Merkel's Next Step: Shock and Awe
Comment of the Day

June 22 2012

Commentary by David Fuller

Merkel's Next Step: Shock and Awe

This sensible editorial from Bloomberg will help us to assess Europe's progress on union next week. Posted without further comment, here is the opening:
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.


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.
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