Ambrose Pritchard-Evans – Telegraph.co.uk July 25, 2012
Europe is “sleepwalking towards disaster”, according to the 17 experts, who warned that over the past few weeks “the situation in the debtor countries has deteriorated dramatically”.
“The sense of a neverending crisis, with one domino falling after another, must be reversed. The last domino, Spain, is days away from a liquidity crisis,” said the economists. They include two members of Germany’s Council of Economic Experts and leading euro specialists at the London of School of Economics, all euro supporters.
“This dramatic situation is the result of a eurozone system which, as currently constructed, is thoroughly broken. The cause is a systemic failure. It is the responsibility of all European nations that were parties to its flawed design, construction and implementation to contribute to a solution. Absent this collective response, the euro will disintegrate,” they added in a co-signed report for the Institute for New Economic Thinking.
The warning came as contagion from Spain pushed Italy’s borrowing costs to danger levels, with two-year yields rocketing 40 basis points to more than 5pc. The Milan bourse tumbled 3pc, led by bank shares. Italian equities have been in freefall since it became clear two weeks ago that the EU’s June summit deal had failed to break the nexus between crippled banks and sovereign states.
The crisis is starting to ricochet back into Germany, where the PMI manufacturing index for July fell to its lowest since mid-2009. Doubts are emerging about the creditworthiness of the German state itself.
The giant US bond fund PIMCO said on Tuesday that it would retreat further from the German bond market after Moody’s issued a negative watch on the AAA ratings of Germany, the Netherlands and Luxembourg. “We’re expecting a further ratings downgrade in the future,” said the group.
Moody’s warned that Germany faced the “risk of a shock” from a Greek euro exit and the likely knock-on effects through Spain and Italy, as well the “German banks’ sizeable exposure to most stressed euro area countries”. The warning had no immediate effect on German debt markets. Two-year yields remained below zero due to safe-haven effects.
Moody’s cut the outlook on the Eu’s bailout fund, the European Financial Stability Facility, to negative from stable on Tuesday night.
The 17 economists said Europe’s political waters have been muddied by disputes over eurobonds, debt-pooling, subsidies and fiscal union. None of this was necessary to break the logjam, they said.
They claimed the system could be stabilised immediately by creating a lender of last resort to back-stop the bond markets, either by mobilising the ECB or by giving the eurozone bail-out fund (ESM) a banking licence to borrow from the ECB.
The deeper problem can then be managed through a European Redemption Fund that takes over a chunk of the “legacy debt” left by the errors of early EMU, much like Alexander Hamilton’s sinking fund in the US to clear up the mess after America’s revolutionary war.
The proposal is based on a plan by the German Council of Experts. Each country puts all debt above the Maastricht ceiling of 60pc of GDP into the fund. Each would be responsible for its own debt but would be able to borrow through joint bonds, raising money on Germany’s credit card.
The debt would be paid off over 20 years, with each state putting up foreign reserves, gold and other collateral to ensure compliance. It is the opposite of fiscal union: the eurozone would return to fiscal sovereignty and, since the liabilities would be fixed and the fund self-liquidating, it would comply with Germany’s constitution.
The authors say such a move would be the “game changer” missing since the crisis began. It would be costly for Germany, but “orders of magnitude” cheaper than the alternative. The German Council of Experts has said the country would suffer €3 trillion (£2.3 trillion) of damage if EMU blows apart, a claim hotly disputed by eurosceptics.
In a veiled rebuke to hard-line politicians in Germany, the economists said the root cause of the crisis has been the boom-bust effect of rampant capital flows over the past decade – not delinquent behaviour by feckless nations. “The extent to which markets are currently meting out punishment against specific countries may be a poor reflection of national responsibility,” they stated.
But they said the current course had become hopeless. Deepening recession is “tearing at the social fabric of the deficit states”.
The lack of any light at the end of the tunnel is leading to a populist backlash in both the debtor and creditor states. The only question is whether the North or the South succumb to revulsion first.