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NEW YORK "“ After the Greek and Irish crises and the spread of financial contagion to Portugal, Spain, and possibly even Italy, the eurozone is now in a serious crisis. There are three possible scenarios: "muddle through," based on the current approach of "lend and pray"; "break-up," with disorderly debt restructurings and possible exit of weaker members; and "greater integration," implying some form of fiscal union.
The muddle-through scenario "“ with financing provided to member states in distress (conditional on fiscal adjustment and structural reforms), in the hope that they are illiquid but solvent "“ is an unstable disequilibrium. Indeed, it could lead to the disorderly breakup scenario if institutional reforms and other policies leading to closer integration and restoration of growth in the eurozone's periphery are not implemented soon.
The crisis started with too much private debt and leverage, which became public debt and deficits as crisis and recession triggered fiscal deterioration and private losses were mostly socialized via bailouts of financial systems. Then, distressed sovereigns that had already lost market access "“ Greece and Ireland "“ were bailed out by the International Monetary Fund and the European Union.
But no one will bail out these super-sovereigns if the sovereigns prove to be insolvent. Thus, the current strategy of kicking the can down the road will soon reach its limits, and a different plan will be needed to save the eurozone.
The first institutional reform takes the form of a larger envelope of official resources, which would mean a quasi-fiscal union. Official resources currently are sufficient to bail out Greece, Ireland, and Portugal, but not to prevent a self-fulfilling run on the short-term sovereign and financial liabilities of Spain and other potentially distressed eurozone members.
So, even if these countries were to implement the necessary fiscal and structural reforms, an increase of official resources would nonetheless be needed. Because nervous investors don't want to be last in line in case of a run, a disorderly rush to the exits is likely when official resources are insufficient.
Short of full fiscal unification "“ or a variant of it in the form of eurozone bonds "“ this increase in official resources would occur through a much-enlarged European Financial Stability Facility and a much greater commitment by the European Central Bank to long-term bond purchases and liquidity operations to support banks. Since quasi-fiscal union implies that the eurozone's core economies could end up systematically bailing out those on the periphery, only a formal loss of fiscal sovereignty "“ a credible commitment by the peripheral countries to medium- and long-term fiscal discipline "“ could overcome the current political resistance of Germany and others.
But even a larger envelope of official resources is not sufficient to stem the insolvency problems of Greece, Ireland, and, possibly, Portugal and Spain. Thus, a second set of policies and institutional reforms requires that all unsecured creditors of banks and other financial institutions need to be "treated" "“ that is, they must accept losses (or "haircuts") on their claims. This is needed to prevent even more private debt being put on government balance sheets, causing a fiscal blowout. If orderly treatment of unsecured senior creditors requires a new cross-border regime to close down insolvent European banks, such a regime should be implemented without delay.
Similarly, super-sovereigns cannot continue to bail out distressed sovereigns that are insolvent rather than illiquid. Thus, in addition to an orderly resolution regime for banks, Europe must also implement early orderly restructurings of distressed sovereigns' public debt. Waiting until 2013 to implement these restructurings, as German Chancellor Angela Merkel proposes, will destroy confidence, as it implies a much larger haircut on residual private claims on sovereign borrowers.
Thus, orderly market-based restructurings via exchange offers need to occur in 2011. Such exchange offers can limit private creditors' losses if they are done early. That way, formal haircuts on the face value of debt can be avoided via new bonds that include only a maturity extension and an interest-rate cap that is set below today's unsustainable market rates. Waiting to restructure unsustainable debts would only lead to disorderly workouts and severe haircuts for some private creditors.
Finally, Europe needs policies that restore competitiveness and growth to the eurozone's periphery, where GDP is either still contracting (Greece, Spain, and Ireland) or barely growing (Italy and Portugal). Without growth, it will be difficult to stabilize public and private debts and deficits as a share of GDP "“ the most important indicator of fiscal sustainability. Moreover, without growth, the social and political backlash against painful belt-tightening will eventually undermine austerity and reform.
Unfortunately, fiscal austerity and structural reforms are "“ at least in the short run "“ recessionary and deflationary. So other policies are needed to restore growth. The ECB should pursue a much looser monetary policy to jump-start growth, with a weaker euro to help boost the periphery's competitiveness. In addition, Germany should delay its fiscal consolidation; if anything, it should cut taxes for a couple of years to boost its own growth and "“ via trade "“ that of the periphery.
In the next few months, it will become clear whether European policymakers can compromise and implement reforms that dampen the threat of a eurozone breakup. Either the EU moves in the direction of a more stable equilibrium of closer integration, or the risk of an unstable and disorderly breakup scenario will rise significantly.
Nouriel Roubini is Chairman of Roubini Global Economics (www.roubini.com), Professor of Economics at the Stern School of Business, NYU, and co-author of Crisis Economics.
Copyright: Project Syndicate, 2010. www.project-syndicate.org For a podcast of this commentary in English, please use this link:http://media.blubrry.com/ps/media.libsyn.com/media/ps/roubini33.mp3
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Username Password New registration Forgotten password lukehlee 05:30 16 Dec 10Prof. Roubini,
Every high government official and many top economic experts have tried to solve our continuing economic crisis and revitalize the economy over the last several years, but to no avail. It seems we are in a serious dilemma, and no clear solution has yet emerged to avoid an upcoming even deeper recession, possibly another Great Depression.
