’s governments would be giving investors the confidence to provide most of the necessary loans and capital themselves, as happened in 2009 with U.S. banks, when the government guaranteed their recapitalization.
The most obvious way to achieve this would be to start issuing jointly guaranteed euro bonds. We’ve long been in favor, but this approach looks especially difficult politically. It’s explicit “fiscal union,” which Germany has said can’t happen without new moves toward political union -- something Europe doesn’t want and might take months or years to negotiate anyway.
A faster approach would be to have the European Central Bank stand behind an enlarged role for the ESM, which might first need to be turned into a “bank” with the ability to borrow from the ECB. In effect, this would commit unlimited euros to the ESM’s operations. It also would make the ECB lender of last resort to the EU’s sovereign borrowers, a step we have been advocating for months.
In a way, that’s fiscal union, too, albeit lightly disguised. Here’s the balance Europe has to strike: Find a line of retreat for Merkel that does not amount to humiliating defeat, and at the same time tells markets that the rules have changed. An ECB-backed ESM could be the way.
If Merkel agrees to stronger measures, she will want to assure Germany that the new approach is consistent with the old one, nothing important has changed and no vital principle of fiscal responsibility has been discarded. This kind of rhetoric, signaling hesitation and lack of resolve, is self-defeating. Yet some of it will be politically necessary and will have to be endured.
Recognizing the danger not just to its own economic prospects, but also to the rest of the world economy, the EU needs to act boldly -- and have investors understand that’s what it’s doing. Merkel has our sympathy. She faces an enormous political challenge. For all our sakes she must rise to it.
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