The lack of a common treasury is now being remedied: first came the Greek rescue package, then a temporary emergency facility. The financial authorities are a little bit pregnant and it is virtually certain that some permanent institution will be set up. Unfortunately, it is equally certain that the new arrangements will also be flawed. For the euro suffers from other shortcomings. Policymakers are confronted notonlybyacurrencycrisisbutalsobyabankingcrisisandacrisisinmacroeconomictheory.
The authorities are making at least two mistakes. One is that they are determined to avoid defaults or haircuts on currently outstanding sovereign debt for fear of provoking a banking crisis. The bondholders of insolvent banks are being protected at the expense of taxpayers. This is politically unacceptable. A new Irish government to be elected next spring is bound to repudiate the currentarrangements.MarketsrecognizethisandthatiswhytheIrishrescuebroughtnorelief.
Second, high interest rates charged on rescue packages make it impossible for the weaker countries to improve their competitiveness vis-à-vis the stronger ones. Divergences will continue to widen and weaker countries will continue to weaken. Mutual resentment between creditors and debtors is liable to grow and there is a real dangerthattheeuromaydestroythepoliticalandsocialcohesionoftheEU.