Over the last several years, various economic bubbles in the equity market have not been removed and still remain in the market. Potential fiscal risks such as high deficit problems have been significantly aggravated in many countries, especially in many European countries such as Ireland, Greece, Spain and Portugal. We cannot imagine when they will burst again and when the new crisis will occur. In other words, the possibility for these to be “an economic tsunami” is very high. In this case, employment in every country will inevitably plummet, and the deficits of almost all countries in the world, particularly the US Federal Deficit, will uncontrollably skyrocket. It could be another Great Depression. This is the worst case scenario. We must not allow this to happen.
The current economic situation is analogous to the ant death spiral, an event that takes place in the natural world. I strongly believe we have made “a serious mistake” in the market over the last 20 to 30 years of the Modern Information Age, and it has created an economic death spiral in the market or economy. If we do not break down this cycle and explore a new order for survival, I believe that every new effort will be just as ineffective and useless as everything else we have tried.
I strongly suggest you to see this article: "Breaking Down the Economic Death Spiral – and Saving the World Economy" http://t.co/8pMwQh7
The clock is ticking, and time is not working in our favor. We should and must act immediately – before it is too late.
Sincerely,
Luke H. Lee
Rothbarth 04:47 17 Dec 10Sadly, I don't see that this is much of a recipe--that's an indication of the extent of the mess rather than an indictment of Profess Roubini's analysis. How easy will it actually be to devalue the € when other countries are also trying to devalue their currencies? And in any case, devaluation per se doesn't do that much to help the periphery countries; their problem is that the unit cost of German labour is lower than the unit cost of, say, Greek labour. That problem is not solved by devaluation; German export goods remain cheaper in € terms than Greek export goods. Furthermore there is no way of addressing that problem which doesn't involve painful wage deflation in the periphery, and hence a nastier, more prolonged recession in those countries.
AUTHOR INFO Nouriel Roubini Nouriel Roubini is Chairman of Roubini Global Economics, Professor of Economics at the Stern School of Business, New York University, and co-author of the book Crisis Economics. MOST READ MOST RECOMMENDED MOST COMMENTED The Irrepressible 1930's Robert Skidelsky Europe's Inevitable Haircut Barry Eichengreen Alternatives to Austerity Joseph E. Stiglitz The Retreat of Macroeconomic Policy J. Bradford DeLong The Euro at Mid-Crisis Kenneth Rogoff A New World Architecture George Soros No Time for a Trade War Joseph E. Stiglitz Let A Hundred Theories Bloom George Akerlof and Joseph E. Stiglitz The Risky Rich Nouriel Roubini Avatar and Empire Naomi Wolf Europe's Inevitable Haircut Barry Eichengreen Alternatives to Austerity Joseph E. Stiglitz Thinking the Unthinkable in Europe Dani Rodrik No, You Can't Bjørn Lomborg Land for Peace in Kosovo Charles Tannock ADVERTISEMENT PROJECT SYNDICATEProject Syndicate: the world's pre-eminent source of original op-ed commentaries. A unique collaboration of distinguished opinion makers from every corner of the globe, Project Syndicate provides incisive perspectives on our changing world by those who are shaping its politics, economics, science, and culture. Exclusive, trenchant, unparalleled in scope and depth: Project Syndicate is truly A World of Ideas.
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Prof. Roubini,
Every high government official and many top economic experts have tried to solve our continuing economic crisis and revitalize the economy over the last several years, but to no avail. It seems we are in a serious dilemma, and no clear solution has yet emerged to avoid an upcoming even deeper recession, possibly another Great Depression.
Over the last several years, various economic bubbles in the equity market have not been removed and still remain in the market. Potential fiscal risks such as high deficit problems have been significantly aggravated in many countries, especially in many European countries such as Ireland, Greece, Spain and Portugal. We cannot imagine when they will burst again and when the new crisis will occur. In other words, the possibility for these to be “an economic tsunami” is very high. In this case, employment in every country will inevitably plummet, and the deficits of almost all countries in the world, particularly the US Federal Deficit, will uncontrollably skyrocket. It could be another Great Depression. This is the worst case scenario. We must not allow this to happen.
The current economic situation is analogous to the ant death spiral, an event that takes place in the natural world. I strongly believe we have made “a serious mistake” in the market over the last 20 to 30 years of the Modern Information Age, and it has created an economic death spiral in the market or economy. If we do not break down this cycle and explore a new order for survival, I believe that every new effort will be just as ineffective and useless as everything else we have tried.
I strongly suggest you to see this article: "Breaking Down the Economic Death Spiral – and Saving the World Economy" http://t.co/8pMwQh7
The clock is ticking, and time is not working in our favor. We should and must act immediately – before it is too late.
Sincerely,
Luke H. Lee
Sadly, I don't see that this is much of a recipe--that's an indication of the extent of the mess rather than an indictment of Profess Roubini's analysis. How easy will it actually be to devalue the € when other countries are also trying to devalue their currencies? And in any case, devaluation per se doesn't do that much to help the periphery countries; their problem is that the unit cost of German labour is lower than the unit cost of, say, Greek labour. That problem is not solved by devaluation; German export goods remain cheaper in € terms than Greek export goods. Furthermore there is no way of addressing that problem which doesn't involve painful wage deflation in the periphery, and hence a nastier, more prolonged recession in those countries.
Project Syndicate: the world's pre-eminent source of original op-ed commentaries. A unique collaboration of distinguished opinion makers from every corner of the globe, Project Syndicate provides incisive perspectives on our changing world by those who are shaping its politics, economics, science, and culture. Exclusive, trenchant, unparalleled in scope and depth: Project Syndicate is truly A World of Ideas.
Project Syndicate provides the world's foremost newspapers with exclusive commentaries by prominent leaders and opinion makers. It currently offers 52 monthly series and one weekly series of columns on topics ranging from economics to international affairs to science and philosophy.
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