Unless it is a lot bolder, the euro zone risks being overwhelmed by the markets.


Fighting fire with fire

Unless it is a lot bolder, the euro zone risks being overwhelmed by the markets

IT WAS the Great Fire of 1666 that prompted the establishment of London’s modern fire brigade, organised at first by private insurers, but later coming under public management. In Paris, on the initiative of Louis XV, the pompiers have been fighting fires since 1733. Few Europeans today could imagine a city without a public firefighting service, or a home without fire insurance. But when the architects of the single currency built the euro, they thought that sharing the risk of disaster might merely encourage recklessness and even arson. Better than this moral hazard was to make each country master of its own fate. Why should those living in brick houses save the feckless in their wooden huts?

Now that a great financial blaze has taken hold, the euro zone is facing its 1666 moment. Unless tamed, the conflagration might not spare anybody. The interconnectedness of Europe’s banks (see article), encouraged by the single currency, is acting as a combustible channel for flames to travel from building to building. Greece and Ireland have already gone up in smoke. The flames are licking at Portugal and Spain; Italy and Belgium worry that they might be consumed too. Despite the cries for help, Germany, the great lord in town, does not want to spend more treasure saving its neighbours. Yet even German bond yields are starting to rise.

“We have to stop the bush fires turning into a Europe-wide forest fire,” declares Olli Rehn, the European Union’s economics commissioner. Prevarication makes matters worse. The euro zone’s actions have been hesitant and haphazard. It belatedly improvised to contain the blaze in Greece this spring and then put together €750 billion ($980 billion) in bail-out funds, now being drawn on for Ireland. The EU urges all to protect themselves by cutting budget deficits. It plans closer scrutiny of national budgets and economic policies, and tougher sanctions for miscreants. Yet a better fire code in future may not quench today’s fire.

Angela Merkel, Germany’s chancellor, has taken to denouncing fleeing investors, threatening to make them pay. Her menaces only make them run faster. Their panic is caused not just by fear that some countries cannot repay their debts, but also by scepticism about politicians’ ability to do very much to help. One can almost hear London’s Lord Mayor in 1666, as recorded in Pepys’s diary: “Lord, what can I do? I am spent. People will not obey me. I have been pulling down the houses. But the fire overtakes us faster than we can do it.”

Jean-Claude Juncker, the prime minister of Luxembourg, certainly looked spent when, after chairing a meeting of euro-zone finance ministers on December 6th, he said he had “no new decisions” to announce. Only hours earlier, Mr Juncker had surprised his colleagues in an article co-written with Italy’s finance minister, Giulio Tremonti, urging euro members to issue collective Eurobonds. Such “E-bonds” might eventually account for up to 40% of the euro zone’s GDP.

The idea is a variation on a proposal made in May by the Bruegel think-tank in Brussels, which suggested a limit of 60% of GDP for pooled “blue” bonds. These would clearly reduce interest rates for weaker countries, but even stronger ones might benefit from the existence of a larger and more liquid market. “Red” bonds over the debt threshold would become especially risky, encouraging discipline without causing outright collapse.

Mr Juncker and Mr Tremonti suggested that their plan would “send a clear message to global markets and European citizens of our political commitment to economic and monetary union and the irreversibility of the euro.” Instead the Germans, Dutch and Austrians sent the authors a clear message to shut up. The most creditworthy countries in Europe do not want to muddle their debt up with that of the biggest credit risks. Another idea that went unheeded was the call, made quietly by the IMF and more loudly by Belgium, for the bail-out fund to be enlarged. “We can’t have a new debate every week,” complained Germany’s Wolfgang Schäuble. Better to complete the measures in hand and see if they work. But in the view of the IMF’s boss, Dominique Strauss-Kahn, such a piecemeal approach is dangerous. A “comprehensive solution” is needed.

Trichet le pompier

For the moment the task of fighting the flames is falling largely to Jean-Claude Trichet, president of the European Central Bank. The Frenchman has been dousing the financial system with liquidity and buying up the government bonds of troubled countries. To critics, including some members of his own board, this risks stoking inflation and turning the ECB into a “bad bank” in which rotten assets just pile up. To supporters, though, Mr Trichet is the hero of the hour for resorting to unorthodox policies even as others dither. He has been chosen as the winner of the Charlemagne prize, conferred by the German city of Aachen for outstanding contributions to European unity. It was bestowed on the euro in 2002. Now Mr Trichet is being honoured for trying to save it.

Using the ECB to back sovereign debt might be seen in some quarters as another stealthy step towards fiscal union. One more foundation stone quietly being laid is the first issuance next year of common bonds, for Ireland, by the European Financial Stability Facility. One way or another, say enthusiasts, a Eurobond is just a matter of time. That might provide an insurance policy for the future. But what of the current inferno?

Some say that in the end a radical step may be needed: to restructure the debt of banks and governments alike. This would be like the garrison in the Tower of London bringing out gunpowder in 1666 to blow up nearby houses so as to create a true firebreak. That action, Pepys notes, “at first did frighten people more than anything, but it stopped the fire where it was done”.

from PRINT EDITION | Europ

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