There is no escape from this gloomy scenario as long as the authorities persist in their current course. They could, however, change course. They could recognize that they have reached the end of the road and take a radically different approach. Instead of acquiescing in the absence of a solution and trying to buy time, they could look for a solution first and then find a path leading to it. The path that leads to a solution has to be found in Germany,which,astheEU’slargestandhighest-ratedcreditorcountry,hasbeenthrustintothepositionofdecidingthefutureofEurope.
That is the approach I propose toexplore.
To resolve a crisis in which the impossible becomes possible it is necessary to think about the unthinkable. To start with, it is imperative to prepare for the possibility of default and defection from the eurozone inthecaseofGreece,Portugal,andperhapsIreland.
To prevent a financial meltdown, four sets of measures would havetobetaken.
First, bank deposits have to be protected. If a euro deposited in a Greek bank would be lost to the depositor, a euro deposited in an Italian bank would then be worth less than one in a German or Dutch bank and there would be a run on the banks of other deficit countries. Second, some banks in the defaulting countries have to be kept functioning in order to keep the economy from breaking down. Third, the European banking system would have to be recapitalized and put under European, as distinct from national, supervision. Fourth, the government bondsoftheotherdeficitcountrieswouldhavetobeprotectedfromcontagion.Thelasttworequirementswouldapplyevenifnocountrydefaults.
All this would cost money. Under existing arrangements no more money is to be found and no new arrangements are allowed by the German Constitutional Court decision without the authorization of the Bundestag. There is no alternative but to give birth to the missing ingredient:a European treasury with the power to tax and therefore to borrow.Thiswouldrequireanewtreaty,transformingtheEFSFintoafull-fledgedtreasury.
That would presuppose a radical change of heart, particularly in Germany. The German public still thinks that it has a choice about whether to support the euro or to abandon it. That is a mistake. The euro exists and the assets and liabilities of the financial system are so inter-mingled on the basis of a common currency that a breakdown of the euro would cause a meltdown beyond the capacity of the authorities to contain. The longerittakesfortheGermanpublictorealizethis,theheavierthepricetheyandtherestoftheworldwillhavetopay.
The question is whether the German public can be convinced of this argument. Angela Merkel may not be able to persuade her own coalition, but she could rely on the opposition. Having resolved the euro crisis,shewouldhavelesstofearfromthenextelections.
The fact that arrangements are made for the possible default or defection of three small countries does not mean that those countries would be abandoned. On the contrary, the possibility of an orderly default—paid for by the other eurozone countries and the IMF—would offer Greece and Portugal policy choices. Moreover, it would end the vicious cycle now threatening all of the eurozone’s deficit countries whereby austerity weakens their growth prospects, leading investors todemandprohibitivelyhighinterestratesandthusforcingtheirgovernmentstocutspendingfurther.
Leaving the euro would make it easier for them to regain competitiveness; but if they are willing to make the necessary sacrifices they could also stay in. In both cases, the EFSF would protect bank deposits and the IMF would help to recapitalize the banking system. That would help these countries to escape from the trap in which they currently find themselves. It would be against the best interests oftheEuropeanUniontoallowthesecountriestocollapseanddragdowntheglobalbankingsystemwiththem.
It is not for me to spell out the details of the new treaty; that has to be decided by the member countries. But the discussions ought to start right away because even under extreme pressure they will take a long time to conclude. Once the principle of setting up a European Treasury is agreed upon, the European Council could authorize the ECB to step into the breach, indemnifying the ECB in advance against riskstoitssolvency.ThatistheonlywaytoforestallapossiblefinancialmeltdownandanotherGreatDepression.